What is Defeasance?

Defeasance is a provision within a loan agreement that enables a borrower to refinance or sell a property before the underlying loan’s maturity date.

The loan documents will have a defeasance clause, allowing for a substitution of collateral that releases the property from its mortgage.

This process allows the borrower to avoid the prepayment penalties often found in commercial real estate loans

How does Defeasance work?

A defeasance allows the collateral—the commercial property—to be released from the mortgage and replaced with a portfolio of qualifying government securities. These securities are carefully structured to generate sufficient cash flow to cover the loan’s remaining scheduled debt service payments through maturity. This enables the borrower to release the property from the loan and sell or refinance it without triggering the loan’s prepayment penalty.

Does the interest rate market impact my defeasance cost?

Yes, the interest rate environment at the time of defeasance can have a significant impact on the cost. Specifically, the relationship between the original loan’s interest rate and current market rates affects the cost of the securities portfolio required to defease the loan.

For example, if you have a CMBS loan that was originated in a low-interest-rate environment, today’s higher interest rates can make the defeasance less expensive.

In a defeasance, a portfolio of U.S. Treasury securities is purchased to replicate the loan’s remaining principal and interest payments, as well as the final balloon payment. The securities portion of the defeasance is essentially the present value of those remaining loan cash flows, based on current market yields. If current rates are higher than the rates in effect when the loan was originated, the same future cash flows can generally be replicated with a lower-cost portfolio of securities. Conversely, if a loan was originated in a high-rate environment and is being defeased when market rates are lower, the cost of the required securities portfolio will generally be higher.

In today’s market, many borrowers fall into the first category: CMBS loans originated in a historically low-rate environment that are now being considered for defeasance in a higher-rate environment. This can create a meaningful opportunity to reduce the cost of defeasance.

Jennifer Siegel

Director of Defeasance

Jennifer Siegel is our Director of defeasance Services and a Managing Director of the Walnut Creek, California office. She has over 15 years of derivatives experience hedging interest rates, currencies, and commodities. Her prior positions include derivatives sales roles at Bank of America and Rabobank.

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We will guide you every step of the way and make sure:

We identify all the factors that can impact your defeasance date.
We select appropriate third-party vendors to implement your defeasance.
We insure your peace of mind throughout the entire process.

Call us today at (415) 510-2100

Let’s talk about how Derivative Logic’s expertise helps you meet your goals.

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Next Steps

We are skilled at accurately estimating the cost of a defeasance. The critical information we need you to share is:

the legal name of your property, and
a handful of details from your loan agreement, and
when you’ll close your defeasance (to match your best guess as to when you will close your refinanced loan or property sale).

With these facts we can recreate your loan amortization schedule and calculate the cost low risk securities based on current market prices. We also estimate the fees you must pay specific professionals who handle the exacting legal and financial details necessary to close your defeasance on time.

Simply fill out the form above to begin, or call us today at (415) (510-2100.

Understand Defeasance terminology – visit our Defeasance Glossary

FAQ’S

Why would I need to Defease my loan?

Many commercial real estate loans include prepayment restrictions that can make it costly or difficult to pay off a loan before maturity. Loans are often structured in this way to compensate the bondholders with a stake in the commercial mortgage-backed security (CMBS) that contains the loan.

Prepayment is an issue because investors expect a set number of interest payments for the life of the bond. If a borrower pays early, they lose that future income. A defeasance provides a way to satisfy those obligations, allowing borrowers to sell or refinance a property without triggering the loan’s prepayment penalty.

When can I Defease my loan?

Most loans include a lockout period of two to three years from the closing date, during which defeasance is not permitted. Once the lockout period expires, defeasance is generally available for the remainder of the loan term, subject to any restrictions that may apply in the months before maturity.

The specific lockout period and other timing requirements are outlined in your loan documents and can vary significantly from one loan to another. We recommend reviewing your note and loan agreement carefully to understand

when defense is available. Contact us with any questions about the defeasance provisions of your specific loan.

How Much Does a Defeasance Cost?

Every defeasance has two primary cost components: (1) the cost of the securities used as substitute collateral and (2) transaction costs.

The largest component is typically the cost of the securities portfolio, which is driven primarily by prevailing Treasury rates. In a low-rate environment, the securities required to generate the loan’s remaining cash flows are more expensive, resulting in a higher defeasance cost. Conversely, when interest rates are higher, the cost of the securities generally declines, reducing the overall cost of defeasance.

Transaction costs consist of the fees charged by the various parties involved in the defeasance process and generally range from $45,000 to $65,000, excluding borrower’s counsel fees. Actual costs can vary depending on the size and complexity of the loan, as well as the fees charged by the loan servicer and its legal counsel.

What Parties Are Involved?

Defeasance is a legal- and documentation-intensive process that requires coordination among multiple parties. Derivative Logic manages these relationships on your behalf, serving as the central point of contact throughout the transaction and coordinating the process from initial analysis through closing.

Depending on the loan and transaction structure, the parties involved may include:

Master Servicer: Oversees and administers the defeasance process.
Broker-Dealer: Sources and prices the securities portfolio used as substitute collateral.
Securities Intermediary: Holds and administers the defeasance securities.
Successor Borrower: The legal entity that holds the defeasance securities and assumes the borrower’s payment obligations.
Independent Accountant: Verifies that the securities portfolio is sufficient to satisfy the loan’s remaining debt service obligations.
Rating Agencies: Provide required ratings or approvals, where applicable.
Special Servicer: Participates when required under the loan documents.
Escrow Agent: Facilitates the transfer and closing of the transaction.
Legal Counsel: Includes the servicer’s counsel, borrower’s counsel, and successor borrower’s counsel.

How long is the defeasance process?

A standard defeasance process typically takes approximately 30 days from engagement through closing. This timeline allows for servicer approval, preparation and review of legal documents, securities structuring, accounting verification, and escrow funding.

Your loan documents will typically require 30–60 days’ advance written notice to the servicer of your intent to defease. While some servicers may accommodate an expedited timeline, they may charge additional fees for doing so. With close coordination and cooperation among all parties, a defeasance can sometimes be completed in less time; however, we recommend allowing at least 30 days to provide sufficient time to address any issues and avoid unnecessary costs or last-minute complications.

What are the first steps?

The first step is to engage a defeasance consultant. Once Derivative Logic is engaged, we coordinate the entire process and serve as the central point of contact for all parties involved.

The process begins with the borrower submitting an executed Defeasance Notification Letter and required deposit to the servicer. We then schedule a kickoff call with the servicer’s counsel, borrower’s counsel, and Derivative Logic. During this call, we outline the steps required to complete the transaction, provide a comprehensive list of required documents, establish

the working group of all parties involved, and develop a detailed timeline through closing.

What is a successor borrower and how is it created?

When a CMBS loan is defeased, the loan is not paid off. Instead, the property is released as collateral and replaced with a portfolio of securities structured to generate sufficient cash flow to make all remaining scheduled loan payments through maturity. To complete the defeasance and fully separate the original borrower from the loan, a successor borrower is established to assume the loan and hold the securities portfolio. The successor borrower remains responsible for the defeased loan through maturity.

The defeasance provisions in the original loan documents determine who has the right to establish the successor borrower. Depending on the specific loan documents, that right may belong to the original borrower, original lender, CMBS servicer, or another designated third party.

What is the residual?

When a defeasance is structured, there can be residual value created in the transaction. It comes from two sources.

There is float, which is the interest earned between when a security is redeemed and when the next payment is made on the defeased loan. This mismatch is created because most of the time we cannot find a security that matures on the exact same day as the loan payment is due. The cash can sit in an account earning interest for a short time between those two dates.

The other area of residual value comes from the par repayment provision.

Many loans allow for prepayment without a penalty a few months before the maturity date. Securities or cash could remain in the defeasance account after prepayment of the loan if the loan contains that provision and if the loan documents require the defeasance collateral be sufficient to make all of the payments through the maturity date.

What happens to the residual?

Who benefits from any residual created in the defeasance is determined by the language in the loan’s defeasance clause. Contact Derivative Logic today to review your loan documents and explore how that can be structured.

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Jennifer Siegel

Director of Defeasance

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Understand Defeasance terminology – visit our Defeasance Glossary

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