What is Defeasance?
Defeasance enables a borrower to refinance or sell their property. Provisions in many Loan Agreements restrict borrowers from paying off their loan early to release them from their mortgage obligations. Defeasance substitutes a skillfully constructed basket of low-risk securities to replace the borrower’s property as collateral for a mortgage.
Why Can’t Borrowers Pay-off Their Mortgages?
Securitization is the process in which commercial real estate lenders transform loans into investment grade securities. Securitization is an important source of funding for lenders that enables them to make new loans. Paying off commercial mortgages pooled into a security before they reach maturity can compromise the economics of these complex investments. Lenders insist on prepayment restrictions in their loan agreements so their assets are eligible for securitization. Borrowers receive favorable rates to motivate them to accept prepayment restrictions.
Defeasance Empowers the Borrower
Because of securitization, mortgages need to live on to maturity. Borrowers need to be free of their mortgages to refinance or sell their properties. The fundamental problem is that a borrower remains tied to a loan because their property serves as loan collateral. Defeasance arranges for the borrower to pay for and substitute lower risk collateral for the property. This collateral is a carefully constructed portfolio of US Treasury and sometimes Agency securities. The portfolio produces the cash flow needed to make the remaining loan payments. During the defeasance we transfer the portfolio of collateral and responsibility for the loan to a new legal entity called a Substitute Borrower. Once all required legal opinions, accounting reports and other safeguards for the other stakeholders are complete the defeasance process releases the property from its collateral obligations and the former borrower is free to refinance or sell their property.
Call Derivative Logic Early
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.
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