Most CMBS conduit loans have a prepayment penalty called defeasance that gives borrowers the ability to unencumber the underlying real estate to sell or refinance the property. When a loan is defeased the borrower substitutes the existing collateral with a portfolio of U.S. securities structured to match the debt-service schedule of the loan through the maturity date. The loan remains in place and provides the CMBS bondholders with the same future cash flows they would have received if the loan was never defeased. Many firms specialize in handling the entire defeasance process for borrowers. If the cost of the securities exceeds the mortgage balance, the amount is the “penalty” that must be paid by the borrower.
Whether the cost of securities exceeds the mortgage balance is a function of interest rates, particularly U.S. securities. When interest rates are low the cost of securities to defease a loan are high, and when interest rates are high, the cost of securities to defease a loan is lower. With the rise in interest rates on U.S. securities, many borrowers are finding that defeasance securities costs have fallen significantly.
The rise in interest rates is resulting in a strong pipeline of loans being defeased. An important point to remember is that loan servicers charge an expediting fee, typically $10,000, to process a defeasance quicker than 30 days. Therefore, it is important to contact the servicer at least 30 days in advance of a refinance or sale requiring defeasance. For assistance in your next defeasance transaction, contact Mike Sneden (firstname.lastname@example.org) or Gary Unkel (email@example.com).