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Defeasance Frequently Asked Questions

Why Defeasance?

If you’re looking to refinance a loan with more favorable terms or unwind a project to free up capital, a defeasance is one of several methods to prepay your fixed rate financing if your lender securitizes their originations. Reach out to our experts for evaluation of your loan documents to ensure you’re eligible.

What is Defeasance?

In the event of a sale or refinance, defeasance is a method used to release the borrower from the original obligations of a CMBS loan. Since CMBS loans are frequently securitized, the obligation to the bond purchaser must continue to be fulfilled and therefore, cashflow from the property is replaced by a portfolio of securities which secure the debt and mimic the required debt payments.

What are some challenges associated with CMBS defeasance?

CMBS defeasance can be a time-consuming process which could leave borrowers facing a material prepayment penalty on top of the third-party fees associated with the process. One of the more significant risks associated with defeasance is the interest rate risk that comes with purchasing the securities portfolio utilized to defease the loan – you are vulnerable to market movements until closing.

  • There are tools available to hedge these risks such as swaptions! Feel free to reach out for a walk through on how these can be used to protect or lock in a favorable prepayment penalty.
What’s the typical defeasance timeline?

We suggest getting things rolling 45 days out from closing to allow ample time for all parties to complete the transaction.

Generally, loan documents call for no less than a 30-day notice of intent to defease. In many cases, providing less than a 30-day notice results in the transaction being considered “expedited” which can result in additional fees.  

  • It is possible to complete an expedited defeasance in a week or potentially less if all parties are responsive and nothing is unordinary about the transaction.
  • Expedite fees can run from $5K-$10K depending on the Master Servicer, their counsel, and the amount of time ahead of closing.
How do I get started?

The first step in the defeasance process should be connecting with our defeasance team who will complete a review of your loan documents, pull together a cost estimate based on the defeasance provisions, and advise on the appropriate next steps.

After the initial review, we suggest a quick call to walk through the mechanics of the process, answer any questions, and discuss the next steps.

  • Our goal is to provide effective knowledge, transparency, and guidance so we can all work towards a smooth closing.

Following a brief call, the typical next step is to execute the defeasance notice and deliver it along with the Master Servicer’s required good-faith deposit.

  • We help coordinate this process to ensure the notice is delivered to the appropriate group, the wire is sent to the correct account, and the transaction is kicked off in a timely manner.
What do I need to provide to get started?

We’ve compiled a separate resource here where we outline items that you can prepare for kick off so you can hit the ground running.

What if the underlying sale/refinance falls through and we must pull out of the transaction? What happens to my deposit?

If the deal dies prior to circling securities, most third parties will charge for the work completed to date. In total, this will generally amount to $20K-$30K, so many borrowers consider the good faith deposit sunk once it’s delivered and therefore will only kick the process off once their buyer has gone hard in the case of a sale.

  • Note: Many times, you will find the servicer processing fee to be non-refundable per the loan documents.

Failure to close after circling presents additional risk considering the broker would then need to unwind the portfolio. Any loss in the value of the portfolio would have to be covered in addition to any third-party breakage costs which could range from $20K-$30K.

What is a rating agency review? Why would I need it?

A nationally recognized statistical rating agency, such as Fitch or Moody’s, can elect to conduct a review if the loan being defeased is of significant size in the securitization pool.

The purpose of a RAC review is to evaluate creditworthiness and provide the opinion of counsel that states the defeasance will not cause a tax to be imposed on the Securitization Vehicle. Securitized CMBS loans will fall into a REMIC, so their review would ensure the defeasance does not cause the mortgage to fall outside of the scope of REMIC rules.

The Borrower is responsible for any costs and expenses incurred in connection with Rating Agency and Servicer fees which can range from $15K-$25K.

How is my securities portfolio structured?

The loan documents will ultimately govern the requirements for structuring your portfolio. Most loans require the portfolio to be structured through Maturity or up to an open prepayment window (e.g. three months prior to Maturity).

The type of collateral (securities) permitted includes non-callable US Treasury obligations and in some cases other securities backed by the full faith and credit of the US Government such as Fannie Mae, Freddie Mac, or Federal Home Loan Banks (FHLB) securities.

Pensford will work with a pool of broker-dealers and the portfolio accountant to ensure sufficiency and efficiency of the portfolio so that all the requirements are met at the lowest cost possible to the borrower.

How does funding for the portfolio work?

When you are ready to close, the portfolio will typically be paid for with proceeds from the underlying sale or refi.

The securities portfolio must be paid for in full before closing can be authorized. This is one area where escrow gets involved as they will collect lenders funds, as well as buyer’s equity in the event of a sale. The initial portion of these funds will be disbursed to pay for the securities portfolio per a closing instruction letter circulated by servicer’s counsel.

When will funding be required for closing?

We recommend having a conversation with your new lender or purchaser regarding funding early in the process – in most cases funding occurs on day 1 of closing.

The wire to pay for securities is due no later than 2 pm eastern on the day of closing (day 2). This deadline has no flexibility and missing it can result in a “failed defeasance” where the securities are returned to the broker dealer and the whole process must be started over.  

  • Ideally, all parties will have funded into escrow by close of business on day 1 of the defeasance process (the day securities are circled). This helps ensure there are no unforeseen delays which inhibit the ability to pay for securities before the deadline on day 2 (closing day).

Many of our repeat clients will include a funding provision in their PSA to get ahead of this and mitigate any wires risk.

We have funds in our escrow reserves (FF&E/Property/Insurance) - can we apply these reserves to help cover the costs at closing?

This is a popular request but unfortunately, it’s currently not something servicers are able to accommodate. The escrow reserves are returned post-closing via check or wire, typically within 10-15 business days. Servicer’s counsel will circulate a Return of Escrows and Reserves form as part of their checklist to confirm how you will receive these funds.

Can I make things easier for future prepayments?

To the extent you can, we highly recommend negotiating the language in your loan around prepayments. You can limit certain costs and structure the transaction to work well for you and your goals! Feel free to reach out for helpful tips specific to your loan structure.

What does a defeasance Closing look like?

The defeasance process has several moving parts and one way to ease the workload for all parties is by splitting the close into two separate days. The first day can be viewed as a dry close where we will also purchase the portfolio. The second day is when the portfolio will settle, and the transaction officially closes. We’ve expanded further on what the two-day defeasance closing process entails.

Will I be paying double interest?

Interest is typically calculated in arrears, based on the number of days in the month prior to the installment due date. That being said, double interest doesn't necessarily come into play here as the debt payments will be covered either through your normal means prior to closing (drawing ACH, cash, etc.) or through the securities portfolio post-closing, so it all ties out in the end.

Do I need to close on a payment date?

While some loan documents may call for the defeasance to be effectuated on a payment date, common practice frequently allows you to elect a business day based on the underlying closing, even if it is in the middle of a pay period. Most servicers tend to be indifferent to this so long as there are no defaults and debt payments remain current.