What is defeasance and why is it so prevalent?
Defeasance is the exchange of one form of collateral for another. This specialized financial transaction is especially prevalent in the commercial real estate industry where commercial mortgage backed Securities (CMBS), otherwise known as conduits, have grown increasingly popular.
Are defeasance costs tax deductible?
Are defeasance fees deductible? Yes, companies can deduct these fees as interest expense. The IRS acknowledged the defeasance costs deductibility in Rev. Rule 85-42, which describes “in-substance defeasance.” However, the defeasance fee may be taxable to the lender if not offset by exchange expenses. What is in-substance defeasance?
What does defeased mean?
noun 1. A rendering void; an annulment. 2. a. The voiding of a contract or deed. b. A clause within a contract or deed providing for annulment. Summary When referring to municipal bonds, a defeasance relates to methods by which an outstanding bond issue can be made void, both legally and financially.
What is another word for defeasance?
Synonyms for defeasance include repeal, nullification, abrogation, cancellation, annulment, abolition, voiding, invalidation, rescindment and quashing. Find more ...
What Is the Defeasance Process?
Why is defeasance important?
What is required for a defeasance?
How old does a mortgage have to be to be defeasanced?
Why do defeased securities carry lower yields than comparable securities?
How long does it take to defease a loan?
Does a defeasance release the mortgaged property from the lien against it?
See 4 more
About this website
What does defeasance of a loan mean?
A defeasance clause is a term within a mortgage contract that states the property's title (a fancy word for “ownership”) will be transferred to the borrower (mortgagor) when they satisfy payment conditions from the lender (mortgagee).
What happens when a bond is defeased?
In a legal context, defeasance renders the outstanding bonds paid thereby removing all obligations of the issuer for payment of the bonds.
How is defeasance penalty calculated?
The prepayment penalty typically is determined by calculating the present value of the remaining loan payments, with a discount rate equal to the current yield on the U.S. Treasury that matures closest to the loan's maturity date. The only transaction fee is a small processing fee to the loan servicer.
What does defeasance mean in real estate?
Understanding Defeasance If a borrower prepays a loan, this cash flow is disrupted. A defeasance guarantees that the loan payments will continue to be met, even after the property is released.
Can you make money on defeasance?
The distinct advantage that defeasance provides over other prepayment options is significant due to its ability to create an income-generating event when market interest rates rise.
What happens when a bond is Funged?
Fungible Bonds means further bonds that may be issued by the Issuer with terms and conditions that are identical to the Bonds in all respects except for the Issue Date and/or Issue Price.
What is a defeasance payoff?
With defeasance, the debt obligation does not go away, but the defeasance process releases the mortgaged property's title to the borrower. That allows the borrower to refinance or sell the property before the loan has been fully paid off.
What are loan defeasance costs?
Defeasance Costs means expenses incurred in the defeasance or prepayment of secured indebtedness including, but not limited to: prepaid interest, yield maintenance or other prepayment premiums, legal, accounting and consulting fees directly attributable to the defeasance of debt; the write‑off of deferred financing ...
What does Defease mean?
To annul or render voidTo annul or render void a contract or stipulation; to abrogate.
Is defeasance a prepayment penalty?
In some cases, the borrower will be required to pay the entire remaining interest on the note at the time that the debt is repaid. However, in many instances, the terms of the loan will call for a defeasance, which is effectively a prepayment penalty, but that can offer some flexibility to the borrower.
Are defeasance costs deductible?
A defeasance premium paid under a legal defeasance is deductible as a payment of interest in the year incurred.
What does call defeased mean?
Call Defeased Termination of certain of the rights and interests of the bondholders and of their lien on the pledged revenues or other security in accordance with the terms of the bond contract for an issue of securities.
What does it mean when bonds are issued at 99?
For example, if a corporate bond is quoted at 99, that means it is trading at 99% of face value. In this case, the cost to buy each bond is $990.
What does call defeased mean?
Call Defeased Termination of certain of the rights and interests of the bondholders and of their lien on the pledged revenues or other security in accordance with the terms of the bond contract for an issue of securities.
What does MMD mean for bonds?
The municipal market data (MMD) yield curve is the most widely referenced yield curve in the municipal bond market. For investors familiar with the U.S. Treasury yield curve, which quotes the yield to maturity (YTM) on non-callable Treasury bonds, the conventions of the MMD curve might seem unorthodox.
What happens when a bond gets downgraded?
A downgrade in a stock is a response to an unexpected negative event for a company or the industry in which it operates. A downgrade in a bond is an indication of an increased risk that the company or government borrowing money will be unable to repay its debts.
Understanding Defeasance in Five Minutes - PropertyMetrics
Defeasance, in its simplest terms, is the substitution of collateral. In the world of commercial mortgage-backed securities (CMBS), the substitution involves a borrower replacing the real estate securing its a loan with a portfolio of U.S. securities. The portfolio is designed to generate the same debt-service through the term of the loan as the original ...
What is Defeasance? How Does It Work? - Multifamily Refinance
Multifamily Refinance 515 E Las Olas Blvd Suite 120 Fort Lauderdale, FL 33301. [email protected] (954) 280-8471
Key Distinctions Between Prepayment and Defeasance - Otten Johnson
In light of the recent "return" of some CMBS (Commercial Mortgage-Backed Securities) loan originators to the capital markets, and the outstanding volume of pre-2008 CMBS loans, now is an ideal time for a brief overview of CMBS defeasance. Defeasance and loan prepayment yield a similar result for the borrower – release of the deed of trust – but they provide a much different result for the ...
Defeasance and Its Impact on Real Estate Transactions - The Tax Adviser
While a properly structured defeasance transaction can generate a significant deduction, taxpayers should consider the totality of the transaction when assessing the after-tax impact.
Loan Defeasance Clause – Everything You Need to Know
This AAI Guide compiles the best information on loan defeasance clauses for commercial loans, including FAQs and their use in CMBS loans.
What Is the Defeasance Process?
The defeasance process is a means by which borrowers can substitute securities, typically bonds backed by the U.S. Treasury, for the existing collateral on their mortgage, such as a home or similar property. It can also be used in other kinds of financial transactions. The securities must be of sufficient value to generate enough cash flow to cover the remaining principal and interest owed on the loan.
Why is defeasance important?
Defeasance originated in the bond market as a way to help ensure that investors would receive their expected yields in the event that the bond issuer decided to prepay their obligations to their bondholders. However, defeasance became popular in the world of real estate financing when securitized lending took off.
What is required for a defeasance?
Defeasance generally requires that the borrower obtain legal and financial services from specialists well versed in the defeasance process. These will include a broker-dealer. This is because defeasance requires the creation of newly-formed entities, such as a successor borrower.
How old does a mortgage have to be to be defeasanced?
The first rule prohibits defeasance if the mortgage is less than two years old. The rules define the day when the loan was securitized as the beginning of the two years, rather than the day when the loan was closed. Some loans will specify that the loan must be even older than two years for defeasance.
Why do defeased securities carry lower yields than comparable securities?
Defeased securities tend to carry lower yields than comparable securities because the fund backing it as collateral reduces credit risk.
How long does it take to defease a loan?
The number of parties involved and the cost of defeasance will vary, as laws governing the process differ from state to state. The process will normally take just over 30 days.
Does a defeasance release the mortgaged property from the lien against it?
These securities must be of sufficient value to generate enough cash flow to cover the remaining principal and interest owed on the loan. In the case of defeasance, the debt obligation does not go away, but the defeasance releases the mortgaged property from the lien against it.
What is a defeasance?
Defeasance is a provision in a contract that voids a bond or loan on a balance sheet when the borrower sets aside cash or bonds sufficient enough to service the debt.
What is defeasance in real estate?
In the broadest sense, defeasance is any provision that nullifies the agreement in which it is contained. The provision includes various requirements that must be met, most often by the buyer, before the seller is required to release his interest in a particular property. Defeasance entails a borrower setting aside sufficient funds, often in cash and bonds, to cover his or her associated debts. This functions as a way to render the debt obligation null and void without the risk of prepayment penalties. Since the amounts owed and the amounts set aside offset, they are functionally removed from balance sheet as monitoring the accounts is generally unnecessary.
Why are offsets removed from balance sheet?
This functions as a way to render the debt obligation null and void without the risk of prepayment penalties. Since the amounts owed and the amounts set aside offset, they are functionally removed from balance sheet as monitoring the accounts is generally unnecessary.
Will Kenton be an economist?
Will Kenton is an expert on the economy and investing laws and regulations. He previously held senior editorial roles at Investopedia and Kapitall Wire and holds a MA in Economics from The New School for Social Research and Doctor of Philosophy in English literature from NYU.
Is defeasance a complex process?
The process of defeasance is generally considered complex and is rarely undertaken solely by the borrower. Often, a variety of lawyers and financial experts are necessary to ensure the portfolio is properly structured and supplies the fund's need to offset the debt owed.
What is defeasance in mortgage?
Defeasance, in its simplest terms, is the substitution of collateral. In the world of commercial mortgage-backed securities (CMBS), the substitution involves a borrower replacing the real estate securing its a loan with a portfolio of U.S. securities. The portfolio is designed to generate the same debt-service through the term of the loan as the original collateral. This allows the lien on the original collateral to be released.
Why is defeasance important in CMBS?
CMBS investors are happy because the original note remains in place, and while the collateral has changed from real estate to a portfolio of securities, the portfolio is designed to create the same loan payments as if the original collateral had remained in place.
What Rules Control Defeasance Rights?
A borrower’s right to defease, appoint a successor borrower (part of the process detailed below), what types of securities can be included in the portfolio, and the conditions of defeasance are found in their mortgage or loan documents, which vary from lender to lender. In the absence of such defeasance language, a borrower generally has no right to defease. Here is an example of typical defeasance language.
What Is The Difference Between Defeasance And Yield Maintenance?
Unlike defeasance, where the original collateral is replaced and the original loan stays in place, yield maintenance is the prepayment of the original loan. The prepayment consists of (i) the outstanding balance on the original note, and (ii) a penalty.
How long does it take to defease a loan?
A borrower is considering defeasance. What’s his first step? What happens next? Let’s walk through the process. A process that typically takes 30-45 days to complete (though it will only take you 3 minutes to read this summary).
How to determine if a defeasement is allowed?
The easiest way to determine if defeasement is allowed and appropriate for a borrower is to ask someone who works with them every day: a defeasement consultant. The consultant can begin their initial review with as little as a property address. From this they can pull from public records the mortgage encumbering the property and its defeasement provisions. However, it can speed up the process if a borrower can provide all loan documents.
Who drafts defeasement agreements?
Typically the lender will draft the defeasement agreement and forward to it and other documents to the borrower and consultant for signature. They will also ask the borrower to provide documents necessary for the lender’s review.
How Can Borrowers Conduct Defeasance on Their Loans?
In most cases, a borrower will hire an expert defeasance consultant to conduct the defeasance process on their behalf. While, in theory, a borrower could do the process themselves, it would require expertise and resources that the average real estate investor or investment firm simply does not have.
What Types of Loans Require Defeasance?
Common types of loans that are securitized into bonds include CMBS or conduit loans, Fannie Mae multifamily loans, and Freddie Mac multifamily loans .
How does defeasance work?
Defeasance is the process through which a borrower is released from the financial obligations of its debt. The borrower purchases a portfolio of government bonds as replacement collateral to secure the debt and to generate the cash flows required to meet the scheduled payments of principal and interest remaining on the loan.
What happens to cash in a defeasance account?
Cash sits in the defeasance account for short periods of time, where it earns interest at money market rates. The float value is released to the successor borrower when the loan is repaid at maturity.
What is Chatham's role in a defeasance?
Chatham provides cost estimates, advises the borrower on how to navigate the defeasance process, engages counterparties, and ensures that the defeasance is executed in a timely and cost-effective manner. If allowed by the loan documents, Chatham can also purchase the defeasance bonds and establish the successor borrower entity that will assume the loan at closing.
What is residual value in defeasance and where does it come from?
Residual value comes from two different sources: float value and prepayment value.
What is the overall defeasance timeline?
We recommend allowing at least 40 days to complete the defeasance process. In most cases, the loan servicer will waive any stated notice period and will also waive any requirement that the defeasance close on a loan payment date. However, loan servicers may charge expediting fees for closing in less than 30 days from the date of notice and deposit.
How are the defeasance bonds purchased?
The cash required to purchase the defeasance bonds usually comes from the proceeds of a refinance or sale of the property.
Who sets the transaction fees for these parties?
The parties involved in a defeasance set their fees independently. Any estimate of the transaction fees is based on past experience and standard fee schedules. Some parties will discount their fees if several loans in the same securitization are defeased at once.
How does a defeasance work?
In a defeasance, the issuer purchases government securities for deposit in an escrow account. The escrow account is held by a bank or trust company that serves as escrow agent. Under the terms of an escrow agreement, the government securities are irrevocably pledged to the payment of the outstanding bonds. The government securities are in a principal amount such that the principal and interest earned are sufficient to retire the principal of and interest on the outstanding bonds as they come due. The government securities and all costs related to the defeasance are paid with funds accumulated in the various accounts established for the outstanding bonds or with other available funds.
Why is defeasance important?
Essentially, defeasance allows an issuer to collateralize outstanding debt with a portfolio of "risk-free government securities", thereby instantly removing the debt from the issuer's balance sheet. This occurs because the government securities generate the cash flow needed to pay all interest and principal on the outstanding bonds when due.
What are the benefits of defeasance?
1. Depending on interest rates and market conditions, defeasance may enable an issuer to extinguish debt at the best possible price.
What is defeasance in finance?
A defeasance is a financing tool by which outstanding bonds may be retired without a bond redemption or implementing an open market buy-back. Cash is used to purchase government securities.
What is defeasance of municipal bonds?
Defeasance of municipal bonds. 1. A rendering void; an annulment. 2. a. The voiding of a contract or deed. b. A clause within a contract or deed providing for annulment. When referring to municipal bonds, a defeasance relates to methods by which an outstanding bond issue can be made void, both legally and financially. ...
Why do bondholders benefit from defeasance?
In fact, the bondholders benefit because the bonds are not redeemed and are secured by a portfolio of risk-free government securities. 3. Defeasance does not require lengthy or costly proceedings, as is often the case with tender offerings. 4. Defeasance does not require the issuance of new debt. Mechanics of Defeasance.
Can a defeasance be done with cash?
Although a defeasance is generally the outcome of a refunding transaction, a defeasance can also be accomplished with cash rather than the issuance of any bonds. This article focuses on the concept of a defeasance and the use of cash for this purpose. General Description. A defeasance is a financing tool by which outstanding bonds may be retired ...
What Is the Defeasance Process?
The defeasance process is a means by which borrowers can substitute securities, typically bonds backed by the U.S. Treasury, for the existing collateral on their mortgage, such as a home or similar property. It can also be used in other kinds of financial transactions. The securities must be of sufficient value to generate enough cash flow to cover the remaining principal and interest owed on the loan.
Why is defeasance important?
Defeasance originated in the bond market as a way to help ensure that investors would receive their expected yields in the event that the bond issuer decided to prepay their obligations to their bondholders. However, defeasance became popular in the world of real estate financing when securitized lending took off.
What is required for a defeasance?
Defeasance generally requires that the borrower obtain legal and financial services from specialists well versed in the defeasance process. These will include a broker-dealer. This is because defeasance requires the creation of newly-formed entities, such as a successor borrower.
How old does a mortgage have to be to be defeasanced?
The first rule prohibits defeasance if the mortgage is less than two years old. The rules define the day when the loan was securitized as the beginning of the two years, rather than the day when the loan was closed. Some loans will specify that the loan must be even older than two years for defeasance.
Why do defeased securities carry lower yields than comparable securities?
Defeased securities tend to carry lower yields than comparable securities because the fund backing it as collateral reduces credit risk.
How long does it take to defease a loan?
The number of parties involved and the cost of defeasance will vary, as laws governing the process differ from state to state. The process will normally take just over 30 days.
Does a defeasance release the mortgaged property from the lien against it?
These securities must be of sufficient value to generate enough cash flow to cover the remaining principal and interest owed on the loan. In the case of defeasance, the debt obligation does not go away, but the defeasance releases the mortgaged property from the lien against it.
What Is The Defeasance Process?
How The Defeasance Process Works
- With defeasance, the debt obligation does not go away, but the defeasance process releases the mortgaged property’s title to the borrower. That allows the borrower to refinanceor sell the property before the loan has been fully paid off. Defeasance clauses are common in certain types of mortgage contracts, particularly those in states that follow what is known as title theory. In tit…
Steps in The Defeasance Process
- If your mortgage contains a defeasance clause, it should specify how to proceed. You will, of course, need to purchase the alternative collateral to use as a replacement unless you already happen to have it. In more complicated instances (such as commercial real estate), the borrower will generally need to obtain the legal and financial services of specialists who are well-versed i…
Defeasance and Securitized Loans
- Defeasance originated in the bond market as a way to help ensure that investors would receive their expected yields in the event that the bond issuer decided to prepay its obligations to its bondholders. However, defeasance became popular in the world of real estate financing when mortgage securitizationtook off. Securitized loans are generally held by entities known as real e…
What Is Defeasance
Breaking Down Defeasance
Example of Defeasance
Creating Defeasance Accounts
The Defeasance Clause
- As part of a mortgage agreement, the defeasance clause provides the borrower the right to secu…
Similar arrangements also exist with a variety of other large-scale, financed purchases. This includes most vehicle loans. Once the debt is paid in full, the financing company terminates its interest in the property and subsequently releases the property to the buyer.