One aspect of a defeasance is the use of a Successor Borrower entity (SBE) to hold the securities portfolio and make the remaining loan payments. In a defeasance, value is created in the SBE in two ways, Float Income and Prepayment Value. At Capital Defeasance Group, we make sure our clients are aware of this value and have a chance to share in it through the Defeasance Refund™ payment if they desire. Sharing may not be appropriate for all borrowers, and we recommend consultation with legal and tax professionals before deciding whether to share in the Defeasance Refund™ payment.
Float Income
Float Income is created because of regulations that require the bond payments to be received by the Successor Borrower in advance of the loan payment date. The Successor Borrower entity will therefore always have a cash balance that will earn interest. In compliance with defeasance requirements, this accruing interest cannot be used towards any of the loan payments.
Prepayment Value
Prepayment Value is created as a result of the no-penalty prepayment period at the end of the loan’s life, typically 30-90 days prior to maturity. Depending on interest rates at that time, it may be advantageous to prepay the loan and avoid some of the costs of the final interest payments. The savings is unpredictable due to the variability of market interest rates but can be substantial if prevailing government security yields are significantly lower than the loan interest rate.
