What opinions and reports are required for my defeasance?
In addition to the main documents and obligations (read more on Documents and Obligations), a defeasance may also require several opinions and reports. Two are always required:
- The accountant’s verification report confirming that the securities portfolio will be able to make all required loan payments through maturity
- Successor Borrower opinions confirming that it is a bankruptcy remote special purpose entity
Back to FAQ
What is the REMIC opinion and who writes it?
Most securitization trusts elect to be treated for tax purposes as real estate mortgage investment conduits (REMICs). The loans held in these conduits are held in a trust and must comply with REMIC regulations to maintain their favorable tax status. Each defeasance requires a REMIC opinion stating that the defeasance will not affect the favorable REMIC tax status of the particular CMBS pool/securitization holding the loan. A law firm, typically the loan servicer’s counsel, writes this opinion specifying that the REMIC requirements have been met.
Back to FAQ
How do I know if I need a rating agency “no downgrade letter”?
Rating agencies typically only review defeasance for large loans, usually defined as having initial principal balances above $20m, or representing a significant portion of the affected loan securitization pool. On most smaller loans and many mid-size loans, the rating agencies will decline to review the defeasance and the servicer will waive any requirement for a rating agency letter. (Read more on Waiver and Consent Agreement)
Back to FAQ
How do you construct the securities portfolio?
The complexity and importance of the securities portfolio makes it essential to retain a defeasance advisor who brings experience in capital markets and bond trading to the transaction. One of the most complicated steps is the identification and optimization of the securities portfolio to be used as substitute collateral for the original loan. The universe of government securities must be optimized against the borrower’s unique loan terms, a task further complicated by the fact that the required government securities pay interest semi-annually versus conduit loans’ monthly payments.
Capital Defeasance Group uses sophisticated proprietary algorithms to optimally design and then purchase the lowest cost portfolio of securities. The portfolio will be purchased on the first day of the closing period, and the final cost of the portfolio is dependent on bond market conditions at that time. This purchase is completed through a competitive process with unaffiliated broker dealers so that the borrower may be assured that they are receiving fair market prices for their securities without mark-ups.
Once the securities have been purchased and placed in a special purpose Successor Borrower entity, a certified public accountant must validate that the proceeds from the securities are sufficient to meet all of the loan payment obligations. In addition to this accountants’ report, the rating agencies may have to validate that the substitution of the securities for the property as collateral has not adversely impacted the creditworthiness of the specific CMBS securitization that holds the loan. The rating agencies issue a “no downgrade letter” to confirm their validation of the defeasance. Specific documentation must also be prepared that pledges the securities to the lender as the collateral for the original loan. (Read more on Documents and Obligations)
Back to FAQ
What types of securities can I use as defeasance collateral?
To protect the REMIC status of the securitization, the borrower must pledge substitute collateral comprised solely of “government securities” within the meaning of the Investment Company Act of 1940. This definition includes U.S. Treasury obligations, Fannie Mae and Freddie Mac (“Agency”) obligations and certain interest rate strips of the Resolution Funding Corporation (“REFCO”). Your loan documentation may not explicitly declare what type of securities are required. If possible, Capital Defeasance Group will request that the servicer approve the use of the highest yielding securities (typically agency securities) because that will significantly reduce the cost of the defeasance securities portfolio. However, many defeasance provisions in loan documents do specify the use of U.S. Treasury securities, which may be referenced with language such as “U.S. Government Securities defined as direct obligations backed by the full faith and credit and of the United States of America.”
Back to FAQ
Is there any kind of cash deposit I must make up front?
The Servicer’s counsel and defeasance advisor typically require a portion of their fees up front, but there is no cash deposit needed for the largest portion of cost, the securities portfolio. Some loan documents may specify a large cash deposit that must be placed with the Servicer. In most cases, the Servicer will waive this requirement. (Read more about the Waiver and Consent Agreement) In general, the borrower is not required to make any large payments until the defeasance closing.
Back to FAQ
Who sets the transaction costs?
Third parties, such as the accounting firm and the rating agencies, set their own fees, the Securities Intermediary charges a transaction for cost maintaining the securities portfolio and wiring the loan payments, and the Servicer and Servicer’s counsel typically have standard fees. Most of the third party transaction fees are outside the borrower’s control, but Capital Defeasance Group has arranged prenegotiated low fees with our network of third party service providers. The most important cost of the defeasance is the securities portfolio and Capital Defeasance Group always ensures a fair and competitive market price for the securities that are free from any additional fees, profits or hidden mark-ups.
Back to FAQ
What are the tax implications of a defeasance?
We recommend you consult with your tax advisor on the tax implications of a defeasance. In general, the main question for tax purposes is whether or not the defeasance was done at a discount or premium to the unpaid principal balance. If the defeasance cost exceeds the unpaid principal balance of the original loan, the resulting defeasance premium and fees may be tax deductible. The return of any residual value from the Successor Borrower to the original borrower or any affiliated entities may also have tax consequences. (Read more on Sharing the Defeasance Refund™ payment)
Back to FAQ
Do I take on any liability during the defeasance process?
No significant liability is incurred until the securities are purchased on the first day of the three-day closing. After the securities are purchased by Capital Defeasance Group on the borrower’s behalf, the borrower is liable for any fees and/or market losses incurred if the securities are resold because of a delay/cancellation of the closing. Also, the borrower remains liable for any fees paid or any costs incurred by the Servicer, the Servicer’s counsel, the accountant, the defeasance advisor, the rating agencies and other third parties.
Back to FAQ
