Accountant's Report - The loan documents typically require that the borrower deliver to the servicer an agreed upon procedures letter from an independent public accountant acceptable to the servicer. The agreed upon procedures letter is addressed to the borrower, trustee, servicer, rating agencies and successor borrower and confirms that the cash receipts from the government securities serving as the pledged collateral will be sufficient, without taking into account any future reinvestment proceeds, to make all remaining monthly payments due under the note. It is commonly referred to as an "Accountant's Report."
Amortization - Amortization is the repayment of a debt by the borrower in a series of installments, comprised of principal and interest, over a period of time. A fully-amortizing loan is a loan for which the term of the loan matches the term of the amortization schedule such that the loan balance is paid to zero at maturity by making equal monthly payments over the term. With the exception of loans secured by credit tenant leases, most CMBS loans are not fully amortizing. Rather, they typically have a five, seven or ten year term and require the borrower to make monthly payments based upon a twenty-five or thirty year amortization schedule. This results in lower monthly payments than a fully amortizing loan but requires a balloon payment at maturity in order to repay the loan in full.
Basis Points (bps) - There are one hundred basis points in one percentage point. The term "basis points" is used in financial circles to describe percentages that include hundredths of one percent. For example, a sensitivity analysis for the cost of a defeasance portfolio would tell you how much the cost of the portfolio will change for every 25 basis points (or 1/4%) of movement in yield.
Bid/Ask - The bid price is the highest price at which a buyer is willing to buy a security at a given time. The ask price is the lowest price at which a seller is willing to sell a security at a given time.
CMBS - CMBS is an abbreviation for "Commercial Mortgage-Backed Securities." Loans for which the lender's exit strategy is securitization by transfer of a pool of loans to a REMIC Trust are referred to interchangeably as "CMBS loans" and "conduit loans."
Conduit Loan - A conduit loan is the same as a CMBS loan. The word "conduit," in this context, refers to the pass-through tax status of the REMIC Trust to which the lender intends to transfer the loan in a securitization. In fact, the "C" in "REMIC" stands for "conduit."
Coupon/Interest – The coupon or interest rate for a loan is the stated annualized percentage rate of interest paid by a borrower to a lender in exchange for the use of the lender's money for a period of time.
Custodian - See "Securities Intermediary."
Defeasance - Defeasance is a substitution of collateral. A portfolio of qualified U.S. government securities is structured such that it will produce sufficient cash flow to make all remaining payments due under the note as and when the same come due. The securities are pledged to the lender in exchange for the lender's release of the real estate from the lien of the mortgage. Conduit loan defeasances involve a number of parties, require a number of deliverables, and generally take about thirty days to complete.
Defeasance Account Agreement - The defeasance account agreement is a typical lender prepared document in CMBS defeasances that sets forth the terms pursuant to which the securities intermediary will hold the pledged collateral on behalf of the lender, apply the proceeds thereof to the payment of the debt, reinvest any unused funds, and distribute any remaining collateral to the successor borrower after the loan is paid in full. It is the mechanism by which the lender exercises possession and control over the collateral to perfect its security interest in the collateral under Article 8 of the Uniform Commercial Code.
Defeasance Assignment, Assumption and Release Agreement - The defeasance assignment, assumption and release agreement is a typical lender prepared document in most CMBS defeasance transactions. It sets forth the terms of (i) the assignment of the note, defeasance pledge agreement, defeasance account agreement and pledged collateral from the original borrower to the successor borrower, and (ii) the lender's release of the borrower from the original loan documents.
Defeasance Borrower's Certificate - The defeasance borrower's certificate is a typical lender prepared document in CMBS defeasances that contains a litany of representations and warranties from the borrower confirming that it has not committed certain acts or omissions that would result in a default under the loan documents. It also confirms that the borrower has completed all other requirements (except those that have been waived by the lender in the defeasance waiver and consent agreement) of the defeasance provision in the borrower's loan documents. This certificate is sometimes referred to as the "Borrower's Certificate," "Certificate of Pledgor" or "Defeasance Certificate."
Defeasance Note - Most defeasance transactions do not require a defeasance note. Defeasance notes are used for CMBS defeasances in two situations: 1) when the real estate securing the loan is located in the State of New York (or certain other jurisdictions) and the borrower requests that the lender structure the transaction as a "New York-style defeasance" in order to reduce mortgage recording taxes on its new loan by the amount of the mortgage recording taxes previously paid on the current outstanding principal balance of the existing loan (a "New York-style Defeasance Note"); and 2) when the borrower elects to do a partial defeasance, pursuant to the defeasance provisions in its loan documents, in order to obtain the release of just a portion of the real estate encumbered by the loan (a "Partial Defeasance Note").
Defeasance Pledge and Security Agreement - The defeasance pledge and security agreement is a typical lender prepared document in CMBS defeasances. It creates the pledge of the government securities by the borrower to the REMIC Trust and grants the lender a security interest in the government securities.
Defeasance Waiver and Consent Agreement - The defeasance waiver and consent agreement is a typical lender prepared document in CMBS defeasances. As the defeasance process has evolved, some non-economic procedural requirements that were included in many defeasance provisions have become inapplicable. For example, some defeasance provisions state that the defeasance must occur on a payment date. In practice, such a requirement is unnecessary and is routinely waived by the servicer in the defeasance waiver and consent agreement. This agreement also is sometimes referred to as the "Modification, Waiver and Consent."
Float - For a defeasance portfolio to be 100% efficient, each payment from a security would have to be made from the government to the securities intermediary and from the securities intermediary to the loan servicer on a loan payment date. Most defeasance provisions require that securities be selected that redeem as close as possible to, but prior to, the payment date for which the resulting funds will be needed for a monthly payment. Based upon (i) defeasance provision requirements, (ii) the typical payment dates for the universe of eligible securities (typically, the 15th or 30th of the month), and (iii) the dates loan payments are due (typically, the 1st, 5th or 11th day of the month), even the most efficient portfolio practicable will have some inefficiencies. Therefore, cash received from the securities is reinvested in a AAA rated money market fund or other permitted investment that earns interest until the money is needed for a scheduled loan payment. This interest is sometimes referred to as "float."
Free Delivery - Free delivery in the context of the purchase of the portfolio of securities that serve as the pledged collateral for a defeasance means that the broker-dealer delivers the securities per the buyer's instructions before the buyer makes payment for the securities. The opposite of "free delivery" is "delivery vs. payment", which means that the purchase price for the securities must be delivered to the broker-dealer before the broker-dealer will release the securities. Beware of anyone who uses the term "free delivery" to imply that there is no cost to the securities purchase. "Free delivery" is a term of art in the securities industry that simply describes the timing of payment and has nothing to do with fees, costs or mark ups included in the securities cost.
Loan Term - The loan term is the amount of time set by the lender for a buyer to repay the loan in full. Most CMBS loans have 5-year, 7-year or 10-year terms.
Lock-out Period - REMIC regulations stipulate a minimum two year period, commencing on the date a loan is securitized, during which the loan cannot be defeased. However, some defeasance provisions in loan documents state a longer period, the "lock-out period", during which the loan is locked-out from defeasance.
New York Perfection Opinion – Regardless of where the real estate is located, CMBS defeasance transactions are governed by New York law, so a New York perfection opinion issued by a law firm (often the loan servicer's counsel) is required by the loan servicer. The NY perfection opinion letter confirms that the REMIC Trust has a perfected security interest (by possession and control under Article 8 of the UCC) in the government securities that serve as the pledged collateral.
New York-Style Defeasance - A New York-style defeasance can be arranged for borrowers defeasing loans secured by property located in the State of New York (and in certain other jurisdictions). A New York-style defeasance is an accommodation by the servicer in response to a borrower request to structure the transaction to allow the borrower to mitigate mortgage recording taxes. In simplified terms, (i) the REMIC Trust assigns the existing loan to the borrower's refinance lender, (ii) a portion of the refinance proceeds is used to purchase the government securities that will serve as the defeasance collateral, (iii) the refinance lender and the borrower enter into the defeasance pledge and security agreement and defeasance account agreement, (iv) the borrower signs three new notes in favor of the refinance lender (the first, the defeasance note, in the amount of the current outstanding principal balance of the existing loan, the second, the "gap note," in an amount equal to the difference between (a) what the refinance lender is willing to lend to the borrower on the new loan, and (b) the amount of the defeasance note, and the third, the consolidated note, combines the original note and the gap note into one amended and restated note), (v) the defeasance note, pledge agreement and account agreement are assigned by the refinance lender to the REMIC Trust, (vi) the borrower pays mortgage recording taxes on the amount of the gap note when a related "gap mortgage" is recorded, and (vii) the borrower pays no mortgage recording tax on the consolidated mortgage securing the consolidated note, because it has already paid mortgage recording taxes on the original note (when the original mortgage was recorded) and on the gap note (when the gap mortgage was recorded in connection with the defeasance closing). Click here for more technical information.
No-downgrade Letter - A no-downgrade letter refers to a letter from a rating agency confirming that the defeasance, as evidenced by the defeasance documents submitted to the rating agency for review, will not result in a downgrade of the rating assigned to the bonds issued by the REMIC Trust that holds the loan.
Par Repayment Provision - The promissory note that the borrower signed in favor of the lender when the loan was made may contain a provision whereby the loan can be prepaid during a stated period (usually three months) prior to the maturity of the loan without the payment of any prepayment penalty or premium. Such a loan that may be repaid at par just prior to maturity can be said to have a "par repayment provision." Depending upon the specific language in the loan documents, a loan may have no par repayment option at all, it may have a par repayment option that is negated after defeasance, or it may have a par repayment option that survives defeasance. A par repayment provision that survives defeasance can create value in the pledged collateral account, if the loan documents also require that the defeasance collateral consist of securities sufficient to make all remaining payments through the maturity date. In such cases, securities and/or cash may remain in the account after prepayment of the loan. However, as with an undefeased loan secured by real estate, the borrower (which is the successor borrower after defeasance) must actually wire the outstanding principal balance of the loan and any accrued interest and fees to the lender in order to accomplish a par repayment and receive any remaining collateral.
Pooling and Servicing Agreement - A pooling and servicing agreement is a written agreement among a lender, a REMIC Trust, and a loan servicer. The "PSA" sets forth the obligations of the parties with respect to the securitized loans and usually includes guidance with respect to the defeasance of such loans. While the PSA is instructive when the loan documents require the loan servicer to exercise discretion, the borrower's agreement with its lender is still reflected solely in the loan documents.
PV Payment - To the extent there may be value, after a defeased loan is paid in full, from float or a par repayment provision and that value is expected to significantly exceed the successor borrower's costs and profit expectations, a defeasance facilitator may be able to assist interested borrowers in obtaining a PV payment at closing. A PV payment is a payment at closing that equates to the present value of a percentage of the estimated future residual.
Rating Agency - Rating agencies are private companies that, among other things, rate the creditworthiness of the bonds issued by a REMIC Trust. The four best known rating agencies are Moody's Investors Services, Standard and Poor's, Fitch ICBA and Dominion Bond Rating Services (DBRS). Typically, at least two of the four major statistical rating agencies rate the bonds issued to investors by a REMIC Trust. Because an improperly executed defeasance can create issues that could cause the REMIC Trust to lose its tax status as a REMIC, the rating agencies review the defeasance documents for certain large loans that meet the criteria established by the rating agencies for review. The fee charged by a rating agency for its review of a defeased loan is typically paid by the borrower pursuant to language in the borrower's original loan documents.
REMIC Opinion - CMBS defeasance transactions must be completed in compliance with REMIC regulations, so a REMIC opinion issued by a law firm (often the loan servicer's counsel) is required by the loan servicer. The REMIC opinion confirms that the defeasance, as structured and documented, will not cause the REMIC Trust to lose its tax status as a REMIC.
REMIC Trust - REMIC is an abbreviation for "Real Estate Mortgage Investment Conduit." A REMIC Trust is the entity to which a lender transfers its loans when it securitizes them. There are a number of complex regulations in the U.S. tax code that govern the creation and maintenance of a REMIC Trust. REMIC Trusts issue bonds to institutional investors that are backed by commercial mortgages.
Residual - The term "residual" is sometimes used to refer to the accumulated float and par repayment value, if applicable, in the pledged collateral account after a defeased loan is paid in full. Depending upon interest rates, the security of permitted investments, the successor borrower's compliance with the defeasance documents and avoidance of default, fees charged by the servicer and/or securities intermediary, and other factors, a given defeased loan may or may not produce residual and, if it does, may produce more or less residual. In any event, to the extent there is residual, the defeasance documents direct the intermediary to deliver it to the successor borrower when the successor borrower has fully satisfied its obligations as the borrower under the defeasance documents.
Securities - Securities is a general term that includes all instruments representing evidence of ownership of debt issued by a corporation or governmental agency or department. Securities that may be used to defease a CMBS loan are typically limited to direct obligations of, or obligations backed by the full faith and credit of, the United States government, that are not callable or subject to early redemption.
Securities Intermediary – In the defeasance context, the securities intermediary (sometimes referred to as the "custodian") is an agent of the lender, usually a financial institution, that holds the government securities serving as the defeasance collateral. While the securities intermediary holds the securities, the securities are owned by the successor borrower who must account for income from the securities and expense from the loan and file tax returns. The custodian collects interest and principal payments on the government securities, sends the monthly principal and interest payments on the defeased loan directly to the loan servicer, and reinvests any unused funds for the benefit of the successor borrower pursuant to the defeasance account agreement. The use of a securities intermediary allows the lender to perfect its security interest in the defeasance collateral under Article 8 of the Uniform Commercial Code by possession and control of the collateral through an agent.
Securitization - Securitization refers to the process by which a lender transfers loans to a REMIC Trust. In simplified terms, when a lender securitizes a pool of loans the lender is paid for the transfer of the loans out of the proceeds of bonds issued by the REMIC Trust to which the loans are transferred, and the lender is able to remove the loans from its books.
Servicer – The servicer is typically a large institution that interacts directly with the borrower (pursuant to a pooling and servicing agreement) to collect monthly mortgage payments, hold the borrowers' escrowed funds, request financial statements, renew UCC financing statements, respond to borrower requests and the like. When a borrower seeks to defease a CMBS loan, the servicer engages legal counsel to draft defeasance documents and ensure that the defeasance requirements in the loan documents are satisfied. The borrower is responsible for paying the fees of the servicer and servicer's counsel, which vary from servicer to servicer and from law firm to law firm.
Successor Borrower - The successor borrower is a special purpose, bankruptcy remote entity that assumes the defeased loan, takes an assignment of the government securities that serve as the pledged collateral, is responsible for making the required monthly principal and interest payments until the loan is repaid in full, and is responsible for maintaining its existence for the remaining term of the loan. In most cases, the successor borrower is an affiliate of the defeasance facilitator. The successor borrower charges a fee at closing that is sufficient to cover its costs in assuming the defeased loan. In most cases, the successor borrower does not charge fees for its expenses through the remaining term of the loan. Rather it relies on future residual from float and/or par repayment to cover its costs and provide incentive to comply with the defeasance documents until the loan is paid in full.
Yield - The rate of return on an investment over a given time, expressed as an annual percentage rate. Yield is affected by the price paid for the investment as well as the timing of principal repayments. As the yield on the government securities that serve as defeasance collateral increases, the cost of the portfolio of securities decreases, because it takes fewer securities at a higher yield to match the interest rate (or yield) on the loan to be defeased. Conversely, as yields on government securities decline, it takes more securities to match the interest rate on the loan, so the cost of the required defeasance securities increases.