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Defeasance provisions have become commonplace in loan documents. Yet most people are intimidated by the word "defeasance" and very few people know how it actually works. Don't be intimidated because, in a practical sense, defeasance is merely the process of changing the collateral of a loan from real estate to bonds backed by the government of the United States. In the process, the loan is assumed by a new entity (commonly referred to as the Successor Borrower). To defease a loan, all you have to know is that you will need a defeasance consultant. We hope you will hire DefeaseIt. However, when you first get your loan, there are things that you can ask your lender which will save you or your client significant amounts of money down the road. Many of these things the lender will easily agree to because they are no "skin off their nose." Below are 5 easy things to ask for at the time you get the loan.

1. Agency Bonds - - The ability to use "Agency Bonds" is the most significant way to create savings. In a defeasance transaction there are basically two types of bonds that can be used, either U.S. Treasury Bonds (i.e. T-Notes, T-Bills, T-Bonds or Treasury Strips) or U.S. Government Agency Bonds (e.g. Fannie Mae Bonds and Freddie Mac Bonds). Even though both types of bonds are backed by the full faith and credit of the United States, Treasury Bonds are more expensive because they are direct obligations of the United States, as opposed to being just guaranteed obligations of the United States as with Agency Bonds. We have seen the use of these bonds make hundreds on thousands of dollars difference-even on loans smaller than $20,000,000. This means savings, and usually big savings, every time. Here is language you need to watch for in the defeasance provision:
"U.S. Government Securities shall mean direct, non-callable, fixed rate obligations of the United States of America."
Change that language to read:
"U.S. Government Securities shall mean non-callable, fixed rate obligations that are "government securities" within the meaning of Section 2(a)(16) of the Investment Company Act of 1940, as amended."
Do this and you or your client just saved a lot of money at defeasance time.

2. Successor Borrower - Many people do not know that the loan does not go away when you defease it. In fact, the loan continues to exist until the maturity date of the loan or a short period prior to the maturity date. On the date that your property is sold or refinanced, the old loan is actually assumed by another entity which is usually controlled by either the loan servicer or a defeasance consultant like DefeaseIt. Since you are not going to have to worry about the loan anymore-who cares? You should, because the Successor Borrower makes money and DefeaseIt will share this money with you while the loan servicer will not. But how does the Successor Borrower make money? The answer is float interest. Bonds must be bought and cashed-in to make the payments on the loan each month. That means that the bonds must mature prior to the date of each monthly loan payment. That money is deposited into a money market account that earns interest which we call the float interest. The float interest is especially significant with respect to the balloon payment at the end. Say that you have a $20,000,000 balloon payment at the end of the loan, but the only matching bond matures 20 days before the balloon payment is due-in this case the Successor Borrower earns interest on $20,000,000 for 20 days. At 4.5% interest that's $49,315. That is a significant amount of money to anybody. You wouldn't want the loan servicer to pocket that when you could have the opportunity to share in it. Watch for language that allows the lender to appoint the Successor Borrower and change the language to read that the Borrower has the right to appoint the Successor Borrower. They are probably going to want the right to consent to this, so add language that this consent shall not be unreasonably withheld, conditioned or delayed. Even better would be to try to work in language that an affiliate of a defeasance consultant whose affiliates have previously acted before as successor borrowers, is an acceptable successor borrower. Share in the float interest and don't give a free gift to the servicer.

3. Free Prepayment Period - If you ask, lenders will usually let you work in language allowing the payoff of the loan without penalty some time period prior to maturity. This is commonly referred to as the Free Prepayment Period. You can usually talk your lender into a Free Prepayment Period of 3 months prior to maturity, but start the negotiation asking for 6 months. Why does this make a difference if you are going to defease it? Because DefeaseIt is usually able to get the servicer to consent to structuring a defeasance portfolio that ends when the Free Prepayment Period begins (Note: Make sure that there is no language in the defeasance provision that would override this). This means you are not buying bonds to cover the loan payments during Free Prepayment Period, saving you a significant amount of money.

4. Bond Purchase - Some loan servicers are in the securities business and, if the language allows, will force you to purchase the bonds from them so that they can make money on the trade. The servicer generally marks the bonds up $3,500 to $5,000, which is an expense that you can avoid entirely if DefeaseIt purchases your bonds. Also, you do not want the loan servicer purchasing your bonds as there might be ways to structure the portfolio of bonds more efficiently, saving you money. DefeaseIt works with its broker dealers to create the most efficient portfolio possible; however, DefeaseIt never makes a fee on the bond purchase. Make sure that defeasance provision reads that you have the right to purchase the bonds.

5. Defeasance Processing Fee - Negotiate the servicer's defeasance processing fee at the time you get the loan. All servicers charge this fee but the range varies depending on the servicer-from $10,000 to $25,000. Try to negotiate $10,000 up front.

You may contact us at the time you are negotiating a loan if you have questions regarding a defeasance provision. DefeaseIt provides this service at no charge because we hope that you will call on us when you defease your loan down the road.

Buddy Cramer *

* Buddy Cramer (State Bar of Texas, Southern Methodist University, J.D., 1993, University of Texas at Austin, B.B.A., 1984) is a founding partner of Carrie, Cramer & Weatherbie, LLP. Mr. Cramer has represented borrowers in real estate transactions exceeding one billion dollars with lenders (predominately CMBS lenders).
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