Loan Defeasance Once Again On the Rise

WASHINGTON, DC-Offering more evidence of normalizing markets five years after the capital markets collapse, defeasance is back as a going concern. Trepp data show $10.1 billion worth of loans were defeased through Nov. 30; the Commercial Real Estate Finance Council says this is a 140% jump over the same period a year ago.

Writing in the most recent issue of CREFC's CRE Finance World, Christina Zausner, the association's VP of industry & policy analysis, quotes Morgan Stanley's Richard Hill on the cause of the uptick in volume of loan defeasance. “Defeasance was a bigger strategy prior to the downturn,” Hill, head of CMBS and CRE debt research at Morgan Stanley, told Zausner. “As financings increasingly become available and markets continue to normalize, you would expect to see more defeasance, especially as loans mature in greater numbers.”

Zausner explains that “a CMBS loan often includes a requirement that allows prepayment only if the borrower pledges high-quality securities—in the form of zero-coupon Treasury bonds—in place of the loan.” In short, defeasance is a substitution of collateral and an assignment of debt. The strategy, she notes, once again is being favored by borrowers.

This is due to multiple factors, Zausner wrotes. These include the concern about increased rate volatility amid the tapering discussion and other issues, the ongoing stabilization of property values and especially the coming expectation of loan maturities.

Quoting Paul Vanderslice, co-head of Citigroup's US CMBS group and CREFC's immediate past president, she notes that “Many borrowers are concerned about Treasury bond rates dropping, causing the price of bonds to rise and, with them, the cost of defeasance. As counterintuitive as this may sound, a borrower cannot release equity in a property without refinancing existing debt with a new loan.”

 “We are still in a period of economic transition,” comments Stephen M. Renna, CREFC's president and CEO. “And the industry still has to face the issue of expected loan maturities. The uptick we're tracking in defeasance activity is clearly a sign of that movement, and, provided interest rates stay low, we expect 2014 to exceed current levels of activity.”