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CRE Finance World, Autumn 2013

Rate Moves Move the Dial on Defeasance efeasance activity has accelerated to $5.8 billion through August. Volumes are up by 131% over the same period the year prior and 26% in 2013 year-to-date versus the full year 2012. If a loan is a part of a CMBS pool, it oftentimes will include a requirement that only allows prepayment in the event that the borrower pledges high quality securities in place of the loan. Defeasance in the CMBS sector generally requires that the borrower offer zero-coupon Treasury bonds in the amount necessary to cover future payments to maturity. Chart 1 Defeasance Activity Jan 2012–Aug 2013 Source: Trepp A couple of factors drive a borrower’s decision to resort to defeasance: interest rates and property values. Both come together to create the incentives and the conditions under which an owner will consider the high up-front costs of defeasance. In 2013, the tapering discussion and other issues started to influence interest rates, and to convince the industry that borrowing costs could break out of the lower range going forward. Paul Vanderslice, Citigroup Co-Head of the US CMBS Group, says: “Many borrowers are concerned about rates dropping and their defeasance costs rising. As counterintuitive as this may sound, CRE Finance World Autumn 2013 8 a borrower cannot release equity in a property without refinancing existing debt with a new loan.” Property values continued to recover this year, especially for premium buildings in tier 1 markets. Lisa Pendergast, Co-Head of CMBS Strategy and Risk at Jefferies LLC, suggests that borrowers may have found current conditions to be something of a sweet spot. At some point, jobs and GDP growth will need to support incremental increases in values and to justify the cap rates that will make refinancing attractive. If the borrower cannot take equity out, the economic benefits of defeasance generally disappear. In addition to rate volatility and property values firming, the “wall of maturities” continues to advance, pressing the question of selling and refinancing. Chart 2 CMBS Maturities Source: Trepp Richard Hill, Head of CMBS & CRE Debt Research at Morgan Stanley, puts the recent uptick in volume into perspective. “Defeasance was a bigger strategy prior to the collapse. As financings increasingly become available and markets continue to normalize, you would expect to see more defeasance, especially as loans mature in greater numbers.” D Christina Zausner VP, Industry and Policy Analysis CRE Finance Council


CRE Finance World, Autumn 2013
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