CMBS defeasance swells amid low interest rates

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Activity in defeasance for commercial mortgage-backed securities loans increased in 2019, thanks to low interest rates, according to a recent report from Trepp, a provider of data, analytics and technology to the global securities and investment management industries.

In the commercial-mortgage-backed securities world, defeasance is a process through which a borrower replaces a loan’s scheduled payments with a commensurate cash flow from government securities, according to the report. This action is taken when the borrower wants to pay off a loan before it is open to prepayment.

CMBS defeasance activity reached a post-recession peak of $21.2 billion in 2015, according to analysts. It then dropped to $15.9 billion in 2016 and then $6.4 billion a year later because few loans were in their peak defeasance windows. However, in 2018, activity increased 51 percent to $9.7 billion. Further, in 2019, volumes increased 57 percent to $15.31 billion, translating to 840 total defeased loans compared with 2018’s 554 loans.

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The benefits of owners turning to defeasance include: taking advantage of current lower interest rates from when they took out the loan or to tap equity that was created by an increase in property values. Trepp noted that the defeasance surge is being driven by today’s low interest rates as borrowers seek to refinance higher coupon loans. The average coupon rate for all loans defeased in 2019 was 5.03 percent, compared with a 4.43-percent average coupon for all securitized conduit loans the previous. A coupon rate is calculated on the face value of the bond which is being invested.

Typically, borrowers who look to defeasance do so closer to the CMBS loan’s maturity because the cost to defease a loan increases as the time to maturity increases. However, analysts noted that because rates have declined so much and property values have increased enough to justify higher costs, more borrowers are refinancing through defeasance. More than 50 percent of loans defeased last year had more than four years left until maturity. That figure is up from 40 percent in 2018, according to the report.

Following are a few key points from Trepp’s research:

  • Of the 840 loans that were defeased in 2019, the lowest amount came from the lodging sector at only 4 percent. By contrast, the highest outstanding balance was backed by the office sector at 37 percent.
  • New York had the largest share of defeasance volume at 26 percent, followed by California with 17 percent and Texas with 8 percent. Analysts noted that each of these states includes at least one major market where property prices have skyrocketed.
  • Two notable defeased loans in the hotel industry were: New York City’s Dream Hotel Downtown with a $120 million mortgage and a Hyatt portfolio in New York with a balance of a little over $85 million.
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