Erika Morphy is co-editor of Debt and Equity Journal, from which this article is excerpted.
Los Angeles—Providing upfront payments on a defeased CMBS loan's residual value is the latest development in this specialized space. Unlike earlier innovations, this offering appears to be driven by newer providers eager to make a dent in the market.
A newcomer to the defeasance industry, Reliable Defeasance has completed more than 50 transactions valued at nearly $1 billion. Executives at the firm attribute its growth not only to aggressive marketing but also to its so-called monetization product, which essentially pays clients up front for the expected residual value of the securities at maturity.
"This has been a very potent lure for driving business," Eric Ridel, business development manager for Reliable Defeasance says. "Reliable offers the borrower the option to take a monetized version of the residual value at the closing of the defeasance to offset some of the costs associated with the defeasance or the future amount when the term of the original note expires."
REITs, which are prevented from sharing in the float on a later date because of regulatory issues, are major beneficiaries of the product, adds Stewart Wolmark, a principal of Reliable Defeasance. "It has also been beneficial to publicly traded companies for compliance reasons."
Reliable Defeasance is not the only defeasance provider offering upfront payments of the residual value, but it is among a small group. Not long ago, even sharing this money--essentially, the float associated with the securities purchased as part of the defeasance--with clients was considered a leading edge practice in the industry.
Now, providing a discounted face value to clients--say, giving the client $75,000 now as opposed to $100,000 when the securities mature--has become the newest way defeasance providers are differentiating themselves in the market. Kennett Square, PA-based Chatham Financial, a specialty finance firm that has been sharing residual value with clients for a number of years, has also begun offering upfront payouts as well, says Sam Heriegel, a defeasance consultant at the firm. "We are seeing more companies offering upfront value or payouts. I definitely agree it is a trend."
There are concerns, however, among defeasance providers about this latest evolution in the industry. John Hosmer, president and CEO of Commercial Defeasance LLC in Charlotte, NC, the largest provider of defeasance services in the industry, notes that offering face amount of the residual value is difficult to roll out on a programmatic basis, although the company has begun to do so on a deal by deal basis.
"Essentially you are trying to make an educated guess as to what the residual value will be on a future date, which is dependent on interest rates. To offer this, a company has to use its cash flow or tap a line of credit. Furthermore, there is not any collateral to pledge and there are limitations on defeasance documents that relegate such a program to an affiliated entity. So there is some risk involved in making those present value payments," he says.
In addition, he adds, not every loan is an ideal candidate. A loan maturing in 2008, for instance, is relatively easy to structure to mature the day before the transaction. Loans that have longer terms to maturity are better candidates for a sharing arrangement or present value payment, Hosmer says.
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Erika Morphy
Erika Morphy has been writing about commercial real estate at GlobeSt.com for more than ten years, covering the capital markets, the Mid-Atlantic region and national topics. She's a nerd so favorite examples of the former include accounting standards, Basel III and what Congress is brewing.
