Defeasance vs Yield Maintenance: Differences Explained

What’s the difference between Defeasance and Yield Maintenance?

From a monetary standpoint, defeasance and yield maintenance (YM) feel similar, but they have some core differences. Here’s the executive summary:

• Defeasance is a process resulting in a substitution of collateral. YM is just math where a lumpsum penalty is calculated and paid.

• Defeasance is a release – the successor borrower steps in, and the loan still exists after closing. YM is a payoff – there’s no successor borrower and the loan ends after closing.

• Loans subject to defeasance are in lockout for 24-36 months (check those dates!). Many loans subject to YM don’t have any lockout period.

The Longer Version

Defeasance

Generally, you cannot “prepay” a CMBS loan that has been securitized. Instead, a regimented process must be followed where you replace the current collateral (real property), with a portfolio of securities that will secure the debt and mimic the cashflows provided by the loan payments.

The collateral swap would “release” you from the current loan obligations, allowing you to proceed with a sale or refinance. Since the loan is securitized, the process will be dictated by REMIC rules, which among other things, outline collateral criteria (often Treasury or Agency securities), lockout periods, etc.

A typical defeasance process spans about 30-days (although shorter is possible) and involves a number of third-parties with different roles.

Yield Maintenance

Yield Maintenance is a lump sum payment, which is calculated and made to the lender at the sale or refi closing. The penalty generally amounts to the present value of interest only payments based on the “rate differential” through maturity.

• The rate differential is the Fixed Rate minus the yield of Treasury securities with the same remaining term as the loan.

The idea being the lender is indifferent between holding the loan through maturity and reinvesting in riskless assets following the prepayment.

Another prepayment method frequently interchanged with yield maintenance is known as “Make Whole.” Make whole amounts to the same penalty as yield maintenance but is derived from (i) PV of all future P&I payments including the balloon, (ii) less the outstanding principal balance.

Since yield maintenance and make whole are just math, the necessary lead time is shorter than defeasance. However, many lenders still frequently ask for 30 days notice.

Which Is Better – Defeasance or Yield Maintenance?

While both prepayment types have their ups and downs, the penalties generally shake out to be similar. Here are somethings that can impact the cost:

• Yield curve shape
• Portfolio/calculation end dates
• Availability of higher yielding securities such as Agency (defeasance only)
• Replacement rate adjustment such as +0.50% or +0.75% (YM only)

To get an understanding of your defeasance or yield maintenance premium, check out our calculators below.

• Defeasance
• Standard Yield Maintenance
• Agency Yield Maintenance
• Make Whole

For more on prepayments or to talk to an expert, reach out to defeasanceteam@pensford.com or 704-887-9880.