January 25, 2001

This update addresses the January 5, 2001 announcement by Standard & Poor’s (“S&P”) of new and clarifying criteria for defeasing securitized commercial real estate loans.

BACKGROUND
Most commercial real estate loans originated for securitization in recent years have provided that the only method of obtaining a release of the mortgage throughout most of the loan term is the defeasance of the loan through the pledging of U.S. Treasuries. These mortgage loans are typically pooled together in a securitization through which rated securities known as Commercial Mortgage Backed Securities (“CMBS”) are issued. S&P, one the agencies that rates CMBS, recently announced new and clarifying criteria for the defeasance of loans in securitization pools rated by S&P.

DISCUSSION & SIGNIFICANCE
The most significant announcement was that certain non-callable U.S. government guaranteed obligations may now be used, in addition to U.S. Treasuries, as permitted defeasance collateral. These new obligations include Ginnie Mae securities, Fannie Mae securities and many other types of non-callable U.S. government guaranteed securities. These alternative securities typically trade at spreads above current U.S. Treasury rates with comparable maturity dates. Consequently, early estimates are that savings could be up to 5% or greater in the cost of purchasing these alternative securities rather than U.S. Treasuries as the defeasance collateral. This cost is typically the largest cost in defeasing a securitized loan, and when coupled with the significantly greater pool of potential defeasance securities (especially considering the drop in Federal government borrowing in recent years), should result in a significant reduction in a borrower’s total defeasance costs.

On new commercial mortgage loans intended for securitization, lenders and borrowers may want to add these alternative securities as permitted defeasance collateral. The potential costs savings and greater pool of securities may make it easier for lenders to sell defeasance as a viable “prepayment” option. In addition, a pricing “premium” may develop on new loans for lenders who limit their borrowers’ potential defeasance collateral to U.S. Treasuries. Because most existing securitized mortgage loans provide in their loan documents that defeasance can only be accomplished by the pledging of U.S. Treasuries, the responsiveness and ability of loan servicers and lenders to accommodate an existing borrower’s request to pledge these alternative securities has not yet been determined.

S&P also announced that “No Downgrade Confirmations” would not be required in connection with the defeasance of loans with balances under ,000,000 or less than 1% of the pool balance, provided that the pool servicer delivers to S&P a certification of certain items. In addition, according to S&P, partial defeasance of a loan should typically only be permitted if the borrower provides defeasance collateral in an amount equal to 125% of the portion of the loan to be defeased.

For more information or to arrange an interview, please contact Leeza Hoyt, APR or Vanessa Amin, The Hoyt Organization, 310-373-0103 or the following attorney at Pircher, Nichols & Meeks: Douglas E. Lahammer, 310-201-8900.
Founded in 1983, Pircher, Nichols & Meeks is a national real estate law firm with a diversified real estate practice that includes litigation, bankruptcy, corporate, tax and public finance matters. Based in Los Angeles, the 45-attorney firm also maintains a full-service office in Chicago. The Los Angeles office is located at 1999 Avenue of the Stars, Los Angeles, CA 90067; phone: (310) 201-8900.

The PN&M Newsletter on Real Estate Law is published as a service to our clients and friends. It is intended to provide general information and should not be acted upon without first obtaining professional advice appropriately tailored to your individual needs.