The “Defeasance Collateral” Definition

In the past few years, some lenders’ CMBS loan documents have been revised to allow the defeasance collateral to include agency securities.  However, other lenders have been slow to adopt such a change even though REMIC regulations allow it.  If the defeasance collateral definition in a new Conduit Loan only allows for “direct, non-callable obligations of the United States of America for the payment of which its full faith and credit is pledged” (e.g. only T-Bills, T-Notes and STRIPS), try to negotiate expansion of the defeasance collateral definition to include agency securities (e.g. FNMA, FHLB and FHLMC bonds).

Why does it matter?

While the spread between agency securities and treasuries is currently as narrow as it’s been in some time, Agency securities historically have had a significantly higher yield than treasuries.  That could be the case again when a newly originated loan is ready to be defeased.  A higher yield on the securities portfolio lowers the borrower’s cost to purchase the Defeasance Collateral.  Therefore, negotiating an expanded definition of Defeasance Collateral prior to closing a Conduit Loan can reduce the borrower’s cost to defease down the road when the borrower wants to sell or refinance.

Sample language:

“Defeasance Collateral” shall mean direct obligations of the United States of America that are not subject to call, prepayment or early redemption, or other obligations which are “government securities” within the meaning of Section 2(a)(16) of the Investment Company Act of 1940, that provide for payments on or prior to, but as close as possible to, all successive Payment Dates through and including a Payment Date selected by Borrower during the Open Payment Period.

Down in the Weeds:

    • The defined term describing eligible defeasance collateral could be “Defeasance Collateral”, “U.S. Obligations”, or “Government Securities”.
    • Don’t be surprised if the lender conditions the inclusion of agency securities on their acceptability to the Rating Agencies at the time of defeasance.  Currently, agency securities are acceptable to the Rating Agencies if there is specific language in the loan documents allowing them.
    • Instead of referring directly to the definition of “government security” in the Investment Company Act of 1940, some definitions refer to Treasury Regulation Section 1.860G-2(a)(8)(ii) which refers to the definition of “government security” in the Investment Company Act of 1940, so that language also works.
    • Section 2(a)(16) of the Investment Company Act of 1940, as amended through January 3, 2012, states:

“Government security” means any security issued or guaranteed as to principal or interest by the United States, or by a person controlled or supervised by and acting as an instrumentality of the Government of the United States pursuant to authority granted by the Congress of the United States; or any certificate of deposit for any of the foregoing.

For a complete list of condensed Tips for Negotiating New Conduit Loans, follow this link: