The “Payment Date” Definition:
While it may seem like a minor detail, the wording of the “Payment Date” definition in a lender’s CMBS loan documents can have a big impact on the price a Borrower pays for the Defeasance Collateral when the Borrower sells or refinances. Ideally (from a defeasance standpoint), the Payment Date definition should state that a payment due on a Payment Date that is not a Business Day will be made on the immediately succeeding Business Day (not the immediately preceding Business Day).
Why does it matter?
A succeeding Business Day Convention in the Payment Date definition allows greater flexibilityDefeasance Payment Date and efficiency in structuring the securities portfolio that comprises the Defeasance Collateral. The most efficient (and therefore cheapest) portfolio would have a security redeeming on the date of each monthly payment, including the balloon payment. Greater efficiency reduces the cost to purchase the Defeasance Collateral. Because most Conduit Loans have a ten year term and a thirty year amortization schedule, there is a balloon payment due on the Maturity Date. If the balloon payment happens to be due on a non-Business Day, the potential cost savings from negotiating a succeeding Business Day convention in the Payment Date definition increases significantly.
If (a) the monthly Payment Date is the 1st day of each month, (b) the balloon payment is due on Sunday, October 1, 2023 (a non-Business Day), and (c) the loan documents state that a payment due on a Payment Date that is not a Business Day must be made on the preceding Business Day, the balloon payment would become due on Friday, September 29, 2023, and the closest maturing eligible security would mature on September 15, 2023 (14 days of inefficiency). With a succeeding Business Day convention, the closest maturing security would mature on Saturday, September 30, 2023 (only 2 days of inefficiency). Depending upon market security yields and when during the 10 year loan term the Borrower decides to sell or refinance, the additional defeasance cost to the Borrower attributable to those extra 12 days of inefficiency on a $20 million CMBS Loan could be as much as $25,000.
Down in the Weeds:
While the biggest impact is felt with the balloon security, there is potential for increased costs due to inefficiency in the securities portfolio comprising the Defeasance Collateral with every monthly Payment Date that happens to fall on a non-Business Day.
Whether the definition of Defeasance Collateral states that the securities must mature “on or prior to” each Payment Date or “prior to” each Payment Date is equally important. Similar to the “succeeding vs. preceding” issue with respect to the Business Day Convention applicable to Payment Dates, “on or prior to” provides greater flexibility and efficiency in structuring the securities portfolio than “prior to” with respect to the date on which the securities make payment. That being said, some loan servicers will not allow the Defeasance Collateral to include a security maturing on a Payment Date no matter what the loan documents say.