Defeasance is the process through which a borrower is released from the obligations of its debt. The borrower purchases a portfolio of government bonds as replacement collateral to secure the debt and to generate the cash flows required to meet the future obligations of the debt. The future obligations of the debt include both the remaining principal and future interest owed on the loan.
The defeasance bonds are owned by a newly-created entity called a Successor Borrower. The Successor Borrower also assumes the debt obligations from the original borrower. A Securities Intermediary holds the bonds in a restricted account and sends the income from the bonds to the loan servicer to meet the debt obligations. An independent Accountant reviews the transaction and certifies that the bond portfolio is sufficient to satisfy the debt.
The defeasance process is coordinated by the Defeasance Consultant and takes 30–45 days. The borrower begins the process by submitting a notice of intent and defeasance deposit to the Loan Servicer. The Loan Servicer will prepare legal documents for the borrower to review and execute and will also request due diligence documents from the borrower. Once the documents are finalized, the defeasance can close.
The closing takes place in escrow over 2 to 3 days. On the first day of the closing process, the borrower locks in the price of the bonds and commits to purchasing them. The borrower funds escrow the day before the final closing date. On the final closing date, the bonds are delivered to the Securities Intermediary bank and funds are disbursed from escrow to purchase the bonds. The defeasance closes simultaneously with the underlying refinance or sale of the property.