What is yield maintenance and how does it differ from defeasance?
Both yield maintenance and defeasance allow borrowers to unencumber the underlying real estate asset. However, from a legal and economic perspective, the two processes are fundamentally different. Yield maintenance is the actual prepayment of the loan. Defeasance, on the other hand, entails a substitution of collateral and assumption of the loan by the Successor Borrower.
A yield maintenance prepayment usually consists of two portions:
- The loan’s unpaid principal balance.
- A prepayment penalty – this is typically determined by calculating the Present Value of the remaining loan payments, with a discount factor equal to the current yield on the U.S. Treasury that matures closest to the loan’s maturity date.
The only transaction fee associated with yield maintenance is a small processing fee to the loan servicer. In contrast, the cost of defeasance is determined by the price of a portfolio of bonds that are sufficient to provide for the remaining loan payments, plus transaction fees to several third parties. For borrowers, yield maintenance is generally simpler and less time-consuming than defeasance.
Chatham’s online Prepayment Calculator is designed to give an estimated prepayment penalty for the specified loan. It is designed for use with fixed-rate, US-denominated debt based on the general assumption that the prepayment premium equals the greater of the minimum penalty, or the present value of all scheduled future debt payments (after the prepayment date) discounted at a treasury yield, less the principal repaid.
The Prepayment Calculation is only an estimate – specific debt prepayment provisions are not considered in the calculation. The results should not be used as a precise indication of the Yield Maintenance Costs but rather as a guide to help inform a decision as to whether prepayment is a viable strategy for a borrower.
Chatham Financial has executed over $100 billion total notional defeased, and returned over $169 million in residual value to borrowers. Defeasance consultants are a part of Chatham's global real estate financial risk management practice, solving common but complex capital markets challenges for commercial and multifamily real estate investors.