How is the cost of defeasance on a CMBS loan calculated?

Mechanics and what drives the cost

Defeasance mechanics: the borrower buys a portfolio of US Treasury securities whose cash flows exactly match the remaining payment schedule on the CMBS loan. The Treasuries become the loan collateral; the property is released. The trust continues to receive scheduled payments from the Treasury portfolio.

Cost driver: the spread between the loan's coupon rate and current Treasury yields at the matched maturities. When current Treasury yields are below the loan coupon, the Treasury portfolio needed to replicate the loan's cash flows is more expensive than the loan balance, that excess cost is the economic defeasance cost.

Worked example: $20M CMBS loan at 5.50% with 5 years remaining; current matched-maturity Treasuries at 4.0%. The Treasury portfolio needed to replicate the loan's remaining cash flows costs roughly $21.4M to $21.6M depending on the structure of the underlying loan. Economic defeasance cost = $1.4M to $1.6M plus $75K to $125K of consultant and legal fees.

When defeasance is most expensive: in declining-rate environments, when Treasury yields are well below the loan coupon. In rising-rate environments, when Treasury yields approach or exceed the loan coupon, defeasance can be inexpensive or even produce a net benefit to the borrower.

Open window alternative: most CMBS loans have a 90-day open window at the back end during which prepayment is allowed without defeasance and without penalty. Refinancing inside the open window is the cleanest path. Borrowers planning refi should target funding within the open window when possible.

Defeasance consultants: defeasance is a specialized execution typically handled by a defeasance consultant who structures the Treasury portfolio, manages the trust mechanics, and coordinates with the special servicer. Fees are negotiable; expect $50K to $150K depending on loan size and complexity.