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Borrowers wishing to release properties from a conduit loan typically find themselves faced with one of two alternatives at their disposal.
Borrowers wishing to release properties from a conduit loan typically find themselves faced with one of two alternatives at their disposal. Depending on the language in the loan documents, CMBS loans may be paid off early through yield maintenance or through the substitution of collateral via defeasance. While both courses of action relieve the borrower of their obligations on the loan, there are significant differences between the two.
Yield Maintenance
Most borrowers are familiar with yield maintenance, as it was the only alternative available for a borrower wishing to prepay a CMBS loan throughout the early 1990s. Yield maintenance is an actual prepayment of the loan made up of two parts: the remaining principal balance on the loan and a prepayment penalty. Theoretically, this yield maintenance penalty allows the lender (and subsequently the bond holders) to attain the same yield as if the borrower had made all scheduled payments through maturity.
In most cases, the yield maintenance penalty is based on the difference between the interest rate on the loan and a specified reference rate--also known as the replacement rate. Typically this reference rate is defined as the rate on the U.S. Treasury with the closest maturity to the loan. The resulting interest rate differential represents the loss that the lender faces as a result of the prepayment. The remaining payments on the loan are multiplied by this interest rate differential and then discounted to a present value using the replacement rate as a discounting factor. The final result is the total penalty amount.
For example, a borrower has a 10-year interest-only...