October 19, 2007
New Defeasance Firm Pays Advances
Eight-month-old Reliable Defeasance is trying to break into the mortgage-defeasance business by capitalizing on borrowers' dissatisfaction with the common practices of business already active in that arena.
The Los Angeles company is trying to win over borrowers interested in defeasing their securitized mortgages by offering to pay them a pre-determined amount in advance against the likely residual profits that result after the loan becomes eligible for prepayment.
The firm's principal, Stewart Wolmark, said Reliable is also trying to compete by offering borrowers flat fees and streamlined processing. Wolmark was previously a managing director with CDR Financial Products, a financial-services firm based in Beverly Hills.
He said his strategy appears to be working, noting that the firm has thus far defeased 65 loans with a combined balance of some $1.5 billion. By yearend, Wolmark hopes to have completed about $2 billion of defeasance transactions, despite an overall slowdown in the defeasance business.
Reliable has positioned itself in the market to respond to borrowers who have been voicing their displeasure about hidden windfall profits that advisors pocket as part of the defeasance process, a complex maneuver that enables borrowers to circumvent loan-prepayment curbs. One property owner, Larkey-Wrigley, has even filed suit against an active player in the field, Commercial Defeasance, for failing to share undisclosed revenues from the defeasance of a securitized loan.
Defeasance is a technique for replacing a securitized mortgage with a loan backed by government securities with maturities and payment schedules that roughly match those of the property loan. It enables the borrower to sell or refinance the underlying property without disrupting bondholders' expected cashflow.
Because loans usually become eligible for prepayment three months before final maturity - and sometimes as much as one year beforehand - defeasance advisors who take control of the "successor borrower" can pay off the "loan," or government security, when it becomes eligible for prepayment.
Defeasance advisors have drawn the ire of borrowers for pocketing the residual profits that result from a mismatch between the defeased loan and the government securities portfolio. Reliable tries to estimate that profit and advances the borrower its projected share before settling up when the loan matures.
Wolmark predicted that advancing payments would become the industry standard as borrowers, who are growing more sophisticated about defeasance, seek greater transparency and lower costs.