Defeasance: Collateral Substitution Mechanics
Defeasance is not a loan payoff; it is a legally binding collateral substitution. CMBS loans are packaged into public bond trusts where bondholders expect uninterrupted monthly interest distributions. Prepaying principal early would disrupt bond cash flows.
Under defeasance, the borrower uses sale or refinance proceeds to purchase a customized portfolio of U.S. Treasury securities and federal agency bonds. The coupon payments and principal maturities of these Treasuries match the exact remaining monthly debt service of the original loan.
The Role of the Successor Borrower
Once the Treasury portfolio is purchased, the original borrower transfers the loan and securities collateral to a specialized "Successor Borrower" entity (managed by a professional defeasance company). The original real estate is completely released from the mortgage lien, allowing the property to be sold or refinanced with a clean title.