Year Published
1999
Abstract
To protect against losses when borrowers prepay to take advantage of declining interest rates,
banks and insurance companies have come to rely on "yield maintenance" clauses. These
provisions require the borrower to make a lump sum payment to cover the lender’s potential loss
from reinvesting prepaid sums. For reasons described later, yield maintenance provisions have
proved woefully insufficient to compensate the holders of securitized commercial mortgage loans
when borrowers prepay. Increasingly, mortgage loans originated for sale through commercial
mortgage backed securities (CMBS) only allow prepayment through defeasance. Under
defeasance provisions, prepaying borrowers must provide Treasury obligations exactly
matching the cash flow of all scheduled mortgage payments. This article compares the practical
consequences of yield maintenance to defeasance provisions for commercial borrowers and
mortgage bond investors.
banks and insurance companies have come to rely on "yield maintenance" clauses. These
provisions require the borrower to make a lump sum payment to cover the lender’s potential loss
from reinvesting prepaid sums. For reasons described later, yield maintenance provisions have
proved woefully insufficient to compensate the holders of securitized commercial mortgage loans
when borrowers prepay. Increasingly, mortgage loans originated for sale through commercial
mortgage backed securities (CMBS) only allow prepayment through defeasance. Under
defeasance provisions, prepaying borrowers must provide Treasury obligations exactly
matching the cash flow of all scheduled mortgage payments. This article compares the practical
consequences of yield maintenance to defeasance provisions for commercial borrowers and
mortgage bond investors.
Research Category