Residual value is cash in the defeasance account that is not pledged to make the loan payments. Residual value comes from two different sources: float value and prepayment value.
Float value accrues gradually over the remaining life of the defeased loan. It arises from small timing mismatches between the incoming cash receipts from the matured bonds and the outgoing loan payments. Cash sits in the defeasance account for short periods of time, where it earns interest at money market rates. The float value is released to the Successor Borrower when the loan is paid off.
Prepayment value arises when provisions in the loan documents require the defeasance bonds to provide for all remaining loan payments through the loan’s maturity date but still allow the loan to be paid off on the early open prepayment date. The Successor Borrower will pay off the principal balance of the defeased loan on the early open prepayment date. When the loan is paid off, the remaining bonds in the defeasance account are released to the Successor Borrower, who then immediately sells them on the market. The difference between the sale price of the released bonds and cost to pay off the defeased loan is the prepayment value.
Chatham pioneered the concept of sharing residual value with the original borrower. Since the year 2000, we have returned more than $100 million in residual value to our clients. Chatham gives borrowers the option to receive this value on either the defeasance transaction closing date or the early open prepayment date. As part of Chatham’s continuing commitment to transparency, we always disclose the total amount of residual value earned and the exact terms of our sharing arrangements.