What is a successor borrower?

Within the context of a refinancing or sale transaction, the job of a successor borrower is to take on the payment responsibilities of the original borrower after a commercial real estate (CRE) loan has been defeased. Just as the portfolio of fixed income securities replaces the real estate asset as collateral, a specifically created, single-purpose entity, known as a successor borrower, replaces the borrower as the loan obligor. Together, the purchase of the replacement collateral and the formation of the successor borrower entity allows the borrower to be legally and financially released from the loan. The single most important way to reduce securities costs is to conduct an effective auction that results in the most efficient portfolio possible, with a variety of independent parties (accountants, attorneys, rating agencies, et al.) providing checks and balances in the process.

The language in a typical fixed-rate CMBS loan agreement provides for one of three parties to form or designate the successor borrower: the original borrower, the original lender, or the loan servicer. Chatham Financial has been providing successor borrower services to these parties since the early 2000s, and currently leads the market in accepting successor borrower designations.

The borrower has good reason to take notice of these successor borrower designation rights at loan origination. Retaining the ability to designate the successor borrower is negotiable on many new CMBS loans and is determined between the borrower and lender at the time of loan origination. In addition to successor borrower designation rights, the right of the borrower to direct the purchase of defeasance collateral and to retain the economics of the open prepayment window can also have implications for both optimal securities pricing and minimizing third-party fees. Chatham regularly reviews this language and advises on optimal language for new loans on behalf of clients.

Following a defeasance, the successor borrower selector (or designator) has the rights to share in any leftover cash, or “residual value,” that remains in the defeasance account once the underlying loan matures.

Residual value can accrue in two ways. The first, called “float value”, comes from money market interest that accrues when disbursements from the securities sit in the defeasance account as cash over one or multiple nights. Even in portfolios optimally structured to match the payments of the loan being defeased, the securities will sometimes generate cash receipts slightly before the loan payments are due. The second source of residual value, called “prepayment value”, is often more significant but increasingly uncommon in newer CMBS originations. This type of residual value arises when the loan agreement requires the defeasance securities to cover all loan payments through the maturity date, but allows the successor borrower to prepay the loan early at the open prepayment date (often three months before the maturity date). This releases the unused securities to the successor borrower, who can sell them on the market to recoup the cost of the prepayment and retain any excess value.

Chatham was the first provider of successor borrower services to disclose the amount of residual value to clients and set the standard for generous sharing arrangements that return the majority of residual value to the original borrower. This significant step in bringing transparency to a defeasance market that been historically opaque is indicative of Chatham’s guiding principles.

Whether negotiating a new CMBS loan and looking for assistance with borrower-friendly language or getting ready to extinguish existing debt via defeasance or prepayment, Chatham provides second-to-none education to and advocacy for its clients.

Chatham Financial has executed over $167 billion total principal defeased, and returned over $200 million in residual value to borrowers. Defeasance consultants are a part of Chatham's global real estate financial risk management practice, solving common but complex capital markets challenges for commercial and multifamily real estate investors.