Limited Service Hotels

Juggling Default Interest, Defeasance, and Previous Major Advisory Company Engagement

Background

Two Midwest Limited Service Hotels were in a non-monetary default due to the bankruptcy of one of the loan’s guarantors. One of the loan guarantors, who was no longer an owner or affiliated with ownership, filed for personal bankruptcy, despite the loan being current for payments and completely unrelated to the Property’s performance. Prior to THG coming on board, the owner had engaged a large advisory company whose negotiations with the Servicer lead to a dead end. Servicer communication had gone dark and the loan was still in the Special Servicer’s possession.

Challenges
  • First, one of the two hotels was in default under its franchise agreement with Fairfield Inn and Suites because it had failed to begin the required property improvements per the PIP (Property Improvement Program) agreement. But to undertake the required improvements and meet Fairfield’s standards, the hotel needed more than close to $2MM of capital improvements.
  • Second, there was close to $2MM of defeasance and default interest left to be paid off by the Borrower, thus a refinance of the loans did not make economic sense given current value of the properties.
  • Third, a major nationwide borrower advocacy company had previously worked on the assignment. They had contacted the Servicer and attempted to negotiate, 1. a pay-off of the two loans, at par; and 2. a waiver of the defeasance and default interest (close to $2MM). The Servicer denied the borrower advocacy company’s request. When THG came on board, the Borrower was no closer to resolution than at the outset and the Servicer continued to keep this deal on their watch-list.
Goals

Once we reviewed our client’s situation and the current state of the negotiations, our goals included:

  • Pay-off of the CMBS loans
  • Recapitalize the property with new debt financing and new equity
  • Begin the property improvement program
  • Retain Fairfield Suites and Inn as the franchisor
  • Enable Borrower to hold on to the property for the long term

Since the property was in default, the Lender was allowed to charge default interest according to provisions for such under the loan agreement, which added an additional 5% to the existing interest rate. Additionally, when a loan is pre-paid prior to its maturity, the Lender is entitled to defeasance. Defeasance is a “treasury make whole” prepayment penalty—a tool by which an investor, who’s invested in those bonds, continues to get their return over the remaining balance of the loan term.

Execution & Outcome

THG presented the economics to the Servicer, showing them how they could recoup the highest net present value (NPV). We were able to convince the Servicer that par pay-off would produce the highest return to their bondholders.

Additionally, if they were unwilling to waive the defeasance and default interest, we argued that the Owner was likely to lose their business franchisor; should that happen, the property’s value would plummet.

The Special Servicer agreed with the analysis and negotiated a Par payoff of the loans, which the Borrower was able to refinance with new debt, including capital to be funded for the necessary PIP monies.

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