Lesson 3 of 25 · 6 min

The same shortfall stated in collateral and in cash

A gap of sixteen thousand can require sixteen, twenty-six or forty-two thousand, depending only on the route.

One shortfall has several sizes, and which size applies depends on where the cure comes from. This is not a subtlety. The three figures differ by a factor of more than two and a half on the same gap.

Start with a collateral value of $845,000, a threshold of 62 percent and a balance of $540,000. The permitted balance is $845,000 × 0.62 = $523,900, so the shortfall is $16,100.

Cash from outside the pledge reduces the balance and leaves the collateral untouched, so the cure is the gap itself: $16,100. Collateral posted from outside raises the denominator only, and each new dollar of collateral buys 62 cents of permitted balance, so the requirement is $16,100 ÷ 0.62 = $25,967.74. Check it from the other direction: the collateral value at which $540,000 is exactly 62 percent is $540,000 ÷ 0.62 = $870,967.74, which is $25,967.74 more than $845,000.

Selling pledged collateral is the third route and the most expensive, because it moves both sides at once. Each dollar sold cuts the balance by a dollar and the permitted balance by 62 cents, so it closes only 38 cents of gap. The requirement is $16,100 ÷ 0.38 = $42,368.42. That is 2.63 times the number printed on the notice, and the derivation of that multiple is the subject of two later lessons.

cash = B − t × V; collateral posted = (B − t × V) ÷ t; collateral sold = (B − t × V) ÷ (1 − t)

B: The balance, including accrued interest.
V: Collateral value on the basis the agreement names.
t: The maintenance threshold as a decimal.
B − t × V: The shortfall itself, which is also the cash figure. The other two routes divide it.

Key terms

Outside cash: Money arriving from beyond the pledged account. It shrinks the balance without shrinking the collateral, so it cures at one-to-one.
Posting collateral: Adding assets to the pledge. Each dollar added raises the permitted balance by the threshold, so the requirement is the gap divided by the threshold.
Cure route: Which of the three mechanisms closes the gap. The gap is one number; the amount required is three different numbers.

Worked example

One gap, three prices

Collateral value $845,000, threshold 62 percent, balance $540,000.

Permitted balance: $523,900
Shortfall: $16,100
Cure by outside cash: $16,100
Cure by posting collateral: $25,967.74
Cure by selling pledged collateral: $42,368.42

The notice says $16,100. Depending on the route, the action required is $16,100, $25,967.74 or $42,368.42 — and only the first equals the printed figure.

Check yourself

Collateral value $1,240,000, threshold 55 percent, balance $715,400. How much collateral would have to be posted from outside to cure the shortfall?

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Educational only. Nothing in this lesson is investment, legal or tax advice, or a recommendation to enter into any transaction. Figures are illustrative and computed from the inputs stated in the lesson.