Lesson 11 of 25 · 6 min

In what order the lender sells

The sequence is chosen for certainty of execution, and cash inside the pledge is not outside cash.

The order of liquidation is not the order you would choose, and the reason is that you and the lender are optimising different things. You would sell to preserve a plan, a tax position or a hedge. The lender sells to obtain a known amount of cash with the least uncertainty about whether it arrives.

A representative account: a cash balance of $4,800, a short-duration bond fund worth $61,000, a broad equity index fund worth $240,000, a single large-company stock worth $470,000 and an illiquid holding worth $88,000. The total is $863,800. At a 71 percent threshold the permitted balance is $613,298, and against a balance of $651,723 the shortfall is $38,425, requiring a sale of $38,425 ÷ 0.29 = $132,500.

The sequence applies the cash first, then the bond fund, then part of the index fund: $4,800 plus $61,000 is $65,800, leaving $132,500 − $65,800 = $66,700 to come from the index fund. The single stock and the illiquid holding are untouched, even though the single stock is the largest position and, in most such cases, the one that caused the breach.

One detail in that sequence is routinely misread. Applying the $4,800 of pledged cash is not the same as receiving $4,800 from outside. Pledged cash is collateral, so using it reduces the balance and the collateral value together and closes only 29 cents of gap per dollar — exactly like a sale. Cash cures one-to-one only when it comes from beyond the pledge.

Money already inside the pledge cures at the forced-sale multiple. The one-to-one cure requires cash the lender did not already have a claim over.

Key terms

Liquidation sequence: The order in which pledged assets are sold, generally running from most certain to least certain to execute.
Pledged cash: A cash balance inside the collateral account. It counts as collateral, so applying it shrinks both sides of the test.
Sole discretion: Language letting the lender choose the assets and the order without reference to the borrower's preferences.

Worked example

Filling a $132,500 sale from the top of the list

Cash $4,800, bond fund $61,000, index fund $240,000, single stock $470,000, illiquid holding $88,000. Threshold 71 percent, balance $651,723.

Shortfall: $38,425
Sale required: $132,500
Pledged cash applied: $4,800
Bond fund sold: $61,000
Index fund sold: $66,700
Balance and collateral after: $519,223 / $731,300

The position that fell was never sold. The positions that were easiest to sell were sold, in descending order of certainty.

Check yourself

Your pledged account holds $4,800 of cash. A shortfall of $38,425 exists at a 71 percent threshold. How much of the gap does applying that cash close?

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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.