Lesson 18 of 25 · 7 min

Cross-collateralisation and the call that reaches another account

The shortfall is computed on the total, and the sale lands wherever selling is easiest, not where the loss happened.

Two pledged accounts under one agreement are not two loans with two tests. They are one test, computed on the sum, and cured from whichever account the lender prefers.

Cross-collateralisation is the term for this, and it is the ordinary arrangement rather than an unusual one. The agreement defines collateral as the assets in every account subject to it, so the maintenance test reads a single aggregate collateral value and a single aggregate balance. Nothing in the arithmetic knows which account holds what.

Follow one case. Account one holds a concentrated position worth $640,000; account two holds a diversified portfolio worth $1,150,000. The aggregate is $1,790,000, the threshold is 60 percent, and the balance is $1,020,000 against a permitted $1,074,000 — passing, with $54,000 of room in balance terms. The concentrated position then falls 34 percent, to $422,400. The aggregate becomes $1,572,400, the permitted balance becomes $943,440, and the shortfall is $76,560. The cure by sale is $76,560 ÷ 0.40 = $191,400.

Where does that $191,400 come from? The position that fell is now worth $422,400 and is, by construction, the harder of the two to sell in size. The diversified account is worth $1,150,000 and sells in minutes. So the sale is taken from account two, and the arithmetic checks: a balance of $828,600 against collateral of $1,381,000 is exactly 60 percent. The account that lost nothing funded the entire cure, and the position that caused the breach is a larger share of what remains than it was before.

Cross-collateralisation means a loss in one account is a claim on another. The test is aggregate; only the execution is account-specific, and it follows liquidity.

Key terms

Cross-collateralisation: A structure in which every pledged account secures the whole balance, so the test is computed on the combined total.
Aggregate collateral value: The single collateral figure the test reads. It does not distinguish between the accounts contributing to it.
Concentration residue: The effect of funding a cure from the diversified account: the position that fell becomes a larger share of what is left.

Worked example

The bill lands in the wrong account

Account one $640,000 concentrated, account two $1,150,000 diversified, threshold 60 percent, balance $1,020,000. Account one falls 34 percent.

Aggregate before: $1,790,000
Account one after a 34 percent fall: $422,400
Aggregate after: $1,572,400
Shortfall: $76,560
Sale required: $191,400
Position after, sold from account two: $828,600 / $1,381,000

Account two fell by nothing and paid $191,400. Account one caused the shortfall and was left intact, and larger as a share of the collateral.

Check yourself

Two accounts are pledged under one agreement. A 34 percent fall in the smaller one creates a $76,560 shortfall at a 60 percent threshold. Which account is likely to be sold, and why?

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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.