Partial Release of Security: a Worked Example

When a bank takes mortgages over several properties, or a mortgage and a general security agreement, the documents are usually written so that every asset secures the whole debt. Nothing in that structure assigns part of the loan to part of the security. A borrower who sells one asset is therefore asking the bank to give up some of its protection while the debt stays where it is, and the security documents generally give the borrower no right to that. The facility agreement may: some portfolio and development facilities set out in advance the terms on which an asset will be released.

Where no such terms exist, the bank treats the request as it would a new application. It asks two questions. Will the security left behind still cover the debt by enough? And will the income left behind still pay the interest? The sale proceeds are how both questions get answered, because the part that reduces the debt is the part that keeps the ratios where the bank needs them.

Banks reach the figure in a few common ways. Some ask for all the net proceeds. Others ask for whatever repayment brings the remaining loan back within the facility's tests, and some facilities fix the figure in advance as a percentage of the value or loan amount allocated to each asset. Where more than one method applies, the agreement often takes the higher. The test-based method runs like this:

If the repayment required is more than the net proceeds, the sale cannot go ahead on those terms without other money or other security. If it is less, the bank may still ask for more, for instance to bring the loan back to where it was at the start, or to reduce exposure to a borrower it is less comfortable with than when it lent.

A company that owns four industrial units, constructed for this page like every figure in it, has an interest-only loan of US$6.0m at 6.5% secured over all four. Its covenants require loan-to-value of no more than 65% and interest cover of at least 1.50 times. Both levels are the example's, not market norms. Unit A is worth US$3.0m and is let to a strong tenant at a net rent of US$0.24m a year; units B, C and D are worth US$7.0m together and earn US$0.405m net, because C is half empty. The company wants to sell A, which would bring in US$2.9m net of costs. Figures in US$m:

The value test alone would have let the company keep US$1.45m of its US$2.9m. The income test asks for US$1.85m, because unit A carries 30% of the portfolio's value but 37% of its rent. The owner keeps US$1.05m.

Now suppose it sells unit C instead, valued at US$2.0m, for US$1.9m net. The remaining value is US$8.0m and the remaining rent US$0.565m. On value the rest supports US$5.2m (8.0 × 65%); on income, US$5.79m (0.565 ÷ 1.50 ÷ 6.5%). The value test now binds and the repayment is US$0.8m, leaving the owner US$1.1m from a smaller sale. Selling the weak unit releases cash to the owner; selling the strong one mostly releases it to the bank.

A release request often arrives with a clause already in play. Many facility agreements require disposal proceeds to be applied in mandatory prepayment, so the bank's ask may be set by the agreement before it is set by the arithmetic. A release is also different from a substitution, where the borrower offers a new asset in place of the one sold; the bank then values the replacement and checks its title and income before it lets the old one go.

In a development loan the calculation is done before the first sale, so the developer can settle each unit without a fresh request. Portfolio facilities sometimes copy the idea, allocating a share of the loan to each property and fixing in advance what must be repaid when one is sold. Where that has been agreed, the negotiation happened at signing; where it has not, it happens now, with the bank holding the stronger hand.

DEFINED IN ONE PARAGRAPH → · THE ALL-MONIES CLAUSE → · RELEASE PRICE →

The credit officer's paper on a release reads like a small application: current valuations of what remains, the income it produces, the borrower's use of any proceeds it keeps, and whether the business still services its debt once the sold asset's earnings have gone. A buyer's deposit and a settlement date add pressure, which is why a borrower that asks before signing the sale contract usually gets a better hearing than one that asks a week before settlement.

The documents follow the decision. Over land, the bank signs a partial discharge: in New Zealand a partial discharge of mortgage lodged through Landonline, in Australia a discharge of part lodged with the state or territory titles office, and in England and Wales form DS3, the form the land registration rules prescribe for releasing part of a registered title from a charge, or its electronic equivalent. For a UK company, the company or the bank may also file form MR05 so that the Companies House register shows the property released. Over personal property in New Zealand and Australia, the bank releases the asset to the buyer and, where its registration describes that asset specifically, such as a serial-numbered vehicle, amends the PPSR registration. At settlement the bank's figure arrives as a payout figure for the part being released, and settlement proceeds against it.

LVR, SECURITY AND COLLATERAL → · WHAT YOUR BANK HOLDS AS SECURITY →