What are primary and secondary sources of repayment?

The primary source is the money expected to repay a loan in the normal course, such as a business's operating cash flow, the sale of completed units, or a customer's payment for goods financed. The secondary source is the fallback if that money does not arrive, such as the sale of secured assets, a guarantee or support from an owner. Lenders decide mainly on the first and use the second to limit their loss.

Can collateral be the primary source of repayment?

For most business loans, no: security is the fallback for when the expected money does not come, not the plan for repaying the loan. There are narrower cases. On a bridge, the sale of a specific asset may be the plan from the start, and it is then the primary source even though the asset is also security. Lenders treat that as a defined transaction, with its contract and timing tested, rather than as a general approach.

What is the source of repayment for a line of credit?

Usually the conversion of stock and receivables into cash as customers pay. Sales turn into invoices, invoices into receipts, and receipts reduce the balance before the next cycle draws it again. That is why a lender reads debtor quality, stock movement and the business's lowest balance through the year. A line that stays fully drawn and does not swing down may no longer be repaid from trading, and may be funding a longer-term need.

What happens if the primary source of repayment fails?

The lender first looks for a repair: a longer term, a smaller repayment schedule, more equity, a change to the business. If the source is gone for good, attention moves to the second way out, including security and guarantees, and to what the lender would recover and when. The loan is likely to be regraded and may be provisioned. Whether the lender enforces depends on the agreement, the law in the market and what is achievable.

// WORKED EXAMPLETHE ARITHMETIC A DECISION RESTS ON

Primary Source of Repayment: a Worked Example

Name the money first. Then check it exists, suffices and arrives.

BY MICHAEL SHANG · SIXTEEN YEARS IN COMMERCIAL BANKING · UPDATED 2026-11-09 · 6 MIN READ

// THE SHORT ANSWER

Before a lender asks what a loan is secured on, it asks which money will repay it. That money is the loan's primary source of repayment, and it differs by facility: trading cash on a term loan, a named sale on a bridge, a customer's payment on a trade loan. Naming it turns a general impression of the borrower into a test that can fail. Does the money exist, is there enough of it, and does it arrive before the repayment falls due? One borrower can pass that test on one facility and fail it on another.

BASIS Practitioner judgment from sixteen years in commercial banking, set out in How Bankers Think (Highbank Press, 2026). Every borrower on this site is a composite constructed for teaching, not a client. The market is mid-market commercial lending as practised in New Zealand and Australia; where a convention differs elsewhere, the page says so.

// MAKE THE CALL

Issue 10 — The Dissent. The paper recommends approval. You found the hole. You're the third vote of five — and the RM outranks you. Your call first, then the senior banker's.

Read the file →

PART OF Credit Analysis for Beginners

// 01 — WHY A LENDER NAMES THE SOURCE FIRST

A bank earns a thin margin on a loan and expects to be repaid by the borrower's own business, not by selling what it holds. The prudential texts say so plainly. Australia's credit risk standard requires an authorised deposit-taking institution to assess credit risk primarily on the strength of a borrower's repayment capacity, without undue reliance on collateral, and the international guidelines take the same line: lending criteria should cover a credit's purpose, structure and source of repayment.

The reason is practical. Selling assets is slow, costly and most likely to be needed when they are worth least. A loan that can only be repaid by a forced sale of its security has already assumed the borrower will not succeed in paying.

// 02 — HOW THE SOURCE IS TESTED

Facility Usual primary source

Term loan operating cash flow

Overdraft, revolver stock and debtors turning into cash

Trade loan payment for the goods financed

Development loan sale of the units

Investment property rent for interest; sale or refinance for principal

Bridge one named sale or refinancing

Three tests run across all of these. The first is whether the money exists outside the forecast: a signed contract, a recurring pattern of cash, an order from a real buyer. The second is size, after everything that ranks ahead of the lender, such as tax, selling costs and an earlier mortgage. The third is timing against the repayment schedule, since cash that arrives after the due date still leaves the borrower in default on the day.

Matching the source to the facility is half the work. An overdraft used to buy a building is the plain mismatch: the building will not turn into cash in the way the overdraft needs. A self-liquidating facility is the opposite case: the transaction it finances generates the cash that repays it.

// 03 — THE EXAMPLE

A shop-fitting firm, constructed for this page like every figure in it, takes three new facilities from one bank: a five-year term loan for a cutting line, a six-month bridge to buy a larger workshop before the old one is sold, and a 120-day trade loan to import shelving for a supermarket refit. Interest is 8 per cent on each. The firm's old workshop is under contract, conditional on the buyer's finance. Amounts are in US$ millions.

Term loan 3.0, source: operating cash

Cash after tax and maintenance capex 1.26

Year 1 debt service 0.60 + 0.24 0.84

Cover 1.26 ÷ 0.84 1.50×

Bridge 2.0, source: sale of the old workshop

Contract price 2.60

Selling costs −0.10

Existing first mortgage −0.40

Net proceeds 2.10

Bridge plus six months' interest 2.08

Left over 0.02

Trade loan 0.8, source: customer's stage payment

Stage payment 1.10, loan plus interest 0.82

Payment due on programme, day 105 15 days before maturity

Refit runs six weeks late, day 147 27 days after maturity

The three loans fail, or pass, in different ways. The term loan passes on cover, so the lender's remaining work is on whether US$1.26m repeats. The bridge is large enough with US$20,000 to spare, but the money does not yet exist: until the buyer's finance is confirmed, the contract is an expectation. The trade loan has ample money and the wrong date. A six-week slip on a refit is ordinary, and the facility as proposed would be in default for nearly a month with US$1.1m on its way.

None of this needs a decline. The bank can make the buyer's unconditional contract a condition precedent to drawing the bridge, and write the trade loan to 150 days or tie its maturity to the stage payment. The figures are the example's; a different file might set either differently.

// 04 — HOW IT DIFFERS FROM THE SECOND WAY OUT

The second way out is what the lender turns to when the primary source fails: security, a guarantee, a sponsor, a refinancing. On the shop-fitter's term loan it might be a charge over the cutting line, which might bring US$1.2m at a forced sale, and a guarantee from the owners. Second sources are read differently. They are contingent, usually slower than a sale in the ordinary course, and tested in the conditions in which they would be called on.

Two cases blur the line. Refinancing is a legitimate primary source for the principal on some property and bullet loans, but it depends on another lender's future decision, which is the subject of refinancing risk. And Australian guidance accepts there may be limited instances where reliance on collateral for serviceability is appropriate, while not expecting that to reflect wider portfolio practice. Those are specific structures, not a licence to lend on security alone.

DEFINED IN ONE PARAGRAPH → · HOW BANKS APPROVE BUSINESS LOANS → · LVR, SECURITY AND COLLATERAL →

// 05 — WHERE IT DECIDES A FILE

A credit paper usually states the repayment source in a line near the top, and much of what follows is the evidence for it. If that line cannot be written clearly, the facility may have the wrong shape, the wrong term or the wrong purpose. A request that says "working capital" for money going into a building will read poorly for that reason, whatever the borrower's history.

When a loan is in difficulty the same line governs the file. If the primary source has gone and the lender's plan now rests on its security, the file has changed character even if every payment so far has been made, and the bank's view of the grade and provision should follow. The sequence a lender cares about is the one the example shows: which money, how much, by what date.

SERVICEABILITY → · HOW TO WRITE A CREDIT PAPER →

// SOURCES

The documents the statements on this page rest on. Each was opened and checked when cited.

Australian Prudential Regulation Authority, Prudential Standard APS 220 Credit Risk Management, 2022 — paragraph 42 — Requires authorised deposit-taking institutions to assess credit risk primarily on repayment capacity and not to rely unduly on collateral as a substitute for assessment — paragraph 42.
Basel Committee on Banking Supervision, Consolidated guidelines, CRI10 General credit risk management — paragraphs 10.23 and 10.31 — Lists a credit's purpose, structure and source of repayment among lending criteria, and says transactions should rest primarily on the borrower's repayment capacity — section 10.31.
Australian Prudential Regulation Authority, Prudential Practice Guide APG 220 Credit Risk Management — Acknowledges limited instances where reliance on collateral for serviceability could be appropriate, without expecting that to reflect wider portfolio management — section on collateral and guarantees.

// QUESTIONS PEOPLE ASK

What are primary and secondary sources of repayment?: The primary source is the money expected to repay a loan in the normal course, such as a business's operating cash flow, the sale of completed units, or a customer's payment for goods financed. The secondary source is the fallback if that money does not arrive, such as the sale of secured assets, a guarantee or support from an owner. Lenders decide mainly on the first and use the second to limit their loss.
Can collateral be the primary source of repayment?: For most business loans, no: security is the fallback for when the expected money does not come, not the plan for repaying the loan. There are narrower cases. On a bridge, the sale of a specific asset may be the plan from the start, and it is then the primary source even though the asset is also security. Lenders treat that as a defined transaction, with its contract and timing tested, rather than as a general approach.
What is the source of repayment for a line of credit?: Usually the conversion of stock and receivables into cash as customers pay. Sales turn into invoices, invoices into receipts, and receipts reduce the balance before the next cycle draws it again. That is why a lender reads debtor quality, stock movement and the business's lowest balance through the year. A line that stays fully drawn and does not swing down may no longer be repaid from trading, and may be funding a longer-term need.
What happens if the primary source of repayment fails?: The lender first looks for a repair: a longer term, a smaller repayment schedule, more equity, a change to the business. If the source is gone for good, attention moves to the second way out, including security and guarantees, and to what the lender would recover and when. The loan is likely to be regraded and may be provisioned. Whether the lender enforces depends on the agreement, the law in the market and what is achievable.

// NEXT TO IT

// ON WHOSE DESK

The seats that read this term in an ordinary week. Each page says what the seat is for, who arrives in it, and the shape of the round it runs.

Credit sanctionerHolds delegated authority and signs — or declines — the lending the front line brings.
Credit analystReads a borrower and writes the recommendation a decision-maker will act on.
Portfolio managerOwns the credit on a book after the money is out — reviews, covenants, ratings and early warning.

THE IN-TRAY · ONE MINUTE

Make the call on one file.

A short file on the ground this page covers. Every option opens with how far it sits from a senior banker’s read.

THE CALL · CHAPTER 1

A builders' merchant asks to lift its overdraft from US$1.5m to US$2.5m on the back of sales up 25%. The relationship manager suggests leaving the price where it is, to keep them happy.

What do you ask first?

5 MORE ON CHAPTER 1 · THE THREE QUESTIONS →WHERE DO YOU READ FROM? THE PLACEMENT →

THE READING ROOMIN ONE PARAGRAPHPrimary source of repayment What is the primary source of repayment on a business loan?