Which schedule an act sits in matters more than the act: the same default costs the guarantor 19.3 times more if it springs full recourse.
A bad boy guarantee exposes the sponsor in two very different ways. For "loss" carve-outs, such as misapplied rents or unpaid taxes, it pays only the lender's actual loss from the act. For "full recourse" triggers, such as a voluntary bankruptcy filing or an unpermitted transfer, it pays the whole deficiency: the debt plus interest and costs, less what the property fetches. On an illustrative $40,000,000 loan secured by a building now worth $31,000,000, that is $830,000 under the loss carve-outs against $16,060,000 under springing full recourse, 19.3 times as much.
Worked in full in How to Read a Real Estate Loan Agreement by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
A non-recourse real estate loan lets the borrower walk away from a failed property with the lender limited to the collateral. The carve-out guarantee, signed by the sponsor or a parent, is the price of that protection: it puts the guarantor back on the hook if the borrower or its owners behave badly. The agreement lists the acts in two schedules, and which schedule an act sits in matters far more than the act itself.
Loss carve-out exposure = the lender's loss caused by the act
Full recourse exposure = loan + accrued interest + default interest + enforcement costs − net recovery from the property
In Excel: =MAX(0, Loan*(1+(Rate+DefaultMargin)*Months/12)+Costs-Value*(1-SaleCosts))
| Input | Value |
|---|---|
| Loan balance | $40,000,000 |
| Interest rate, default margin | 5.75%, 4.00% |
| Months from default to sale of the property | 14 |
| Property value at sale | $31,000,000 |
| Sale costs | 6% |
| Lender's legal and receiver costs | $650,000 |
| Rents misapplied by the borrower | $450,000 |
| Property taxes left unpaid | $380,000 |
Step 1, the loss carve-outs. The borrower diverted $450,000 of rent after default and left $380,000 of taxes unpaid, which rank ahead of the mortgage. The guarantor owes those losses: $830,000.
Step 2, the lender's claim if full recourse springs. Fourteen months of contract interest on $40,000,000 at 5.75 per cent is $2,683,333. Default interest at 4.00 per cent adds $1,866,667, and enforcement costs $650,000. The claim is $45,200,000.
Step 3, the recovery. The building sells for $31,000,000, less 6 per cent of costs: $29,140,000.
Step 4, the deficiency. $45,200,000 less $29,140,000 is $16,060,000, 40.2 per cent of the original loan. Under a springing recourse trigger that is the guarantor's bill. The $830,000 of loss carve-outs is not paid on top: the lender cannot recover the same shortfall twice, so the deficiency becomes the single claim.
| Line | Loss carve-outs | Full recourse |
|---|---|---|
| Loan balance | 40,000,000 | |
| Contract interest, 14 months | 2,683,333 | |
| Default interest | 1,866,667 | |
| Enforcement costs | 650,000 | |
| Less net sale proceeds | −29,140,000 | |
| Misapplied rents and unpaid taxes | 830,000 | (not added) |
| Exposure | 830,000 | 16,060,000 |
The same guarantee, the same loan and the same default produce a bill of $830,000 or $16,060,000 depending on which schedule the triggering act appears in. That is why the negotiation over a carve-out guarantee is mostly a negotiation over which acts sit in the full recourse list, and why sponsors fight to move SPE covenant breaches into the loss schedule or to limit them to breaches that cause substantive consolidation.
At a loan to value of 129.0 per cent, the property covers only part of the claim, so the full recourse exposure has to be paid from the sponsor's other assets, after it has already lost the building. That is precisely the incentive the lender wants: a sponsor facing a $16 million bill will not file for bankruptcy to delay a foreclosure.
| Value at sale | LTV | 9 months | 14 months | 24 months |
|---|---|---|---|---|
| 24,000,000 | 166.7% | 21,015,000 | 22,640,000 | 25,890,000 |
| 28,000,000 | 142.9% | 17,255,000 | 18,880,000 | 22,130,000 |
| 31,000,000 | 129.0% | 14,435,000 | 16,060,000 | 19,310,000 |
| 36,000,000 | 111.1% | 9,735,000 | 11,360,000 | 14,610,000 |
| 42,000,000 | 95.2% | 4,095,000 | 5,720,000 | 8,970,000 |
| 46,000,000 | 87.0% | 335,000 | 1,960,000 | 5,210,000 |
The exposure does not disappear when the property is worth more than the loan. At $42,000,000, a 95.2 per cent loan to value, the guarantor still owes $5,720,000 because default interest, costs and sale costs sit on top of the principal. At 14 months the claim is fully covered only above $48,085,106, an 83.2 per cent loan to value. Every month of delay, often the very delay a bankruptcy filing buys, adds $325,000 of interest and default interest to the bill.
A full recourse trigger is often tripped by accident: a transfer of an indirect interest above the permitted threshold, a pledge of equity to a mezzanine lender not approved under the loan, or a missed SPE formality. At a 10 per cent chance of an inadvertent trigger in a default, the expected cost on this loan is $1,606,000, roughly twice the loss carve-outs themselves.
Treating "full recourse" as the loan amount. The exposure is the deficiency, and two things move it more than the principal: the property's value at the time of sale and the time it takes to get there. A sponsor who reports the guarantee as a $40,000,000 contingent liability overstates it today, and one who reports it as nil because the building was worth more than the loan at closing has missed default interest, costs and fourteen months of accrual. Remove default interest by negotiation and the bill on this case falls to $14,193,333; the larger levers are which acts trigger recourse and whether it can be cured.
The recourse provisions of the book's case loan, with the cure and maturity arithmetic, are in the free workbook for this book. For what a guarantee actually collects once the guarantor is pursued, see how much a personal guarantee is worth, and for the interest that accrues in default, how default interest is calculated.
Typically a voluntary bankruptcy filing or a collusive involuntary one, a transfer or financing the loan prohibits, and sometimes a breach of the single-purpose entity covenants. On a $40,000,000 loan with a building worth $31,000,000, the trigger turns an $830,000 loss carve-out exposure into a $16,060,000 deficiency claim against the guarantor.
No. It is the deficiency: principal plus accrued and default interest and enforcement costs, less the net proceeds of the property. On the worked loan that is $16,060,000, 40.2 per cent of the $40,000,000 balance, and it rises by $325,000 for every month between default and sale.
Yes, once full recourse springs. Default interest, enforcement costs and sale costs sit on top of the principal, so at a $42,000,000 value, a 95.2 per cent loan to value, the guarantor still owes $5,720,000 after 14 months. The claim is fully covered only above $48,085,106.
This article is one calculation from How to Read a Real Estate Loan Agreement. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
Get the book on Amazon →Free companion files
Also on Amazon UK · Amazon Germany · Amazon France · Amazon Canada
Reading guide: real estate investing, finance and fund management → · All 1340 articles →
If this book helped, or didn’t, a few lines on Amazon are worth more than they look: they are what the next reader goes on. Write a review. The workbook stays free either way.