The two types of default

When it comes to lending there are 2 types of default; monetary; generally a failure to meet an interest payment or similar, or non-monetary default, such as the failure to supply evidence of annual insurances, or to meet a special condition of the loan. Most defaults will trigger penalties and in turn may lead to an event of default (EOD). Where an EOD occurs, it is usual for the loan manager to become mortgagee in possession and move to realise the asset and repay the loan from sale proceeds.

To mitigate lending risks you need to have the following in place:

1. an extensive loan origination network populated by experienced people who have strong and long standing relations with borrower
2. highly experienced credit teams divided between an acceptance desk (who work to filter and improve credit submissions) and a credit approval team, who assess risks, consider and structure loan conditions and generally set the loan to maximise reward and mitigate risk
3. a credit committee charged with oversight and review, that can question, support and assist in achieving better outcomes
4. active management, where regular reviews and prompt actions on concerns, make for a better managed investment and finally;
5. a specialist asset management and recovery workout team that can move quickly in the rare event where things do go wrong and in so doing limit risks and maximise recoveries.

As can be seen from the above, even if a loan goes into default, it does not mean that the investor’s capital need be at risk or indeed the receipt of interest income. Defaults are not desirable, but they do occur and can be managed such that investors may be inconvenienced, not necessarily out of pocket.