Why a Loan Default Does Not Mean a 100% Principal Wipeout

Why a Loan Default Does Not Mean a 100% Principal Wipeout

This blog post is contributed by CrowdFund Talks user, Bendahara. Bendahara is an avid user of our forum and describes himself as an ex-banker. He invests on the Funding Societies platform. In this guest post, he addresses two questions most often asked by investors on defaults and why a loan default does not mean a 100% principal wipeout. 


If a loan defaults, will I lose 100% of my principal?

Answer:
It is very unlikely that you will lose 100% of your principal investment. Depending on the schedule of repayment, most of the loans will repay the principal amount + interest (P+I) while others will pay interest (I) until towards the end of the loan where they will return your principal.

Unless the borrower defaults on its first repayment, it is not likely that you will lose 100% of your principal. Based on my experience, even for the most hardened defaulters, the probability of a default on first repayment is less than 1% even though there is possibility of late repayment.

In short, the more aged the loan before defaulting, the more likely it is to recover your principal.


When a loan goes into default, is it non-recoverable?

Answer:
No, when a loan goes default, it definitely does not mean it is non-recoverable. In the event of a late payment, the lender (in this case, the P2P lending platform) will start to prompt the borrower to find out what are the reasons for their late payment.

In some cases, the borrower may reflect that they have a mismatching cash flow. In this case, the lender could change the repayment date to match the cash flow situation of the borrower.

However, there are cases where the borrower actually struggle with the payment due to reasons such as unexpected dip in revenue. The lender could restructure the loan by either extending the tenure to lower the monthly payment or to change the repayment schedule from monthly principal + interest (P+I) to just monthly interest (I) for a certain period of the tenure until the borrower has the ability to repay the principal.

In the worst-case scenario, when the borrower has defaulted and the borrower has pledged a personal guarantee, the lender could trigger the personal guarantee. If the loan is not a secured loan, the lender could proceed to take legal action on the borrower.

Do note that taking legal action against the borrower will always be the last resort as it could bankrupt the borrower. Those with secured loans with the borrower has the priority over the borrower assets. Legal proceedings could take a long time and in the end, whatever that you get may not even be able to cover your legal fees.

Based on my experience, 80% of the borrowers that fall in the default definition will be able to turn around and eventually pay off the loan while the 20% are the ones that will be irrecoverable.

As long as you do your due diligence and diversify, you will not likely to lose sleep over defaults.


Disclaimer: The views above are personal opinions and views of the author and not of Funding Societies. The information is meant purely for informational purposes and should not be relied upon as financial advice. Readers may wish to approach a financial adviser before relying on any advice provided by this post to make any decision to buy, sell or hold any investment product.


Understanding Defaults at Funding Societies

At Funding Societies, a business term loan or secured loan is defined as default when a repayment remains unpaid 90 days past the due date. The threshold for the definition of default is lowered to 60 days for invoice financing.

Actions taken by Funding Societies in the case of a default

  1. Understand the cause of delayed repayments
  2. Adjust the repayment dates  (if applicable)
  3. Deploy in-house collections team
  4. Restructure the loan (if applicable)
  5. Engage external debt collection agency – similar to banks (if applicable)
  6. Take necessary legal action
    All directors of the company are required to provide personal guarantees on the loans. In the event of non-payment from the company, the personal guarantors are still liable to repay the loan in their personal
    Capacities.
    The legal process could include issuing a Letter of Demand (LOD), Writ of Summons (WOS), Statutory Demand (SD), Bankruptcy Petition (BP), Enforcement Proceedings, Writ of Seizure and Sale (WSS) and Company Winding Up Proceedings depending on the borrower’s situation and cooperation in the process.

Repayment delays and defaults are part and parcel of investing in P2P investments, especially in the SME lending space. Delays in receivables, loss of revenue and other factors that may be outside of the borrower’s control can result in delays in repayments, and even defaults. Therefore, we concur with our investor and guest writer, Bendahara in that the best way to mitigate default risk is by diversifying your investments.

Read his original thread here and join our community at Crowdfund Talks!
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