How A Borrower Going Into Default Can Actually Be Beneficial to Investors

Why a borrower defaulting isn’t the bad news many investors think it is

One of the most common questions we get asked when speaking with a prospective investor is ‘what happens when a borrower goes into default?’ While we have previously answered this question in our FAQ article here, what we haven’t explained in detail is how a borrower going into default can actually benefit investors.

Risk Mitigation: Diversification and Security Properties

Before going into the details of how a borrower default can impact the returns of our pooled mortgage fund, it’s best to first understand the ways that the risk of borrower default is mitigated by the fund. 

Pooled mortgage funds don’t have just one loan in their loan portfolio. In the case of APG’s pooled mortgage fund, PMAC Trust, there are around 30 active loans in our portfolio at any given time.

This means that pooled funds provide instant diversification when an investor first invests. The risk to the investor is spread across multiple loans so even if one borrower defaults, other loans in the portfolio will still be performing.

Moreover, all loans within the portfolio are secured by a mortgage over a security property. This means that in the event of a default, there are still means for loan recovery by liquidating the security property (more details below). 

Other risk mitigation activities include conducting extensive due diligence on the part of the fund manager to make sure that the loans in the portfolio have the best chances of getting repaid.

And finally, but probably most importantly, the loans included in the portfolio all have conservative loan-to-value ratios (LVRs). We’ll only ever lend a maximum of 75% of the value of the security property (and generally the LVR is a lot lower than 75%). This means that if a borrower goes into default we have a strong chance of being able to recover the loan amount when we sell the security property. Even if property prices have dropped we’ve included at least a 25% buffer between our loan amount and the original property value. 

Higher interest, higher returns

So as you can see, we’re doing everything we can to reduce the risk of a default having a negative impact on the returns of the fund. However, as mentioned above, a default can actually work in favour of our investors and that is because when a loan is overdue the borrower is liable for paying higher interest on the loan amount after the due date (similar to the way you have to pay higher interest if you don’t pay off a credit card). 

Below is an example of a loan that went into default but this ended up being a positive for the fund returns.

CASE STUDY: 7.5% ROI to 11.2% ROI

One of the previous loans in the Pooled Mortgage Fund’s portfolio was a $990,000 loan to a winery in NSW who required funds for property improvements and additional equipment for them to increase stock and improve sales impacted by drought and lockdowns during Covid.  The plan was for them to get their business back on track and then refinance to another lender.

The original return on investment (ROI) for the loan was 7.5%. But due to unforeseen circumstances, there was a delay in the refinancing of the loan and the borrower was unable to pay back the loan within the agreed term of 12 months. In this instance, the higher interest rate was charged. However, recovery was delayed due to the requirements to meet the “farm debt mediation” process required for rural properties.

In the end the borrower obtained finance and repaid the loan including the higher interest that was owed for the additional 11 months taken to repay the loan. As a result, the ROI for the loan jumped from 7.5% to 11.2% which has provided a positive impact on the return for our investors.

The Best Possible Solution

If a borrower goes into default, the credit team tries to come to an arrangement with the borrower that is the best solution for all involved including the investors. For instance with the loan discussed above, rather than moving straight to taking possession of the security property, which can involve a lengthy legal process, it was decided that offering a loan extension would be in the best interests of the borrower and our investors.

If an arrangement can’t be made, then legal proceedings will follow with the aim of liquidating the security property in order to receive the full loan amount as well as any interest owed, including the higher interest. 

About APG’s pooled mortgage fund 

APG’s pooled mortgage fund is used to finance a variety of small business and property development loans. It’s managed by a team of experienced mortgage managers who conduct extensive due diligence on each of the borrowers and all loans are secured by Australian real estate. 

One of the main benefits of a pooled mortgage fund is that it is a true, set-and-forget investment that allows investors to create a passive income stream. 

The pooled mortgage fund is open to all investors and provides passive income via quarterly distributions. Investors also have the option to sign up for our Distribution Reinvestment Plan where you can choose to have your distribution reinvested each quarter rather than paid out, in order to compound your interest. 

To learn more about the fund you may contact our Investor Relations team and they will gladly answer any question you may have. 

This information is of a general nature and does not constitute professional advice. You should always seek professional advice in relation to your particular circumstances. The returns mentioned are not guaranteed.

If you have any questions about investing in private mortgages then please send us a message via our Contact Page.