P2P Lending: What happens when a default occurs?

As with any investments, P2P lending is not without its risks. A major risk associated with P2P lending is default risk. Instead of treating default risk like an elephant in the room, it is best to openly discuss about it because clarity on this matter gives investors or potential investors the confidence to invest in P2P lending.

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When you have a peace of mind, you’ll always be smiling like Fortune Cat
What may constituted an event of default?

P2P lending operators arrange and enter into a loan agreement and/or its variants with SME borrowers, on behalf of investors. The obligations of a lender and borrower are dictated in a loan agreement. In most loan agreements, an event of default is usually a bunch of don’ts, such as:

  1. Failure to make repayments towards the loan on time.
  2. Inability to make repayments towards the loan.
  3. Other breaches of the loan agreement.
  4. The borrower company is in the process of being wound up or already being wound up.

When an event of default occurs, a P2P lending operator has an option to terminate the loan agreement, and hence, recovering the outstanding balance of the loan and interest.

What happens when repayments are not timely?

Before employing the full force of the law, P2P lending operators would exercise practical means to ensure repayments are made.

The best way to deal with late-paying SME borrowers is for the P2P lending operators to get in touch with the SME borrowers and be frank and diplomatic about the lateness. Sometimes, a cause for the lateness could be as trivial as a mere oversight in making repayment or key personnel members are unavailable to sign off cheques.

P2P lending operators, such as Funding Societies Malaysia, usually allow a grace period of 7 days, after the date of the supposed repayment for SME borrowers to repay. Late repayment fee will be imposed for any failure to adhere to repayment schedule after said grace period.

What happens when repayments are still not forthcoming?

Sometimes, despite the SME borrower’s best effort to make repayments, when repayments are still not forthcoming, a concrete solution is needed to recover the outstanding loan and interest. A P2P lending operator could choose to terminate the loan agreement when the event of default is triggered. If this happened, the likelihood of lawyers being involved is high. The end result could be, although very rarely, the winding up of the defaulting SME borrower.

Winding up is a process of dissolving a company. When a company is being wound up, the affairs of the company are taken away from the directors and  put into the hands of liquidators. As it is being wound up, the company bears an obligation to its creditors to pay off their debts. Therefore, it is not uncommon for assets of the company to be liquidated to achieve said goal.

However, if a company is an ongoing concern (still running a sustainable business), it is more likely that the shareholders and /or directors of the company would take proactive measures to avoid being wound up. It can do so by selling off assets such as inventories such as land, or even refinancing mortgages. However, all of these take time.

If need be, the directors, who personally guaranteed the obligation of a company, could also contribute to the repayments on behalf of the company. This is because the directors’ necks are on the line too. If they unable to satisfy the indebtedness of the company, then they may face bankruptcy. These are compelling reasons for the directors to ensure that the company, for which they have personally guaranteed, is not wound up.

Conclusion

Funding Societies Malaysia, defines an event of default, with regard to Business Term Financing, as repayments which are delayed for more than 90 days. As for Invoice Financing, repayment delay of more than 60 days would trigger an event of default.

After almost a year investing with Funding Societies Malaysia, I notice that, in the event of any lateness in repayments, Funding Societies Malaysia will follow up with the SME borrowers and allow them some time to fulfill their outstanding repayments. In addition, Funding Societies Malaysia will notify investors of any late repayments and set a future date for the SME borrowers to make those repayments. That way, investors are not left in the dark while SME borrowers are given some leeway to make good on their late repayments.

As investors, we should also do our part to ensure that proper risk management are put in place to achieve a successful investment in P2P lending. I have always advocated that P2P lending investors should analyse a potential investment note, invest an appropriate amount towards a particular investment note and diversify.

Despite all that has been said about default risk, such a risk is still low in the Funding Societies platform. Their default rate in South East Asia is only 1.31%, at the time of writing.

Referral program

If you are new to investing, or would like to add some diversity to your investment portfolio, you’d be delighted to know that Funding Societies Malaysia has a referral program where it will top up an additional RM50.00, for free, into your account, once you have deposited and invested a minimum of RM1,000.00.

To participate in this promotion, please register an account via this LINK (be careful not refresh the link before completing the registration as it will affect the promotion code), or alternatively, use the promotion code: j1mzpcw5 when registering through Funding Societies Malaysia.

 HELPFUL LINKS

Click the link if you would like to know more about P2P financing with Funding Societies Malaysia.

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