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By Dino Rebellato, Investor Relations Manager, Millbrook Group
Summary: First mortgages have built-in risk minimiser (collateral); significant loans demand greater due diligence; recovery rates high when default does occurs; experience a great teacher.
OK, you now know that one of my favourite films was the Kubrick classic, Dr Strangelove, a dark comedy about the risks of nuclear winter in an intense atmosphere of atomic bomb diplomacy.
Understanding risk is central to any investment decision. First mortgages provide attractive income with the protection of real estate collateral. This important risk mitigator is clearly a necessary but not sufficient condition when lending. Human nature, being fallible, requires you to exercise a healthy degree of scepticism and apply thorough due diligence when assessing a borrower’s application for a loan.
In the era of machine learning and artificial intelligence there has been a move towards automated credit assessment processes and this may well be appropriate for cost-effective assessment of portfolios of hundreds or thousands of small loans. Significant loans such as first mortgages demand a much higher level of due diligence.
A first mortgage loan may default for any number of reasons. The important and critical role of a mortgage manager such as Millbrook is to minimise the potential of default. When defaults do happen, history suggests the recovery is likely to be very high, if not 100% of principal and interest. As part of the loan contract, borrowers are acutely aware of the costs and legal issues that come with default and our experience has been that borrowers work hard to avoid getting into this situation. So how do you make an intelligent assessment of the creditworthiness of a borrower?
Experience is a great teacher. Millbrook is in the fortunate position of having well-developed relationships with many of its borrower clients over a twenty-year history. Having such relationships is a clear advantage for boutique lenders who focus on particular markets. But what happens when you do not have an existing relationship? When we receive an application for funds from an unknown party, Millbrook demands face-to-face meetings where the proposal is reviewed.