What is a default?

Facility agreements define default precisely, and the remedies and notice periods depend on the wording and the statutory framework around it. A payment default is missed principal or interest instalments beyond any agreed grace period, for example three consecutive monthly repayments. A covenant or technical default is a breach of a non-payment term such as a loan-to-value ratio, interest cover or a reporting obligation.

Cross-default clauses mean a default under one facility triggers default under another held by the same borrower. An insolvency event, whether voluntary or forced, is an event of default that gives the lender the right to accelerate. Enforcement is a separate step: against a company in voluntary administration it needs the administrator's consent or the court's leave. Losing a licence the business needs to operate can be a default too. Consumer products like personal loans and car loans generally follow the simpler payment-default path; commercial and asset finance facilities can carry specific triggers.

The two words are often used interchangeably but mean different things. Delinquency is the operational measure: a payment is late and the account is 30, 60 or 90 days overdue. It drives collections activity and credit reporting. Default is the legal or contractual status that may follow if the borrower does not cure the delinquency within the timeframes in the contract, or trips an event-of-default trigger.

The consequences differ accordingly. Delinquency prompts reminders, calls and hardship offers, while default lets the lender accelerate the debt, call on guarantors and enforce security. Loans in default or seriously overdue may also be classified as non-performing loans for provisioning purposes.

For a consumer borrower, a payment default that meets the statutory conditions is recorded with credit reporting bodies and impairs future borrowing, the debt can be accelerated, repossession or sale of secured assets can follow, and suppliers may tighten their terms. For the lender it means credit losses, higher provisioning, capital strain and regulatory attention if defaults are handled poorly.

Lenders quantify the risk with three metrics: probability of default (PD), the likelihood of default over a set horizon; loss given default (LGD), the share of the exposure expected to be lost after recoveries and security; and exposure at default (EAD), the balance outstanding when default occurs. Expected loss is PD multiplied by LGD multiplied by EAD, and it underpins risk-based pricing, provisioning under the expected credit loss model in AASB 9 Financial Instruments and APRA's prudential standard on credit risk, APS 220.