Minimizing Risk
Around Loan Participations

The benefits, challenges, and risk-reducing strategies lenders need to know.

loan participations

Section 1:

Overview

A robust loan participation program can be a key to success for many lenders. For the lead lender, selling loan participations can allow them the ability to originate loans above legal lending limits, manage concentrations and relationship exposure, and generate fees and servicing income. For the participants, purchasing participations provides access to the lead lender’s capabilities, diversification of the portfolio and an increase in deal flow while staying within credit limits. 

Despite the benefits of loan participations, these transactions are not without challenges and risks. According to the FDIC, if the agreement is not appropriately structured and documented, a participation loan can present unwarranted liabilities to both the seller and purchaser of the loan.

To help lenders minimize these risks, we’ve created this ebook to give Financial Institutions a better understanding of how to benefit from and avoid the common pitfalls of these types of loans.

What are
Loan Participations?

As defined by the FDIC, a loan participation is an arrangement under which a lender originates a loan to a borrower and then sells a portion of that loan to one or more other financial institutions. The lead or originating lender retains a partial interest in the loan, holds all loan documentation in its own name, services the loan, and deals directly with the customer for the benefit of all participants. 

There are three levels of loan participations: 

  • Participation: This level indicates separate and distinct contracts between the borrower and the lead lender, bank, and between the lead and buying banks.
  • Syndication: At this level, a single contract among the borrower, the lead lender, and all the syndicate members is created.
  • Assignment: In this agreement, there is an outright transfer of all rights and obligations of the seller to the buyer.

A Look at
Loan Balances for Credit Unions

The credit union industry’s collective loan-to-share ratio is at a record high,
prompting growth opportunities for credit unions that are not without risk.

Loan Participations

Section 2:

Benefits

Loan participations can be beneficial for all parties involved as there are many perks for both the lead bank and the participating banks alike.

Selling Loan Participations:
Benefits for the Lead Bank

As the lead bank in a loan participation, you can expect to satisfy the lending needs of your customers without exceeding your lending limits. You also stand to reduce relationship exposure or mitigate concentration limit challenges and enhance liquidity by obtaining fees and servicing income. Entering this type of agreement also means you can benefit from risk diversification by sharing the credit risk with other financial institutions while still maintaining control.

Along with the benefits for lead lenders come a few responsibilities, too. As the selling bank, you are obligated to originate the credit as well as hold the loan documentation in your bank’s name, draw up the actual participation agreement, and handle any services associated with the loan such as disbursement of payments and sharing borrower’s financial information. 

Buying Loan Participations:
Benefits for the Purchasing Bank(s)

Loan participations are a great way for purchasing banks to supplement their loan portfolios and increase loan growth with additional deal flow — especially when demand is low. Another benefit for participating lenders? Loan portfolio diversification across different geographic regions, industries, and product types. 

Purchasing banks have responsibilities, too, when it comes to these agreements. Duties include: determining if the participation fits their loan criteria by analyzing the credit and collateral of the borrower; maintaining borrower credit information for the duration of the loan; and agreeing to the terms of the participation contract.

A Look at
Loan Balances for Credit Unions

The credit union industry’s collective loan-to-share ratio is at a record high,
prompting growth opportunities for credit unions that are not without risk.

Section 3:

Risks

As with most legal agreements, there are certainly risks associated with loan participations on both ends of the spectrum. If a loan participation is not appropriately structured or accurately documented, unwarranted risks can arise. Knowing the potential pitfalls can help all participants plan for and mitigate these challenges. 

Know the Risks

For lead lenders, the risk lies in the following scenarios:

  • Failure to properly underwrite and retain evidence
  • Failure to adhere to contract terms, such as neglecting to obtain operating statements or forwarding payments
  • New loan products or lines of business not covered under the current policy  

For purchasing lenders, the risks include:

  • Loss of flexibility and control
  • Becoming overly reliant on the lead lender
  • The inability to obtain timely information
  • Loss exposure under workout or liquidation

Agreement Considerations in the Face of
Bankruptcy, Foreclosure, & Default

Two other major risks that both parties face are bankruptcy, foreclosure, and when a borrower defaults. From a legal perspective, the lead lender has the sole right to legal recourse and, according to the courts, participants are not entitled to a creditor status. 

Because of this, there are certain scenarios that should be addressed in the participation agreement. It should be required that the lead bank consult with participants prior to taking any action on defaulted loans. Resolution procedures should also be drafted in case one or more of the following events occur: participating banks can’t agree on how to handle a defaulted loan; potential conflicts arise when more than one loan to the borrower defaults; and when instances like insolvency, breach of duty, negligence, or misappropriation requires the termination of the relationship between lead and participating banks.

Section 4:

Opportunities

While the risks surrounding loan participations carry serious implications, there are steps you can take to reduce those risks and protect the parties involved. One way lenders can combat the challenges around these loans is by making sure you have an experienced team working to facilitate the agreement.

Questions Financial Institutions Should
Be Asking

While the thought of handing off the loan participation process to a third party can be quite appealing, lenders should be well aware of what’s involved from start to finish. Before purchasing a loan, entering a participation, or signing a third-party contract,  financial institutions would be wise to consider the following:

  • Do the loan policies address relevant purchases?
  • Do I understand the terms and limitations of agreements?
  • Have I performed the appropriate due diligence?
  • Have I obtained the necessary board or committee approvals?

Addressing the items on this will help you cover your bases and ensure that you are making an informed decision and entering a secure, credible agreement.

Capital Market
Solutions
at MountainSeed

As part of our Capital Market Solution services, MountainSeed offers lead lenders an ability to sell participations while offering buying institutions access into MountainSeed’s buyer network. The network consists of 600+ financial institutions that regularly buy and sell participations, we’ve built an efficient process that allows financial institutions to quickly underwrite participation opportunities and only see relevant loan opportunities.  

MountainSeed serves as a conduit in the market for clients looking to participate out loans to other financial institutions that care about credit culture. We facilitate introductions on a deal once a high-level indication of interest is shared by a buyer. MountainSeed only works on participation opportunities that are attractive for each party.

Financial Experience
You Can Trust

At MountainSeed, our long-term relationships with community banks and credit unions throughout every state provides us with a unique understanding of the market. We see $25B in CRE loan volume on an annual basis, and our team possesses decades worth of experience in the commercial real estate and lending arenas. 

Best of all, MountainSeed guarantees full transparency. We don’t charge sellers any fees, and we always put the client first. Our leadership believes that we must deliver value for every buy-side and sell-side client — a true rarity in the industry.

Experience the
MountainSeed
Difference

Ready for a new way to manage your commercial real estate needs? From appraisal management and review to property tax appeals, our team of experts will walk you through every step and answer any questions along the way.