Participations – What You Need to Know
Entering into Participations can be profitable to both the originating and participating institutions. Some of the advantages include the ability to lend higher amounts to borrowers, manage credit and geographic concentration risks. However, if not originated and maintained correctly, there are many risks that would be detrimental to your institution’s credit portfolio.
When purchasing a participation, the originating financial institution has already done the due diligence required by their credit policy. However, one of the biggest risks for participations is thinking that the participating institution only has to briefly review the originating institution’s loan underwriting, sign the participation agreement, fund the participation, and collect payments. If this sounds too easy, it is.
There is much more involved and without proper due diligence by the buying institution, this participation will already be in trouble.
In order to maintain a healthy loan participation portfolio, there is one principle that needs to be in the forefront at all times – participations either bought or sold must comply with both the selling and purchasing institution’s credit policy, procedures and regulatory compliance. As a buying institution, potential purchased loans must be underwritten just as if you were making the loan directly. This requires making sure the selling bank provides all necessary documentation used to originally underwrite and approve the loan. The purchasing bank is now responsible for underwriting the loan according to their loan policy. That means analyzing all data such as financials for all borrowers, co-borrowers and guarantors, collateral, terms and conditions and any other terms and conditions to compare against the results of the selling bank’s analysis.
Next is the participation agreement. What are the terms and conditions such as recourse provisions, servicing and loan documentation responsibilities, order of payment (first in, first out, prorate, etc.), and rights and remedies for breach of contract. You also want to take into consideration consultation with participants in the case of default, resolution provisions in case of disagreements between the participants and termination provisions. These are just a few of the specific terms that need to be carefully reviewed to make sure your institution will be comfortable entering into the participation.
The participation is on the books and loan servicing will begin. The originating institution is responsible for servicing the loan and passing on to the participating institutions. Payments collected by the originating institution are pro-rated according to the participation agreement and sent to the participating institution. The originating institution is responsible for collecting documentation required of the borrowers to maintain credit quality, collateral stability and lien position. Copies of this documentation collected by the originating bank are sent to the participating institution. However, it is the responsibility of the participating bank to make sure they are receiving all required documentation from the originating institution in order to maintain their credit quality. Any time payments or required documentation is not received in a timely manner, the originating institution should be contacted immediately to determine if there are any issues.
Bottom line, any participating institution must treat the participation loan as if they made the loan themselves. All processes and procedures required by credit policy and internal guidelines must be followed in the same manner as if the loan was being originated directly.
Posted on Friday, February 22, 2019 at 12:15 AM
by Baker Hill