This document provides an overview of strategic loan participations for credit unions. It discusses the benefits and risks of loan participations for both selling and buying credit unions. Key points covered include regulatory compliance requirements, accounting standards, best practices for due diligence and risk management, and common problems to avoid. Loan participations allow credit unions to diversify assets, manage interest rates and liquidity, and increase lending capacity. However, both selling and buying credit unions must carefully assess credit and compliance risks to avoid potential legal liabilities.
2. E. Andrew Keeney, Esq.
Kaufman & Canoles, P.C.
150 West Main Street, Suite 2100
Norfolk, VA 23510
(757) 624-3153
eakeeney@kaufcan.com
Harvey L. Johnson, CPA
Witt Mares, PLC
150 West Main Street, Suite 1150
Norfolk, VA 23510
(757) 627-4644 x315
hjohnson@wittmares.com
3. Topics for Consideration
• Overview of Loan Participations
• Operational, Legal and Compliance Risks
• Tips to Avoid Risk, Abuses and Potential
Liabilities of Loan Participations
• Some Contract Tips
• Accounting Requirements
• Best Practices
4. GROWTH!!!
• As of June 2011
– 1,432 FICU’s reported loan participation loans with
total balances of $12.8 billion
– Since 2007 31% increase – up from $9.7 billion
5. What is a
Loan Participation?
• Defined by federal regulation as a “loan where one or
more eligible organizations participates pursuant to a
written agreement with the originating lender.”
• Essentially a loan made by one or more credit unions
to a single borrower and is typically accomplished by
an originating credit union selling a portion of a loan
to a second credit union.
6. Benefits of Loan Participations
to Seller
• Increase liquidity
• Increase ability to serve members since
participating lenders can extend loans for
higher amounts
• Mechanism to manage interest rates
• Manage credit and geographic concentration
risks
7. Benefits of Loan Participations
to the Buying Credit Union
• Diversified balance sheet
• Use of excess liquidity
• Increased revenue
8. Risks of Loan Participations
to Selling Credit Union
• Regulatory compliance
• Full disclosure
• Credit administration
• Accounting requirements
9. Risks of Loan Participations
to Buying Credit Union
• Risk assessment
• Strategic planning
• Due diligence
• Contracts and legal review
• Underwriting credit risks
• Internal controls
• Accounting requirements
10. NCUA Rules and Regulations
12 CFR § 701.22
• Organizations eligible to participate in loan
participations are:
– federal or state-chartered credit unions
– CUSOs
– any federally-chartered or federally-insured financial
institution
• Amount regulated by NCUA:
– no amount specifically identified for a federal credit union
– no federal credit union shall obtain an interest participation
loan if some of that interest and other indebtedness exceeds
10% of the federal credit union’s unimpaired capital or
surplus
11. Other NCUA Limitations
A federal credit union originating lender must:
• originate loans only to its members
• retain an interest of at least 10% on the face amount of each
loan (no reference to recourse or non-recourse)
• retain the original or copies of the loan documents
• require the credit committee or loan officer to use the same
underwriting standards for participation loans as other loans
underwritten and approved at the credit union
A written master participation agreement
12. Other Limitations
A participating federal credit union that is not
an originating lender shall:
• participate only in loans it is empowered to grant
• adopt a board-authorized participation policy setting forth loan
underwriting standards prior to entering into a participation
• participate in participation loans only if made to its own
members or members of another participating credit union
• retain original copies of participation agreement and a schedule
of all covered loans; and
• obtain approval of Board of Directors or ALCO
13. Other Limitations (cont.)
A risk assessment and due diligence shall be
performed prior to entering into any third-party
arrangement.
This is a mandatory requirement regardless of
whether or not the other party is a credit union
or a CUSO.
14. Due Diligence Items/Checklists
• Inspection of property/In person
• Review and analysis of appraisal
• Environmental Assessment
• Likelihood of resale
• Guarantors
• Loan servicer
• NCUA regulations & guidelines
– Section 701.22
– NCUA Letter No. 08-CU-26
15. Contract Issues/Checklists
• Loan servicer rights
• Representation & Warranties
– Underwriting policies
– Collection procedures
– Review of loan documentation
• Notice Provisions
• Attorney review of contract
• Accounting requirements and financial impact
17. Sale Accounting of Loan Participations –
FASB ASC 860-10-40
• Sale Criteria: In order for the Lead institution to account for the transfer of a
participating interest as a sale (vs. a secured borrowing), the loan
participation must:
‒ Qualify as a “Participating Interest; and
‒ Meet the requirements for sale accounting treatment.
• If the transfer meets the definition of a “participating interest,” then the
transferor (i.e., Lead Credit Union) must evaluate whether the transfer meets
the conditions to qualify for sale accounting:
1) Isolation of the transferred assets from the Lead,
2) The Participating Credit Union has the right to pledge or exchange the assets
received, and
3) The Lead does not have effective control over the transferred assets.
18. Definition of Participating Interest
• In general, a participation meets the definition of a “participating interest” if it
has the following characteristics:
1) Pro Rata Ownership
2) Proportionate Division of Cash Flows – All cash flows remittances are divided equally in
accordance with their share of ownership (except any cash flows allocated as compensation
for servicing).
3) Same Priority of Rights – No interest is subordinated to another interest, and no Participant
has recourse against Lead Credit Union other than standard representations and warranties
and contractual servicing and administrative obligations.
4) No Single Party May Pledge Entire Loan – No participating interest holder (including Lead)
has right to pledge entire financial asset unless all participating interest holders agree to do
so.
• If the participation does not meet the definition of a “participating interest,”
both Lead and Participating Credit Union must account for it as secured
borrowing with a pledge of collateral.
– Consider legal lending limits!
19. Is the Loan Participation a
Sale or Secured Borrowing?
• Indicators of a Sale • Indicators of a Secured Borrowing
– Language of purchase and sale – Recourse against the Lead
in the participation agreement – Repurchase obligation of the
(intent) – Guaranty of repayment by Lead
– No recourse, repurchase – Receipt by Participant of a greater
obligation or guarantee by Lead rate of repayment and yield (e.g., a
– Require Lead to promptly remit higher interest rate) than received
proceeds to Participants by Lead
– Payments by borrower are not – Termination of participation that
comingled with other funds does not coincide with loan
– Maturity, interest rate and other maturity
loan terms mirror borrower – Retainage by Lead of complete
agreements held by the Lead control over the participated loan
(e.g. collateral / assignment)
21. Risk Assessment & Strategic Planning
• “Caveat emptor” ‒ let the buyer beware!
• Identify potential risks during the planning and initial assessment
– Increases the opportunity to mitigate losses by determining in advance
the necessary controls and reporting systems.
• Examiners will evaluate the effectiveness of the credit union’s risk
assessment relative to each type of risk.
• Ensure the Board (and lending staff) have adequate training on loan
participations and member business lending
• Consider staffing, business recovery plans, internal controls
22. Establish Risk Tolerance Through
Strong Policies and Procedures
• Policies and procedures should consider the following items:
– Specific types of loan to be participated
• Consider staff experience and expertise – diversification is key
• How deviations from existing underwriting standards will be handled
– Establish reasonable concentration limits by
• Loan types
• Collateral types and limits (LTV)
• Industries (volatile or unstable markets)
• Geographical locations (credit union and individual loans)
– Underwriting Criteria
• Credit scores
• Loan-to-value limits
• Need for Cash flow analysis (MBLs)
– Analysis of appraisal assumptions and final valuations
23. Risk Measurement,
Monitoring and Control
• Complete a post-closing review of all loan documents to determine
that all terms and conditions are in accordance with the original
terms presented
– Agreements should include buy back provisions for missing
documentation, loans made outside of policy/agreement, other
nonconformities
• Monitor the loan as you would any other loan (payments,
delinquencies, internal reviews, etc.)
• Monitor liquidity and financial health of lead institution
• Obtain annual financial statements for larger, more complex
participations (i.e. MBLs)
• Independent audits of participating and lead credit unions
participation programs
25. Top 5 Loan Participation Problems
1. Lack of experience / training
2. Lack of contract and legal review
3. Participating Credit Union fails to conduct an independent
credit analysis
4. The Lead or Participating Credit Union fails to fund its pro-
rata amounts under credit agreement
5. Accounting for participation as a sale vs. secured borrowing
26. Final Thoughts
• Start small and gain experience over time.
• Training , Training, Training
– Credit unions must fully understand all aspects of the loan participation
arrangement.
• Treat like any other 3rd party relationship – risk assessment, due
diligence and monitoring.
• Management should determine whether bond coverage is
adequate for the new products and services.
• Seek legal counsel.
27. Other Guidance
• Supervisory NCUA Letter 08-CU026 – Evaluating
Loan Participation Programs
• NCUA Examiner’s Guide – Chapter 10, Pages 10A-
34 (participation loan & impermissible policies &
practices)
• NCUA Letter to Credit Unions 07-CU-13 – Evaluating
Third Party Relationships
• NCUA AIRES Questionnaire – Loan Participations
• Kaufman & Canoles’ Credit Union Newsletter
28. E. Andrew Keeney, Esq.
Kaufman & Canoles, P.C.
150 West Main Street, Suite 2100
Norfolk, VA 23510
(757) 624-3153
eakeeney@kaufcan.com
Harvey L. Johnson, CPA
Witt Mares, PLC
150 West Main Street, Suite 1150
Norfolk, VA 23510
(757) 627-4644 x315
hjohnson@wittmares.com