How to Manage Loan Participations: Buyer and Seller Perspectives

Loan participations can be valuable tools for banks seeking to achieve loan growth, manage risk exposure, or retain customer relationships without exceeding legal lending limits. During RMA’s recent Credit Risk Management Audio Conference Series, Jeff Sapp, associate director, Credit Risk, RMA led a discussion with Kirby Evanger, CPA, chief credit officer, Bank of North Dakota about best practices in loan participations.

Banks sell a portion (or a participation) of its loans in order to retain the customer relationship and help manage its balance sheet and loan concentrations. It can also be a source of fee income for the bank. With today’s competitive market driven by loan growth, banks seek to buy loan participations to diversify their loan portfolio in different industries, geographic areas, or collateral types. Although loan participations create opportunities for banks on both sides of the deal, they can also create challenges and risks.

On the seller side, there is a risk for participant failure. Proper due diligence needs to be performed to mitigate that risk. It is the responsibility of the selling bank (or lead bank) to keep the buyer informed as to the performance of the loan. The selling bank also needs to determine how best to manage the loan participation, i.e., how many banks to allow in the participation group.

Purchasing banks must perform their own due diligence on the loan. Since there is no direct contact with the buyer, the purchasing bank relies solely on the lead bank for loan information. Therefore, the purchasing bank must be completely comfortable with the lead bank. Loan participations also bring regulatory scrutiny. Regulators will want to ensure that the participating bank is completing its due diligence on the loan. With less of a majority ownership on the loan, the purchasing bank has less power than the lead bank, and needs to feel confident that the lead bank can properly perform its role.

Evanger advised banks to request the underwriting on the loan from the lead bank at the start, validate calculations and conclusions, and evaluate the overall presentation for anything that might have been missed. Participating banks will learn quickly which banks perform solid underwriting and which don’t. When dealing with those that don’t, more due diligence will be required.

Join us for the next installment of the Credit Risk Management Audio Conference Series on May 14, Getting into the Weeds: Risks and Compliance Considerations in Providing Financial Services to Marijuana, Hemp, and CBD Businesses.

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