The Pros and Cons of Participation Loans

Managing these loans requires a careful and calculated approach.

December 24, 2010
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Loan participations offer the best of cooperative philosophy put into practice—sharing the risks among borrowers while sharing the rewards of attractive yields. But they also offer challenges due to their complexity and increased regulatory scrutiny.

Balancing the risks and rewards is key to successfully implementing and maintaining a loan participation program at your credit union, according to “Loan Participations,” a white paper from the CUNA Lending Council.

Experience is critical in participation lending, says Brad Mundine, regional manager of credit union protection risk management at CUNA Mutual Group. “If a participation loan doesn’t fall within the credit union’s general loan policy, it’s difficult to be underwritten in accordance with the credit union’s appetite for risk.”

Managing participation loans requires a careful and calculated approach from experienced lending staff, he says. These loans also require constant oversight as market risk and credit risk change over the loan term. If your credit union doesn’t have the necessary on-staff expertise to manage these loans, vendors or third-party underwriters might be options to investigate.

If your credit union decides to partner with a vendor, Mundine suggests taking these steps before signing a third-party agreement:

  • Use a formal request for proposal (RFP).
  • Check out the third party with the Better Business Bureau and other consumer organizations. Have problems surfaced in the past?
  • Check vendor insurance coverage types—professional liability, employee error, and omission. Review what's covered and what’s not. Is there too much uninsurable risk?
  • Review vendors' audited financials—including income statements and balance sheets.
  • Have an attorney review your contract/agreement with the vendor.
  • Conduct a formal cost-benefit analysis.
  • Request and conduct interviews with references.
  • Verify vendor endorsements by any trade associations.
  • Review the organization, management, and ownership structure—board of directors and management team.
  • Review the lead lender’s host loan servicing system to determine if it can handle computation and reporting of participation interests.

Next: Board due diligence

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