The Pros and Cons of Participation Loans

Managing these loans requires a careful and calculated approach.

December 24, 2010
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Board due diligence

The board, in its role as watchdog, needs to ensure that management has a thorough understanding of the risks, underwriting, pricing, and terms of each loan program, whether it’s member business lending, real estate, or construction lending, he adds.

In fact, since loan participations are more complicated and have stirred the attention of regulators, the board’s role requires special attention, notes the white paper. Participation loans should be reported to the board on a monthly basis as a separate program, with trends in loan growth, charge-offs, and delinquencies.

Mundine suggests boards consider a series of questions and action steps in their deliberations and due diligence for loan participations.

Questions for boards to ask about loan participation proposals include:

  • Where is the opportunity coming from? Is it a credit union service organization (CUSO), a credit union, or another third party?
  • Is the loan participation a good fit for our credit union? Is it compatible with the organization’s business plan?
  • What can we expect to see in loan growth and other key financial projections? What parameters and ratios are needed to track the effectiveness of the program?
  • What is the credit union’s ability to underwrite? Does the lending staff have specific experience in, for example, commercial real estate, if that skill is required? If not, are vendors vetted that can provide that service?

If the credit union decides to undertake loan participations, Mundine says the board should:

  • Develop a loan participation policy, and propose a change in bylaws if needed;
  • Ensure that the credit union conducts its own independent analysis of every participation loan undertaken, regardless of the lead lender’s reputation in a given area of lending;
  • Develop an annual plan for participation loans; and
  • Monitor the plan by tracking variances in key ratios—delinquency, loan growth, charge-offs—on a monthly basis.

 Next: Loan participation case studies

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