For credit unions, loan participations offer a means of mitigating risk and enhancing returns, while also giving them the ability to diversify their portfolios through collaboration.
Credit unions have a storied history of collaborating with one another. This type of relationship enables all involved parties to reduce risk and increase profitability. Additionally, loan participation helps free up capacity, increase liquidity, and reduce concentrations.
Participation loans are initiated when one borrower (individual or organization) is granted a loan by multiple lenders (credit unions, banks, etc.). The lead credit union administers the loan and serves the borrower/member. The risk associated with a high dollar loan is minimized by spreading it among other credit unions.
Why Do Credit Unions Buy/Sell Loan Participations?
Common reasons credit unions buy into participation loans include:
Buying loan participations enable the credit union to share in the profits of the credit union, which can help if the credit union is struggling in a slow market or experiencing less-than-stellar loan growth.
Buying participation loans allows credit unions to better diversify their assets. The credit union is able to invest in a variety of loans and loans in different locations. This limits the exposure to potential losses if a natural disaster or economic issues hits a particular community
During the process, the lead credit union usually partners with other financial institutions. In these instances, a financial institution is considered one that is federally chartered or federally insured or is any state or federal government agency. Additionally, the borrower in the relationship must be a member of a participating credit union, signifying the originating credit union when the originator is a credit union.
How Does it Work?
The purchasing credit union has the ability to buy loan types that the credit union in question has the ability to grant. This means if the purchasing credit union could have made the same type of loan to one of its members, the loan qualifies as a type of loan in which a credit union can buy a loan participation interest. The loan terms must comply with applicable regulations. As such, this means that the buying credit union must comply with the business lending regulations, including having a business lending policy and an employee or hired advisor that has at least two years experience in business lending of the type of loans involved.
The buying and selling of whole loans by a credit union allows the organization to manage and leverage risk on their balance sheet. As such, credit unions can sell loans on the secondary market to financial organizations such as Freddie Mac and Fannie Mae. This process can be a good strategy for credit unions to free up liquidity to make additional loans. Additionally, credit unions can also retain loan servicing rights to help strengthen member relationships.
Loan participation is a loan where one or more eligible parties participate pursuant to a written agreement with the originating credit union. The structure requires the originating credit union’s continuing participation throughout the life of the loan. A credit union may not purchase a loan participation from any source other than the originating credit union. Additionally, federally chartered credit union originators and sellers must retain at least 10% of the outstanding balance of the loan. State-chartered credit unions must retain at least 5% of the outstanding balance of the loan.
By its very nature, loan participation is a collaborative process that brings credit unions together to achieve the balance sheet goals of all parties. The buyers generate income and diversify their portfolio by purchasing a percentage of a loan (or pool of loans) from another credit union. Sellers free up liquidity and manage risk by off-loading loans from their portfolio to the purchasing credit union.