Participate, with Due Diligence

Participation loans are heavily criticized, and this has to do with risks that are often uniquely associated with participations, which credit unions will not typically encounter with other loans.

A major risk to consider with participations is out-of-territory lending. Lenders are assumed to have a strong command of their local market, but they are unsure what constitutes an acceptable risk 100 miles down the interstate highway. The truth is, the same tools can generally be used to underwrite a loan in a different market. This may include reports concerning occupancy and rental rates in real estate, or reports that show trend and level for prices in commercial or industrial loans. The key is establishing the condition and direction of the market.

 Another risk which tends to be cited with participation loans is the lack of experience in the lending type.  NCUA regulations concerning MBL types notoriously require two years experience in a specific lending type. But, guidance for participations also notes that a credit union may purchase a participation that is not within a defined lending type of a credit union’s loan policy. This seems to run counter to the intention of the two-year experience requirement.

 The participation guidance does require that a credit union establish underwriting procedures for loan types that fall outside normal loan policy for the credit union. The only two logical ways to deal with non-conforming MBL participations would seem to be through either education and research on the proposed lending type, or contract with an independent party which has expertise on the loan type.

 While education and research on a new proposed lending type may seem cumbersome, it actually brings attention to another risk credit unions are often cited for - which is lack of analysis of loan participations. Even if the participation is within a defined lending type the credit union permits, the onus is still upon the purchasing credit union to analyze the participation to see if it fits policy and underwriting standards

 When a credit union purchases a participation, it must complete and document its own analysis of the participation. Since this is already a requirement no matter the lending type, the desire to participate in a non-conforming lending type may seem like less work since the burden of analysis will always be required.

 Credit union staff may be concerned they have a lack of experience with a lending type, and be unable to successfully or comfortably produce their own analysis. In this case, we have found credit unions can solicit help from a different credit union which may have experience in the area. The experienced CU can act as a consultant and advise on key risks and benchmarks, and even give their own opinion as to the level of risk present. In this way, a credit union can purchase a participation, for which they do not have experience in the lending type, without having to contract with a third party for underwriting.

 Participations do have added risks, but like many risks, they are manageable if you are willing to take steps to mitigate them. In other words, participations are really like any other loan a credit union will make; they simply require an appropriate level of due diligence.