Risks and Liabilities of Loan Participations


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Part I of a presentation by Andy Keeney of Kaufman & Canoles to the Police Officer's Credit Union Conference, June 2012.

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Risks and Liabilities of Loan Participations

  1. 1. Risks and Liabilities of Loan ParticipationsPolice Officer’s Credit Union Conference kau fC AN .com
  2. 2. E. Andrew Keeney, Esq.Kaufman & Canoles, P.C.150 West Main Street, Suite 2100Norfolk, VA 23510(757) 624-3153eakeeney@kaufcan.com kau fC AN .com
  3. 3. Topics for Consideration• Definitions and Requirements of Loan Participations• Due Diligence Items and Checklists• Contract Issues and Checklists• Tips to Avoid Risks, Abuses and Potential Liabilities of Loan Participations kau fC AN .com
  4. 4. Participated loan relationships are co-lendingarrangements in which the originating lendersells an interest in the loan to the participant. kau fC AN .com
  5. 5. GROWTH!!!• As of June 2011 – 1,432 FICU’s reported loan participation loans with total balances of $12.8 billion – Since 2007 31% increase – up from $9.7 billion kau fC AN .com
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  8. 8. What is a Loan Participation?• Defined by federal regulation as a “loan where one or more eligible organizations participates pursuant to a written agreement with the originating lender.”• Essentially a loan made by one or more credit unions to a single borrower and is typically accomplished by an originating credit union selling a portion of a loan to a second credit union. kau fC AN .com
  9. 9. General Risks and Benefits• Degree of risk varies based on whether credit union is seller or buyer• Sale is with recourse or non-recourse• The size and complexity of individual loans• Level of experience and expertise on both sides• External economic factors kau fC AN .com
  10. 10. Benefits of Loan Participations to Seller• Increase liquidity• Increase ability to serve members since participating lenders can extend loans for higher amounts• Mechanism to manage interest rates• Manage credit and geographic concentration risks kau fC AN .com
  11. 11. Benefits of Loan Participations to the Buying Credit Union• Diversified balance sheet• Use of excess liquidity• Increasing revenue kau fC AN .com
  12. 12. Risks of Loan Participations to Selling Credit Union• Regulatory compliance• Full disclosure• Credit administration kau fC AN .com
  13. 13. Risks of Loan Participations to Buying Credit Union• Risk assessment• Strategic planning• Due diligence• Contracts and legal review• Underwriting credit risks• Internal controls kau fC AN .com
  14. 14. NCUA Rules and Regulations 12 CFR § 701.22• Organizations eligible to participate in loan participations are: – federal or state-chartered credit unions – CUSOs – any federally-chartered or federally-insured financial institution• Amount regulated by NCUA: – no amount specifically identified for a federal credit union – no federal credit union shall obtain an interest participation loan if some of that interest and other indebtedness exceeds 10% of the federal credit union’s unimpaired capital or surplus kau fC AN .com
  15. 15. Other NCUA LimitationsA federal credit union originating lender must:• originate loans only to its members• retain an interest of at least 10% on the face amount of each loan (no reference to recourse or non-recourse)• retain the original or copies of the loan documents• require the credit committee or loan officer to use the same underwriting standards for participation loans as other loans underwritten and approved at the credit unionA written master participation agreement kau fC AN .com
  16. 16. Other LimitationsA participating federal credit union that is notan originating lender shall:• participate only in loans it is empowered to grant• adopt a board-authorized participation policy setting forth loan underwriting standards prior to entering into a participation• participate in participation loans only if made to its own members or members of another participating credit union• retain original copies of participation agreement and a schedule of all covered loans; and• obtain approval of Board of Directors or ALCO kau fC AN .com
  17. 17. Other Limitations (cont.)A risk assessment and due diligence shall beperformed prior to entering into any third-partyarrangement.This is a mandatory requirement regardless ofwhether or not the other party is a credit unionor a CUSO. kau fC AN .com
  18. 18. Related Provisions• Prepayment penalties for a federal credit union cannot be collected (12 USC § 1757(5) (A)(viii))• Buying credit unions may only participate in loans in which the original lender remains a participant (Office of General Counsel Opinion 07-1035) kau fC AN .com
  19. 19. NCUA Examiners’ Warnings (from NCUA Examiners Guide, Chapter 10, Part 2)Examples of Unsafe and Unsound OperatingPolicies and Procedures in Loan Participations:• Purchase of loans without investigation of borrowers’ credit positions, the condition of the security or the property and the adequacy of appraisal reports• Purchase of unacceptably high-risk loans to obtain purchase discounts or net yields above current market averages• Sales of high-yield loans and replacement of these loans with lower-yield loans kau fC AN .com
  20. 20. NCUA Examiners’ Warnings (cont.)• Sales of loans at a time when no current or projected demand for loanable funds exists• Participation sales only for creating income from a yield differential of particularly risky practice under the conditions described immediately above kau fC AN .com
  21. 21. Due Diligence Items/Checklists• Inspection of property/In person• Review and analysis of appraisal• Environmental assessment• Likelihood of resale• Guarantors• Loan servicer• NCUA regulations & guidelines – Section 701.22 – NCUA Letter No. 08-CU-26 kau fC AN .com
  22. 22. Contract Issues/Checklists• Loan servicer rights• Representations & warranties – Underwriting policies – Collection procedures – Review of loan documentation• Notice provisions• Attorney review of contract kau fC AN .com
  23. 23. War Stories & Examples kau fC AN .com
  24. 24. Other Guidance• Supervisory NCUA Letter 08-CU026 – Evaluating Loan Participation Programs• NCUA Examiner’s Guide – Chapter 10, Pages 10A-34 (participation loan & impermissible policies & practices)• NCUA Letter to Credit Unions 07-CU-13 – Evaluating Third Party Relationships• NCUA AIRES Questionnaire – Loan Participations kau fC AN .com
  25. 25. Please return for the next session: Roadblocks to Avoid Risks,Abuses & Potential Liabilities of Loan Participations kau fC AN .com
  26. 26. E. Andrew Keeney, Esq.Kaufman & Canoles, P.C.150 West Main Street, Suite 2100Norfolk, VA 23510(757) 624-3153eakeeney@kaufcan.com kau fC AN .com
  27. 27. Risks and Liabilities of Loan ParticipationsPolice Officer’s Credit Union Conference kau fC AN .com