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Strategic Loan Participations: Getting Started

Strategic Loan Participations: Getting Started



E. Andrew (Andy) Keeney and Harvey Johnson, CPA presented a webinar on strategic loan participations in August 2012.

E. Andrew (Andy) Keeney and Harvey Johnson, CPA presented a webinar on strategic loan participations in August 2012.



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    Strategic Loan Participations: Getting Started Strategic Loan Participations: Getting Started Presentation Transcript

    • Strategic Loan Participations: Getting Started August 16, 2012
    • E. Andrew Keeney, Esq.Kaufman & Canoles, P.C.150 West Main Street, Suite 2100Norfolk, VA 23510(757) 624-3153eakeeney@kaufcan.comHarvey L. Johnson, CPAWitt Mares, PLC150 West Main Street, Suite 1150Norfolk, VA 23510(757) 627-4644 x315hjohnson@wittmares.com
    • Topics for Consideration• Overview of Loan Participations• Operational, Legal and Compliance Risks• Tips to Avoid Risk, Abuses and Potential Liabilities of Loan Participations• Some Contract Tips• Accounting Requirements• Best Practices
    • 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
    • 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.
    • 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
    • Benefits of Loan Participations to the Buying Credit Union• Diversified balance sheet• Use of excess liquidity• Increased revenue
    • Risks of Loan Participations to Selling Credit Union• Regulatory compliance• Full disclosure• Credit administration• Accounting requirements
    • Risks of Loan Participations to Buying Credit Union• Risk assessment• Strategic planning• Due diligence• Contracts and legal review• Underwriting credit risks• Internal controls• Accounting requirements
    • 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
    • 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
    • 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
    • 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.
    • 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
    • Contract Issues/Checklists• Loan servicer rights• Representation & Warranties – Underwriting policies – Collection procedures – Review of loan documentation• Notice Provisions• Attorney review of contract• Accounting requirements and financial impact
    • Strategic Loan Participations: Getting Started Accounting for Loan Participations
    • Sale Accounting of Loan Participations – FASB ASC 860-10-40• Sale Criteria: In order for the Lead institution to account for the transfer of a participating interest as a sale (vs. a secured borrowing), the loan participation must: ‒ Qualify as a “Participating Interest; and ‒ Meet the requirements for sale accounting treatment.• If the transfer meets the definition of a “participating interest,” then the transferor (i.e., Lead Credit Union) must evaluate whether the transfer meets the conditions to qualify for sale accounting: 1) Isolation of the transferred assets from the Lead, 2) The Participating Credit Union has the right to pledge or exchange the assets received, and 3) The Lead does not have effective control over the transferred assets.
    • Definition of Participating Interest• In general, a participation meets the definition of a “participating interest” if it has the following characteristics: 1) Pro Rata Ownership 2) Proportionate Division of Cash Flows – All cash flows remittances are divided equally in accordance with their share of ownership (except any cash flows allocated as compensation for servicing). 3) Same Priority of Rights – No interest is subordinated to another interest, and no Participant has recourse against Lead Credit Union other than standard representations and warranties and contractual servicing and administrative obligations. 4) No Single Party May Pledge Entire Loan – No participating interest holder (including Lead) has right to pledge entire financial asset unless all participating interest holders agree to do so.• If the participation does not meet the definition of a “participating interest,” both Lead and Participating Credit Union must account for it as secured borrowing with a pledge of collateral. – Consider legal lending limits!
    • Is the Loan Participation a Sale or Secured Borrowing?• Indicators of a Sale • Indicators of a Secured Borrowing – Language of purchase and sale – Recourse against the Lead in the participation agreement – Repurchase obligation of the (intent) – Guaranty of repayment by Lead – No recourse, repurchase – Receipt by Participant of a greater obligation or guarantee by Lead rate of repayment and yield (e.g., a – Require Lead to promptly remit higher interest rate) than received proceeds to Participants by Lead – Payments by borrower are not – Termination of participation that comingled with other funds does not coincide with loan – Maturity, interest rate and other maturity loan terms mirror borrower – Retainage by Lead of complete agreements held by the Lead control over the participated loan (e.g. collateral / assignment)
    • Best Practices in EffectiveLoan Participation Programs
    • Risk Assessment & Strategic Planning• “Caveat emptor” ‒ let the buyer beware!• Identify potential risks during the planning and initial assessment – Increases the opportunity to mitigate losses by determining in advance the necessary controls and reporting systems.• Examiners will evaluate the effectiveness of the credit union’s risk assessment relative to each type of risk.• Ensure the Board (and lending staff) have adequate training on loan participations and member business lending• Consider staffing, business recovery plans, internal controls
    • Establish Risk Tolerance Through Strong Policies and Procedures• Policies and procedures should consider the following items: – Specific types of loan to be participated• Consider staff experience and expertise – diversification is key• How deviations from existing underwriting standards will be handled – Establish reasonable concentration limits by• Loan types• Collateral types and limits (LTV)• Industries (volatile or unstable markets)• Geographical locations (credit union and individual loans) – Underwriting Criteria• Credit scores• Loan-to-value limits• Need for Cash flow analysis (MBLs) – Analysis of appraisal assumptions and final valuations
    • Risk Measurement, Monitoring and Control• Complete a post-closing review of all loan documents to determine that all terms and conditions are in accordance with the original terms presented – Agreements should include buy back provisions for missing documentation, loans made outside of policy/agreement, other nonconformities• Monitor the loan as you would any other loan (payments, delinquencies, internal reviews, etc.)• Monitor liquidity and financial health of lead institution• Obtain annual financial statements for larger, more complex participations (i.e. MBLs)• Independent audits of participating and lead credit unions participation programs
    • Top 5 Loan Participation Problems
    • Top 5 Loan Participation Problems1. Lack of experience / training2. Lack of contract and legal review3. Participating Credit Union fails to conduct an independent credit analysis4. The Lead or Participating Credit Union fails to fund its pro- rata amounts under credit agreement5. Accounting for participation as a sale vs. secured borrowing
    • Final Thoughts• Start small and gain experience over time.• Training , Training, Training – Credit unions must fully understand all aspects of the loan participation arrangement.• Treat like any other 3rd party relationship – risk assessment, due diligence and monitoring.• Management should determine whether bond coverage is adequate for the new products and services.• Seek legal counsel.
    • 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• Kaufman & Canoles’ Credit Union Newsletter
    • E. Andrew Keeney, Esq.Kaufman & Canoles, P.C.150 West Main Street, Suite 2100Norfolk, VA 23510(757) 624-3153eakeeney@kaufcan.comHarvey L. Johnson, CPAWitt Mares, PLC150 West Main Street, Suite 1150Norfolk, VA 23510(757) 627-4644 x315hjohnson@wittmares.com
    • Strategic Loan Participations: Getting Started August 16, 2012