Purchasing Loans and Loan Participations

Issue/Inquiry

The Bank does not engage in one-to-four family residential lending. It is considering purchasing loans or loan participations in such loans from another financial institution, which will service the loans. As a prerequisite to the purchase, the Bank would underwrite the purchase of the loan or loan participation as though it were originating the loan. If the Bank does not offer or engage in residential lending, does that preclude it from purchasing loans or loan participations in such loans originated by another bank, which will service the loans?

Response Summary

The Bank is not limited by the types of loans it originates as to the types of loans or loan participations it purchases. From a risk management standpoint, the Bank should have the same degree of knowledge and expertise in its credit and collateral analysis as though it were the originator.

Response Detail

Participation loans grant financial institutions the opportunity to participate in a loan or other credit facility already entered into by a lead bank, which is generally the party originating the loan and dealing directly with the borrower. The lead bank may then recruit other financial institutions to participate in the loan under different methods or structures (e.g., assignment or sub-participation). Therefore, funds finally lent to the borrower may originate either from available lending funds of the lead bank or funds contributed by the participants.

There do not appear to be any federal laws or regulations that would prevent a financial institution from purchasing participation interests in types of loans that it does not originate itself. For instance, the FDIC Advisory (FIL-49-2015) (the “FDIC Advisory”) regarding the purchase of loans or loan participations does not refer to limitations on such purchases based on whether the purchasing institution makes such loans.

Similarly, the Community Reinvestment Act states that loan examiners will consider the amount of loan participations purchased when evaluating an institution’s record, provided that the credit needs of its assessment area are met with respect to the origination or purchase of specified types of loans, but without reference as to whether the financial institution has originated loans of the same type. Community Reinvestment Act: Interagency Questions and Answers Regarding Community Reinvestment, 21(f)(1) – 1.

While the Bank is not limited in the types of loans or loan participations it can purchase by the types of loans it originates, it is limited from a risk management standpoint by the degree of expertise it can bring to bear on the loans or loan participations it purchases. The FDIC Advisory provides that a financial institution should approach loan purchases and participations as if it were the principal originating institution. For that reason, participations and purchases should be subject to the financial institution’s internal policy guidelines, independent credit and collateral analysis, profitability analysis, written purchase or participation agreements, and due diligence. The guidance also calls for management to assess its ability to transfer, sell, or assign interest, and to obtain necessary board approvals.

With respect to the independent credit and collateral analysis performed by a financial institution for a loan or participation interest that it purchases, the FDIC Advisory states that it must ensure that it has the requisite knowledge and expertise specific to the type of loan or participation it purchases, and that it obtains all appropriate information from the seller to make such determination. The financial institution should perform an analysis sufficient for determining whether the loan or participation conforms to loan policy guidelines and is consistent with the risk appetite of the Board of Directors.

A financial institution that approaches the purchase of loans or loan participations as though it were the originating bank will remain in accordance with the FDIC Advisory, which establishes the standards that financial institutions should fulfill in this regard.

This entry was posted on Monday, September 9th, 2019 at 6:00 am.