This article was originally published on CUInsight.
According to the NCUA, “A properly managed and risk-focused loan participation program can increase asset yields, improve earnings, generate additional loan growth, reduce risk by diversifying the loan portfolio and assist with balance sheet management.”[1]
Historically, loan participation has been a growth strategy reserved for larger financial institutions with elaborate loan origination channels and staff with capital markets expertise. Luckily for credit unions, those days and barriers to entry are finally coming to an end.
Due to the emergence of fintech origination channels and intuitive technology platforms, credit unions of all shapes and sizes now have the opportunity to supplement their organic growth and more effectively manage their balance sheets by incorporating loan participations into their long-term growth strategy.
Loan Participation Strategy, Then and Now
As defined by the FDIC: A loan participation is an arrangement under which a lender originates a loan to a borrower and then sells a portion of that loan to one or more other financial institutions. The originating lender retains a partial interest in the loan, holds all loan documentation in its own name, services the loan, and deals directly with the consumer for the benefit of all participants.[2]
Historically, most participation transactions completed by credit unions were just that – one-time transactions. A typical deal involved a localized commercial loan, a few local participants, and limited third-party assistance. While still beneficial if done correctly, the process of completing these transactions is long, manual, and cumbersome. They also add an element of risk and complexity for inexperienced participants.
In recent years, due to the new origination channels and technology mentioned above, credit union loan participations have made a shift from localized commercial loans to more geographically diverse commercial and consumer loans, offered through digital platforms and third-party programs.
This shift allows credit unions to build a more comprehensive, long-term strategy that considers access to recurring volume, asset diversification, and streamlined transactions. Examples of these programs include:
- Student loan participation programs: A customizable education lending platform that offers the opportunity to build lifetime relationships with young consumers.
- Home improvement participation loans: Digital loan offers that capitalize on market trends to drive recurring, low-risk loan volume.
- Home equity participation lending: Piggyback loans offered to super-prime borrowers as an alternative to jumbo mortgage financing to pull in above-average yields with low credit risk.
Benefits of Loan Participation
As credit unions experience decreased loan production in the wake of an economy attempting to recover from the coronavirus pandemic, there is a pressing need to implement more dynamic, flexible lending strategies that are outside of a credit union’s traditional business model. As the pandemic has rapidly accelerated the digitization of financial services, an increasing number of borrowers are shopping outside of their primary financial institutions to find the loans that fit their specific needs (i.e. loan amount, type, and terms).
- Expand Lending
Today, incorporating loan participations into the credit union’s growth strategy is important as ever, as they offer an opportunity to re-capture a share of lost loan production, now and beyond the pandemic, while not compounding already-heightened risk concerns that may be associated with the credit union’s field of membership or geographical region.
Diversifying and expanding lending through participations can result in the following value-adds:- Gaining access to an alternative lender’s unique credit appetite and consumer base, while keeping your lending criteria in place
- Investing in pools of loans without taking on servicing burdens and origination overhead
- Enhancing your traditional asset strategies to attract a wider range of borrowers and asset types
- Addressing the lending needs of more diverse consumers outside of your core consumer base
- Testing unfamiliar loan and borrower types to evaluate performance before offering directly
- Capitalizing on opportunities beyond the geographical limitations of your field of membership
- Responding to COVID-19 consumer trends and needs with more dynamic, flexible loan growth options
- Elevating your brand visibility and digital footprint by accessing lead lenders’ top-notch technology and service solutions
- Reducing overhead costs associated with direct lending, i.e. personnel, office space, and technology
- Offset Risk
Another highly attractive benefit of loan participation programs is the fact that credit risk is shared with the primary lender originating the loans, and other participants within a given pool of loans. While originating lenders can benefit by serving more borrowers, expanding direct lending, and managing liquidity without exceeding their desired lending thresholds, participating financial institutions benefit by building diversify their portfolio and sourcing lending opportunities unavailable on a direct basis, while participating only in a portion of the risk.
Buying and selling loan participations across multiple asset types offers the following benefits related to risk mitigation:- Sharing credit risks with a set of geographically and structurally diverse lenders
- Mitigating exposure from short-term and long-term interest rate risks
- Capitalizing on opportunities to mitigate losses by leveraging larger scale underwriters and servicers managing portfolios offered to the secondary market
The diverse origination channels and innovative fulfillment platforms delivering loan participation opportunities to credit unions today present one of the most effective strategies to manage liquidity concerns, generate interest and non-interest income, and diversify the risk profile of their portfolios.
“The appeal is simple,” reports Marc Rapport in a recent article on CreditUnions.com. “Participation loans allow lenders to partner with other lenders to reduce risk exposure and increase profits.”[3]
Reach out to your Allied Solutions sales representative or contact us through our website to learn more about Allied Solutions’ loan participation programs, which offer a diverse mix of options to help you meet your growth goals: alliedsolutions.net/contact-us.
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[1] https://www.ncua.gov/newsroom/ncua-report/2016/abcs-loan-participation-due-diligence
[2] https://www.fdic.gov/news/events/ny/2013-04-04.pdf
[3] https://www.creditunions.com/articles/loan-participations-sharing-risk-and-reward/