Participations: lending’s ‘Swiss Army Knife’

Jeff Hamilton calls loan participations the Swiss Army Knife of the loan portfolio.

“There are so many things you can do with respect to your balance sheet through loan participations,” says Hamilton, vice president of credit at Catalyst Corporate Federal Credit Union, a CUNA associate business member. “You can address concentration risk and interest-rate risk. You can address liquidity in some respects, and they can help you manage your profitability and capital.”

In a loan participation, one or more organizations share the risk associated with a loan or pool of loans by purchasing a portion of the loan(s) from the originating or lead lender.

Hamilton provides an example of a credit union with an excessive concentration of mortgages.

“They can do a mortgage loan participation where they sell mortgages off their balance sheet and mitigate interest-rate risk and replenish liquidity. Then they can recycle the money by lending it out again, serving more members.”

Loan participations also facilitate growth by enabling sellers to capitalize on lending opportunities that would otherwise be beyond their typical balance sheet capacity. Sales replenish liquidity and preserve line-of-credit-borrowing capacity.

By purchasing loan participations, credit unions can achieve higher income and growth, boost profitability, and build capital. Credit unions can use loan participations as a balance sheet management tool to diversify income streams and partner with other credit unions to capitalize on lending expertise for different loan types.

But there’s a learning curve for credit unions just getting their feet wet in loan participations, he says. Organizations such as Catalyst Corporate can assist credit unions in managing these initial steps, providing a strategy for buyers and sellers to manage excess liquidity and loan demand through its automated loan participation exchange platform.

The Loan Participation Exchange, or LPX, brings together credit unions wanting to sell loan pools with a nationwide audience of buyers.

“Most credit unions understand the credit metrics that go into making a lot of loans, such as credit scores, loan to value, and similar measures,” Hamilton says. “Since no two deals are exactly alike, the nuances will come in the structure of the loan participation itself.”

He says loan participation volume has increased significantly in recent years.

“It gets back to the fundamental mission of the credit union,” Hamilton says. “If your members are active and you want to keep making loans and serving them, this is a great way to do that.”