I want to address the issue of loan participations. My clients have expressed a keen interest in loan participations. With basically no return on overnight funds and the loan demand from the members a little soft, some credit unions that have loans to sell through loan participations are helping the yield of other credit unions so long as the transaction is properly structured and as many protections are in place as possible.
The NCUA is placing more and more emphasis on "regulatory control" of loan participations. Chairman Debbie Matz has recently publicly stated that NCUA will be crafting "enhanced" regulations so that all credit unions involved in loan participations will have some "skin in the game." In fact, the entire front page of the NCUA Report for October 2011 was devoted to NCUA's increased attention to loan participations.
NCUA will be increasing the requirements regarding due diligence for all loan participations. They will be requiring credit unions to undertake more thorough and comprehensive reviews before, during and throughout the life of the loan participation. There are a number of key topics that I would like to bring to your attention at this time so as you contemplate loan participations, you may be better protected and most certainly better prepared.
1. Some contracts regarding loan participations make reference to guarantors, yet there is usually very little documentation or, for that matter, due diligence with respect to any guarantors. This issue is becoming more and more important, especially if the loans at issue are commercial real estate loans or sizable member business loans.
2. In addition, as part of your continuing due diligence, it may be worthy of consideration to visit the subject property for the loan in question before and during the loan participation. If that is not possible, you may at least want to do due diligence and visit the originating credit union's offices to confirm that you are satisfied with the operation of that credit union.
3. Another area of increasing concern is that of the servicer and the rights, if any, that the servicer may have. Some agreements provide the servicer with absolute authority to modify the loan, and sometimes that modification is to the detriment of the credit union.
4. Some contracts often address underwriting standards and call for a representation or warranty that the underwriting standards have been reviewed, are consistent with the credit union's goals and objectives, and are approved. However, some fail to review the asset liability policies of the originating credit union or at least their underwriting standards.
5. There is a saying that all loans are good loans, until they go bad. Sometimes the loan does not go bad for at least two to three years. Some contracts call for a right to rescind/buy back the loans if there is determined to be a material misrepresentation of fact that was discovered within the first 18 months of the loan. Clearly, if the loan does not go delinquent for at least two years or more, this 18-month buy back is not of benefit, so I encourage you to consider a buy back right for the term of the loan.
6. When all else fails, double-check the regulations. As you know, Section 701.22, Loan Participation, lists the details and requirements for all loan participations. Please remember that the regulations require a written master participation agreement to be properly executed and acted upon by the credit union's Board of Directors or if delegated by the Board, the Investment Committee or senior management. Regulations also provide that a participating federal credit union that is not the originating lender shall: (1) participate only in loans that it is empowered to grant; (2) has a participation/investment policy in place which sets forth the loan underwriting standards prior to entering into a participation agreement; (3) participate in participation loans only if made to its own members or members of another participating credit union; (4) retain the original or a copy of the written participation loan agreement and a schedule of the loans covered by the agreement; and (5) obtain the approval of the Board of Directors and Investment Committee of the disbursement of proceeds to the originating lender.
I also suggest that you read and review once again NCUA Letter No. 08-CU-26, which was addressed to all federally insured credit unions and pertains to evaluating loan participation programs. Although the document is somewhat stale, it continues to be the leading authority. The letter and its accompanying supervisory letter will be the template for future NCUA examinations. It is probably this document that will be further expanded, revised and enhanced by the NCUA as it continues to move forward and implement new regulations so that there is further "skin in the game" on loan participations.
Clearly, loan participations have a lot to offer but also include a lot of risk. Review the contract carefully with your lawyer.
E. Andrew Keeney is a Norfolk, Va.-based credit union attorney with more than 35 years of experience.