A New and Improved Loan Participation
As the national economy shuffles along its slow path to recovery, credit unions need additional tools to meet the multitude of challenges ahead.
Loan-to-share ratios, for example, are currently hovering at 69.7% as net interest margins continue to decline and regulations limit access to borrowers outside current markets and geographic reach.
Loan participations are experiencing a renewed interest among credit unions as they are one answer to these roadblocks, especially since there is an anticipated expansion in loan demand for the near future – in residential and commercial mortgages, business, auto and student loans.
By joining a loan participation network, credit unions gain admission to a larger pool of borrowers, which can increase lending capacity quickly without the high costs of doing so on its own and without the added expense of hiring new staff.
These networks also help to spread risk geographically. As the Great Recession affected some parts of the United States more than others, it makes sense to diversify risk. A loan participation network enables the credit union to reach borrowers beyond its local geographical area to more favorable lending areas.
There are, additionally, a number of benefits from association with a network, including managing the considerable expense of keeping up with competitors and regulations, as well as new technology. By sharing expenses and rewards in a network, credit unions can achieve economies of scale and have access to innovative technology and valuable expertise.
On the income side of the calculus, benefits can be substantial and impressive. Participation returns for student loans, for instance, can be comparable to small business loans in the range of 300 to 400 basis points net ROI.
Individual student loans are usually smaller than business loans, averaging $12,500. Student loan consolidations average around $50,000, but can go as high as $150,000. These smaller loans make it easier to comply with new participation regulations that limit the concentrations of loans, especially those in large amounts from a single originator.
Smaller credit unions that lack the resources for some types of loans have the opportunity for economies of scale realized by joining a network. These institutions may not have a commercial lending or mortgage department, but networks provide access to the expertise needed to manage these assets. Marketing resources are similarly shared, allowing participants to get more for their investment and market to a larger and more diverse market of borrowers.
Liquidity management is also upgraded through a network as funds are freed up for additional loans and other purposes. Members benefit from a larger source of loan funds. A network that is properly managed and capitalized can help ensure that there is continuous oversight on underwriting and loan performance.
Perhaps the most compelling reason that loan participations will become more widespread is the notion that technology has dramatically changed the process. All of the steps are now handled electronically, which is imperative for time-sensitive assets like student loans.
There is a critical need for a quick turnaround because of the requirement of delivering tuition to the student's school on a timely basis. Having the information available electronically takes the guesswork out of the process.
Traditional participations relied on the loan originator's underwriting and due diligence. Buyers would view the loan jacket and documents post-funding. Newer methods offer more transparency and equitable treatment for participants.
All of the lenders are present at the time of origination and have full access to the loan jacket and all documents — proof of identity, income and debt-to-income ratios. Each lender conducts underwriting and due diligence of the loan at origination. All of the lenders have the choice to fund or not fund the loans, so you have 10 lenders making a decision, resulting in 10 distinct loan approvals.
Risk is shared by each of the 10 lenders as well. If, for instance, a $100,000 loan defaults and is charged off, each lender is responsible for only a tenth of the loan, or $10,000. This also allows participants to leverage their funds, as a commitment of $2 million in origination funds can be leveraged into $20 million of participation loans.
Loan participations are here to stay and are becoming a critical part of the credit union movement's future.
Vince Passione is CEO of LendKey Technologies Inc. in New York City. He can be reached at (646) 626-7404 or firstname.lastname@example.org.