FRESNO, Calif. - Their numbers may be small, but some creditunions looking to diversify their mortgage portfolios in the midstof a low-interest rate environment are reaping the benefits of aloan participation program. Though only 6% of all credit unionshold participations loans, some have seen their loan-to-shareratios increase by an average of 2.5% as of the first quarter of2003, according to Callahan & Associates. Industry watchersstill consider the loans to be in the infancy stage for creditunions even though they've been around for more than a decade."They've been around for 10 years but a key benefit to buyers,especially now, is the cash flow aspect of participations as aninvestment," said Jim Mulford, president of Jim Mulford Consulting,a loan participation broker. "With interest rates where they are,you want your money back quickly to reinvest as rates climb backup." The way a loan participation program works is a credit union,which can be either the seller or originator, locates aconglomerate of loans that may share similar traits such as rate ortype. The average term and weighted average yield are identified sothat the rate and term of the participation can be determined. NCUAstipulates that the originating credit union keep a minimum of 10%of the loan. Generally, when establishing a new relationship with alender, a participating credit union may share the risk equallywith a 50/50 split. As a result, the participant credit unions orthe purchasers of the loan, retain essentially the same rights,share the same risks and reap the same rewards as the originatingcredit union. There is a perception that loan participation is aviable option for credit unions in the midst of tight liquiditycrunches and while that may be true, some find that a loanparticipation can offset a mortgage-laden portfolio, Mulford said.By participating off a portion of the mortgage slice, a creditunion can obtain a more stable diversification. Likewise, thoselooking to improve their return on assets, can use a process thatallows for the same funding to be reused to generate fee income.Paragon Financial Group, the CUSO for Paragon Federal Credit Unionuses the following example to explain the `multiplier strategy': acredit union participates 90% of $1 million in auto loans fourtimes, each time retaining 10% of every loan, and the return of 8%yields closer to 10%, said James Milhaven PFG vice president. Thisonly works if the credit union has the volume to roll over thefunded portion each time it enters the participation market. Still,"there is a safety factor that cannot be overlooked," Milhavensaid. "Most permissible investments are removed from probabledefault risk and that is not always the case with loans. It isvital to ascertain that the loans are underwritten according tosound practices and if so the risk is minimal, and as long as theyare priced appropriately, a much better investment." Milhaven saidsmaller credit unions with limited resources can also have themuscle to vie with larger credit unions through participation loansin a low-rate environment. Indeed, Countryside Federal CreditUnion, with $56 million in assets and 8,600 members, ventured intoparticipation loans in 1998, and has seen a payoff that has fueledits "tremendous loan engine." As of June 2003, Countryside had$30.7 million in first and second mortgage loans, with nearly $6.5million reflected on the books, the balance participated, said GerdHenjes, Countryside's president/CEO. "We were constantly facing aliquidity crunch because the lending side was so strong," Henjessaid. "You get back the principle and the interest and it justsimplifies your life." An added benefit is that loan participationscan actually improve a credit union's capital position when used toreplace brokered deposits or borrowed funds, Mulford said. "Becausea participation is carried on your books as a contra-asset, yourcapital ratio does not deteriorate as it would with other types offunding sources," Mulford said. Ironically, Evangelical ChristianCredit Union's first loan participation client in 1986 was to abank. Since then, it has amassed one of the most successfulprograms in the nation, selling to 42 credit unions with $750million in loan participations. The credit union made the difficultdecision to cease its consumer lending operation, instead choosingto pursue a niche - lending to churches - a market that waswoefully underserved, said Kevin Bates, ECCU's participation loancoordinator. "Our members were going elsewhere for auto, home andconsumer loans. There's a high amount of liquidity, people aren'tborrowing, they're going to places like Ditech," Bates said ofECCU's decision to stop offering consumer loans. "Zero percent carloans are moving members away from credit unions. It was adifficult decision for us but we've found a viable niche market(with churches)." In a low-interest rate environment, Bates said "awell, underwritten, low-interest rate loan can easily stack upagainst a corporate CD." "You compare $5 million in an investmentat your corporate at 3.5% but if you can get the same $5 million at4.5% (through a loan participation loan), you increase your shareand the equity you would use for your investment." Strong loandemand drove Norlarco Credit Union in Fort Collins, Colo. toventure into loan participation two years ago, said Charles Mabry,president/CEO. Since 2001, Norlarco sold more than $120 million inloans and purchased $10 million. "It's been profitable for us,"Mabry said. "We originate the loans and keep 10%. We keep a bit ofthe margin and continue to make up for the portions we sell. It's agreat way for us to balance our portfolio." Norlarco, which has$280 million in assets and 42,000 members, has an added bufferagainst default risk through its shared CUSO, Centennial Lending.The credit union, along with Premier Members Federal Credit Unionand Warren Federal Credit Union are Centennial's owners, whichenables sharing of each participation loan and "spreads the riskout among the three of us," Mabry said. Historically, credit unionsneeding funds went to their members first and then to the brokeredCD market, Mulford said. But since most CDs cap at $100,000, "thisbecame cumbersome to manage," Mulford said. Depending on the regionof the country and the financial makeup of the membership, loanparticipations are "not for everyone." "When I first starteddigging into the idea of loan participations, I found that creditunions in the upper Midwest were having a field day with loanswhile credit unions in California and Florida couldn't give moneyaway," Mulford said. "I also found that credit unions with highersalaried FOMs seemed to have less loan demand than those whosemembers were equal to or below average." [email protected]

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