Faced with heightened competition, a slow economic recovery, and tepid loan demand, community banks are looking to enhance profitability through prudent lending with attractive yields, often outside of the real estate sector where they have significant concentrations. Commercial and industrial loan participation arrangements may offer one answer, but it’s important to choose a participation partner carefully. Here is a list—by no means exhaustive—of what you might look for in potential partners.
1. Consider your bank’s business objectives.
Your bank’s core mission is to serve your community. Before joining a participation organization, ensure that you understand how a relationship with that group will align with that mission. Look for an organization that will help you meet your bank’s strategic goals and benefit you in terms of enhanced profitability and asset diversification. Of course, you should consult with your own advisors to ensure that all of your questions are satisfactorily answered.
2. Look beyond size.
Loan participation arrangements offer community banks more than just the opportunity to serve clients with credit needs that are otherwise too large for the bank. Participations also offer the potential for geographic and industry diversification, which can be especially beneficial to community banks facing protracted regional recoveries. Participations can offer a buffer against fluctuating local economic conditions without increasing banks’ existing overhead costs.
3. Communicate with your regulators, and look for a partner who does the same.
Community bank examiners may review closely any loan participation arrangements. Open and early communication with examiners may help avert potential concerns and improve their understanding of the business line. An ideal loan participation partner regularly communicates with all applicable banking regulators and provides support to banks looking to satisfy applicable guidance and regulations.
4. Remember that loan participations may involve a relationship with a third-party service provider and involve certain risks.
Banks should examine the risks of third-party arrangements just as they would examine the risks of their own activities. Third-party arrangements require thorough risk management to carefully evaluate and continuously monitor potential partners. Therefore, if you are seeking out a loan participation partner, look for one who offers comprehensive disclosure materials and historical credit performance data. Ask for and review all documentation that explains the risks involved. Remember that not all partners are the same. Some are Registered Investment Advisers with fiduciary duties to their clients and are paid for providing advice. Others generate income predominately by reselling assets.
5. Strong communication is essential in any relationship.
Loan participation organizations should put their clients’ needs first. Bankers should be attentive to potential sources of conflicting interests and what, if anything, the organization does to align its interests with its clients’ interests. Ideally, bankers participating in the loans should help govern the organization’s direction, operations and credit policies. If participants would like an increased focus on a particular loan type, they can work together to achieve that objective. They should be able to regularly communicate with each other, and all bankers aligned with such an organization should have the opportunity to learn from each other and to express opinions on relevant matters.
6. Be selective, and expect the same from your partner.
Not every loan is right for every bank. Loan participation organizations should thoroughly evaluate potential loans on a variety of criteria and only recommend those loans that meet every criterion. They should also have some type of risk retention procedure. Banks should always have the option, whatever the reason, not to participate in a particular loan. No bank should be compelled to make a loan that doesn’t align with its business objectives.
7. Establish lending policies and procedures and ensure that an independent credit decision is made on each loan.
Expect your loan participation partner to maintain lending policies, and be sure to also have your own. Such policies should define limits around participation loans and identify the bank employees responsible for managing the business and reporting the results to senior management. The credit information necessary to both underwrite and conduct ongoing monitoring of borrowers should be easily available through a secure document delivery system. Banks should use this information to make their own, independent decisions about which loans they fund.
