Participation loans are

loans In finance, a loan is the tender of money by one party to another with an agreement to pay it back. The recipient, or borrower, incurs a debt and is usually required to pay interest for the use of the money. The document evidencing the debt ( ...

made by multiple lenders to a single borrower. It is similar to

syndicated loan A syndicated loan is one that is provided by a group of lenders and is structured, arranged, and administered by one or several commercial banks or investment banks known as lead arrangers. The syndicated loan market is the dominant way for l ...

but each lender passes the funds to the lead financial institution which provides the loan to the lender. Several banks, for example, might chip in to fund one extremely large loan, with one of the banks taking the role of the "lead bank". This lending institution then recruits other banks to participate and share the risks and profits. The lead bank typically originates the loan, takes responsibility for the

loan servicing Loan servicing is the process by which a company (mortgage bank, servicing firm, etc.) collects interest, principal, and escrow payments from a borrower. In the United States, the vast majority of mortgages are backed by the government or governm ...

of the participation loan, organizes and manages the participation, and deals directly with the borrower.

Credit unions A credit union is a member-owned nonprofit cooperative financial institution. They may offer financial services equivalent to those of commercial banks, such as share accounts (savings accounts), share draft accounts ( cheque accounts), credit ...

can also participate loans in the same manner.

Structure

Participations in the loan are sold by the lead

financial institution A financial institution, sometimes called a banking institution, is a business entity that provides service as an intermediary for different types of financial monetary transactions. Broadly speaking, there are three major types of financial ins ...

("FI") to other FI's. A separate

contract A contract is an agreement that specifies certain legally enforceable rights and obligations pertaining to two or more parties. A contract typically involves consent to transfer of goods, services, money, or promise to transfer any of thos ...

called a loan participation agreement is structured and agreed among the FI's. Loan participations can either be made on a

pari passu ''Pari passu'' is a Latin phrase that literally means "with an equal step" or "on equal footing". It is sometimes translated as "ranking equally", "hand-in-hand", "with equal force", or "moving together", and by extension, "fairly", "without pa ...

basis with equal risk sharing for all loan participants, or on a senior/subordinated basis, where the senior lender is paid first and the subordinate loan participation paid only if there are sufficient funds left over to make the payments. Such senior/subordinated loan participations can be structured either on a LIFO (Last In First Out) or FIFO (First In First Out) basis (see

FIFO and LIFO accounting FIFO and LIFO accounting are methods used in managing inventory and financial matters involving the amount of money a company has to have tied up within inventory of produced goods, raw materials, parts, components, or feedstocks. They are used to ...

Usage

The most compelling reasons that financial institutions use participation loans are as follows: * Selling loan participations allows the lead bank to originate an exceptionally large loan that would otherwise be too large for it to handle by itself. By engaging other banks as participants, the lead bank can remain within its own legal lending limits and still come up with sufficient cash for funding. * Banks that buy loan participations share in the profits of the lead bank. If a lending institution isn't doing much business on its own, or is in a slow market, it can team up with a profitable "lead bank" in a healthier market to generate more lending income. * Buying participation loans is a way for banks to diversify their

assets In financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything (tangible or intangible) that can be used to produce positive economic value. Assets represent value of ownership that can b ...

. By investing a variety of loans in different locales, they reduce their

risk In simple terms, risk is the possibility of something bad happening. Risk involves uncertainty about the effects/implications of an activity with respect to something that humans value (such as health, well-being, wealth, property or the environ ...

and exposure to potential losses if a calamity, such as a natural disaster or severe

economic depression An economic depression is a period of carried long-term economic downturn that is the result of lowered economic activity in one or more major national economies. It is often understood in economics that economic crisis and the following recession ...

, were to strike their particular community. * Selling loan participations allows a bank to reduce its

credit risk Credit risk is the chance that a borrower does not repay a loan In finance, a loan is the tender of money by one party to another with an agreement to pay it back. The recipient, or borrower, incurs a debt and is usually required to pay ...

to a customer or specific community that entails greater than average risk. * Selling participation loans allows the lead bank to keep control of more of an important customer relationship or even an entire customer relationship of large customers of the bank, instead of sharing the relationship with other competing banks.

References

{{Reflist Credit Loans

Structure

Usage

See also

References