By Jeff Hamilton, CFA, Vice President of Member Credit
Comprehensive due diligence on the loan originator, seller and servicer is an essential ingredient for success in any loan participation purchase.
In most loan participation transactions, the originator, seller and servicer roles generally belong to the same credit union.
The nature of the transaction, such as the characteristics of the loan(s) in the participation, borrower credit rating and lender experience, will drive the focus of the analysis. Look at these key items when collecting due diligence on each component of a loan participation offering:
1. Originator
In reviewing the credit union as the loan originator, a participant will want to learn how the credit union conducts its lending activity and what its risk tolerance is. Evaluating the following will provide a good understanding of the lending origination process:
- Loan policies and procedures
- Underwriting guidelines
- Exception policy and approval requirements
- With knowledge of the origination process and parameters in hand, the next step is to review the loan files to ensure they were originated in accordance with credit union guidelines.
2. Seller
A review of the credit union as the seller should give the participant confidence in the institution’s financial stability. Several documents will provide this information:
- Current audited financial statements
- Interim financial statements (if audited are not available)
- NCUA 5300 Call Reports
- Financial performance reports
3. Servicer
The most important review is probably of the credit union as servicer. It’s important because the buyer/participant will be dealing with the selling credit union in this capacity for remainder of the life of the participation. The buyer/participant must be comfortable with how the credit union handles the payments and collections for the loans. For this role, it is critical to review the following for insights into how the credit union handles the loans:
- Servicing policies and guidelines
- Modification policies, procedures and approvals
- Collection procedures
- Loan program credit performance history
Loan participation portfolios are typically serviced by the seller but occasionally by third-party loan originators or servicers. In these instances, buyers will need to ensure the seller’s guidelines and procedures establish how the servicer will administer the loans. Some loan participation programs, like the Loan Participation Exchange (LPX) from Catalyst Corporate, may provide all the above items as a part of their due diligence packages.
The loan participation agreement signed by buyers and sellers defines the terms of the transaction and the roles and responsibilities of the parties. The agreement customarily delegates servicing responsibilities to the seller, outlining their obligations and responsibilities. Typically, language is included that states the seller will service the loans in each portfolio with the same standard of care the seller would employ in servicing similar loans for its own account. Finally, the agreement should also address circumstances and conditions under which participants may replace the servicer and any other matters involving the ongoing administration of the loan(s).
With sound due diligence, loan participations can serve as a viable opportunity for buyers to purchase attractive earning assets and for sellers to manage their balance sheet.
The Loan Participation Team at Catalyst Corporate works with credit union sellers and buyers, facilitating an efficient sales process for optimal execution. For more information, contact us today.