Academic journal article ABA Banking Journal

Documenting Loan Participation Agreements: Practical Tips for Lenders. (Special Advertising Supplement Executive Summary)

Academic journal article ABA Banking Journal

Documenting Loan Participation Agreements: Practical Tips for Lenders. (Special Advertising Supplement Executive Summary)

Article excerpt

Loan syndications and participations (together called "colending") have surged in popularity since 1991. This article focuses on participations, not syndications, where a lead bank funds a borrower and sells fractional interests to participating financial institutions who then share in the revenue stream from the borrower.

A typical loan participation involves a lead bank who lends directly to the borrower and sells to participating banks a portion of the loan. For most financial institutions, there are three motivations for selling a participation interest in a commercial loan: (1) to satisfy safety and soundness lending limits, (2) to hedge risk, (3) to earn non-interest fee income. To achieve these objectives, financial institutions must document their participations with care. These seven tips help realize the benefits of participations.

Remember the Regulator

Participation agreements are generally scrutinized as part of safety and soundness examinations. Examiners look for terms and conditions that provide for sharing of information about the borrower and the credit during the entire life of the loan and participation. It is also important to address the lead bank's administrative responsibilities, especially in the face of disagreement about how to handle the borrower's default.

Many routine participation agreements do not address the key points required by safety and soundness regulations or contain elements of recourse.

The Duty of Care

A lead bank's relationship to a participant can fall into one of four basic categories: seller of a property interest, independent contractor, disclosed agent, and fiduciary.

Many participation agreements contain language that imposes fiduciary or agency duties upon the lead bank. These are dangerous provisions. In many circumstances a lead bank may have to sacrifice its own interests for the interests of the participant. Fiduciary obligations should be eschewed altogether. If the lead bank agrees to be a disclosed agent, the provisions should be carefully drafted.

Sell No Securities

Is a participation interest a "security" under federal securities laws? Generally, no. Although it can be, unless the agreement includes the correct language. Failure to include that language exposes the lead bank to the risk that the sale of a participation interest does not comply with federal securities laws. …

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