These FAQ’s are based upon Part 701.22 of the NCUA Regulations and apply to federal credit unions. State chartered credit unions follow their state law but most states follow the NCUA Rules for loan participations.
What organizations are eligible to participate loans with credit unions?
Credit unions may only participate loans with other credit unions, financial organizations and CUSOs. A financial organization is a federally chartered or federally insured financial institution or any state or federal government agency and their subdivisions.
If a credit union originates a loan (the loan is closed in the name of the credit union), how much of the loan can they sell to qualify the loan for a loan participation?
An originating federal credit union may sell up to 90% of the face value of the loan and must retain 10% of the face value of the loan for the life of the loan. The key concern to NCUA is that the originating borrower has “skin in the game”. The purpose being that if there is self-interest in the performance of the loan, the originator will exercise greater care in the underwriting of the loan.
If a state chartered credit union, bank or CUSO originates a loan how much of the loan can they sell to qualify the loan for a loan participation?
If the originator is a state chartered credit union, bank or CUSO, NCUA will permit the originator to hold 5% of the face value of the loan instead of 10%.
Must the borrower be a member of a participating credit union?
Yes. The borrower must be a member of a participating credit union. This means the originating credit union when the originator is a credit union. When the originator is a bank or CUSO, the first credit union participant cannot buy a loan participation until the borrower becomes a member of the credit union. The borrower has to be qualified for and actually made a member if the borrower is not already a member of the buying credit union. Once the borrower is a member of one participating credit unions other credit unions can buy loan participations in the loan without making the borrower a member of their credit unions. There is no minimum loan percentage interest that the credit union with the member relationship has to hold.
What type of loans can a credit union buy?
The buying credit union can buy loans of a type it is empowered to grant. This means if the buying credit union could have made the same type of loan to one of its members, the loan qualifies as a type of loan in which a credit union can buy a loan participation interest. The loan terms have to comply with applicable regulations. In the case of business loans, this means that the buying credit union must comply with the business lending regulations including having a business lending policy and an employee or hired advisor that has at least two years experience in business lending of the type of loans involved.
What documents must be retained?
There must be a loan participation agreement setting forth the rights and duties of the parties. Typically this is a master agreement and each deal has a loan participation certificate which sets forth the particular financial terms of a particular loan participation interest. The seller must retain the originals or copies of the loan documents. The buyer has to have a schedule of the loans purchased.
Who must approve the purchase of a loan participation interest by a credit union?
The board of directors or investment committee of the buying credit union have to approve the purchase of a loan participation interest. This is a requirement of the regulation so that even if there is a delegation of lending authority to specific staff, the board of directors or investment committee must ratify the approval. If there was improper authority to approve that would no doubt result in a DOR on future loans but the loan purchase would still be effective as to all parties to the loan participation sale.
Can the amount of the loan participation be removed from the aggregate business lending cap?
Yes. When you sell a loan participation interest that is owned by the credit union the amount of the loan participation interest can be removed from the amount counted to your regulatory cap if the sale is without recourse and meets true sales treatment under GAAP. Note that if a CUSO originates a loan and sells the loan participation to a credit union, the true sales analysis is not an issue and only the amount of the loan participation interest purchased is counted toward the cap.
A true sale is one where the loan participation interest sold is isolated from the seller so that the buyer has all the indicia of ownership and no creditor of the seller may reach the loan participation interest even in a bankruptcy situation. It requires a detailed examination of bankruptcy rules and state debtor and creditor law and can be costly legal opinion to obtain.
Can a loan participation interest in a loan be purchased that has a prepayment penalty?
Under the General Counsel Opinion 02-0824 addressed to Guy Messick, a credit union can buy a loan participation interest in a loan that has a prepayment penalty, provided if the credit union is not permitted to hold loans with prepayment penalties, it cannot enforce that portion of the prepayment penalty. For example, if a credit union buys 75% of a loan, 75% of the prepayment penalty cannot be charged to the borrower even if there is a lender that could impose the prepayment penalty.