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Credit Union
Cooperation Through Loan Participation Agreements
It is my premise that this formal and informal cooperation between credit unions needs to be encouraged and increased for the continued health of the credit union movement. The pressures upon credit unions from members, regulators and the competition has never been greater. Unless credit unions go to the well of their strength and extend the types and levels of cooperation between credit unions, credit unions will be playing into the hands of the competition. All credit unions are stronger by the success of each credit union and weaker by the failure of an individual credit union. As Legal Counsel to the National Association of Credit Union Service Organizations, I have witnessed the success of CUSO's providing operational services to multiple credit unions. Credit unions have combined resources to provide services such as shared branch service centers, data processing services and mortgage origination services. Through economies of scale, credit unions have reduced operational costs and provided expertise, new services and levels of services which they could not afford to provide individually. The participating credit unions are stronger for this cooperation and their members are much better served. There is an opportunity for cooperation between credit unions outside of CUSO's which, in my humble opinion, is grossly underutilized. That opportunity is the use of loan participation agreements. Section 701.22 of the federal regulations empowers credit unions to enter into loan participation agreements. The concept of a loan participation arrangement is that a credit union originates a loan or series of loans from its members. The loans must be made in accordance with the credit union's written loan policy and be approved by its credit committee or loan officer. The originating credit union may sell up to 90% of each loan to another credit union called a participating credit union. The participating credit union may purchase interests only in the types of loans it is authorized to grant to its members. The participating credit union must have the approval of its board of directors or investment committee. A written loan participation agreement with the originating credit union must be signed prior to disbursement of the loan. The originating credit union usually is the credit union that services the loan, i.e. collecting the payments and applying them in accordance with the loan participation agreement. The servicer usually earns a fee deducted from the loan payments for this responsibility. What does each credit union gain by loan participation arrangements? The originating credit union creates liquidity and satisfies a loan demand from its members. Loans are made which otherwise may not have been able to be made due to lack of funds or unacceptable loan concentration levels in either a member or in the type of loans. For example, if the credit union's loan policy provides that no more than 30% of its loan portfolio will be in first mortgages, what happens when its members' demand is greater than this limit? The credit union could sell some loans to the secondary market but what if the rates are unfavorable? By having a loan participation arrangement with other credit unions, the originating credit union could sell portions of future mortgage loans to other credit unions and stretch its funds available to loan to its members without having to turn members away or take a hit in the secondary market. When the secondary market turns more favorable, some loans in the loan portfolio could be sold. If we substitute car loans in the above example, loan participation arrangements are even more valuable as there is not a widely recognized secondary market in car loans. There would be no choice but to turn away members if the concentration level in car loans was exceeded. The advantage to the participating credit union is the ability to invest its money in high quality loans with a favorable return. The other investment opportunities available to the participating credit union do not customarily yield comparable rates of return. What does the credit union industry gain from loan participation arrangements? Firstly, credit union members are served. The members of the originating credit union receive the loans they need and the members of the participating credit union receive a favorable return on their assets. Secondly, credit unions have a method to address concentration issues without sacrificing services to their members. Thirdly, a vehicle is created to allow money to flow to where it is needed and can best be used. Some credit unions are loan rich and some credit unions are cash rich. Most credit unions are loan rich sometimes and cash rich other times. The loan participation arrangement can be the vehicle that allows the money in the credit union industry to flow to the point that member services are needed and allows the assets of the credit union industry, as a whole, to work at the most favorable rates of return. The ability to move money to the point of need in the market is the concept of any secondary market. The mortgage secondary market has stabilized and strengthened the mortgage market in this country. Loan participation arrangements can serve as a stabilizing and functional secondary market for the entire credit union loan portfolio. I encourage multiple credit union participation in these loan participation arrangements. The opportunities multiply with each credit union in the arrangement. I also recommend that the loan participation agreement be submitted to your regulator so that the arrangement is not a surprise at audit. The loan participation agreement could be structured in many ways. For example, the following concepts could be incorporated in an agreement: (1) a credit union could commit a pool of money for specific types of investments to be underwritten by the designated originating credit union within specific underwriting criteria, (2) each signatory credit union could have the ability to originate loans and the other signatory credit unions could decide to participate on a loan by loan basis after reviewing their cash position and the respective loan, or (3) a participating credit union that had the staff and expertise to service the loans could service all loans, regardless of origination. Entering into a loan participation agreement and setting up the loan participation arrangement does not mean that the credit union has to make a current commitment of any loans or cash. Building the vehicle does not mean you have to ever drive it. But if you do not build the vehicle, it may not be there when you need it and you will never know how far it could take you. If the mark of a good manager means that options are created to allow the organization to meet whatever changes occur, then I suggest that the option of the loan participation arrangement is too good of an option not to put in place for your credit union. For a minimum investment of time and money, your credit union can have a management option that can, at most, revolutionize the way your credit union is managed and, at least, be a safety net in difficult times. Loan participation agreements are worth exploring with your fellow credit unions. Give them a call. Guy A. Messick is an attorney in practice with the law firm of Lastowka & Messick, P.C., Mr. Messick is general counsel to credit unions and credit union service organizations and serves as Legal Counsel to the National Association of Credit Union Service Organizations. Mr. Messick also provides legal consulting services to credit unions and credit union service organizations nationwide. Lastowka & Messick P.C. |