What is a Loan Participation?
In a loan participation, two or more banks fund one loan to a customer. The lead bank makes the loan and then sells a portion to at least one participating bank.
Loan Participations & Legal Lending Limits
A loan participation can enable a lead bank to approve loans that, under normal circumstances, would be above its legal lending limit—the maximum amount that a financial institution can loan directly to a customer. Legal lending limits are set by regulatory bodies and are in place to manage bank risk.
For example, if a financial institution receives a loan application above its legal lending limit, it may solicit other banks to “participate” in the loan. A lead bank’s loan presentation to a potential participating bank would normally include information such as:
- Amount loaned by the lead bank
- Collateral value
The prospective participating bank then determines whether or not to approve the offer. If it does, the participating bank must fund its portion when the loan closes so that the lead bank is never over the legal lending limit with that borrower.
Lead Bank Responsibilities on a Loan Participation
Loan participation administration can become complicated for lead banks. Not only do these financial institutions issue participating banks their pro-rata shares of incoming loan payments, but lead banks also bear the burden of ongoing due diligence. They are required to send copies of pertinent documents as they acquire them to participating banks. These include the recorded deed of trust/mortgages, as well as updated financials, tax returns, and other documents. Some loan management systems, such as AccuAccount, provide loan participation features that automatically send new items to participating banks.
In the event of loan foreclosures, lead banks invoice participating banks for their share of legal fees and then distribute pro-rata shares of the net proceeds from sale of the collateral.
Additional Loan Management Resources
Looking for more information about loan management in the banking industry? Be sure to check out our extensive resource library with free spreadsheets, whitepapers, and ebooks.
Browse our banking definitions page for more terminology.
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