Commercial Loan Participations for Small Banks

A loan participation is the sale of a fractional ownership in a loan asset by the bank that has the primary relationship with a borrower “the lead bank” to another financial institution “the participant bank”.  The participation is documented with a loan participation agreement, which is structured and agreed among the banks. While the term participation and syndication has been used interchangeably, a syndication is usually a term reserved for really large loans which are originated by large money center banks and marketed to many lenders at once. Syndicated loans are also usually made to large well known companies and are supported by a more active secondary market.

There are two main reasons why a commercial bank might participate a portion of a borrowing relationship.

Due to legal lending limit or risk diversification: Sometimes a small commercial bank is restricted in its ability to service large business borrowers due to regulatory limitations. For example, US national banks extensions of credit to one borrower are limited to 15 percent of the bank’s capital and surplus.  In the real world, most bank lenders have in-house exposure limits below regulatory requirements. A 10% limit is common.

As a source of liquidity: By selling a portion of an existing loan, the lead bank can diminish the capital requirements and/or use the cash received to lend again.

Commercial lenders are enthusiastic about loan participations. The lead bank is grateful to be able to service a large commercial customer, while the participating bank or banks are happy to put some money to work without the trouble of actually having to do the selling and marketing.

The key to a participation is that both lead bank and participant bank are required to do their own due diligence. This is documented on the legal documents prepared by the lawyers. However, it has been my experience that it is always a good idea to provide a notice reinforcing this point to any potential participant. After all you will be making a package with copies of all the financial information, might as well use it as an opportunity to reinforce the rules of the game. Below you can find a sample of a notice, but make sure that you read my disclaimer, realize that I am not an attorney, and that at best it should be taken as a basic and incomplete example.

For this example let’s assume that you are a lender for West Bank, and your largest borrower XYZ, Corp. has approached you with a request to finance the acquisition of a large building to house their operations. In order to being able to do the deal, you are approaching East Bank to come in as a participant.

NOTICE TO RECIPIENTS

RE:  XYZ Corp. Building Acquisition Credit Facility

The enclosed Confidential Information Memorandum (“Memorandum”) and evaluating material are being furnished to East Bank who is being invited to participate in the above referenced extension of credit. The Memorandum has been prepared solely for informational purposes from information supplied by or on behalf of XYZ Corp. (“Borrower”), and is being furnished by West Bank (the “Lead Bank”) to you in your capacity as a prospective lender (the “Recipient”) in considering the proposed Credit Facility described herein (the “Facility”).

ACCEPTANCE OF THIS MEMORANDUM CONSTITUTES AN AGREEMENT TO BE BOUND BY THE TERMS OF THIS NOTICE. IF THE RECIPIENT IS NOT WILLING TO ACCEPT THE CONFIDENTIAL INFORMATION MEMORANDUM AND OTHER ENCLOSED EVALUATION MATERIAL ON THE TERMS SET FORTH IN THIS NOTICE, IT MUST RETURN THE CONFIDENTIAL INFORMATION MEMORANDUM AND ANY OTHER EVALUATION MATERIAL TO THE LEAD BANK IMMEDIATELY WITHOUT MAKING ANY COPIES THEREOF, EXTRACTS THEREFROM OR USE THEREOF.

Completeness: The lead bank bears no responsibility (and shall not be liable) for the accuracy or completeness (or lack thereof) of the Memorandum, Evaluation Material or any information contained therein. No representation regarding the Evaluation Material is made by the lead bank. The lead bank has not made any independent verification as to the accuracy or completeness of the Evaluation Material, and has no obligation to update or supplement any Evaluation Material or otherwise provide additional information.

Reliance: The Memorandum and Evaluation Material have been prepared to assist interested parties in making their own evaluation of the Borrower and the Facility and does not purport to be all-inclusive or to contain all of the information that a prospective participant may consider material or desirable in making its decision to become a lender. Each Recipient of the information and data contained herein should take such steps as it deems necessary to assure that it has the information it considers material or desirable in making its decision to become a lender and should perform its own independent
investigation and analysis of the Facility or the transactions contemplated thereby and the creditworthiness of the Borrower. The Recipient represents that it is sophisticated and experienced in extending credit to entities similar to the Borrower. The information and data contained herein are not a substitute for the Recipient’s independent evaluation and analysis and should not be considered as a recommendation by the lead bank that any Recipient enter into the Facility.

Confidentiality: The Recipient acknowledges that the Borrower and Guarantor(s) consider the Evaluation Material to include confidential, sensitive or proprietary information and agrees that it shall use reasonable precautions in accordance with its established procedures to keep the Evaluation Material confidential.

You can learn more about participations/syndications as well as corporate credit analysis by buying and reading the following books from Amazon The Handbook of Loan Syndications and Trading or Standard & Poor’s Fundamentals of Corporate Credit Analysis

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