Real Estate Terms

Participation Loan Definition

Participation loans involve more than one lender. These loans are popular because they allow borrowers to obtain large amounts of money. In these loans, different lenders come together to share the funding of the loan. These loans are used when lenders want to retain their valued customers. However, the lending limits of these lenders restrict them from entertaining their customers. In these cases, participation loans are helpful as they allow for increasing their limits. In this post, I’ll define participation loans with the help of examples so that you have a better concept while preparing for a real estate exam.

What Is a Participation Loan?

A participation loan is a loan that different lenders share. These lenders include credit unions, banks, and various financial institutions. It is a collaborative process that allows lenders to come together to improve their ongoing balance sheet. With the help of these loans, their income is increased, which is visible on the balance sheet indicating good performance as lenders. The participation loans also enable the lenders to buy a pro-rata amount.

Loan participation is a process that allows the banks to approve loans that, otherwise, are not possible because of the legal lending limits. The process occurs between two or more banks or financial institutions and allows them to share the ownership of a particular loan. Loan participants in a participation loan include the lead bank and other lenders.

While loan participation programs allow the lending participants to offer loans to the borrowers, they also require the lending partners to share the risks equally. Sometimes, the loans can be structured in subordinate loans and junior mortgages to prioritize the lenders that will receive the loan repayments first.

Pro-rata Amount

A pro-rata amount is a share that allows lenders to take proportions instead of all the amount. Similarly, if a bank owns 10% of a loan, it can expect a pro-rata share of 10% of the total repayments obtained by the participation loan.

Legal Lending Limits

Legal lending limits allow the banks to offer a maximum dollar amount to the borrower. The legal lending limit is a bank’s capital and surplus percentage. A bank can’t provide an amount more than this limit. These limits are set and regulated by the Office of the Comptroller of the Currency (OCC).

Lead Bank

A lead bank is a bank that underwrites and originates a loan. This financial institution takes responsibility for organizing, managing, and distributing the participation loan. The lead bank, in this case, deals with the borrower directly. To perform all these services, the lead bank gets additional fees too. For these reasons, the bank is called a ‘lead underwriter.’ The lead bank issues this loan and then sells a portion of it to at least one participating bank. The other banks that offer these loans to the borrowers.

Loan Participation Agreement (LPA)

A loan participation agreement is an agreement between the lead lender, the borrower, or the loan participant. In this agreement, the lead bank controls the loan and the dealings with the borrower. Other lenders participating in this loan purchase an interest in the loan and offer it to the borrower. Financial institutions use Loan Participation agreements (LPA) to spread their risks. However, sometimes LPAs can also cause disputes and disagreements between the banks.

Loan Participation Note (LPN)

A loan participation note is a financial tool that allows the investor or lender to buy a portion of an outstanding loan issued by a lender. With a loan participation note, the lead bank issues the loan after underwriting it. On the other hand, the participant lenders purchase the loan.

Loan Participation Vs. Syndication

In loan syndication, the lead syndicate (bank) issues separate loans with the help of different lenders, and all the lenders become the originating lenders. It is a process where multiple lenders come together and provide a portion of the loan requested by a single borrower. Loan syndication is usually done when the loan amount is very high, and the risk is high too. The lead bank manages the syndication processes and manages the funds that are provided to the borrower. With syndications, each participant in the loan has a direct contractual relationship with the borrower. This means that each lender in the team provides financing to the borrower. Whereas, with participation loans, the contractual relationship is only between the lead bank and the borrower. The lead bank has a separate relationship with the participating lenders, but the borrower doesn’t get any direct funding from them. 

In loan participation, the borrower obtains a loan with only one bank, and the bank asks other lenders to participate. Loan participation requires the borrower to enter into one loan, while syndication allows the borrower to enter into multiple loans. Thus, the main difference between the participation loan and syndication is the number of loans the borrowers enter.

Benefits of Loan Participation

Banks and financial institutions use participation loans to improve their liquidity, enhance their customer services, and for improving interest rate risk management. The participants may also benefit from the higher loan-to-share ratio, diversified balance sheet, and increased earnings. The main aim of loan participation programs is that the bank or credit union wants to meet the needs of the customers. The following are the main benefits of participation loans:

Risk Sharing

When financial institutions offer loan participation to other lenders, it reduces the overall risk. Loan participation programs allow banks to diversify their assets. Investing in participation loans allows the banks to share the risk and exposure to losses in a financial crisis.

Origination of Large Loans

With the help of loan participation, the lead bank can originate a large loan amount; otherwise not possible due to the legal lending limits. This way, the lead bank can remain within the legal lending limits and still originate a larger loan amount. Thus, a sufficient cash amount can be provided to a loyal customer with the help of these loans.

Profit Sharing

Banks and credit unions can buy loan participations and share the profits of the lead bank. This is helpful for those financial institutions that aren’t performing well, and teaming up with a lead bank can benefit them. Participating in a loan is suitable for those investors who want to take advantage of a healthier market.

Shared Service Responsibilities

Sometimes, the participating lender can’t serve multiple loan participants. This way, the loan participation allows the participants to operate on behalf of a third-party servicer to service the loan.

Improved Customer Relationships

Offering participation loans allow the lender to retain valued customers. Thus, the bank can benefit from the participation loan instead of pushing the loyal customers to the competition.

What Is a Participation Mortgage?

Participation mortgage is a type of home loan that requires different parties to come together and share the proceeds that result from the sale of the property. Plus, the parties will also benefit if it is a rental property. Loan agreements may include partnerships between lenders and borrowers, among different borrowers and lenders. These mortgages increase purchasing power and also reduce the risks to participants. Thus, most of these mortgages are available with lower interest rates as multiple lenders are involved.

In commercial real estate transactions, participation mortgages are common. These loans involve two or more parties that decide to participate in the loan and share the equity. Many investors purchase apartment complexes, office buildings, and more properties that produce ongoing income.

Participation Loan Examples

Suppose a company XYZ wants to buy land and build a large development that includes a mall and a golf course. To build this, the company needs a loan of $2 billion. The company goes to a bank for loan approval. However, the loan is too large for the bank, and its legal lending limits don’t allow it to provide this amount. Besides that, the bank’s risk tolerance is lower than the amount, and thus it decides to form a loan syndicate.

The bank acts as the lead bank and asks other banks to participate. It contacted various banks and credit unions so that they could participate and make up the total loan amount of up to $2 billion. Since the loan is offered to a single borrower, it is called syndication. The lead bank contributes $750 million, and the remaining $1.25 billion is shared among other syndicate members.

The lead bank organizes the terms, conditions, covenants, and other necessary details. Once the loan agreement is complete, XYZ receives the loan through the lead bank.

Frequently Asked Questions

Which Is Better, Loan Syndication or Loan Participation?

Loan syndication is expensive as multiple lenders finance the loan for a single borrower. However, participation loans are created to distribute the risk of the lenders. The difference between syndication and loan participation is difficult to identify, and the only way to identify them is by reading the loan agreement. One must carefully read the contractual terms, the contract, and other terms and conditions.

What are the Risks involved with Participation Loans?

Besides offering numerous benefits to the lender, a few risks are involved with participation loans. Though these loans spread the risks with multiple lenders, they are still riskier than conventional loans. In most cases, the larger the loan, the larger the loss.

What to Know for the Real Estate Exam

Loan participation allows a financial institution to originate a loan and let other lenders participate in it and purchase portions from it. This allows the lead bank to distribute the risk and create a large loan that is more than its funding capacity. Whether an investor is buying or selling a loan, participation loans can benefit them. Loan participation may provide financial institutions to manage their legal lending limits and interest rates, increase revenue, diversify their balance sheet, and improve liquidity. I hope that you have now understood how loan participation works. If you’re preparing for a real estate exam, this can be helpful for you. Learn hundreds of more real estate definitions to pass the real estate exam with excellent scores.

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