FDIC Publishes Advisory on Effective Credit Risk Management Practices for Purchased Loan Participations | Practical Law

FDIC Publishes Advisory on Effective Credit Risk Management Practices for Purchased Loan Participations | Practical Law

The FDIC released an advisory letter cautioning financial institutions against over-reliance on lead institutions when purchasing loan participations, and reminding them of the importance of underwriting and administering loan participations in the same diligent manner as if the loans were being directly originated by the purchasing institution. The FDIC also recommends certain practices to ensure that participation lending is conducted in a safe-and-sound manner.

FDIC Publishes Advisory on Effective Credit Risk Management Practices for Purchased Loan Participations

by PLC Finance
Published on 13 Sep 2012 • USA (National/Federal)
The FDIC released an advisory letter cautioning financial institutions against over-reliance on lead institutions when purchasing loan participations, and reminding them of the importance of underwriting and administering loan participations in the same diligent manner as if the loans were being directly originated by the purchasing institution. The FDIC also recommends certain practices to ensure that participation lending is conducted in a safe-and-sound manner.
On September 12, 2012, the FDIC released an advisory letter cautioning financial institutions against over-reliance on lead institutions when purchasing loan participations, and reminding them of the importance of underwriting and administering loan participations in the same diligent manner as if the loans were being directly originated by the purchasing institution. The FDIC warns purchasing banks that over-reliance on lead institutions can cause significant credit losses and has contributed to bank failures, particularly for loans to out-of-territory borrowers and obligors involved in industries unfamiliar to the bank.
The FDIC expects institutions to exercise sound judgment and strong underwriting when originating and purchasing loan participations and recommends several practices that should be implemented by financial institutions to ensure that participation lending is conducted in a safe-and-sound manner. Institutions should implement an appropriate credit risk management framework and should:
  • Create effective loan policy guidelines for participations. The loan policy should:
    • outline procedures for originating and purchasing participation loans;
    • require thorough borrower due diligence at origination and over the lifetime of the participation;
    • mandate an assessment of the purchasing bank's contractual rights and obligations; and
    • consider including commitment limits for aggregate purchased participations, out-of-territory participations and loans originated by individual lead institutions.
  • Create written loan participation agreements which include:
    • a full description of the lead institution's responsibilities;
    • requirements for obtaining timely borrower credit information;
    • remedies upon default; and
    • dispute resolution procedures.
  • Perform the same degree of independent credit and collateral analysis on the loan participations as if the purchasing bank was the originator of the loans.
  • Exercise caution and perform extensive due diligence of participations involving an out-of-territory loan or credit facility to a borrower in an unfamiliar industry. Management should ensure that they clearly understand and monitor:
    • the obligor;
    • source of repayment;
    • market conditions; and
    • potential vulnerabilities.
Although the guidance is applicable to state member banks, other banking institutions may be expected by their regulators to adhere to similar standards.
For more information about loan participations, see Practice Note, Assignments and Participations of Loans.