Real estate loan participations increased 29% year-over-year for the credit union industry, according to first quarter data from Callahan & Associates. As more credit unions enter the loan participations market, two credit unions currently active as buyers and sellers in the space offer up a few tips and best practices.
A Buyer’s Perspective
CU QUICK FACTS
Seattle Metropolitan Credit Union
HQ: Seattle, WA
Data as of 03.31.17
12-MO SHARE GROWTH: 14.6%
12-MO LOAN GROWTH: 20.4%
Seattle Metropolitan Credit Union ($785.7M, Seattle, WA) has been buying participations for several years, according to Jason Elliott, senior vice president and chief financial officer. The credit union has completed a number of Small Business Administration (SBA) loan purchases and made a large residential real estate participation purchase in late 2016.
“The SBA loans are typically commercial real estate backed but can include equipment and other types of loans,” Elliott says.
The CFO receives potential deals on almost a daily basis through a handful of relationships with trusted brokers and connections with other credit unions.
“The brokers and credit unions we’ve established relationships with reach out to see what our strategy is and what we’re looking for, so I am in communication with them quite frequently,” Elliott says.
Jason Elliott, SVP/CFO, Seattle Metropolitan Credit Union
A Buyer’s Benefits
Although one of the benefits of purchasing participation loans lies in the market diversification they offer, Seattle Metro tends to look for deals in its own Pacific Northwest region, where the credit union is more in tune with what’s happening in the local economy and better understands the potential risks.
But diversification is also found in types of loans.
With its recent residential real estate participation purchase, the credit union replaced fixed-rate mortgages, which it sold to Freddie Mac, with an adjustable rate mortgage pool. These loans will re-price at a higher interest rate than the pool the credit union sold.
Unlike selling to Freddie — which requires a credit union to completely divest its interest in the loans, even if it retains servicing — selling to another credit union allows the seller to retain some ownership in that loan pool and continue to earn a piece of the interest income.
“For example, if a seller retains 10% of the pool, they get the bulk of the pool off their books from a risk management/diversification standpoint while still receiving a small portion of the interest income as well as the servicing fee,” Elliott says.
The seller is also likely to sell the pool at a premium to another institution versus directly to Freddie, which increases its initial gain at the time of the sale.
Credit unions need to be more receptive to participations. It’s a great opportunity to explore.
3 Tips For Buyers
1. Do your homework. “Some of the deals we see look too good to be true, so it’s important to find out more and do your own analysis,” Elliott says. This includes finding out more about the selling institution and the broker who brought the deal. Due diligence at Seattle Metro includes going through the underwriting process again using its own standards.
2. Allocate the time. “We look at participations as an investment and compare potential deals to our other investment options,” Elliott says. The overall time involved depends on the type of loan pool, but the CFO can usually complete the initial evaluation of deals within a couple of hours. “I start by pulling the financial information on the institution and look at its net worth, delinquency ratios, etc. to ensure it is financially sound,” says Elliott. Seattle Metro’s policies then identify the sample size its needs to review and put through underwriting, which typically takes two to three weeks for the Washington state credit union.
3. Understand the benefits. Loan participations can be a solid way to diversify a credit union’s balance sheet and income stream. Although intensifying competition in some markets can make this challenging, it is a viable channel for credit unions to generate income. “Credit unions need to be more receptive to participations,” Elliott says. “It’s a great opportunity to explore.”
A Seller’s Perspective
CU QUICK FACTS
State Employees FCU
HQ: Albany, NY
Data as of 03.31.17
12-MO SHARE GROWTH: 9.2%
12-MO LOAN GROWTH: 9.7%
State Employees Federal Credit Union ($3.4B, Albany, NY) has been selling commercial real estate participations for the past half-dozen years but has increased its activity on both the buying and selling side over the past 24-months.
“We use it as a tool to manage the portfolio from several different aspects, including growth,” says Ed Jennings, head of commercial banking. “Selling can help us reduce credit exposure and manage concentration levels, but the specific reasons vary from deal to deal.”
A Seller’s Benefits
Ed Jennings, Head of Commercial Banking, SEFCU
Specific reasons to see a loan might include dealing with a commercial loan that is too large, hitting a saturation level in a certain geographic or product area, or wanting to serve as the lead lender and servicer so the process is invisible from the member’s standpoint.
“The more participants we have, the more we can spread the credit risks,” Jennings says.
SEFCU has developed its own internal hold limit grid that plugs in a range of factors, including the institution’s risk tolerance. This makes it clear and easy to determine how much the credit union is willing to hold on each deal, and, thus, which deals it needs to participate out.
We’ve completed transactions that we might not have been able to do in the past, which has helped the credit union maintain larger relationships.
4 Tips For Sellers
1. Communicate, communicate, communicate. Lining up participants prior to closing is important. So is clear communications with the other institutions and their legal counsels. “In the past, we had occasions where participants weren’t quite ready, but now it is less of a struggle because of our clear communications,” Jennings says. And after the deal, communication remains key. “Share the good, the bad, and the ugly with the other parties — don’t hold back any surprises.”
2. Develop strong relationships. SEFCU sells directly to credit unions and banks it has developed relationships with over the years. “We’re the biggest credit union in the area, so a lot of local institutions look to us first,” Jennings says. This enables the credit union to call on others to ensure placement of the participations as it is underwriting the deal.
3. Know the benefits and have a clear strategy. Selling has allowed SEFCU to be more flexible and better serve members with larger financing needs. “We’ve completed transactions that we might not have been able to do in the past, which has helped the credit union maintain larger relationships,” says Jennings. “However, selling hasn’t charged our risk profile or who we are. We pass on transactions that we deem too risky and stick to our guns, philosophically.”
4. Don’t put the cart before the horse. On the selling side, it is critical to make sure the back-office has reporting and other capabilities in place. A credit union needs processes in place to remit payments to the buyer(s) in a timely fashion and have legal documents and participation agreements that are clear and equitable. Does everyone have equal voting rights? Is the credit union ready to report on a monthly basis? These are just a few of the questions the credit union needs to ask — and answer — before becoming a seller.