Due diligence is a necessary part of the loan participation process, as it is with any loan origination. A credit union buyer must complete due diligence to properly assess whether the loan and the originating institution meet the requirements of its lending policies and risk profile. Not only is diligence important from a business perspective, but it is also required from a regulatory standpoint by the National Credit Union Administration (NCUA).
Historically, the due diligence process has been onerous enough that many credit unions struggled to use loan participations on an ongoing basis (if at all). Fortunately, the emergence of fintech solutions like ALIRO have reduced this friction point by digitizing the due diligence process and eliminating repetitive activities that once represented a significant barrier to entry, especially for smaller credit unions.
In this article, we’ll show how credit unions of all sizes can more easily implement a recurring loan participation program by leveraging the digital due diligence process available today.
Due Diligence for Loan Participations
In order to understand how digitization improves the due diligence process, it’s helpful to review how due diligence works in a typical loan participation program.
Prior to engaging in a deal, the NCUA requires credit unions to have a written loan participation policy including loan underwriting standards and due diligence expectations tailored to its risk comfort level. According to the NCUA, “this means (the buying institution), not the originating credit union, should determine acceptable credit standards, collateral requirements, loan types, documentation expectations, servicing arrangements and aggregate- and single-borrower participation limits.”
Next, the buying institution must perform due diligence on the originating credit union, loan servicer, and, if applicable, any other parties involved (for example, a non-bank originator, marketplace lender or loan purchasing platform/broker). “Individual credit unions are expected to evaluate the originating credit union’s financial condition and loan performance record,” states the NCUA. “Due diligence review must be independent of the originating credit union, though it may be outsourced to a qualified third party.”
Finally, there is diligence at the loan level prior to each sale. Buying credit unions review what is often referred to as the ‘loan tape,’ or group of loans included in the transaction, comparing the credit profile for the loans against the program underwriting. This process typically includes analysis of historical credit scores, geographic location and concentration of loans, loan pool characteristics, and other compliance and regulatory risks.
Some financial institutions will complete full due diligence on all loans in the sale while others may have language in their internal credit policy that allows them to complete due diligence on only a percentage of the sale (e.g., 25% of loans).
The Benefits of Digitization
For some credit unions, the due diligence process is a barrier to entry. For others, it’s a reason to only use participations ad hoc instead of deploying them as an ongoing strategy. The result is that many credit unions miss out on the potential benefits of loan participations, and a lot of money left on the table: Industry reports currently estimate that there is between $300-500 billion in excess and lendable capital within credit unions.
ALIRO is an innovative deal network that was created to remove these barriers and expand loan participation opportunities for credit unions of all asset sizes. With Aliro, credit unions can access multiple deals for various asset classes from a variety of originators, both within the credit union system and outside, using one platform.
One way that ALIRO has democratized participations is by digitizing the due diligence process. Through Aliro, credit unions have access to a comprehensive due diligence packet for each purchase opportunity. This allows credit union buyers to more efficiently conduct all levels of diligence on originators, programs, and loan level assets.
Also, with ALIRO’s recurring forward flow deal structure, buying credit unions only have to complete due diligence on the deal or parties involved up front. After that, they just complete loan level due diligence each month prior to the loan sale. Not having to re-diligence the seller prior to each sale frees up resources, while the recurring nature of ALIRO’s forward flow participations allows for consistent balance sheet management strategies.
By digitizing and removing impediments to the due diligence process, ALIRO allows buying and selling credit unions to transact in a more consistent, transparent, and frictionless way.