Buying and selling whole loans or portions of loans is a common balance sheet management practice for credit unions of all sizes. While loan participations have become increasingly popular in recent years, with transactions reaching record levels in 2020, there’s another way for credit unions to purchase loans: eligible obligations.
Though this structure may be less familiar than loan participations, both are strategies to grow and diversify a portfolio. Therefore, it’s important to understand the differences between them and learn how your credit union can benefit by buying and selling loans that are classified as either loan participations or eligible obligations.
Two ways to access loans
The indirect lending model is a familiar transaction structure for credit unions. Typically, a credit union will contract with a merchant to originate loans at the point of sale, such as at an auto or recreational vehicle dealer, instead of lending directly to consumers.
Another loan sale structure that has become increasingly popular, and one that many credit unions are involved with, is the one that begins with a fintech platform acting as an origination agent on behalf of the credit union. In this structure, the loan is originated by a bank who has partnered with the fintech platform for the sole intent of immediately selling the loan to a credit union (once the borrower becomes a member of that credit union). The bank originates the loan based on the credit union’s underwriting criteria, and, once purchased, the credit union very soon thereafter sells parts of the loan to other credit unions.
The classification of these loan purchases must be accurate to comply with National Credit Union Administration requirements. These classifications may depend on the processes and channels through which the sale and purchase occur. For example, whether or not the transaction involves the purchase and subsequent participation of indirect loans makes a difference in how loans get classified.
A loan participation is a loan where one or more eligible parties participate pursuant to a written agreement with the originating lender. This structure requires the originating lender’s continuing participation throughout the life of the loan. Additional requirements include the following:
- The borrower must be a member of one of the participant credit unions — either the originating lender or one of the lenders purchasing a participation interest in the loan.
- A credit union may not purchase a loan participation from any source other than the originating credit union.
- Federally-chartered credit union originators and sellers must retain at least 10% of the outstanding balance of the loan. State-chartered credit unions must retain at least 5% of the outstanding balance of the loan.
- Purchasing credit unions must have loan policies in place for the type of loan they buy from loan participations.
- There are no restrictions on the amount of loan participation interest that may be purchased. However, buyers are limited to $5 million or 100% of the credit union’s net worth in the aggregate amount of loan participations, unless this limit is waived by the appropriate regional director.
Under the NCUA’s eligible obligations rule, credit unions can purchase loans, in whole or in part, with no continuing contractual obligation between the seller and purchaser. But eligible obligations have several requirements and features:
- The borrower must be a member of the federal credit union in order for the credit union to purchase the loan, unless one the few exceptions specified in the eligible obligation rule is met.
- A credit union can purchase an eligible obligation from any source.
- There is no retention requirement if the credit union sells a portion of the eligible obligation.
- Credit unions can only buy loans that they are eligible to make, and they must have loan policies in place for the type of loans purchased that qualify as eligible obligations.
- The aggregate amount of the unpaid balance of eligible obligations purchased by a credit union can’t exceed 5% of the credit union’s unimpaired capital and surplus.
During the COVID-19 pandemic, the NCUA Board temporarily suspended limitations on the eligible obligations that a federal credit union may purchase and hold, effective through December 31, 2021.
This relief applies to any eligible obligations acquired through 2021. The limitations associated with eligible obligations will only begin applying to loans purchased on or after January 1, 2022 (unless the suspension is extended by the NCUA).
Loan participations and eligible obligations allow credit unions to diversify their loan portfolios, improve earnings, generate loan growth, and manage liquidity. Managing balance sheets has been especially challenging recently with high deposit growth and stagnant direct lending performance. Understanding the difference between the loan participation and eligible obligation rules allows credit unions to tap the tools they need to deploy capital and benefit from available high-yield indirect programs.