In looking for new ways to fund loan origination activity, credit union executives have increasingly set their sights on loan participations. The economics of loan participations appeal to sellers, who enjoy a meaningful gain on sale for selling their direct loan portfolios or working with a fintech partner to originate indirect loans and selling a portion as participations. A consistent program of loan participations can introduce regular fee income and be a welcome tool for ongoing balance sheet management.
However, getting buy-in from executive leadership can sometimes be a challenge. These leaders may not understand how loan participations work or why their financial institution should consider them as a strategic opportunity. They may even incorrectly assume that the unique structure of loan participations makes them too onerous for their particular credit union.
The good news is that CLOs and CFOs who are considering originating loans for participation sales can counter those objections with sound reasoning. Below are three common challenges objections credit union leadership teams might have about selling loan participations and how to overcome them.
Objection #1: The administrative burden is too big
Loan participations have historically been bespoke, one-off transactions that require administrative resources from selling credit unions to facilitate each sale. This often includes sourcing buyers, facilitating manual due diligence across parties, and providing ongoing reporting and payment remittance. For some credit unions, this administrative burden has been a barrier to selling loan participations altogether, while others are limited in the volume they can sell each month because they don’t have the capacity to support more than a couple of buyers.
The rise in popularity of marketplace and fintech originators has created increased opportunity for credit unions to originate indirect loans while technology advancements, including ALIRO, have helped reduce the administrative burden of selling loan participations. Credit unions with strong production in a specific asset class may look to sell their inhouse loan portfolios while others may work with a marketplace lender to originate and sell indirect loan participations. Finding the right partner to help facilitate loan sales can make loan participations a more attractive option for credit unions. For example, ALIRO’s forward flow participation model helps reduce the due diligence and reporting burden for credit unions, particularly for recurring loan sales where each transaction structure is a replica of the last. Credit unions can also lean on third-party servicers for these indirect loans to further reduce the administrative burden.
Objection #2: We don’t want to enter a new asset class with non-members
Credit unions have a high degree of comfort lending to their members. They may also be comfortable lending to non-members through indirect programs, but only in asset classes with which they have a lot of experience and expertise. Combining two unknowns––non-members and a new asset class––may feel too risky for credit unions considering loan participations.
Loan participations, however, can be an excellent way to test-drive a new asset class with reduced risk, since sellers can participate out as much as 90% of the loans.
Selling loan participations also allows credit unions to sample new asset classes for which there’s low organic demand in their geographic location. Credit unions in northern states, for example, may not be able to generate substantial volume on their own for solar loans. Partnering with a fintech that specializes in solar lending to sell loan participations gives them access to a new asset class in a relatively low-risk way, because once again, they’re only holding 10% of the outstanding loan balance.
Another option for credit unions is to start with an asset class with which they are already familiar. A credit union with a successful second mortgage business for example, may find comfort in originating and selling home improvement loans before moving into less familiar asset classes, thus eliminating one of the uncertainties.
Finally, by bringing in new borrowers who aren’t members today, credit unions can take advantage of potential cross-selling opportunities for an even more profitable relationship.
Objection #3: We already do loan participations — why should we pay for a loan participation platform?
Credit unions that are already doing loan participations or other indirect lending programs may wonder why they would pay for a platform like ALIRO. What they may not realize is that they can gain significant efficiencies and scale by having a platform do the heavy lifting for them.
For example, participations have historically been managed through a broker or directly between institutions, with credit unions limited to a small, fractured group of potential buyers—each with their own idiosyncratic processes and paperwork. Selling to even three other institutions under these conditions can be onerous and even risky, given the fact that a buyer could walk away at any time.
ALIRO has solved both the scale and efficiency problems of traditional participations. For one thing, credit unions on the ALIRO platform can reach a much larger number of prospective buyers than if they were to sell participations on their own. Further, sellers benefit from ALIRO’s forward flow, a structure that gives sellers a regular cadence of guaranteed loan purchases by trade-ready buyers.
And with ALIRO, asset sellers aren’t responsible for monthly reporting, processing the movement of funds, or keeping track of every sale separately, with a different set of buyers and different levels of purchase commitment each month. In addition, ALIRO handles record retention so that buyers can access due diligence materials and records all in one place, which means sellers spend less time providing documentation to them.
Because ALIRO relieves team members from having to spend time managing these administrative burdens, staff time can be redeployed to more productive, revenue-generating activities when they aren’t burdened with remitting payments, performing due diligence, and conducting monthly reporting.
Selling loan participations has never been easier
Today, technological innovations have removed the historical friction and costs associated with loan participations to make these programs easy to implement and scale. Credit unions that understand these advantages have an opportunity to expand into new asset classes, diversify their balance sheet, and benefit from gain on sale with a lower administrative burden.