FDIC Recommends Best Practices for Participation Lending

October 3, 2012 at 7:02 pm Leave a comment

On September 12, 2012, the Federal Deposit Insurance Corporation (FDIC) issued an advisory letter reminding institutions of “the importance of underwriting and administering loan participations in the same diligent manner as if they were being directly originated by the purchasing institution.” The FDIC outlined certain best practices for institutions to follow when engaging in participation lending and warned that failing to follow these procedures has exposed institutions to excessive risk and “contributed to bank failures, particularly for loans to out-of-territory borrowers and obligors involved in industries unfamiliar to the bank.

To minimize safety and soundness concerns arising from participation lending, the FDIC recommends that institutions implement the following best practices:

1. An institution should require that loan participations meet the same underwriting, documentation, and compliance standards that the institution applies to loans it originates.

2. An institution needs well-defined policies and procedures in place for its participation lending. These policies and procedures should require the institution to (i) perform due diligence on the borrower at origination and continued due diligence on the borrower during the life of the participation, and (ii) limit the total volume of participations and exposure to certain high risk participations.

3. A written loan participation agreement should, among other things, fully explain (i) the rights and responsibilities of the lead institution, (ii) the procedures to make the borrower’s credit information available in a timely manner, (iii) the remedies available in the event of the borrower’s default, and (iv) the dispute resolution mechanisms.

4. Management should be vigilant of the risks associated with, and conduct thorough due diligence on, “participations involving an out-of-territory loan or credit facility to a borrower in an unfamiliar industry.”

Read the full text of the FDIC’s advisory letter here.

Why this matters:

FDIC-supervised institutions should review their current policies and procedures used when originating and purchasing loan participations and implement best practices to ensure that their lending operations are conducted in a safe-and-sound manner. Even for banks that are not supervised by the FDIC, the advisory letter offers insight into the expectations of bank regulators on managing credit risk.

Entry filed under: Uncategorized.

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