Participation

What does it mean

A Participation is an agreement between two banks where one bank (called the lead bank because they are the bank in charge of the transaction and who has direct communication with the borrower) agrees to sell a portion of the loan to another bank.  In this scenario, the two banks are jointly funding the transaction.  The lead bank typically provides all day-to-day servicing of the loan (collect payments, obtain documents, etc), and in exchange for these actions, the lead bank keeps a servicing fee (typically 0.25%) of the participating bank’s interest rate as compensation for providing these services.  

Why does it matter

A loan can be participated for a variety of reasons, and a banker should be aware of these potential reasons so they can identify potential deals that may need a participant’s help in order to close:

1. Lower Credit Risk - Sometimes a bank would be willing to take on a higher risk loan if the loan balance were lower
2. Stay under Legal Lending Limit - Banks have legal lending limits they must abide by which is the limit to how many dollars can be lent to any one individual/business.  A participation is one option for how to stay under this number while still serving your customer.
3. Amplify lead bank effective interest rate - This one is a little harder to explain, but typically the lead bank retains a servicing fee out of the participant bank’s interest rate.  This servicing gets added to the lead bank’s interest rate which then effectively increases the overall yield of the lead bank.  If the lead bank participates out a majority of the transaction, this servicing fee can raise the lead bank’s rate quite a bit, and by doing so, the lead bank may be able to fund a lower rate to the customer by essentially using another bank’s cost of funds.

Other Relevant Terms

• Loan Structure
• Return to Terminology Library