This post was written by Reed Smith lawyers Susan Alker and Abbey Mansfield.

If you are involved in the syndicated loan market – or if you buy risk participations from other lenders – you’ll want to know about this.  The FDIC recently sent out guidance on the topic of loan participations, reminding financial institutions of the importance of properly managing loan participations.  Of direct concern are underwriting and administration procedures, with the FDIC warning against relying too much on the lead institution in these types of transactions.

In a letter dated September 12, 2012, the FDIC made clear that it expects financial institutions to be exercising “sound judgment” and “strong underwriting” when originating and purchasing loan participations.  Specifically, the FDIC recommended:

  • Have effective loan policy guidelines.  The institution should have a loan policy that outlines procedures for participations.  The policy should require thorough due diligence at origination and over the life of the loan.  The policy should require assessment of the purchasing bank’s contractual rights and obligations.
  • Use a written participation agreement.  The participation should be documented in writing, and should include a full description of lead bank’s responsibilities, requirements for obtaining timely information about the borrower, and establish remedies upon default.  Dispute resolution procedures are also helpful.  Most standard participation agreements include these types of provisions already.
  • Perform your own credit and collateral analysis.  You should perform an independent credit and collateral analysis in the same manner as if you had originated the loan — a thorough and complete job.
  • Be careful.  Certain types of participations involve increased risk.  For example, when purchasing a participation involving an out-of-territory borrower or a borrower in an unfamiliar industry, you’ll want to exercise extra caution and perform extensive due diligence.  Ensure at the time of purchase of the participation — and during the life of the loan — that you carefully monitor the status of the borrower, the sources of repayment, market conditions, and potential vulnerabilities that might affect the credit.