In some loan participation agreements, the participation agreement provides for the allocation of loan payments on some basis other than in proportion to ownership interest. For example, principal payments may be applied first to the participant’s ownership interest and all remaining payments to the lead bank’s ownership interest. In these instances, the participation agreement must also specify that in case of loan default, participants will share in all subsequent payments and collections in proportion to their respective ownership interest at the time of default. Without such a provision, the banks would not have a pro-rata sharing of credit risk. Provided the sales criteria contained in FAS 140 are met, loan participations sold in which the participation agreements provide for the allocation of loan payments, absent default, on some basis other than proportional ownership interests, may be treated as sold and removed from the balance sheet for financial reporting purposes.
However, if the participation agreements do not also contain a provision requiring that all payments and collections received subsequent to default be allocated based on ownership interests in the loan as of the date of default, those participations will be treated as loans sold with recourse for risk-based capital purposes regardless of the financial reporting treatment. Further discussion of loans sold with recourse is contained in the Sales of Assets for Risk-Based Capital Purposes entry in the glossary of the Call Report Instructions. Participations Between Affiliated Institutions – Examiners should ascertain that banks do norelax their credit standards when dealing with affiliated institutions and that participation loans between affiliated institutions are in compliance with Section 23A of the Federal Reserve Act.
The Federal Reserve Board Staff has interpreted that the purchase of a participation loan from an affiliate is exempt from Section 23A provided that the commitment to purchase is obtained by the affiliate before the loan is consummated by the affiliate, and the decision to participate is based upon the bank’s independent evaluation of the creditworthiness of the loan. If these criteria are not strictly met, the loan participation could be subject to the qualitative and/or quantitative restrictions of Section 23A. Refer to the Related Organizations Section of this Manual which describes transactions with affiliates. Sales of 100 Percent Loan Participations – In some cases, depository institutions structure loan originations and participations with the intention of selling off 100 percent of the underlying loan amount.
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