Loan participations can be a valuable tool for both buyers and sellers to actively manage their balance sheets. This is particularly true as investment yields remain at historically low levels and credit unions experience varying loan demand from different fields of membership.
In this QA, Kevin Kesecker, vice president and chief lending officer for SECU of Maryland ($2.9B, Linthicum, MD), discusses what loan participation buyers should look for in general and the extensive due diligence process the SECU of Maryland employs in its own participation program.
Why does the credit union buy loan participations?
Kevin Kesecker: The asset quality attracted us to the consumer participations. We’ve acquired both commercial and consumer loans but have focused more on the consumer side recently. And, of course, the higher yield as it compares to a comparable investment option is a primary driver for us.
YIELDS ON INVESTMENTS AND LOANS
FOR SECU OF MARYLAND | DATA AS OF 09.30.15
Callahan Associates | www.creditunions.com
SECU of MDYield On InvestmentsYield On Loans
| September 2015 | September 2014 | Change |
|---|---|---|
| 1.11% | 1.48% | 33.19% |
| 4.23% | 4.07% | -3.97% |
Source: Callahan Associates.
How do you find sellers?
KK: Most of the sellers have been brought to us by different brokers we have relationships with, some of whom we use for investments.
What do you look for in a deal?
Kevin Kesecker, VP And CLO, SECU of Maryland
KK: We want to make sure, to the extent possible, that the pool is similar to the types of loans we’d originate for our own members. This means the pool is similar from an overall credit quality standpoint to what we would originate internally.
Diversification is also attractive to us. We’re a state-chartered, SEG-based credit union, so a lot of our loans are concentrated based on where our members work. We look for pools to give us geographic and industry diversity.
How do you analyze the deals?
KK: We analyze the deals internally, beginning with our investment area evaluating the expected net return versus a comparable investment. They will use outside tools such as Bloomberg to help them accomplish this.
CU QUICK FACTS
SECU Of Maryland
Data as of 09.30.15
HQ: Linthicum, MD
ASSETS: $2.9B
MEMBERS: 234,364
BRANCHES: 22
12-MO SHARE GROWTH: 5.2%
12-MO LOAN GROWTH: 13.4%
ROA: 0.58%
After that initial step, I or someone else on the lending team will review the credit quality of the pool. We look at the weighted average credit score, weighted average maturity, and collateral in the case of autos and mortgages. These are the basic steps for an initial, high-level analysis to help us communicate to the seller whether we have an interest in moving forward.
What happens next, if there is an interest?
KK: The next step would be to put together a letter of interest that outlines the terms of our offer and formally expresses our interest in the deal. If we have a competitive bid and the seller accepts our offer, we go into a full-blown, extensive due diligence process.
This includes things like due diligence on the lead originator and checking its financial rating through Bauer Financial. We then use Callahan Associates’ CUAnalyzer tool and pull down data on the credit union. At a minimum we look at the CLO and CFO reports to get an overview of the institution’s overall performance. We’ll also obtain the most recent call report and profile from the NCUA, and we’ll typically go to the credit union’s website to pull down its most recent annual report, including the latest external audit.
In addition, we ask the credit union for a copy of its org chart and any applicable policies and procedures that govern the loans we’re interested in. Depending on the size of the credit union, we might also ask for resumes of key lending personnel.
It’s important to ask for a copy of the master participation agreement early on, as well, so we can begin our legal review, which includes an internal review and a final review by our outside legal counsel.
Watch It On-Demand
Learn more about SECU of Maryland’s loan participation process firsthand from Kevin Kesecker in this Callahan Leadership webinar, What I Want As A Loan Participation Buyer.
What else is involved in the more extensive due diligence process?
KK: Another important aspect of the due diligence is looking at the loan pool itself. We do an extensive sorting process and look for any red flags such as a high number of exceptions being granted or loans that don’t conform to the credit union’s stated policies or what we’ve agreed to accept.
We then select 10-20% of the files to conduct a loan-level review. We have a quality control area here that uses a checklist on each individual loan to review them in more detail and make sure they comply with the originator’s policies and procedures and the data provided to us reflects those terms.
How much time does this process take?
KK: For the average pool, it takes 15-20 hours of time in aggregate. This is split among the finance area, lending, and our outside counsel, so there are typically five to six people involved.
What advice do you have for credit unions that want to get into loan participations?
KK: I recommend taking a hard look at your lending policies and procedures and document well what you will and won’t do.
I recommend taking a hard look at your lending policies and procedures and document well what you will and won’t do.
I also think it’s important to address your concentration risk policies by asset class, meaning, if you’re buying auto loan participations, establish concentration limits for direct, indirect, new, used, etc. You need to be that granular with it so it is clear to the board and the regulators what your program does and does not allow.
It’s also important to be aware of potential red flags such as a high number of exceptions and rapid growth, which might make historical loss ratios or expected prepayment speeds less accurate.