At one time in your life, you may have considered going in together with a few friends on the purchase of a boat or a mountain cabin. There is most certainly power in numbers where there is money involved.
The introduction of mutual funds and Real Estate Investment Trusts and other ventures in investing have resulted from the popular practice of pooling investment dollars. Participation loans follow the same concept, only the investment at hand is a credit facility.
In a generic sense, the term participation loan refers to three different types of partnerships that involve loans. A lender can partner with the borrower and take an ownership stake in the project being financed; a group of lenders can become partners and together they will jointly fulfill the debt needs of one borrower; or a group of owners can join forces to borrow the funds.
To reduce any risk involved in borrowing and to increase their purchasing power, borrowers team up. Each partner included in the project will be an individual borrower or mortgagee of the loan, when is is being financed. In these types of circumstances, the lender will usually make it a requirement that each borrower be individually given the responsibility for the entire amount of the loan.
A borrower and a lender most often participate together in commercial real estate mortgages. Offered by the lender, the borrower will have more attractive loan terms to be exchanged with a share of the proceeds when the property is sold. If the mortgage is funding the purchase of undeveloped commercial property, which may later be developed and sold for profit, the lender may ask for a participation arrangement.
Participation among lenders is a common practice in the realm of commercial business lending. There may be a number of reasons that a lender would want to team up with those who compete with them, but it can all be attributed to the need to diversify investments and avoid risk. Lenders manage their loan portfolios as carefully as investors manage their investments.
A lender’s diversification strategy may be easily upset by a large credit facility, but the lender may recruit partner lenders to help share the risk. The other side of the story is that a lender with small capital assets could have difficulty lending out enough to keep its loans diversified. This lender will be allowed to diversify through participation by taking small shares in various credit facilities.
In a participation arrangement, the customer’s primary point of contact is the originating lender, who also is called the lead bank. At the time of the proposal and negotiation phase, the lender usually informs the customer of it’s intention to bring in partner lenders.
The short of the story is, borrowers and lenders both are often open to new partnerships that will help them reduce their risks. Just as you wouldn’t have considered buying that boat or cabin completely on your own, many financing transactions wouldn’t be possible without participation arrangements.
More of Alisdair Cosgrove’s articles are available at Glitec Finance which also offers great personal unsecured loans and debt consolidation loans.
