loan participations | market update

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Loan Participations | Market UpdateJeff Miller

Managing [email protected] | 908-313-8614

www.loan-street.comOctober 23, 2018

Patent Pending. LoanStreet is a registered trademark of LoanStreet Inc.

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LoanStreet is an innovative loan participation platform that enables institutions of all sizes to cost-effectively participate loans in a regulatory-compliant manner.

Jeff has been working with Credit Unions for over 25 years both as an investment advisor and for the past 18 years as a loan participation specialist.

Prior to joining LoanStreet, Jeff ran the participation department for First Jersey CU via FJ Financial Group, a CUSO of FJCU. Jeff also co-founded Paragon Financial Group LLC (PFG), a CUSO owned by Paragon Federal Credit Union.

PFG was a pioneer in the CU loan participation field in the late 90’s and helped usher in a new ‘investment option’ for CUs.

Background


NCUA participation requirements Primary Regulation

• Section 701.22 (“Loan Participations”) governs loan participations by credit unions for both the originating lender and purchaser. http://goo.gl/66YHmy.

Examination Manual• Examiner’s Guide (“Participation Loans”) on pages 10A-34, 35.

http://goo.gl/LWZKlu. NCUA Letter to Credit Unions 08-CU-26

• Supervisory Letter & Exam Questionnaire. http://goo.gl/fyPLARNCUA Legal Opinion Letter 18-0133

• Treatment of Individual Loans https://www.ncua.gov/regulation-supervision/Pages/rules/legal-opinions/2018/loan-participation.pdf

3Patent Pending. LoanStreet is a registered trademark of LoanStreet Inc.

http://goo.gl/66YHmy

http://goo.gl/LWZKlu

http://goo.gl/fyPLAR

https://www.ncua.gov/regulation-supervision/Pages/rules/legal-opinions/2018/loan-participation.pdf

General Regulatory Requirements

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Loan Participation

Policy

Written policy for participations

Policy must be approved by the Board

Covers underwriting standards, permissible loans, limits on aggregate purchases


General Regulatory Requirements

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Written Participation Agreement

May be incorporated by reference into a master agreement

Must be properly authorized & executed by all parties

Must retain a copy of the agreement

Must include: Identification of loans sold Originator’s retained interest Custodian of loan documents Access to financial and performance info Duties and responsibilities of servicer Replacement of servicer


Conduct ALM analysis as appropriate

Conduct appropriate diligence based on size/complexity of the participation purchased

For example:

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Due Diligence Process

Seller Diligence• Review loan policies, servicing policies and

repossession procedures• Review historical performance and financial

reports• Become comfortable with reporting

capabilities

Loan Level Diligence• For consumer loans, buyers typically

request a sampling of loan files• For commercial loans and other loans sold

individually, buyers typically request the full loan file for each loan


Most participated types of loansAuto & Auto Lease

Residential Mortgages & Home Equities

Student

Recreational Vehicle (watercraft, 4x4s, motorcycle, campers, mobile homes)

Member business loans (mostly commercial real estate)


Shows estimated yield to the buyer (based on WAL, Price, Servicing, WAC)

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Deal Sheets – Summarize Key Attributes

Identifies loan type & available principal

Provides pricing & servicing fee retained by the seller and weighted average coupon or interest rate (WAC gross & net) for all loans in pool

Set out weighted average original and remaining term for all loans in the pool

Provides additional relevant details about the pool

Shows weighted average credit score across all loans in the pool



Deal Sheets – Data Analysis & Distribution• Interest• Credit Score• LTV• DTI (if available)

• Original term• Remaining term

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Small Credit Unions

Mid-sized Credit Unions

Large Credit Unions


Who benefits from loan participations

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

<$10M $10M< &<$50M

$50M< &<$100M

$100M< &<$500M

$500M &<$1,000M

$1,000M<

Cost of funds / Average Assets

0%2%4%6%8%

10%12%14%

Q4 2013 Q4 2014 Q4 2015 Q4 2016 Q4 2017 Q2 2018

Loan Growth

<$10M $10M< & <$100M $100M< & <$500M $500M<

0%

20%

40%

60%

80%

100%

Q4 2013 Q4 2014 Q4 2015 Q4 2016 Q4 2017 Q2 2018

Loan-to-Share Ratio

<$10M $10M< & <$100M $100M< & <$500M $500M<

• Large CUs growing with higher capital costs• Smaller CUs have significant excess liquidity• Scalable solution benefits everyone

Maximize lending capacity Risk diversification for both parties Better RoE for both parties

Source: NCUA Source: NCUA

Source: NCUA

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Scaled participations benefit everyone


Benefits for sellers

Generate premiums & servicing income

• At a 50 bps spread, every $10mm principal outstanding equals $50,000 servicing income per year

• For every $10mm principal sold, each point of premium equals $100,000 in premium income

• Maintain Origination Pipeline!


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Example: non-interest incomePrestige Community Credit Union ($92 million in assets)

Never sold loans before12 pools sold over 18 months15 buyers in 11 states1 Standard Agreement

No increase in headcount

Increased non-interest income 10%

“Prestige Community was able to maintain its loan origination pipeline, manage its concentration and liquidity risks and earn substantial non-interest income through up-front premiums and servicing fees on the sold pools.” - Sammy Shanafelt, CEO, Prestige Community Credit Union


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Example: non-interest incomeEnbright Credit Union ($67 million in assets)

“We move loan pools through LoanStreet at the rapid rate we need to generate the liquidity to keep our robust indirect lending program open for business.” - Ron Smith, CEO, Enbright Credit Union


Never sold loans before10 pools sold over 21 months19 buyers in 11 states1 Standard Agreement

No increase in headcount

Maintained pipeline

Increased non-interest income 10%

Generate more interest income

• 4 point spread between loans to investments

• Every $10mm in principal purchased equals $400,000 in additional interest income


Benefits for Buyers

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Example: Increase loan-to-share ratioPriorityONE Credit Union of Florida ($91 million in assets)

“while we were very successful adding HELOC’s and mortgages to our balance sheet, we needed some additional car loans to fine-tune our portfolio mix. We determined that we could increase our loan income and Return on Assets by purchasing auto loans.”

- Nancy Rappaport, CEO, PriorityONE Credit Union of Florida


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Example: Increase loan-to-share ratioNewport News Municipal Employees ($40 million in assets)


56%

59%

62%

66%

69%

57%

50%

55%

60%

65%

70%

75%

Q1 '17 Q2 '17 Q3 '17 Q4 '17 Q1 '18

Loan to Share Ratio

Newport News Credit Unions $10M-$50M

“Originating loans has been a major problem for us over the last few years. Buying loan participations has become an important element of our strategy for growing our loan to share ratio.”

- Mike Popadiuk, Finance Manager

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Reporting – Portfolio Status & Performance

Reports should show:

• Performance status• Defaults • Collateral breakdown• Principal held• Accrued & unpaid interest

Patent Pending. LoanStreet is a registered trademark of LoanStreet LLC.


Reporting – Distribution Summary

Distribution Summary Reports show distributions during the period by pool


Reporting – Loan Level & Payment LevelLoan Level & Payment Level Distribution Reports provide a detailed analysis of all cash flows, including waterfall over time for principal, interest, fees and recoveries or other proceeds

In March NCUA’s General Counsel issued a new opinion on participations

Important considerations Loan participation regulation must be met throughout life of the transaction

Each loan must be identified & treated independently

Common pitfalls for CUs Calculation and collection of servicing fees

“Netting” advances for CPI or other outlays

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NEW NCUA Opinion on Participations


Common method of calculating servicing fees

These methods are prone to errors when there are no payments in a month or multiple payments in a month

The “net interest” ratio is calculated on actual interest received

Ensures accurate calculation of servicing fees

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The Net Interest Ratio or “Golden Ratio”

Beginning Balance * (Servicing Spread / Periods Per Year)

(Servicing Spread / Interest Rate) * Interest Received✔

✗


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Common Errors – Example 1

Start Month 1Full (100%) Principal Outstanding $11,111.11 $10,901.53 Buyer's (90%) Principal Outstanding $10,000.00 $9,811.37 Buyer's Principal Received $188.63 Buyer's Interest Received $41.67

DifferenceSeller’s Servicing Fee $4.63 Passthrough rate to buyer 4.44% - 0.056%

Net Interest Ratio Servicing $4.17 Net Interest Ratio Passthrough to buyer 4.50% 0.000%

100% vs 90% Servicing Fee

Calculating servicing spread on 100% of balance rather than 90% pro-rata ownership results in 5.6 bps more servicing spread earned by the seller

Interest Rate 5.00%Servicing Spread 0.50%Contractual Passthrough 4.50%

Periods per year 12Total periods 48Ownership 90%

Loan Details


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Unscheduled 2nd Payment

Calculating servicing spread on balance results in the seller earning 24.8 bps less servicing spread

Interest Rate 5.00%Servicing Spread 0.50%Contractual Passthrough 4.50%

Periods per year 12Total periods 48Ownership 90%

Loan Details

StartMonth 1 Regular

PaymentMonth 1 Unscheduled

PaymentBuyer's Principal Outstanding $10,000.00 $9,811.37 $9,621.96 Buyer's Principal Received $188.63 $189.41 Buyer's Interest Received $41.67 $37.63

Total / Weighted Average (single

month) DifferenceSeller’s Servicing Fee $4.17 $- $4.17 Passthrough rate to buyer 4.50% 5.00% 4.7476% 0.248%

Net Interest Ratio Servicing $4.17 $3.76 $7.93 Net Interest Ratio Passthrough to buyer 4.50% 4.50% 4.5000% 0.000%


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Improper Netting of CPI Advances

Loan 1 Loan 2Beginning Balance $20,000 $40,000Participant’s Balance $18,000 $36,000Participant Ownership 90.0% 90.0%

Loan DetailsLoan 1 Loan 2

Interest Rate 6.00% 4.00%Servicing Spread 0.25% 0.25%Passthrough Rate 5.75% 3.75%

Loan 1 Loan 2 TotalPrincipal (Participant Share) $332.73 $692.85 $1,025.58 Gross Interest (Participant Share) $90.00 $120.00 $210.00Servicing Fee Deducted $3.75 $7.50 $11.25Net Interest (Participant Share) $86.25 $112.50 $198.75 CPI Applied (Participant Share) ($900.00) $0.00 ($900.00)


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Common Errors – Example 3 (continued)

Improper Netting of CPI Advances

Loan 1 Loan 2Beginning Balance $20,000 $40,000Participant’s Balance $18,000 $36,000Participant Ownership 90.0% 90.0%

Loan DetailsLoan 1 Loan 2

Interest Rate 6.00% 4.00%Servicing Spread 0.25% 0.25%Passthrough Rate 5.75% 3.75%

Loan 1 Loan 2 TotalA/R Increase (P & I paid) $418.98 $805.35 $1,224.33A/P Increase (from CPI purchased) $900.00 $0.00 $900.00End of Month Balances & DistributionsCash Received ($481.02) $805.35 $324.33A/P Balance $0.00 $0.00 $0.00

Proper Results (A/P Table)Cash Received $0.00 $805.35 $805.35A/P Balance $481.02 $0.00 $481.02


Key Take-aways

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Loan level vs payment level detail (ask for and get payment level!)

No servicing fees applied to loans without payment

Calculation of servicing fees using net interest ratio

Look for accounts payable / receivable information on advances


[email protected] | www.loan-street.com

For More Information

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Appendix A – Glossary of termsABS (Absolute Prepayment Speed): a prepayment model that calculates prepayments on a loan as a monthly percentage of the original loan balance. This model is commonly used for auto, truck and recreational vehicle loans.

Coupon or Rate: the interest rate on the loan paid by the borrower, expressed as a percentage rate per annum.

CPR (Constant Prepayment Rate): a prepayment model that calculates prepayments as a percentage of the current loan balance. This model is commonly used for real estate loans and student loans.

DTI Ratio: generally, the ratio of the monthly debt service, interest plus principal (from either the applicable loan obligation or all known obligations), to the borrower’s monthly gross income.

Gross WAC: the WAC before deducting the Servicing Spread charged by the originating lender.

LTV Ratio: generally, the ratio of the original loan balance over the original collateral value. LTV can also be expressed as current balance over the most recent collateral value.

Net WAC: the WAC after deducting the Servicing Spread charged by the originating lender.

Prepayment Model: an algorithm used to determine the rate at which a loan or pool of loans will prepay or repay prior to the maturity date.

Price: the cost as a percentage of par value of the loans to be purchased. For example, a price of 101 means that for every $100 of principal purchased the buyer must pay $101, not including accrued but unpaid interest.

Servicing Retained: means that the originating lender continues to service the loan, including collection of payments.

Servicing Spread or Servicing Fee: the fee charged by the originating lender for servicing the loan. The Servicing Fee is typically paid by reducing the Coupon passed on to the participation purchaser (the Net WAC). For example, a 25 basis point Servicing Spread for a pool with 3% Gross WAC means the buyer receives 2.75% Net WAC and the seller keeps the remaining 0.25%.

Term: the period of time from the loan’s origination

date to maturity date.Weighted Average (WA): is the average of some set of values calculated by giving weight to certain values based on some attribute of the data set. For example, loan pools typically weight averages by principal outstanding. In the context of this memorandum, consumer loan weighted averages are determined by “weighting” loans by giving weight to an individual loan by measuring the current principal outstanding of the loan as a percentage of the total principal outstanding in the pool.

WAC: the Weighted Average Coupon for all loans in the pool, determined by reference to the weight of the current principal balance of each loan in the pool as a percentage of the total principal.

Weighted Average Life or WAL: the estimate of the time it will take for the average dollar of principal in the pool to be paid in full. This estimate takes into account the contractual term of the loans in the pool, adjusted for the assumed rate of prepayments. (see “Prepayment Model” above)


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Appendix B – Sample deal sheet


loan participations | market update

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