How Loan Participation Can Benefit Credit Unions

Credit unions are built on community and collaboration, so it should come as no surprise that partnership between financial cooperatives remains one of their best avenues for success. And while it might not exactly be common knowledge outside of the industry, more and more credit unions are tapping into the potential of loan participation, a shared loan ownership model, to drive growth for the organizations and their members.

To learn more about loan participation, we spoke with Chief Financial Officer Paul Garrigues and Secondary Market Manager Scott Fehrenkamp, both of whom work closely with Amplify Credit Union’s loan participation investors.

Why Financial Institutions Invest in Loans

Any seasoned credit union leader knows that managing your liquidity is the key to success for any modern credit union. Fail to effectively balance your balance sheet – hold onto too much excess liquidity or struggle with concentration issues within your loan portfolio – and your organization may be leaving profitability on the table.

That is where loan participation comes in. Loan participation allows credit unions like Amplify to share ownership of a loan while retaining the borrower relationship. And unlike in-house loan origination, loan participation makes it easy for credit unions to make investments without wading into regulatory minefields.

“Loan participation is just an investment,” Garrigues explains. “It’s just where a credit union wants to put some money. They can go buy a U.S. Treasury security or a mortgage-backed security, or they can go buy interest in a loan. The only difference is the credit profile.”

For many credit unions, the loan participation model provides access to a market that would otherwise be unavailable to them. These credit unions may not have the ability to originate their own loans or may be limited in terms of staffing or capacity. For these organizations, loan participation offers an alternative route to balancing their books and generating interest income.

“We’ve partnered with 150 investors thus far,” Fehrenkamp adds, “but that’s just a fraction of the credit union market. There are over 4,400 credit unions across the country, and we think participation is a viable option for the vast majority of them.”

Benefits of Investing in Participation Loans

What makes a loan attractive to an investor? A lot of that depends on the investor. With a wide variety of loan types and balance available to their partners, organizations like Amplify will often have various packages meant to appeal to different financial goals. That said, here are four core benefits of participation loans to investors.

Transparent Investments

While investing in other credit unions’ loan products may suggest a lack of control over what you’re purchasing, the opposite is often true. For many credit unions – even ones that actively originate their own loans – participation loans can offer a level of transparency that other investments may not be able to match. This is because investors have a detailed view into what, exactly, it is that they are buying.

“When we get a letter of intent from an investor, our portfolio becomes an open book,” Garrigues says. “They get the documentation. They get collateral information. They see all the borrower information and how we wrote the loans. They get to decide if our underwriting standards are up to snuff – and because our historical delinquency rate is 0.36%, they often decide they like what they see.”

Flexible Loan Balances

Another common misconception is the size of the loans. Loan participation portfolios can be comprised of a wide variety of loan types, from auto loans to home equity loans. But because loan participation is commonly connected to larger loan types – such as jumbo mortgages or commercial real estate loans – many credit unions take themselves out of consideration without having all the details.

“Many credit unions assume they have to have tens of millions of dollars to throw around to be successful investors,” Garrigues says. “That’s just not true. At Amplify, we have partnered with other organizations on participation loans as small as $50,000.”

Flexible Loan Categorization

Another benefit is loan categorization. While there are some rules around loan concentration for investors, loan categorization can also be a strategic factor, not just a regulatory one. For one, investors can choose to participate in loans that their credit union is not structured to originate, which may include residential and/or commercial real estate loans for smaller organizations.

But loan categorization can also allow credit unions to be flexible in markets whose lending demands have shifted. “Many real estate markets across the United States have switched from a seller’s market to a buyer’s market,” explains Fehrenkamp. “If you’re an originator who had been counting on a certain amount of loan production, and that production dries up? Loan participation can offer you an alternate pathway to profitability.”

Stable Investments Despite Rate Volatility

The final factor is interest rate volatility. With the real estate boom of the early 2020s, many credit unions now have mortgages on their books with record-low interest rates, which makes them an unappealing product for investors in a higher rate environment. But some institutions, like Amplify, are very intentional with the types of loans they offer investors.

“Amplify focuses on what we call hybrid ARMs,” Garrigues says. “These are loans that are fixed for a specific period – often five or seven years – and then adjust annually thereafter. These rate adjustments are often very attractive to credit unions who want a longer-term earning asset, but one that comes with less interest rate risk.”

Broker Versus Direct Participation

So how does your institution start investing in loans with organizations like Amplify? In most cases, a credit union will travel down one of two paths. Many investors choose to start their loan participation journey by working with an established broker. These brokers maintain relationships with a wide range of financial institutions and provide their clients with helpful experience in evaluating investment opportunities.

However, more experienced investors may choose to work directly with another credit union. As with any third-party relationship, a direct relationship between credit union and investor can save the organization money, foregoing brokerage fees and allowing financial institutions to use established relationships to meet their revenue targets.

Which is the better approach? Unsurprisingly, it all depends on the needs of your credit union. “If you’re looking to make a major investment, and this is your first time entering the loan participation market, you may benefit from working with a broker,” Fehrenkamp says. “But if you’re focused on year-end profitability and have earmarked a little bit of liquidity to turn into interest income, that’s something we would be able to handle one-on-one with even an inexperienced investor.”

Getting Started with Loan Participation

And just as a lender may spend weeks or even months working with a borrower to prepare them to purchase their first home, the team at Amplify Credit Union believes in the importance of education for education’s sake, often with no strings attached.

“Even taken as a whole, credit unions aren’t so big that we can afford to be territorial,” Garrigues says. “Our team has decades of industry experience across organizations of many different sizes – sometimes as buyers, often as sellers. If someone just needs to bounce some loan participation questions off us before, say, putting together a proposal for their board, that’s a call we’re happy to take.”

“In the long run, smarter investors make for a healthier industry,” Fehrenkamp adds. “If we help someone get their feet under them, another active investor only boosts the health of the loan participation market.”