Community Banks Slowly Warming Up to Loan Participations

Loan participations are poised for a comeback as community banks look at ways to keep the business of growing clients.

Small banks have plenty of challenges as they try to book loans, including artificially low interest rates and deleveraging by some borrowers. So community bankers could be slowly warming up to sharing loans, if it means keeping clients away from larger competitors.

"Every community bank eventually has a client that outgrows them, and they lose the relationship, the deposits, everything," says Lee Sachs, chairman and chief executive at BancAlliance.

BancAlliance is one of several firms, including BancVue, StoneCastle Partners (BANX) and Promontory Interfinancial Network that arrange loan participations. BancAlliance, which typically brings loans to its members, said last week that it had underwritten and closed on its first loan referral from a member.

The referral came from West Gate Bank in Lincoln, Neb., which faced the danger of losing a long-time customer. The client, a software developer that had been with West Gate since the late 1990s, was selling itself and the buyers needed to borrow nearly $33 million, backed by future cash flow, for the deal. The amount was beyond the bank's lending limit.

"Normally, you would expect a deal like this to go to one of the larger banks," says John Arrigo, a senior vice president at the $373 million-asset bank. "But we wanted to play a role … to keep the customer and not have to say, ‘We can't handle it.'"

West Gate brought the loan to BancAlliance, which began soliciting loans from members last year. The referral system — designed to give small banks a way to keep key clients and collect fees — is a key component of BancAlliance's game plan.

"We were able to maintain the deposits of the seller and the new entity … and we got a large referral fee from bank alliance," Arrigo says. "We're able to keep a good relationship with the customer, and it helps us get over that hurdle of competing with the biggest banks."

BancAlliance has about 160 members, most of them banks with $200 million to $10 billion in assets. The banks pay asset-management fees to the Chevy Chase, Md., company to participate in loans. BancAlliance keeps at least 2% of the loans it originates; since its founding in 2011, it has originated about $1 billion in loans.

Loan participations have been rebounding in recent years. Nationwide, shared loans increased by 8% in 2013 from a year earlier, to $3 trillion, according to the latest report on shared credits from banking regulators.

Shared loans offer small banks a chance to book loans during periods of low demand, while adding diversity in terms of loan type and geography. But banks that join in loan participations must be cautious, says Keith Leggett, senior economist at the American Bankers Association.

"In the years before the financial crisis, we saw some lax underwriting, and some community banks got burnt by participating in these loans," Leggett says. "Community banks need to maintain their own underwriting of these loans [and] their own standards, instead of relying on the due diligence of the arranger."

Before BancAlliance began accepting member referrals, it wanted to reach a size where it could close the loan even if few participated, Sachs says. It reached that point last year, after gaining new members and raising capital from its original investors, BlackRock (BLK) and BlueMountain Capital.

Arrigo and Sachs would not disclose the size of West Gate's referral fee. Sachs says the network plans to pay referral fees for future loans brought in by members, but there is no formula for determining a fee's size.

BancAlliance has no other member-referred loans in the pipeline, though Sachs says the company is evaluating other loan referrals from members.

"One of the reasons we set up BancAlliance was to help our member banks compete with some of their larger brethren," Sachs says. "This is the first of these, and we certainly hope there are more to come."