With BancAlliance loan participation program, community banks can decide when—and if—to take a loan slice. They can also decide how big a slice and the kind of pie it'll be sliced from.
Art Johnson grew tired of loan participation indigestion.
"We are definitely a bank that has not liked the traditional loan participation model," says Johnson, chairman and CEO at $465 million-assets United Bank of Michigan, Grand Rapids.
Historically the bank had not done many participations--and with understandable reason. Of those that the bank had done, "all of them eventually had a ‘story' behind them," says Johnson.
Besides such complications, Johnson grew to dislike the way lead banks ran the loans, feeling his own institution had little say in the deals and their ongoing management. Besides an element of unfairness, and definite lack of control, Johnson says he felt these deals, in the end, brought his bank few opportunities that it couldn't have found in some form in its own vicinity.
"We were just funding somebody else's loan," says Johnson, "not really getting anything that we couldn't do for ourselves."
|Banker Art Johnson hadn't had good experiences with loan participations in the past, and found the typical process weighted against community bank participants.|
Johnson isn't the only banker who has had issues with participations. During the financial crisis, some community bankers who had taken participations had their own reasons for disliking such loans. When banking institutions running the deals went under, FDIC took over the credits and frequently sold them for a fraction of their value, in an effort to recoup money to avoid laying out Deposit Insurance Fund money. Thus these bankers, too, had a bad taste in their mouths from participations.
Acknowledging the industry history and his past experience, Johnson reflects that his bank now participates in nine outside loans. The bank not only would entertain more, but has set up participations as its own business line.
What accounts for the change of heart is a new twist on participations.
Cooperative approach to lending
About a year ago, as Johnson felt a greater need to diversify and find additional loans beyond what his market demanded, he found himself looking at participation programs again. Among the opportunities he found was the BancAlliance loan network.
The new venture's approach is much different from anything else Johnson reviewed. He says the company's "cooperative loan program" features a pay-as-you-go deal and fee structure. The program requires no upfront investment, and operates under the direction of a board dominated by banker-members. The program's flexibility provides an asset-side match to the greater funding flexibility community banks enjoy today, says Johnson.
Johnson's bank began buying participations of up to $1 million per deal through the program about nine months ago, and early on in his involvement, he thought enough of the approach that he agreed to join the BancAlliance member board. (The related article following this one, detailing the cooperative's approach, addresses how BancAlliance has arranged backup servicing for its deals.)
Unlike other opportunities he'd tried or at least evaluated, the BancAlliance program gave his bank the opportunity to buy into much larger deals than had been available in the past, many with middle-market companies. In addition, the program enables members to pick and choose among participation opportunities. Until a bank decides to get on board with a loan, there's no cost.
Loans range in size from $75 million to $300 million, according to Lori Bettinger, executive vice-president and managing director at BancAlliance. Members choose how extensively they wish to participate, governed by the parameters set by their own managements as well as the guidelines set by their own boards of directors.
Johnson, for instance, thus far, has participated in the $1 million blocks, and his bank at this point has set its total use of the program at up to $30 million, based on appetite and capital levels. Other banks have their own standards. For instance, Charles Cullen, president and CEO at $576.7 million-assets The Provident Bank, Amesbury, Mass., also buys in $1 million units per deal, while Leslie Andersen, president and CEO at $61 million-assets Bennington (Neb.) Bank, holds her bank's individual purchases to $500,000.
In Cullen's case, the program has helped facilitate an institutional gear shift towards more C&I lending, away from a heavy reliance on commercial real estate credit. Plus he had a need to grow further to absorb increasing costs. "Lending is the best return we can get right now," says Cullen.
Johnson points out that these slices are much smaller than what some other participation opportunities he's seen make available. A barrier for his bank in the past was the sheer size of what some lead banks wanted each participant to take.
"You had to take a $10-$15 million piece of the credit to play," says Johnson.
Diversification by industry and geography represents a key element of participating in BancAlliance deals, but that's not all these banks gained by joining the cooperative. A common interest the bankers share is in obtaining variable-rate loans through BancAlliance. It's harder to obtain floating rate loans locally, they point out.
"From an interest-rate perspective, this is really helping us out," says Bennington Bank's Andersen.
In addition, participating in these loans gives the banks the opportunity to work with larger companies' credit needs, Andersen points out. And because BancAlliance is not a lender in its own right, a common concern about participating in loans with a company that could be a competitor on some occasions isn't a factor.
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When a member bank opts into a deal, fees kick in. They vary according to the returns promised, and range from 75-150 basis points.
A measure of the returns to participating banks came from Cullen, speaking at an ABA conference session about the program.
"My CFO told me I shouldn't come here," says Cullen, "because he thought that we should be holding onto this for ourselves." His bank has been in on 16 deals, two of which have already paid off. Currently his bank holds nearly $12 million in BancAlliance participations.
"The rates and returns are much better than what we are experiencing locally," Cullen adds.
Credit underwriting, central and local
All three bankers speak highly of the BancAlliance underwriting process. They say the quality of the organization's work gives them a high comfort level, which also helps give their directors confidence in continuing with the program.
Andersen adds that she's found the loan packages' quality so exemplary that she's circulated the work among her staff as a training aid.
While there's comfort for the bankers in the cooperative's underwriting quality, regulators expect individual lenders to do their own analysis and due diligence, the bankers point out. Johnson says that his institution looked closely at FDIC's guidance on participations. This came in Financial Institution Letter 38-2012, "Effective Credit Risk Management Practices for Purchased Loan Participations," issued last September. A key point of the guidance is a warning against over-reliance on the credit analysis of the organization underlying the participation.
"That was very timely," says Johnson, "and we followed the map."
"You can't just take the BancAlliance writeups and shove it in the file," says Cullen. "You have to show that you've done your own due diligence as well. It's still basic lending-you look at it the same way you look at everything else."
Johnson says there is an adjustment process in taking participations. "We're very used to being able to go out and kick the tires," says Johnson, visiting a borrower's operations to be sure all that's on paper matches reality. But the extensive files available to members buying into a loan, plus ongoing reporting and monitoring that's shared, helped overcome such concerns.
"You've got to get comfortable with the fact that you are lending, say, in South Dakota," says Cullen, "not lending to the guy you always see at Rotary."
Andersen compares the participations to investing in a corporate bond, with the advantage that the program puts member banks in a senior credit position.
Floyd Stoner, senior advisor to Alliance Partners, which runs the program for BancAlliance, says that about a dozen member banks have been through examinations since they began participating with the cooperative. Other than questions about the concept, where the bank hadn't explicitly run it by their agency first, no serious issues have been raised. "That's the track record so far," says Stoner.
BancAlliance: a different take on loan participations
System gives participation buyers a say in deals from the get-go
Community banks have had the opportunity to buy into other lenders' credits for decades. Sometimes this may be as informal as cooperating with another community bank in-market or in a nearby market in a deal too large for either player. Large banks also sell participations to smaller ones, and bankers' banks sell participations to their members. Brokers sell participations in pending and existing deals. And specialized firms like Promontory Interfinancial Network's Bank Assetpoint (an ABA endorsee) facilitate markets where participations can be purchased.
What sets the BancAlliance program apart is that the organization operates as a cooperative venture, incorporating member decision-making and preferences before one dollar is lent. The process begins with upfront deal screening, in which a good 95% of potential opportunities fall out, according to Lori Bettinger, executive vice-president and managing director.
Loans aren't made under the BancAlliance program unless sufficient members indicate interest in participating and stand ready to put up money for their "slice," says Lori Bettinger.
Those deals never reach the banker-members' radar. The 5% that pass the BancAlliance screening then go to the 110 member banks for a first look-see, based on a five-page description. At that time, members express nonbinding preliminary interest in a simple "thumbs up, thumbs down" vote, Bettinger explains.
"It's a two-way street," says Bettinger.
Insufficient interest would end the proposed deal right there. But assuming enough members want BancAlliance to explore the loan, staff underwriters of AlliancePartners, its affiliate, then analyze the credit and work up a formal loan package. Through an online member portal, banks can access the documentation and determine if they want a piece of the deal. At this point, those who are interested tell BancAlliance how big a piece they want. (As a guide to future prospecting, the cooperative asks members to explain why they aren't interested, if that's the case.)
The volume of deal proposals ebbs and flows, according to Bettinger. At present, the organization is putting out about two proposals a week to members for expressions of initial interest.
One element of the BancAlliance structure that appeals to member banks: BancAlliance always has "skin in the game." Bettinger says that the venture takes at least a 2% piece of deals that reach completion. This is funded through its own chunk of equity capital. This comes from the principals' initial investment plus a $150 million capital raise completed last year.
Bettinger explains that a major reason for the capital raise is to provide interested members with flexibility in funding their share of a participated deal. This enables BancAlliance to serve the timing needs of the borrower, while not pressuring the buying member to come up with cash overnight.
"If you're going to play in this game, you've got to be able to commit" on a timely basis, says Floyd Stoner, senior advisor to Alliance Partners, and formerly ABA's executive vice-president for congressional relations and public policy.
Banker-directed loan policies and preferences
Another factor that sets the BancAlliance program apart is its board, which consists primarily of banker members. The board functions somewhat like a bank board, in that it sets overall policies for the cooperative's programs, and provides strategic direction. Bettinger explains that board also guides the cooperative's targets for the types of loans and types of industries that will be sourced.
Banker Art Johnson, a member of the board, explains that first and foremost, the quality of the loan underlying a participation is critical for the board's comfort. However, selection goes beyond that.
"A good credit to a company in a doomed industry is still not a good loan," explains Johnson.
Being a member-driven organization, BancAlliance recognizes that member banks' needs and preferences will vary according to local circumstances. Members' appetites for loans will shift according to local demand and the ongoing need to balance and diversify loan portfolios.
Even so, Bettinger believes there will be an upper limit on how many banks can realistically be part of the cooperative. The organization has 110 members at this writing, and she believes the structure in time will top out at between 200-300 institutions. She says management recognizes that loan growth and expansion of the membership base must be matched, as "we don't want to get too far ahead of ourselves." She adds that expected industry consolidation will also play a role in the membership base, as members acquire other institutions, or are themselves acquired.
While BancAlliance is the "lender of record" for the cooperative, it is not the "lead bank" of a deal. Instead, that role is served by the lender that brings the deal to BancAlliance. The sources of loans include a variety of players, including GE Capital, according to Bettinger. BancAlliance has a backup servicer on standby, contractually, so that member interests would continue to be served in the event of any issues with the organization.
In time, growth will also come from larger loans brought to BancAlliance from members themselves--credits too large for a local bank to handle on its own.
There won't be any favoritism given such loans, Bettinger adds.
"Each loan," she says, "will have to stand on its own two feet."
[This article was posted on March 8, 2013, on the website of Banking Exchange, www.bankingexchange.com, and is copyright 2013 by the American Bankers Association.]