Accounting for Loan Participations – the Finer Points

11/24/2010

By Joseph M. Press, CPA, CFE

As most bankers are aware by now, the Financial Accounting Standards Board (FASB) modified the criteria that must be met in order for a transfer of a portion of a financial asset, such as a loan participation, to qualify for sale accounting. This change was effective for transfers made after January 1, 2010.

Specifically, in order for the transfer of a portion of a financial asset to get sales treatment it must be a "participating interest" and must have all of the following characteristics:

1. It must represent a proportionate (pro rata) ownership interest in the entire financial asset
2. From the date of transfer, all cash flows received from the entire financial asset are divided proportionately among the participating interest holders in an amount equal to their share of ownership.
3. Rights of each participating interest holder must have the same priority (i.e. no subordination)
4. No party has the right to pledge or exchange the entire financial asset unless all participants agree to do so.

The second item above has been receiving much scrutiny, especially in how it affects the handling of line of credit participations. It is not unusual for banks to sell participated interests in lines of credit (or other loans) where the selling bank "fills its plate" first, funding draws on the credit facility until it reaches its lending limit, then participating out the subsequent draws as they are made.

This method of funding the draws in not inconsistent with the requirements set forth in item 2 above, as that requirement deals with the cash flows received from the entire financial asset. The funding method scenario listed here was chosen for discussion purposes because it is a common one. Indeed, there could be a variety of different funding scenarios that would not violate the new rules.

What is important is that when a payment is received from the borrower, it is distributed to all participants (including the lead bank) in a pro rata manner consistent with each participant's interest in the entire financial asset at the time the payment is received. If the participation agreement calls for payments received to be shared in some other manner (for example, last in-first out) that would not be consistent with the new guidance and the selling bank would not treat the loan participation as a sale, but rather as a secured borrowing.

For more information on loan participations, please contact your FBLG advisor or Joseph Press at pressj@fbl-cpa.com or 303-296-6033.