As published in Scotsman Guide's Commercial Edition, October 2007.
Private lenders' primary point of focus is to maximize their investors' returns. They do this by underwriting safe loans and by keeping their investors' funds at work at all times. There are two cogs at work that have to mesh perfectly at all times -- investor dollars seeking borrowers and borrowers seeking investor dollars.
Too much money not being invested in loans impacts portfolio yields. Too little money available curtails the ability to lend. Fund-managers constantly adjust these amounts in an effort to maintain the optimal balance for investors and borrowers. The goal is to have as little money as possible on the sidelines but enough money available to fund attractive loans.
Brokers approaching this machine with a loan scenario have the disadvantage of not knowing how much funding capability a lender has. Frequently, even if a loan's terms are all acceptable to a lender, the loan may not be underwritten because the funds are simply not available at that time.
A solution to this dilemma exists in participations. Although they require a deeper understanding of the lending process and of lenders, as well as leadership skills on the part of the broker, participations can enable you to be involved more closely in the funding process. This is most notable on larger loans.
Spread the wealth
Participations are common with institutional commercial lenders. Lenders simply divide the total amount they will lend to a borrower among themselves. These equal-rate loans enable lenders to fund side by side, rather than having to use the typical structure of one lender having first position and others having subordinate positions.
As the loan amount is divided, so are the responsibilities. Often, one lender will take the lead and perform all of the underwriting and due-diligence functions, providing a detailed loan package to other lenders for review. This lender is called the lead.
In another approach, each lender analyzes the loan information separately before they all compare results. The advantage here is that there are more eyes and heads on a deal to provide insight than a typical loan committee can muster on a review.
Other advantages to lenders include larger loan amounts along with fees and servicing revenues. Further, there are generally more checks and balances and fewer surprises. As a broker, you can see substantially greater commissions.
Stepping up your role
You will be called upon to take leadership roles in participations. In addition to connecting borrowers with lenders, you will be connecting lenders with lenders. To do this, you should be aware of the lenders' needs and constraints. Instead of providing initial introductory and packaging services, you must, at least initially, coordinate lenders who might be unfamiliar with the entire participation approach to funding.
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