Participation agreements are written contracts between banks in which they agree to cooperate to handle an exceptionally large loan to a single borrower. One bank, which for legal or financial reasons cannot make the loan by itself, will originate the loan and then recruit other banks to share in the profits and in the risk. The lead bank will sell participation shares to the participating banks.
Banks may share equally (pari passu) in the risk and reward, or the banks may adopt a senior / subordinate arrangement, with the lead bank being paid first.
Banks use participation agreements for a number of reasons:
- Income generation (for all banks)
- Spreading of the risk
- Spreading of the profits
- Lead bank can retain control of client relationship
- Lead bank can originate the loan when it could not have done so otherwise
- Participating banks can diversity they investments
Banks should be clear on language in the agreement, particularly with regard to the following issues:
- Language about risk and loss so as not to break securities laws
- Lead bank’s fiduciary duty, if any, to participating banks
- Loan fees
- Profit sharing
- Borrower’s default
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