Loan participations have long been a staple of the financial markets. Banks and other loan market participants favor them for a myriad of reasons. For example, they allow the originating (or lead) creditor to remove (or derecognize) underlying loans and commitments from its balance sheet, or to avoid exceeding borrowing limits under internal or regulatory guidelines while maintaining client relationships and administrative control. The originator can oftentimes collect arrangement and administration fees without bearing the associated credit risk. On the participant side, they reduce visibility into an institution’s exposure to a particular credit and enable diversification of a portfolio without the accompanying administrative burden.
But participating in a loan through an intermediary, in this case an originating creditor, creates its own level of risk, namely the credit risk of the originator. For that reason, the participant often wants assurances that the loans and related collateral have been “sold” to it, and it has full property rights in those assets and not merely the right to proceeds from the lead creditor.
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