What Is a Loan Participation Note?
Let me explain what a loan participation note, or LPN, really is. It's a fixed-income security that lets you, as an investor, buy into portions of an outstanding loan or a bundle of loans. If you hold an LPN, you participate pro-rata in collecting interest and principal payments, and you face a proportional share of the default risk.
You'll often see banks, credit unions, or other financial institutions setting up loan participation agreements with local businesses. They offer these notes as short-term investments or bridge financing options.
Key Takeaways
- A loan participation note (LPN) allows investors to purchase a claim to a portion of an outstanding loan issued by another lender.
- With an LPN, the lead bank underwrites and issues the loan, while participant investors subsequently purchase a pro-rata amount.
- LPNs are popular with credit unions, which use participation agreements to foster greater economic participation and community building through sharing risk and reward with local residents and businesses.
How a Loan Participation Note Works
To address the needs of local borrowers and boost loan income, many community banks rely on loan participation agreements where one or more banks share ownership of a loan. They've even formed lending consortia, like the Community Investment Corporation of North Carolina (CICNC), which provides long-term, permanent financing for low- and moderate-income multifamily and elderly housing in North and South Carolina.
One main goal of loan participation notes is to support borrowers in the local community. Other institutions have emerged for similar purposes, and credit unions are a prime example. A credit union is a financial cooperative created, owned, and operated by its participants. Some are large and national, like the Navy Federal Credit Union (NFCU), while others are smaller and more localized.
Credit unions and banks typically offer similar services, such as accepting deposits, originating loans for individuals or small businesses, and providing products like credit and debit cards or certificates of deposit (CDs). The key difference lies in how they handle profits: traditional banks aim to generate returns for shareholders, but many credit unions are not-for-profit, channeling excess funds into projects that directly benefit their member-owners and the community.
Fast Fact: Cooperative Principles of Credit Unions
- Voluntary membership
- Democratic organization
- Economic participation of all members
- Autonomy
- Education and training for members
- Cooperation
- Community involvement
Example of an LPN
Consider Angel V. Castro, a key figure in the Latin American credit union movement, recently honored by the National Credit Union Foundation. He saw that the U.S. model of consumer credit for poverty reduction didn't suit the communities he served. In Ecuador, he organized credit unions to provide credit access specifically for agriculture and other local endeavors, embodying the principles of shared risk and community-focused lending through structures like LPNs.
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