Banking Interpretations

NYSBL 103(1)


To: Thomas Moran, Supervising Credit Risk management Specialist

From: S.A. Fiorella, Associate Attorney

Re: [ ] - Participation Agreement, Banking Law §103

Date: April 8, 1993

This is in reply to Assistant Deputy Kursky's memorandum on the subject dated February 12, 1993.

The [ ]has entered into a loan participation agreement with [ ] dated [ ].

Under the terms thereof, [ ] shall upon demand, repurchase [ ] interest in the loan and pay to [ ] its ratable share of the unpaid balance due under it if [ ] refuses to take such action as [ ] may request to foreclose the interest in the collateral or otherwise enforce its rights against the borrower in default.

The pertinent portion of paragraph 7 of the agreement dealing with the repurchase of loans in default, provides, that upon notice to [ ] of certain events:

"[ ] shall endeavor to reach an agreement as to whether to foreclose on the security interest in the collateral or take any other action. In the event that such agreement cannot be reached within a reasonable period, [ ] shall have the right to determine the question and its decision shall be binding upon [ ] with the same force and effect as if [ ] had concurred therein. In the event that [ ] refuses to take such action as [ ] may request to foreclose the interest in the collateral or to otherwise enforce its rights against the borrower in default, [ ] shall, upon demand, purchase [ ] interest in the loan and shall pay to [ ] its ratable share of the then unpaid balance under the loan ...."

Does the above quoted portion of Paragraph 7 constitute a loan participation "with recourse" or "without recourse". If it is a loan participation with recourse, then the loan limitation of [ ] under Banking Law §103 shall be applicable to it. If it is a loan "without recourse", then there would be no [ ] loan limitation applied to it under Banking Law §103.

Similarly, when a national bank sells a participation in a loan or extension of credit, that portion of the loan sold "without recourse" will not be applied to the bank's lending limits. (Comptroller of Currency Regulations §3332.107,12 CFR 32.107).

When is a loan without recourse and when is a loan with recourse? A loan is "with recourse" when the bank is under an obligation to repurchase it. If it is under no such obligation, then it is "without recourse".

On one hand, counsel for the Bank argues that it is "without recourse", because [ ] ability to demand payment is solely within the control of [ ], so that after the default in the payment of the loan, [ ] may, at its sole option, agree to take such action as [ ] may request, in which event no right of repurchase would be available to [ ]. In addition, it can be argued that the parties have intended a non-recourse sale of the loan participation as evidenced by the prorata sharing of any losses and expenses incurred in connection with the loan.

On the other hand, you advise that the custom in bank loan participations is to lift the non-recourse phrase directly from the [OCC] regulation. While the cited provision 12 CFR 32.107 does not define recourse per se it does state as follows:

§32.107 Sale of loan participation

  1. when a bank sells a participation in a loan or extension of credit, including the discount of a bank's own acceptance, that portion of the loan that is sold on a nonrecourse basis will not be applied to the bank's lending limits. In order to remove a loan or extension of credit from a bank's lending limit, a participation must result in a pro rata sharing of credit risk proportionate to the respective interests of the originating and participating lenders. This is so even where the that repayment must be applied first to the shares sold. In that case, the pro rata sharing may only be accomplished if the agreement also provides that, in case of a default or comparable event defined in the agreement, participants shall share in all subsequent repayments and collections in proportion to the percentage of participation at the time of the occurrence of the event
  2. The provisions of the above paragraph apply to all "loans and extensions of credit," as defined in §32.2(a) of this Part, including "contractual commitments) to advance funds, "as defined in §32.2(d) of this Part.

This provision sets forth the general rule that a non-recourse participation will be subtracted from the selling bank's lending limit, and that a participation would still be considered non- recourse even if repayments are applied first to the co-participant so long as the consequences of a default are shared pro-rata.

In a related vein, our own Legal Interpretation LI 1.5 dealing with participation in letters of credit stresses that favorable lending limit treatment will be enjoyed by the selling bank so long as the coparticipant's commitment is irrevocable.

Implicit in these provisions is that non-recourse means non-recourse. In my opinion the possibility that the co- participants will not agree on the course of action to take on a default, leaving the selling bank with the entire loan exposure, is not so remote an event as to be discounted entirely. While not constituting an unqualified recourse obligation it is nonetheless material.

Because of the recourse aspect of the participation, the entire loan would be counted against [ ] lending limit.