March 26, 1999
Philip Lacher, Internal Auditor
Paragon Federal Credit Union
370 Pascak Road
Township of Washington, NJ 07675
You have asked whether Paragon Federal Credit Union's (Paragon's)
small credit union loan participation program is permissible.
As explained below, the answer is no.
Paragon has entered into loan participation agreements with several
small credit unions. Under the program, Paragon uses its preprinted
loan forms and approves, disburses and services the loans to the
small credit union member. Paragon then seeks reimbursement of
a part of the loan from the member's credit union. Paragon's
attorney, Guy Messick provided an opinion, dated November 23,
1998, stating that this practice is permissible if the small credit
union's name is listed as the lender on the loan documents and
there is documentation in the loan file indicating the small credit
union has approved the loan. The timing of the approval by the
small credit union is unclear.
Contrary to Mr. Messick's opinion, the authority to service the
loan does not include the authority to close and disburse the
loan. Servicing begins after disbursement and constitutes all
actions necessary to ensure proper handling of loans until finalized,
either by payoff, collections, or charge-off. NATIONAL CREDIT
UNION ADMINISTRATION EXAMINER'S GUIDE, p. 9-35 (1997). The participation
rule states explicitly that a participating federal credit union,
that is not an originating lender, must "obtain the approval
of the board of directors or investment committee of the disbursement
of proceeds to the originating lender." 12 C.F.R.
§701.22(d)(4) (emphasis added). The regulation contemplates
that it is the originating lender that is funding the loan.
For this program to be permissible, the following must occur: the originating lender must approve the loan using its underwriting standards; approval by the originating lender must occur prior to disbursement of the loan; it should be clear to the member from the loan documents that he is contracting with the originating lender and not Paragon; the originating lender should issue the disbursement check; and the originating lender must retain at least 10% of the
Mr. Phillip Lacher
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loan. Paragon may service the loan after it purchases its participation
interest. 12 C.F.R. §701.22.(b)(3).
Sincerely,
Sheila A. Albin
Associate General Counsel
GC/MFR:bhs
SSIC 3000
99-0239a
cc: Region II