What Is a Loan Participation Note?

A loan participation note (LPN) is a fixed-income security that permits investors to buy portions of an outstanding loan or package of loans. LPN holders participate on a pro-rata basis in collecting interest and principal payments, and are similarly exposed to a proportional risk of default.

Banks, credit unions, or other financial institutions often enter into loan participation agreements with local businesses and may offer loan participation notes as a type of short-term investment or bridge financing.

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 & reward with local residents and businesses.

How a Loan Participation Note Works

To meet the needs of local borrowers and increase loan income, many community banks use loan participation agreements in which one or more banks share in the ownership of a loan. Community banks have also formed lending consortia. One example is the Community Investment Corporation of North Carolina (CICNC), an affordable housing loan consortium that provides long-term, permanent financing for the development of low- and moderate-income multifamily and elderly housing throughout North and South Carolina.

One of the purposes of loan participation notes is to help meet the needs of borrowers within a local community. Several other institutions have also sprung up for similar reasons. Credit unions are one such example. A credit union is a financial cooperative that is created, owned and operated by their participants. While some credit unions can be large and national in scale, such as the Navy Federal Credit Union (NFCU), others are smaller in scope.

Cooperative principles of credit unions include: voluntary membership, democratic organization, economic participation of all members, autonomy, education and training for members, cooperation, and community involvement.

Credit unions and banks generally offer the same services, including accepting deposits, originating loans for individuals or small businesses and offering financial products such as credit and debit cards and certificates of deposit (CDs). Key structural differences exist in terms of how a commercial bank and credit union use their profits, however. While traditional banks function to generate profits for their shareholders, many credit unions operate as not-for-profit organizations, putting excess funds into concrete projects that will better serve their community of de-facto owners (i.e. members).

Example of an LPN

For example, Angel V. Castro, a pioneer in the Latin American credit union movement, was recently recognized for his efforts by the National Credit Union Foundation. Castro believed that the traditional U.S. model of consumer credit-based poverty reduction would not fit the needs of the people in the communities he worked with. In Ecuador, he focused on organizing credit unions that extended access to credit for its members specifically for agriculture and other endeavors.