Buying and selling loan participations have long been common in the banking business. As the seller of loan participations, a bank may use the practice as a tool for complying with legal lending limits or internally imposed loan limits. Whether as a buyer or seller, a bank may use loan participations as a means to diversify or spread credit risk. Both federal law (for national banks) and South Dakota law (for South Dakota-chartered banks) expressly recognize the ability of banks to buy and sell loan participations. South Dakota state banks need to pause, however, to consider who may be the buyer of loan participations they wish to sell. Buyers of loan participation interests need to consider whether they are subjecting themselves to South Dakota’s money lender statutes and our state’s financial institution income tax (often referred to as the bank franchise tax) when they buy participation interests.
For South Dakota state banks the most relevant statute concerning the sale of loan participations is SDCL 51A-4-16 which provides as follows:
Sale, transfer, or assignment of loan participations.
A bank may sell, transfer or assign participations in mortgage loans and other loans made by a bank to agencies of the state or federal government, to public instrumentalities, or to financial institutions of any type including, but not limited to, banks, savings and loan associations, finance companies, bank holding companies, insurance companies and other financial institutions, whether such institution is incorporated or chartered in the state of South Dakota or in another state.
South Dakota state banks should pause to consider whether the persons and entities listed in SDCL 51A-4-16 constitute an exclusive list of who may be the buyer of their loan participations. The issue becomes relevant, for example, if a South Dakota state bank seeks to sell a loan participation to a natural person who is not one of the types of entities listed in SDCL 51A-4-16.
The issue of who may be the buyer of loan participations does not exist for national banks. Federal law does not impose any limitation on who may be the buyer of loan participations from a national bank. Because national banks are free to sell loan participations to natural persons, presumably South Dakota’s “wildcard statute” found at SDCL 51A-2-14.1 (which grants state banks the same powers that exist under federal law for national banks) should apply here, but a South Dakota state bank that desires to sell a loan participation interest to a natural person may want to consult with the Division of Banking on whether the Division would take issue with that.
Also noteworthy are two issues that the buyer of loan participations needs to consider. First, is the buyer of a loan participation interest engaged in activity that requires a money lender license under SDCL Ch. 54-4? Generally the money lender licensing requirements (which include an exemption for banks) apply to persons engaged in the “business of lending money” which is defined as “the originating, selling, servicing, acquiring, or purchasing of any loan involving a borrower who is a person other than a family member, or the servicing, acquiring, or purchasing of a retail installment contract a party to which is a person other than a family member.” It is likely that regulators in South Dakota view the practice of buying loan participations as an activity that falls within the scope of South Dakota’s money lender statutes.
A person who only occasionally buys a loan participation interest may be eligible for an exemption from South Dakota’s lender licensing requirements. Specifically, SDCL 54-4-37.1 provides that a person who originates, sells, services, or acquires five or fewer loans in a 12-month period is exempt from SDCL Ch. 54-4 pursuant to SDCL 54-4-37.1, as long as the total amount of loans held by that person does not exceed $4 million, but the statute expressly provides that persons eligible for the exemption must still file a report with the South Dakota Division of Banking no later than December 31 of each year with information detailed in the statute. Thus, an occasional buyer of loan participation interests in South Dakota who may be exempt from licensing requirements still must comply with the reporting requirements found in the statute.
Also noteworthy is that SDCL 54-4-37.1 expressly provides that the exemption from licensing requirements does not provide an exemption from South Dakota’s financial institution tax imposed by SDCL Ch. 10-43. Note that the income tax imposed by SDCL Ch. 10-43 applies to financial institutions, and the definition of financial institution includes any person in the business of “buying loans, notes, or other evidences of debt …” (see SDCL 10-43-1(4)). Thus, a buyer of a loan participation interest needs to consider whether he or she is subject to South Dakota’s bank franchise tax even if he or she is exempt from our state’s money lender licensing requirements.
Finally, banks who buy loan participation interests may want to review a past article we provided on avoiding possible lending limit violations when buying multiple participation interests from the same seller.
If you have questions, please contact Davenport Evans Lawyers at 605-336-2880 or [email protected].
Davenport, Evans, Hurwitz & Smith, LLP, located in Sioux Falls, South Dakota, is one of the state’s largest law firms. The firm’s attorneys provide business and litigation counsel to individuals and corporate clients in a variety of practice areas. For more information about Davenport Evans, visit www.dehs.com.