Bank Participation Loan Funds – Potential Inflation Hedge

Relatively new (available since around 1997) and mainly in the domain of high expense ratios and load funds, are senior floating rate funds, one type of bank participation loan mutual fund.

Since interest paid rises with interest rates, this may be an investment to consider as an inflation hedge.

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What are Bank Participation Loans?

If a customer needs a $20 million dollar loan from his bank and the bank does not have that much to loan out – the bank asks other banks to participate in the loan. All the banks contribute towards the money for the customer. The customer’s bank services the loan, collects the payments and distributes the collected money to the other banks. These are loans made to one borrower from multiple lenders.

What are Bank Participation Loan Funds?

Just as home mortgages are bundled together and sold by the banks, so are bank participation loans. Mutual fund companies such as Oppenheimer and Fidelity buy these loans as assets for a mutual fund and then sell shares of the mutual fund to investors.

What are Senior Floating Rate Funds?

Senior floating rate funds are a type of bank participation loan fund. Most fund companies like to use the word ‘senior’ to show that the loans are senior (get paid before) other obligations (such as bonds) if the company with the loan goes defunct. Most fund companies like to use the words ‘floating rate’ in the name because the loans they invest in have floating interest rates. When interest rates go up, the company with the loan pays more interest to the mutual fund that owns the loan and the mutual fund pays more interest to the mutual fund share owner.

Who can invest in bank participation loan funds, including senior floating rate funds?

Anyone can invest in mutual fund shares of a fund which holds bank participation loans.

You might want to consider this type of investment if interest rates are rising, you want income and you can stomach some risk.

A story in The Street compared these to high yield (aka Junk) bonds. However, it indicated that floating rate funds are better because the loans are senior to the bonds (loan holders get paid before bond holders if the company goes under) and the interest paid goes up when rates go up (as opposed to bonds which hold a steady interest rate).

Things to consider before buying (in addition to the above) include:

• High expense ratio fees are typical.
• There is lack of liquidity in some funds (some funds only allow redemption on a quarterly basis).
• Most funds charge a sales load.
• Some funds are closed-end and must be bought on an exchange.

Remember, we are not financial advisors. As always, consult your financial advisor to determine if this investment is right for you.

Sources:

Bank Rate website: http://www.bankrate.com/brm/news/sav/20040908a1.asp

Smart Money website: http://www.smartmoney.com/investing/mutual-funds/interesting-indeed-15847/

The Street website: http://www.thestreet.com/story/938657/why-are-loan-participation-funds-underperforming.html “Why Are Loan Participation Funds Underperforming” by Elizabeth Stanton, May 12, 2000

Advisor One website: http://www.advisorone.com/article/bank-loan-mutual-funds-may-be-good-bet

Inside Biz website: http://www.insidebiz.com/news/bankers-question-credit-union-participation-loans