:max_bytes(150000):strip_icc()/200275051-001-5bfc2b8b46e0fb0083c07b92.jpg "Understanding Loan Strips: Commercial Loan Shares Explained")
Key Takeaways
- A loan strip is a share of a long-term loan that matures in 30 to 60 days.
- Banks sell loan strips to raise capital, funding portions of long-term loans.
- At maturity, banks must resell the strip, find new investors, or fund it themselves.
- If investors opt not to renew, the selling bank must fund the loan strip.
- Loan strips can be exempt from deposit requirements under certain regulations.
What is a Loan Strip?
A loan strip is a commercial loan structure where a bank that makes a long-term loan sells short-term shares of it (often 30 to 60 days) to other lenders or investors to raise funding. It can help banks manage liquidity and give investors a flexible way to participate, but if buyers don’t renew at maturity, the bank must replace that funding, similar to the rollover risk seen in some repurchase-agreement setups.
How Loan Strips Facilitate Commercial Lending
When a bank or other lender makes a long-term loan, it can sell loan strips to investors in order to raise capital to fund the loan. For example, when a bank sells a 60-day loan strip, it is getting money to cover that portion of the loan.
But at the end of the 60 days, the source of funding for the loan has dried up. The bank must either resell the loan strip to that same investor, find a new investor, or fund the loan strip itself.
Regulatory Considerations for Loan Strips
Under certain circumstances, loan strips may be classified as borrowed amounts in the bank’s quarterly financial report to regulators, known as a call report. Since March 31, 1988, bank regulators have considered a loan strip to be a borrowed amount if the investor has the option not to renew the loan strip at the end of the term and the bank is obligated to renew it.
In that case, loan strips are treated not as sales, but as borrowings. The loan strips are then considered deposits and become subject to reserve requirements for depository institutions as set forth by the Federal Reserve under Regulation D.
Important
When a loan strip matures, the lender must either resell it or take on the responsibility of funding it.
Furthermore, if the original investor does opt not to renew the loan strip at the end of the maturity period, the depository institution that sold the loan strip must take on the responsibility of funding the loan strip itself. That’s because the borrower’s loan terms typically extend far beyond the loan strip’s maturity period.
For example, the borrower of the loan being sold as loan strips may have signed on for a loan period of one year, five years or longer—or may have arranged for a revolving line of credit of similar duration. In effect, loan strips bear the characteristics of a repurchase agreement because the bank that is selling the loan strip agrees to buy it back from the purchaser at the purchaser’s discretion.
Loan strip transactions can involve deposit liabilities, such as acknowledgments of advance, promissory notes or other obligations. As such, exemptions from the definition of a deposit as outlined in Regulation D may be applied to these liabilities. For example, when a domestic bank sells a loan strip to another domestic bank, that loan strip may be exempt from deposit requirements as set forth in Regulation D.
The Bottom Line
A loan strip lets a bank fund a long-term loan by selling short-term pieces, then either reselling those strips at maturity or replacing the funding itself. Depending on how it’s structured, the amounts can be treated as borrowings for regulatory purposes, including implications under Regulation D.