Loan Strip: Definition and Function

What is a Loan Strip?

A loan strip is a commercial arrangement where the initial lender on a long-term loan, such as a bank, obtains funding for that loan from other lenders or investors.

A loan strip represents a share of the long-term loan, usually lasting five years. Upon maturity, the holder of the loan strip receives an agreed-upon amount of money. The maturity of a loan strip is typically short term, ranging from 30 to 60 days. A loan strip can also be referred to as a strip participation or a short-term loan participation arrangement.

Key Takeaways

• A loan strip represents a share of a long-term loan that usually matures in 30 or 60 days.
• A bank or lender sells loan strips on a long-term loan, funding that specific portion of the loan.
• At maturity, the bank must resell the strip to the same or new investor, or fund the loan strip themselves.

How a Loan Strip Works

When a bank or lender provides a long-term loan, they can sell loan strips to investors to raise capital. For example, a bank can sell a 60-day loan strip to cover that portion of the loan.

Once the 60-day period ends, the source of funding for the loan strip is exhausted. The bank must then resell the loan strip to the same or new investor, or fund the loan strip internally.

Regulations on Loan Strips

Under certain circumstances, loan strips may be classified as borrowed amounts in a bank’s quarterly financial report to regulators, known as a call report. Since March 31, 1988, loan strips have been considered borrowed amounts if the investor has the option not to renew the strip at the end of the term and the bank is obligated to renew it.

In such cases, loan strips are treated as borrowings rather than sales. They are considered deposits and subject to reserve requirements set by the Federal Reserve under Regulation D.

When a loan strip matures, the lender must either resell it or take on the responsibility of funding it.

If the original investor chooses not to renew the loan strip, the depository institution that sold the strip must fund it. This is because the borrower’s loan terms typically extend beyond the loan strip’s maturity period.

Loan strip transactions can involve deposit liabilities, such as acknowledgments of advance, promissory notes, or other obligations. Exemptions from the definition of a deposit, outlined in Regulation D, may apply to these liabilities. For instance, when a domestic bank sells a loan strip to another domestic bank, it may be exempt from deposit requirements according to Regulation D.

Loan strip transactions can involve deposit liabilities, such as acknowledgments of advance, promissory notes, or other obligations. Exemptions from the definition of a deposit, outlined in Regulation D, may apply to these liabilities. For instance, when a domestic bank sells a loan strip to another domestic bank, it may be exempt from deposit requirements according to Regulation D.