Update to Flash Report issued on April 10, 2020
The Coronavirus Aid, Relief, and Economic Security (CARES) Act that was signed into law on March 27, 2020, offers a lifeline to small businesses and sole proprietors (generally those with 500 or fewer employees) in the form of the Paycheck Protection Programme (PPP) administered by the U.S. Small Business Administration (SBA). This programme authorised $349 billion in forgivable loans, with individual advances based on the size of the small businesses’ average payroll, to eligible small businesses that were in operation on February 15, 2020. The programme officially launched on April 3 and is open until June 30, 2020, subject to availability of funding.
The unprecedentedly quick roll out of the programme caused what many described as chaos across the industry as lenders raced to build the processes, technology infrastructure and staffing necessary to process applications even as programme guidance continued to evolve or change, as was the case when a sample borrower application on which many banks relied to start collecting applications was revamped by the SBA the evening before the programme launched. To the extent these applications had not yet been processed, applicants and lenders were required to re-submit information in the revised format. When the programme opened, most of the largest U.S. banks indicated they were not yet ready to accept applications, although some came online later in the day or over the subsequent weekend, while others continued to disclose that applications would be available soon. Likewise, many community banks began accepting applications on April 3, and the list of participating community bank and credit union lenders continued to grow. In recent days, media reports have surfaced of government officials criticising lender participation, particularly that of the large banks for not stepping up to do their part.
On April 10, Congresswomen Maxine Waters, Chair of the House Committee on Financial Services, and Nydia Velazquez, Chair of the House Committee on Small Business, sent a letter to the CEOs of the four largest U.S. banks expressing concern that the megabanks are favoring certain small businesses and excluding others. The Congresswomen requested that the four banks make periodic reports to their respective committees describing their efforts under the PPP. They asked that these reports include how the banks are prioritising small businesses as well as demographic information regarding the businesses applying and being approved for loans, including minority-owned businesses, nonprofits, churches, independent contractors and small family farms. The first such report has been requested by April 15.
The SBA has struggled with the intake of applications with lenders facing login problems and the intake system, known as E-Tran, reportedly crashing for four hours earlier this week – problems the SBA has attempted to rectify by working with Amazon Web Services to develop a new gateway portal that went live on April 8. According to media reports, newly approved lenders still are struggling to access E-Tran because entry requires an authorisation number that some new lenders have been unable to obtain.
Notwithstanding, after the first two days, SBA officials were reporting that nearly 1,900 lenders had processed almost 78,000 PPP loans totaling $22 billion, and by Friday of the first week of operation the Trump Administration was reporting that 250,000 small businesses – a large number, but a small percentage of the eligible businesses – had received PPP loans totaling $70 billion. The reported numbers, which some suggest are unverified and do not accurately reflect loans that have been approved and funded, continue to climb. On April 7, U.S. Treasury Secretary Mnuchin asked Congress for quick action in allocating another $250 billion to the programme. As of April 9, it appears that the U.S. Senate was deadlocked and another week or two will pass before additional funding is approved, although that outcome seems all but certain eventually.
Despite the activity, significant frustrations remain for small business borrowers. Many banks only accepted applications for existing customers. Even among those, some banks further limited eligibility to existing credit clients, meaning small businesses that only maintain deposit products with their banks were not able to apply. Some lenders have already stopped accepting applications. Even with the additional funding requested, many small businesses may find themselves depending on actions the private sector is taking apart from the PPP.
In the interim, the Treasury Department has continued to provide clarifications to address lender and borrower concerns. This Flash Report, which we will update periodically as new information becomes available, describes the current status of the PPP, its key provisions, and the questions and challenges lenders still face as they work to serve their small business customers.
Treasury Department Rulemaking and Guidance
On March 31, the U.S. Treasury Department issued guidance on how the programme would work, including a sample application form (subsequently updated); however, many unanswered questions still remained. Some of these were addressed with the SBA’s release on April 2 of an Interim Final Rule (IFR) providing more detailed guidance to lenders hours before small businesses could begin submitting applications. The SBA also released instructions on April 3 for insured depository institutions that are not currently SBA lenders and Farm Credit institutions to apply to participate in the programme, and reported over the same weekend that up to 150 new lenders were being added each hour.
The Treasury Department also released and continues to update its PPP Loans Frequently Asked Questions (FAQs). The FAQs document indicates that while it does not carry the force and effect of law independent of the statute and regulations on which it is based, the “U.S. Government will not challenge lender actions that conform to this guidance.”
The SBA has provided a template application form for the PPP. Unlike other SBA programmes, applicants will not have to meet the “Credit Elsewhere” requirement, i.e., will not have to try to obtain some or all of the funds from other sources first.
The following loan terms will be the same for all participants:
- Unsecured, no personal guaranty required.
- Fully guaranteed by the SBA and not subject to any SBA fees.
- Loans can be for up to two months of average monthly payroll costs (salaries up to a maximum of $100,000 per employee, employee benefits including costs for employee vacation, parental, family, medical, and sick leave and state and local taxes assessed on compensation) from the last year, plus an additional 25% of that amount for other specified costs such as small business mortgage and utility costs, up to a maximum of $10 million. A borrower’s payments to independent contractors or sole proprietors must be excluded from payroll costs; however, independent contractors and sole proprietors may be eligible to apply for their own loan under the PPP.
- Loans are made for two years at a 1% fixed rate, with all payments deferred for six months, although interest will accrue during the period. The interest rate has been a point of contention throughout the PPP roll-out process. Although the CARES Act itself provides for a rate of up to 4%, the SBA initially set the programme rate at 0.5%. After lenders raised concerns that this rate would, in many cases, fail even to meet their funding costs, the SBA increased the rate to its current 1%-level per the IFR.
- Lenders must make the first disbursement of the loan no later than 10 calendar days after the loan is approved.
- Loans are forgivable if the proceeds are used to cover eligible costs, and if the borrower retains its employee headcount and compensation levels; any remaining balance will have a maximum maturity per the CARES Act of 10 years from the date on which the borrower applies for loan forgiveness. However, and similar to the loan interest rate as discussed above, the IFR sets the repayment term for PPP loans at two years.
Applicants will need to provide evidence of their payroll costs and certify to their need for the loan, accuracy of the information provided, understanding of the terms of the loan and the forgiveness provision, and that they have not applied for another loan under this programme. Although this certification is intended to mitigate fraud risk associated with concurrent applications, the IFR also explicitly clarifies that small businesses may only receive one loan under the PPP in total and encourages borrowers to consider applying for the maximum eligible amount as a result. We expect this provision may be revisited if the funding pool is increased in a subsequent stimulus bill.
Generally, small businesses with 500 or fewer employees are eligible to apply for a PPP loan. The FAQs clarify several points related to eligibility standards, including the following:
- For employee-based tests, borrowers may use either their average number of employees over defined time periods or the SBA’s usual calculation methodology in which size standards vary by industry, and are generally based on the number of employees or the amount of annual receipts the business has.
- In addition to qualifying for PPP loans under the 500-employee standard (or any alternative industry-specific/NAICS Code employee standard established by the SBA), borrowers also qualify if they are “small business concerns” of a size normally eligible for SBA 7(a) loans. That means borrowers may qualify based on industry-specific revenue-based tests or the SBA’s “alternative size standard” for small business concerns, which requires that the maximum tangible net worth of the business is not more than $15 million and the average net income after federal income taxes (excluding any carry-over losses) of the business for the two full fiscal years before the date of the application is not more than $5 million.
- Employee-based tests are based on the number of employees whose “principal place of residence is the United States.”
- The FAQs also address affiliation that exists when a company controls, is controlled by or is under common control with another company. It has been a particular concern among startups and other small businesses backed by minority investors that such affiliations could leave them ineligible to participate in the PPP.
- Under normal SBA 7(a) procedures, application of size standards requires that the borrower consider the aggregate size of the set of all companies affiliated with the applicant. For now, the SBA has indicated that the normal affiliation standards for SBA 7(a) loans apply to PPP loans, other than as expressly waived by the CARES Act and/or SBA guidance for the Accommodation and Food Services industries, certain franchise companies, companies receiving financial assistance from Small Business Investment Companies, and faith-based organisations. The FAQs confirm that it is the responsibility of the borrower to determine which entities (if any) are its affiliates and determine the employee headcount of the borrower and its affiliates. Lenders are permitted to rely on borrowers’ certifications without needing to make an independent determination of the accuracy of this information.
- Minority owners, who normally may be viewed as still controlling a company through negative control rights (i.e., certain rights to prevent a quorum or otherwise block action by the board of directors or shareholders) may relinquish control for SBA affiliation purposes by irrevocably waiving or relinquishing such rights. Borrowers must certify to programme eligibility (including affiliation-related issues by implication), but lenders do not have an independent obligation to verify the borrower’s affiliation status.
All federally insured depository institutions, federally insured credit unions and Farm Credit System institutions, as well as a broad range of nonbanks, are eligible to participate in this programme. Existing SBA-certified lenders will have delegated authority. Others must apply and be approved by the SBA before making loans. Institutions that are subject to certain regulatory enforcement and/or safety and soundness concerns may not be eligible. The SBA has indicated that it will issue same-day approvals to new lenders.
Loan Agreement and Related Terms
Lenders may use their own promissory note forms or an SBA form of promissory note, at their option, and any terms and conditions, including relating to amortisation and disclosure, that are not inconsistent with Sections 1102 and 1106 of the CARES Act, the PPP IFR and guidance, and SBA Form 2484. The SBA released its own form on April 7, but there are some indications that this form may be revised following industry feedback.
Lenders will not be allowed to charge any fees to applicants, but will receive processing fees from the SBA based on the balance of the financing outstanding at the time of the final disbursement, according to the following schedule:
- Loans $350,000 and under: 5.00%
- Loans greater than $350,000 to $2 million: 3.00%
- Loans greater than $2 million: 1.00%
Agents (e.g., lawyers, accountants, consultants and loan brokers) may assist applicants with the process and receive fees of 0.25% to 1.00%, depending on the size of the disbursed loan. Agent fees must be paid by the lenders, not charged to applicants. On April 2, the American Institute of Certified Public Accountants (AICPA) issued a statement on the role of CPAs as agents for PPP applications, indicating that based on the feedback it had received from many CPA firms, these firms were not planning to charge small business clients for assisting with their PPP applications, either because the CPA firms were committed to assisting their clients pro bono or because they believe the PPP application was simple and does not require their assistance. The AICPA statement went on to say that if a CPA firm is charging fees for advising a small business in deciding which loan programme and tax relief programme is best for its business, it is reasonable that those fees would fall outside the fee provision of the CARES Act and associated fees would be paid by the client. To date, the Treasury Department has not commented on this view.
Lenders will have to verify the dollar amount of average payroll costs and follow applicable Bank Secrecy Act requirements. The IFR specifically refers to compliance with Customer Identification Programme (CIP) requirements, and states the expectation that lenders will “understand the nature and purpose of their PPP customer relationships to develop customer risk profiles” from a BSA perspective and file suspicious activity reports with FinCEN. The PPP FAQs have clarified that (1) a lender making a PPP loan to an existing customer is not required to re-verify borrower identification, unless otherwise indicated by the lender’s risk-based approach to BSA compliance, and (2) that federally insured depository institutions and federally insured credit unions eligible to participate in the PPP programme that have not yet collected beneficial ownership information on existing customers do not need to collect and verify beneficial ownership information, unless otherwise indicated by the lender’s risk-based approach to BSA compliance. As more than one legal analysis of BSA-related requirements has noted, the PPP FAQs are not binding on enforcement of BSA requirements as a general matter; they only address whether a lender has met the SBA’s PPP requirements. FinCEN’s April 3 release, “The Financial Crimes Enforcement Network Provides Further Information to Financial Institutions in Response to the Coronavirus Disease 2019 (COVID-19) Pandemic,” however, does confirm the guidance stated above. The release also indicates that FinCEN will continue to monitor developments and issue more guidance, as needed.
This interpretation by SBA and FinCEN favors existing customers and is contributing to the challenges that small businesses that do not currently have borrowing relationships with existing SBA lenders face in being able to apply for a PPP loan.
The IFR notes that lenders that are not currently subject to BSA by statute must establish an AML programme “equivalent to that of a comparable federally regulated institution.” This requirement, which could represent a significant barrier to fintech firms that wish to join the programme but are not currently subject to BSA requirements, is leading to ongoing discussions between the fintechs and established banks regarding potential partnerships that would, among other benefits, allow the fintechs to leverage the banks’ existing BSA infrastructure.
The SBA has confirmed in its FAQ that a lender does not need a separate SBA Authorisation for SBA to guarantee a PPP loan. However, lenders must have executed SBA Form 2484 to issue PPP loans and receive a loan number for each originated PPP loan.
Some lenders may have limited capital to continue to fund additional rounds of PPP loans until the first such loans already originated are off their books. Loans made under the PPP can be sold in the secondary market. The SBA will not collect any fees for any guaranty sold into the secondary market. Although the IFR states that further guidance on any secondary market advance purchase is forthcoming, as a practical matter, there are significant concerns among community banks and credit unions regarding when and in what form a secondary market will be established. In the interim, on April 6, the Federal Reserve stepped in and announced that it will open a facility to purchase SBA loans offered under PPP, with details to follow on the specifics of the programme.
Lenders may be reimbursed for forgiven amounts in one of two ways:
- Post-forgiveness: After a lender makes a formal determination on a forgiveness application and processes the forgiveness payment, the SBA must pay the lender 100% of the forgiven amount within 90 days of the date of forgiveness (with interest from the date of forgiveness through the date of payment).
- Pre-forgiveness: A lender may request that the SBA purchase the expected forgiveness amount of a PPP loan, or a pool of PPP loans, at the end of week seven of the covered period (that is, seven weeks after origination of the relevant PPP loans). The SBA must purchase these reported forgiveness amounts within 15 days of the report.
The CARES Act and the IFR say that a lender will not be subject to claims or penalties by the SBA for forgiving payments on a PPP loan if the lender bases the forgiveness determination on full documentation received by the lender from the borrower evidencing forgivable payments. A lender also “does not need to conduct any verification if the borrower submits documentation supporting its request for loan forgiveness and attests that it has accurately verified the payments for eligible costs.”
To provide additional inducement to the banking industry to participate in the PPP, the CARES Act also:
- Mandates a zero percent risk weight of these loans for purposes of risk-based capital requirements.
- Provides temporary relief from FASB’s troubled debt restructuring disclosure requirements to banks that modify the loans in a troubled debt restructuring related to COVID-19 on or after March 13, 2020.
On April 9, the federal banking agencies (Federal Reserve, Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation) announced an interim final rule to encourage lending to small businesses through PPP.
The interim final rule, which is effective immediately and subject to a 30-day comment period, modifies the agencies' capital rules to neutralise the regulatory capital effects of participating in the Federal Reserve's PPP facility because there is no credit or market risk in association with PPP loans pledged to the facility. Consistent with the agencies' current capital rules and the CARES Act requirements, the interim final rule also clarifies that a zero percent risk weight applies to loans covered by the PPP for capital purposes.
Time remains of the essence for the 30 million small businesses that are the backbone of the U.S. economy. Progress has been made, but there is so much more that needs to be done.
Protiviti is actively working with our clients to operationalise their PPP participation and, where appropriate, explore alliances that will allow them to respond in a timely manner. Based on this experience, some of the immediate challenges and priorities we expect to be addressed in the coming weeks are:
- Financial institutions will continue to work 24/7 to implement both the borrower-facing and SBA-facing technology capabilities necessary to process and fund applications.
- Significant re-allocation of resources from other lending functions, and/or onboarding of temporary resources, will be required to process the ongoing surge in applications. This is a particular concern during a period in which staffing levels are already challenged by COVID-19-related facility closures, as well as other surge resource needs in areas like loss mitigation and payment disputes.
- A brand new programme that is thus far subject to limited published regulatory guidance, was launched in less than two weeks on hastily implemented technology, and is being operated by personnel who in many cases are not familiar with SBA lending processes in general, is not a recipe for operational excellence. As application volume continues to ramp up, lenders will need to address growing operational risk and compliance concerns throughout the end-to-end origination and servicing process. In this regard, questions about how far lenders should go to challenge and validate documentation provided by applicants to support their eligibility for requested loan amounts, and how to make sure these validation activities are performed and documented consistently, are perhaps the most pressing of many such concerns.
- Clarification of the process for and players in the secondary market for PPP loans is critical. As this market is established, this may require additional process and technology design work for both lenders and the SBA.
- The SBA will need to continue to enhance its own processes to handle onboarding of new lenders and manage the volume associated with this programme.
- Both lenders and the SBA will need to evaluate the lessons learned in the early stages of this programme and improve collaboration to enhance efficiency and effectiveness going forward.
- From a public policy standpoint, Congress will need to consider whether changes to the PPP or an alternative programme (beyond the Main Street Lending programme introduced by the Federal Reserve on April 8) are necessary to provide support to the small businesses (and employees of those businesses) that thus far have been disenfranchised.