PPP - A Lifeline and Industry Threat ?

The Paycheck Protection Program (PPP) offers a case study in government activism. It’s vital: At a time when the economy is reeling from a global pandemic, PPP is designed to support a variety of businesses, non-profits, self-employed individuals, tribal organizations and more. It’s massive: $669 billion to be disbursed in a very short period of time (the deadline to apply for a loan has already been extended once), and the funds can be used for everything from payroll to utilities. It features government oversight: The program is implemented by the Small Business Administration (SBA). And of course there are obstacles: PPP was launched with hastily conceived guidelines and parameters that keep getting adjusted.

No one doubts the need for a massive aid package in this depressing environment. It’s also fair to acknowledge that banks participating in the program can derive significant benefits. Most importantly, there’s a 5% origination fee, which given the volume may offer a boost to the bottom line. Banks also come into contact with a new set of entities that could become clients in the future, and engender long-term goodwill that help the business.

However, even the best of intentions can be laden with landmines. PPP features more than its share, and it’s very important for financial services institutions to avoid stepping on these. And early in August, as we enter the loan forgiveness period, it’s more important than ever to prepare for hard questions and have documentation ready.

First, it helps to look back. The SBA’s Inspector General has pointed out that up to 40% of stimulus loans given out in the past had “inappropriate or unsupported loan approvals.”  Match that with the current volume: $521 billion has been disbursed in only four months, when the normal figure is below $30 billion in an entire year.  Again, these are exceptional circumstances, but the warning signs are blinking, if not flashing.

Next, understand that in some ways, these are not exactly ‘loans’ in the traditional sense. Loan underwriting as most of us know it requires a solid credit history, or some kind of credit worthiness, however that’s defined. In this scenario, however, a credit-worthy business may be denied forgiveness for reasons that fall outside the purview of routine practices, such as records that are not adequately maintained. Meanwhile, a PPP applicant might meet required standards even with bad credit, and therefore get approved. In that sense, PPP outlays are more like financial grants, where specific terms and conditions are more important than best practices in banking.

And of course, remember that the money hasn’t come from the government yet —throughout the operation, the banks involved are on the hook. The funds have already been disbursed, and in vast amounts, without any direct federal assistance. If and when approval or forgiveness is denied, the bank will bear the burden. At this volume, even a small percentage of defaults could wipe out profits from the origination fee.

All this means that despite the umbrella of good deeds, PPP carries serious risk. Here’s a summary of the most prominent risks.

• Default: The history of inappropriate or unsupported approvals associated with stimulus loan could certainly emerge in these circumstances. Match the urgency caused by current conditions with understandable errors in interpreting complex guidelines, and you get a recipe for problems—and that’s in addition to fraudulent representations from unscrupulous parties looking to cash in. Loans with these problems could be ruled ineligible for SBA guarantees, and in an economy where mere survival is a challenge, they’ll probably have a higher default rate.

• Earnings: Loans denied forgiveness won’t go away; in fact, they’ll remain on the books at 1% interest. This is a very dubious situation because there isn’t a concrete timeline for loan approval or forgiveness, and servicing costs for an extended period could have a negative effect on a bank’s own financial structure.

• Capital: Regulators have stated that PPP loans will be excluded from capital risk calculations, but it’s a mistake to see this as an all-encompassing proposition. For exclusion to happen, the loans must be guaranteed by the SBA, and the bank must pledge them to a PPP Liquidity Facility from the Federal Reserve. Loans falling outside of these parameters, or even experiencing a delay in setting up the credit facility, will indeed affect capital risk calculations, and probably not in a good way.

Again, the Paycheck Protection Program is an economic boon and deserves across-the-board support. At the same time, participating banks would be well-advised to have comprehensive risk assessment programs in place to steer clear of potential defaults.