By now you’ve heard about the lending provisions of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). This article is designed to highlight some of the specific provisions that all lenders should be aware of.
Let’s start by making a distinction between the two major small business loan relief programs people are currently buzzing about:
- Paycheck Protection Program (PPP) – This is the actual name of the loan program created by the CARES Act. PPP is administered by the Federal Small Business Administration (SBA) through insured banks and credit unions. These loans are made and held by banks and credit unions and fully guaranteed by the SBA.
- Economic Injury Disaster Loans (EIDLs) – This is a separate SBA loan program not created by the CARES Act, but significantly modified by it. EIDL loans are administered directly by the SBA and lending institutions are not involved in this program.
Many loan applicants will be eligible for both PPP loans and EIDL loans, and it is acceptable to apply for both, but banks and credit unions can only make PPP loans.
PPP loans are intended primarily to help small businesses retain and pay employees. This is an attempt to improve the economy’s employment picture by providing liquidity directly to small employers. But it gets quite complicated. Here are the key elements:
Lenders Who Can make PPP Loans – Your Institution Can Be One of Them!
PPP loans can be made by insured banks and credit unions that are already established as SBA lenders as well as additional lenders determined by the SBA and the Secretary of the Treasury to have the necessary qualifications to process, close, disburse, and service these loans.
Any federally insured depository institution, federally insured credit union, or Farm Credit System Institution is eligible to participate in the PPP loan program as a lender. Submit your application to firstname.lastname@example.org for consideration. Applying to participate does not obligate an institution to actually make loans, but it would add your institution’s name to the SBA’s publicly available list of participants.
PPP Loan Terms
The PPP program calls for the SBA to not collect any application or loan closing fees from the borrower. The typical SBA requirement that the applicant be unable to obtain credit elsewhere is also waived for the PPP program, as well as the requirement to obtain a personal guarantee from a business owner and the requirement to obtain collateral for the loan.
PPP loans will bear interest at 0.5% and are guaranteed by SBA for the entire time any balance is outstanding. Note that all PPP loans are to allow for the deferral of payments (both principal and interest) for at least 6 and no more than 12 months. The SBA is required to issue further guidance on the deferment process within 30 days. The loan maturity is two years. These loans cannot include pre-payment penalty clauses.
Accounting and Reporting Considerations
Notably, the legislation dictates that PPP loans are to receive a risk weighting of zero for the purposes of regulatory capital requirements. The legislation also takes the highly unusual step of exempting all lenders from the generally accepted accounting principles (GAAP) requirements related to troubled debt restructuring (TDR) for PPP loans. In other words, PPP loans are not to be considered TDRs. The Financial Accounting Standards Board has subsequently issued guidance conforming to this legal provision.
Compensation for Lenders
Lenders administering PPP loans are to be compensated within five days of closing by SBA at rates as follows:
- 5% for loans with an original balance of less than $350,000.
- 3% for loans with an original balance between $350,000 and $2,000,000.
- 1% for loans with an original balance of $2,000,000 or more.
PPP Loan Forgiveness
The CARES Act is designed to allow for some or all of the PPP loan balance to be forgiven. The forgiveness provisions tend to be the main attraction for applicants. However, forgiveness is far from automatic. The borrower needs to do two things to have some or all of the loan balance forgiven:
- Spend the loan proceeds on the following in the first eight weeks after the loan proceeds are disbursed.
- Payroll costs (limited to a maximum of $100,000 of annual compensation per employee, pro-rated).
- Interest on any mortgage obligation (but not principal).
- There are two options for the second step:
- Maintain Employment - Maintain employed FTEs for the period February 15, 2020, through June 30, 2020 (the covered period) as compared to the same period in 2019, or maintain employed FTEs for that period compared to the period January 1, 2020, through February 29, 2020, at the borrower's discretion. To the extent employed FTEs decreases, a percentage of the PPP loan is eligible for forgiveness based on the percentage of FTEs in the covered period vs. the selected earlier period.
- Rehire - To the extent reductions in FTE and/or payroll expense take place between February 15, 2020, and the date 30 days after the enactment of the CARES Act (April 26, 2020), the borrower may reinstate its FTE and payroll expense to the February 15, 2020 levels (i.e. rehire employees to the pre-reduction FTE and payroll level) on or before June 30, 2020.
As an example for option 2(a), a borrower which had, on average, 50 FTEs from February 15, 2019, through June 30, 2019, but has only 20 FTEs on average from February 15, 2020, through June 30, 2020, would be eligible to have 40% (20/50) of its PPP loan forgiven if it spent all of the loan proceeds on the specific costs enumerated in 1 above.
An example for option 2(b) would entail an organization that laid off 40 of its 50 employees in early April 2020 but then hired them all back at equivalent wages before the end of June 2020. Assuming employment was restored to the pre-reduction level, there would be no limit on loan forgiveness related to option 2.
Helping borrowers understand that loan forgiveness is not automatic should be a critical part of the guidance provided to applicants when originating these loans.
Lender Compliance Considerations
For lending institutions, the underwriting process for PPP loan applications should not be unusually challenging. Certainly procedures must be established, along with controls over the process. For many lenders, capacity constraints related to existing loan inquiries in light of the COVID-19 disruption are likely to be the biggest challenge.
The CARES Act prescribes documents that a borrower must provide to evidence eligibility for loan forgiveness. Any lender engaging in these loans should become familiar with these requirements. Ultimately the lender needs to “sign-off” on amounts to be forgiven. Therefore, being prepared to collect and evaluate this evidential documentation, as well as establish controls over the review and approval of forgiveness decisions, must be considered. There are provisions in the law to “hold harmless” lenders to whom a borrower presents inaccurate or falsified information in support of PPP loan forgiveness. But it’s still worthwhile to reduce the risk of inappropriate forgiveness and the resulting SBA scrutiny, potential negative publicity, and reputational damage.
Note that there are provisions whereby the SBA may “pre-purchase” the expected amount of the loan to be forgiven. This could accelerate cash flow for the ultimate purpose of allowing the lender to make more PPP loans in the short term. Again, procedures must be established to oversee and control the process of requesting and processing pre-purchase activity.
PPP Loan Limits
PPP loans can be for any amount up to a maximum calculated as two and a half times the organization’s average monthly payroll costs for the last 12 months plus the outstanding balance on any SBA loan made after January 31, 2020. There are specific alternate rules for organizations considered “seasonal employers” for which the 12-month average might not be as meaningful.
Organizations that were not in business for a period of time after February 15, 2020 (purportedly due to COVID-19 impact but that is not required) can use alternate rules focused on recent months of business activity to establish the maximum loan amount.
Note that the initial determination of PPP loan amounts should incorporate a consideration of the amount likely to meet loan forgiveness eligibility requirements. Many borrowers will be able to structure their loans to increase the chances of full forgiveness later. Under any circumstances, PPP loans are capped at $10,000,000 per organization.
Organizations eligible to apply for PPP loans include:
- Small business concerns as previously defined by the SBA.
- Other organizations that have not more than the greater of 500 employees or the number of employees established by the SBA’s “size standards” for the organization’s industry, which are available at this link, including:
- Any business concern.
- Individuals operating under sole proprietorship or as independent contractors and some self-employed individuals.
- Non-profit organizations tax-exempt under 501(c)(3) or 501(c)(19).
- Tribal business concerns described in section 31(b)(2)(c).
- There are numerous other detailed criteria by which other organizations might be eligible, including larger multiple-location companies, franchisees, and others.
There are a lot of details in the Act. Lenders looking to engage in originating and servicing PPP loans should designate an individual to be the in-house expert on this loan program’s provisions and requirements. We are happy to discuss the PPP program in more detail and help you as you evaluate and implement a PPP loan program. Feel free to contact Jeff Paille, CPA, Partner, and his team below.
The information and advice we are providing for this matter relates to COVID-19 legislative relief measures. Because legislative efforts are still ongoing, we expect that there may be additional guidance and clarification from regulators that could modify some of the advice and information provided to you, after the conclusion of our engagement. We therefore make no warranties, expressed or implied, on the services provided hereunder.