Analysis

4 Key Issues Clouding COVID-19 Small Biz Loan Program

By Al Barbarino
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Law360 (April 15, 2020, 8:12 PM EDT) -- As the federal government reportedly closes in on deploying most of the $349 billion in loans that were dedicated to small businesses as part of the $2 trillion Coronavirus Aid, Relief and Economic Security Act, lenders are seeking continued guidance as they contend with significant compliance, reporting and liquidity roadblocks amid immense demand.

The Small Business Administration's Paycheck Protection Program offers two-year loans of up to $10 million, at a 1% interest rate, to cover payroll costs, health care benefits, mortgage interest payments, rent and more, and they'll be forgiven if businesses keep their end of the deal by retaining employees on payroll through the crisis.

Amid media reports Wednesday indicating that the initial funding is nearly depleted and that talks are underway in Washington to strike a deal for additional funding, it will be crucial that the SBA and government regulators address ongoing concerns as lenders grapple with the existing guidance and others claim they're already overextended. 

Here are four key lender concerns.

KYC Requirements

Since the program launch, large banks like Bank of America and Wells Fargo have voiced their struggles with the PPP program, with many initially saying they could only handle requests from existing customers. Small- and midsize lenders in many cases will take the same stance, having less capacity to shell out the amount of debt needed to meet demands.

While only catering to existing clients may sound like a harsh line to draw, attorneys said that, while lenders want to do the right thing, the requirements of onboarding new customers are simply too burdensome.

"Lenders need to prioritize their available resources," said Scott Cammarn, a Cadwalader Wickersham & Taft LLP partner and co-chair of the firm's financial services group. "Not only do they have the SBA PPP loans, they've got credit card loans, mortgage loans, car loans and all of their other business loans to take care of."

In particular, so-called Know Your Customer or KYC requirements, which include checks on money laundering and terrorist financing activity, are a particularly burdensome part of the onboarding process.

"This may be the basis for complaints that banks are unable to respond promptly to PPP application submissions,'" Cammarn said.

The Financial Crimes Enforcement Network issued guidance April 6 saying that, contrary to existing Bank Secrecy Act requirements, eligible lenders would not need to reverify existing customers for loans issued under the PPP. But it left the requirements, including KYC and anti-money-laundering rules, in place for new customers.

"I don't know that lenders' KYC onboarding groups have enough bandwidth to process applications at the speed that the businesses need money," said Alexander Grishman, a partner within Haynes and Boone LLP's financial transactions practice group. "And there's no way a compliance department will be comfortable sending money out the door to a noncompliant business without getting specific waivers from the banking regulators."

However, no such waivers currently exist.

Secondaries Market Guidance

There is confusion around if and how lenders can transfer PPP loans to the secondaries market, Cammarn said. While the SBA and U.S. Department of the Treasury have both stated that PPP loans can be sold in the secondary market, existing SBA regulations do restrict certain loans from being transferred in the secondary market, he noted.

This conflict could tie the hands of lenders looking to use the secondary market to free up funds unless additional guidance is forthcoming on how lenders can use this valuable resource efficiently and safely.

"This program needs firm guidance from the SBA and the Treasury on how a lender can sell these loans quickly and easily so they can reload and start lending again," Cammarn said.

Normally, the SBA has a precise process in place to track the transfer of loans in the secondary market. Indeed, the unchecked transfer of PPP loans into the secondary market could result in major issues when the holder of the loans ultimately asks the SBA for reimbursement upon loan forgiveness, Cammarn said.

That said, such transfer restrictions would hamper lenders' ability to quickly provide much-needed funding.

Loan Forgiveness Reporting

In addition to reviewing initial applications, lenders will need to review documentation from businesses once the issue of loan forgiveness arises. Businesses will need to show they've used a majority of the funds for certain payroll requirements, based on average monthly payroll costs.

Grishman noted that the varying size and complexity of businesses' accounting practices will lead to nonuniformity in the documentation, with some businesses having the luxury of in-house accountants while others will defer to contractors or accounting software services.

"It's going to be interesting to see how the banks are reviewing documentation that might be nonuniform," he said.

"For loans to be forgiven, businesses will have eight weeks to spend the money on three baskets — payroll costs, utility costs and lease or mortgage interest payments," he added. "Lenders will have to aggregate all that documentation, review it and then submit the evidence to the SBA that the money was spent accordingly and that a loan should be forgiven."

There remains a cloud of uncertainty as to who the SBA will hold accountable if this core documentation doesn't check out, on both the part of the lenders and businesses.

"Many clients are concerned that if they do not do everything exactly as prescribed by the SBA, they will lose the guarantee of the loan," said Mike Keeley, a partner with Norton Rose Fulbright whose specialties include corporate and regulatory banking. "This concern is magnified as the rules continue to evolve."

Liquidity Concerns

Last week, the Federal Reserve announced the Paycheck Protection Program Liquidity Facility, aimed at supplying liquidity to participating financial institutions through term financing backed by PPP loans.

But the facility may not be sufficient to appease the liquidity concerns of lenders, Keeley said.

"To facilitate the velocity of disbursements, the Federal Reserve should buy the loans, not offer a liquidity program backed by the loans," he said.

He noted that many lenders are already considering the program a "net loser" financially when factoring in the 1% interest rate and the regulatory costs associated with making the loans.

"In addition, when you look at the cost of onboarding new clients and the KYC issues, and then the Federal Reserve says, 'I'm not going to buy this stuff, but I'll give you a liquidity program so that you can have more cash to disperse,' I think that disappoints a lot of bankers," Keeley said. "They would much prefer to issue the loan then give it back to the government, which is ultimately responsible for it."

--Editing by Breda Lund and Kelly Duncan.

For a reprint of this article, please contact reprints@law360.com.

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