Our multipart livestream series aims to engage in the latest changes related to these uncertain times. You’ll hear strategies for navigating what these developments mean for you.This livestream discussed the paycheck protection program (PPP), the new interim final rule issued April 2 by the SBA, common benefits for lenders of the PPP, and common mistakes lenders should avoid.
In case you missed it:
- Leslie Boyd, Principal
- Charlie Cameron, Managing Principal of Industry, Financial Institutions
- Todd Sprang, Principal
What we talked about:
Boyd: Welcome back to our Livestream Series. This afternoon is a special Monday installation of our Series. Again, our first priority is the health and the wellness of you and your families, and all of us in the CLA family want you to know we are thinking of you as our first priority. We also want to express gratitude to all of the lenders joining us today. We know the last few days have been busy for you as you navigate the PPP and serving your customers. You are playing a critical role in helping support small businesses, which are the energy and backbone of the economy.
Last Tuesday, during our Livestream Series, Todd Sprang and Jack Rybicki spoke to us about the Paychecks Protection Program (PPP). At that time, we could only work off the language in the CARES Act, but now that the SBA has issued further guidance and the Program launched, we will take a deeper dive into the (PPP) from a lender perspective.
I would like to introduce Charlie Cameron, managing principal of CLA’s financial Institutions practice and welcome back Todd Sprang, a principal in our financial institutions practice. Welcome guys!
Todd, Last week you provided us with some expectations for the PPP. Can you and Charlie provide us with a quick update with respect to how actual events unfolded in comparison to expectations?
Sprang: I anticipated three things last week:
- Strong demand – I expected borrower demand to exceed the $349 billion of funding the Program provides. That strong demand still exists and I still think it’s reasonable for that funding total to increase. I also anticipated the program date could extend past June 30 and that’s still a possibility.
- Lenders were ramping up and awaiting additional guidance from the SBA and I expected that guidance in stages. The initial guidance came out from SBA on Friday in the form of an Interim Final Rule and we’ve seen a stream of additional guidance since then, which I expect that to continue.
- Infrastructure – I expected this to be an issue on the first day applications were accepted and there were issues. However, not all lenders started accepting applications first thing Friday morning; some deferred until later in the day and other deferred until Monday. That said, I’m going to turn it over to Charlie for his observations as he had first-hand experience in the field.
Cameron: The majority of lenders are accepting applications even if they are not yet filing, and they are very involved in trying to understand the program guidelines. With the start of the program last Friday, reports were that the SBA funded more than 17,000 loans totaling approximately $5.4 billion. But unfortunately, many lending institutions were not able to gain access to the SBA’s E-Tran System. While processes are now in place for lenders to apply for system access, and the SBA has stated that they are working around the clock to address this logjam, at this point, there continues to be uncertainty around when this issue will be fully resolved. So, because of 1) the system access issue and 2) lack of clear guidance around a few issues for calculating the maximum borrowing amount, it is fair to say that many lending institutions have been a little frustrated with the program rollout at this point.
Boyd: Charlie and Todd, are some institutions choosing not to participate?
Sprang: There is a group of institutions that, for multiple reasons have been slower to commit to the program because of concerns about the program mechanics, liability, availability of internal resources and other issues. Some of those institutions are attempting to refer their borrowers to correspondent lenders or other institutions. That may not work as I am aware of lenders that are choosing to only accept applications from current customers at this time. This is a unique opportunity for an institution to impact their portfolio, right Charlie?
Cameron: Most community lenders that are participating are not motivated by the processing fees they will receive from the SBA (which could be up to 5% of the loan). Instead, they see this as an opportunity to support their local businesses and their broader community during this critical period. They also know that because of the COVID crisis, the credit risk level within their commercial portfolio has been elevated. Supporting borrowers in obtaining this working capital grant, which is what the majority of the loan is, to mitigate some of that undetermined credit risk that these institutions now have within their portfolios should be and is a motivating factor to participate in the PPP. So, for any lending institution with a commercial portfolio, I think you really have to work with your borrowers to help them take advantage of this opportunity.
Boyd: Charlie, Todd mentioned you had first-hand experience on Friday. Can you tell us more specifically what you saw?
Cameron: Overall, we have learned there are applications being completed by the borrowers that reflect a wide range of calculation methods for determining the maximum loanable amount. CLA is assisting financial institutions review of the borrower applications and supporting documentation. Based on those reviews, what appeared to be a pretty simple calculation of the loanable amount originally, has turned out to be more complicated and includes a number of key issues that remain unresolved by the Treasury and the SBA for some borrowers.
Boyd: Todd, considering all of the common issues Charlie just mentioned, where should a lender start their assessment of an application?
Sprang: Overall, from a risk management standpoint, I’ve identified certain components of the application that I believe will either prevent or delay the SBA from performing on their guarantee. In short, situations where the SBA can state that the insititution never should have made the loan.
Examples are, but are 1) Entity was ineligible based on their organization structure 2) They exceeded the 500 employee threshold 3) Fraud – we know there are instances where organizations will fraudulently try to get money out of the system.
This high level assessment is easier for a current customer than a new customer. Most applicants don’t understand this.
Boyd: Charlie, I know borrowers have struggled with the definition of payroll costs and the related calculations that determine the eligible loan amount. Can you give us some examples or observations?
Cameron: Both the statute itself and the Interim Final Rule leave room open for multiple interpretations of the compensation that must be excluded from payroll costs. There are at least three different interpretations we see borrowers and lenders applying in their calculations of payroll costs:
- The first and perhaps simplest is that only salaries, wages and commissions in excess of $100,000 paid to an employee are excluded from calculated payroll costs. In other words, there is no exclusion of any employee benefits or other items within the definition of payroll costs. This method will yield the highest loanable amount under the program.
- The second interpretation is that all compensation, including benefits, should be included for determining employees that subject to the $100,000 limit. So, if we have an employee that has annual salary of $95,000, but receives benefits totaling $15,000, the employees total compensation of $110,000 exceeds $100,000 and therefore we would exclude $10,000 from payroll costs.
- The third interpretation would say that for employees that have salaries, wages and commissions in excess of $100,000, all additional salary, wages and commissions as well as all benefits would be excluded from payroll costs. So under this method, in our last example there would be no exclusion at all for the employee with an annual salary of $95,000, but for an employee with an annual salary of $100,000, all benefits to that employee would be excluded.
There was some additional guidance released by the Department of the Treasury over the weekend that would arguably support the first and simplest interpretation — that you only consider the salary and wages components. However, based on the statute and Interim Final Rule, we believe that all 3 methods are reasonable interpretations until more definitive guidance is released.
Back to the payroll cost calculation--There is an issue surrounding whether or not self-employment income for partnerships and LLCs are included in payroll costs. This is another area we see multiple calculation methods.
- One argument is that owners of partnerships and limited liability companies often compensate themselves through profits distributions, rather than salary. Those making that argument are including these owner distributions in payroll costs, because they are equivalent of salary and wages for these individuals.
The recent SBA FAQ address this issue. Neither the CARES Act statutory language, nor the IFR speaks to this scenario specifically. However, it seems to be the type of compensation outside of the Congressional intent of the underlying legislation.
The definition of payroll costs in the statute encompasses compensation, including “salary, wages, commissions, or similar compensation” as earnings from employment. If the payments are not subject to employment or self-employment tax, it may be difficult to treat those amounts as payroll costs for the purposes of a PPP loan.
- Another position relative to owners of partnerships and LLCs is to include the guaranteed payments in the payroll cost calculation. That seems to be a more accepted position.
- If either the cash distributions or the guaranteed payments are included in payroll costs, those owners are included in the employee headcount for eligibility. Which leads us to our third position on this issue —s ome partnerships and LLCs are not including any owner compensation in payroll costs. That position is sometimes motivated by the ability to not include their owners in the employee count.
Boyd: Charlie and Todd, any closing thoughts?
Cameron: Lenders see this as an opportunity to support their local businesses and their broader community during this critical period. They also know that the credit risk level within their commercial portfolio has been elevated as a result of the COVID-19 crisis, so supporting borrowers in obtaining these working capital funds to mitigate some of that undetermined credit risk that these institutions now have within their portfolios should be and is a motivating factor to participate in the PPP.
Boyd: Thanks everyone for joining us this week. We will have two additional livestreams on Tuesday and Thursday this week to continue to discuss developments related to the PPP program. We encourage you to join and continue to be part of the conversation. Until then, reach out with any questions and have a safe and healthy week.