Asset/Liability Lending & Credit Risk SBA Lending

Navigating Liquidity, Funding, and Return in the Paycheck Protection Program

Kylee Wooten

April 21, 2020

Read Time: 0 min

Key Takeaways

Financial institutions have 10 calendar days to disburse PPP loans
To address financial institutions’ concerns regarding funding PPP loans, regulators have helped to facilitate lending.
There are 3 factors to consider when assessing return and profitability of PPP loans.

Although funds for the Paycheck Protection Program (PPP) have been exhausted as of April 16, financial institutions are still working around the clock to fund the new loans. While participating PPP lenders were grateful to provide loans to small business owners, many financial institutions were also feeling some liquidity and funding pressure in response to the influx of loans.

PPP loans carry a 0% risk weighting, meaning they don’t count against the institution from a risk-based capital standpoint. However, some financial institutions have worried that additional assets could negatively affect the leverage ratio in the short term. “We don’t have to hold more capital against these loans, which is an interesting way to make the availability of this a little better, but it’s going to cost us some money to put these on the books,” explained Dave Koch, Managing Director of Advisory Services at Abrigo, during a recent podcast. While some institutions may have no liquidity problems issuing PPP loans, Koch cautions financial institutions to consider the possibility of needing more cash for potential withdrawals, or other issues that may arise during uncertain economic times. If financial institutions need to borrow money for the loans, there are several avenues they can take to do so, while still making money in the long run, Koch explained.

Window to disburse loans

Financial institutions were frenzied when the Treasury and the SBA initially signaled that approved PPP loans would have to be funded within five calendar days. Shortly after, the Treasury updated its FAQs to include a disbursement timeline of 10 calendar days. By the time the FAQ was issued, financial institutions had been making PPP loans for about four days. This gap in time has left many financial institutions wondering whether or not loans made prior to the issued FAQ would be under the same timeline for disbursal.

Steve Domine, President of Minnesota Community Banking and Senior Vice President of Lending at Stearns Bank, explained during a recent Independent Community Bankers of America (ICBA) webinar that his bank sought both inside and outside counsel to understand the SBA rulings. Stearns Bank, as well as other bankers on the webinar panel, have concluded that loans made outside of that timeframe are not subject to the same restriction.

Funding PPP loans

To address financial institutions’ concerns regarding funding PPP loans, regulators have helped to facilitate lending. On April 9, the Federal Reserve announced additional actions to bolster the effectiveness of the PPP, including the Paycheck Protection Program Liquidity Facility (PPPLF), which supplies liquidity to participating financial institutions originating PPP loans. Non-bank SBA-approved lenders, however, may not participate in the PPPLF at this time.

The PPPLF are non-recourse loans, and the Fed, the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC) have agreed that these loans will not increase the regulatory capital requirements for financial institutions leveraging these loans. Under the facility, the Fed will lend financial institutions the principal amount of the PPP loans with the same maturity date at an interest rate of 35 basis points and no fees.

"As millions of Americans have been ordered to stay home, severely reducing their ability to engage in normal commerce, revenue streams for many small businesses have collapsed,” the agencies explained in a press release introducing the PPPLF. “This has resulted in severe liquidity constraints at small businesses and has forced many small businesses to close temporarily or furlough employees. Continued access to financing will be crucial for small businesses to weather economic disruptions caused by COVID-19 and, ultimately, to help restore economic activity."

The program became available for financial institutions on Thursday. Both Domine and another ICBA webinar panelist, Tommy Bates, President and CEO at Legends Bank, both said their respective banks would be making use of the facility. With the surge in loans and no pressure on capital ratios, both Domine and Bates expressed approval for the program.

Other sources of funding for PPP loans are also available, such as through some Federal Home Loan Banks, where members can get access to short-term advances at discounted rates.

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Return from PPP loans

Some financial institutions may be worried about the profitability of PPP loans, especially if the institution chooses to leverage the PPPLF. When assessing return and profitability, Koch recommends looking at three factors:

Costs to issue the loan
Impact of early repayment
Effect of defaulted loans

There are several costs associated with PPP lending, including staff costs and servicing expenses. When it comes to repayment, the payment structure incentivizes banks to issue smaller loans ($350,000 or less) to receive a 5% processing fee at the time of final disbursement. Maximum returns are positively correlated to how quickly the loan is paid off, diminishing over time. Since the loans are 100% guaranteed by the SBA, potential losses financial institutions experience should be minimal if institutions follow the underwriting guidelines correctly. “Worst-case scenario [from a profitability standpoint], none of these loans pay off early and they go to the two-year term,” Koch said.

Walking through different scenarios during the podcast, Koch found that, over the two-year life on an annualized basis, models show returns from 7-8% up to nearly 20%, mostly impacted by how quickly the loan was paid off. “Where are you going to find that return anywhere else in the market right now with interest rates where they’re at?” Koch said. “The use of a good pricing model or good pricing practices helps us to get through the 1% rate issue. Sometimes, we focus on the interest rate, but we forget about the fee income that’s coming in – that’s really what we’re getting paid on.”

The PPP is still rapidly unfolding. That makes it imperative for financial institutions to adequately consider funding analysis and liquidity management as they evaluate the economic impacts of COVID-19. Financial institutions facing staffing shortages or competing priorities due to programs such as the PPP have outside options available, however. For more information, speak to an advisor.