Did banks play favorites in PPP or were they just being prudent?
WASHINGTON — As lenders dole out a new round of financing under the Paycheck Protection Program, banks are being scrutinized for where they direct loans after criticism that they prioritized high-profile firms.
Lawmakers amplified concerns last week that publicly traded firms such as Ruth's Chris Steak House, Shake Shack and others garnered special treatment from banks in the first round of the program to the detriment of smaller companies reeling from the coronavirus pandemic.
But many observers argue that banks' lending decisisions in the early days of the program were understandable. Financial institutions, mindful of underwriting and fraud risk and lacking Small Business Administration guidance, were likely looking to disburse aid quickly. Fast-tracking loans to reliable clients therefore made sense, they argue.
"They know their customers," said Stephen Minsky, CEO of LogicManager, a Boston-based designer of enterprise risk management software. "That's their job, to avoid fraud. They're resorting to the most certain and the most authentic way of distributing funds and using safety and soundness methods that have always been part of the bank."
The first PPP — launched on April 3, less than a week after Congress authorized the program with $349 billion in funds — was quickly depleted, leading Congress to approve an additional $310 billion last week. The second round of the program was launched Monday.
But the program has been mired in controversy over several issues, including banks' lending decisions. Despite the impression among some small businesses and commentators that loans would be granted effectively on a first-come, first-served basis, a recent New York Times report said some banks provided “concierge” treatment for their larger, more profitable businesses seeking PPP loans. Some large publicly traded companies, including Shake Shack and Potbelly, subsequently returned funds after they had learned PPP funds had dried up so quickly. On Monday, it was reported that the Los Angeles Lakers basketball team also returned its PPP loan.
While lawmakers raised concerns about lenders' early actions, observers say bankers’ lending decisions were inevitable given how quickly the government tried to erect pandemic aid programs.
“You cannot have a gigantic program launched within literally a week of statutory enactment and not expect the institutions to basically use the systems they’ve got, which are designed to serve the customers they prioritize and already have,” said Karen Petrou, managing partner at Federal Financial Analytics.
Sens. Chuck Schumer, D-N.Y., Sherrod Brown, D-Ohio, and Ben Cardin, D-Md., last week called for an SBA inspector general investigation into lenders' prioritizing of larger, wealthier clients to the detriment of small businesses that have taken a severe hit from the pandemic.
“The lack of a prior relationship with a larger bank should not stand in the way of lending to small businesses that are truly small, unbanked, underserved, minority or women-owned,” the senators wrote.
And Sen. Marco Rubio, R-Fla., wrote last week to the CEOs of several large and regional banks asking if their PPP loan approval process containted filters that prioritized applications from certain businesses over others.
“While I recognize the challenges of setting up a program of this size, processes to handle applications, and appropriate guidance to administer the program, it is important for small businesses and nonprofits of various sizes, regional locations, and missions to have equal access to PPP assistance,” Rubio said. His letter was addressed to executives at Bank of America, JPMorgan Chase, Wells Fargo, PNC Financial Services, KeyBank, M&T Bank, Huntington Bancshares, TD Bank, Truist Financial, Zions Bank, Regions Bank, and U.S. Bancorp.
Ian Katz, a director at Capital Alpha Partners, said some of the public uproar about banks prioritizing higher-profile borrowers is the result of many firms and experts believing businesses would receive loans in the order that they applied.
“There was this impression that was created … that this would be first come, first serve,” Katz said.
But Katz said just because a company applies first doesn't mean that a bank will approve its loan before that of a firm that applies later.
“If I submit an application and I’m first and it’s not complete, and they have questions about it, am I first anymore or am I not first?” Katz said. “If somebody comes in eight hours later or the next day, and their application is complete, who is first?”
“Certainly banks felt like it was easiest or most expedient or more profitable, or some combination of all of those, to go with some of their largest clients first on this when doling out the money,” he added.
Petrou said that without sufficient guidance from the SBA on how to prioritize businesses for PPP, banks will naturally go to their larger, more profitable clients first.
“It’s the way banks work,” Petrou said. “Banks have customer prioritization. They have concierge desks for wealthy customers. If you don’t want them to use them, then systems need to be set up in government programs to make it clear.”
Everett Sands, CEO of Lendistry, a fintech community development financial institution based in Los Angeles, said he sympathized with banks that they were “caught between the letter and the spirit of the program, and wanted to do their best for their clients.”
Lendistry made about $10 million of loans during PPP's first phase, ranging from $4,653 at the small end to $250,000. Its median loan size was $44,000.
Minsky of LogicManager said the larger loans some banks made can be traced back to their desire to avoid fraud by lending to borrowers with whom they were familiar. "It's not favoritism," he said.
In the second round of PPP funding, Congress set aside $60 billion for loans specifically made by banks with less than $50 billion of assets, half of which is designated for banks under $10 billion of assets.
A spokesperson for the American Bankers Association said the sheer number of applications for PPP loans has forced some banks to focus on their existing customers.
"Given the flood of applicants, it's understandable that banks would work with their existing customers first because they already had the needed documentation required by the SBA, but the goal has always been to provide help to as many struggling small businesses as possible," the spokesperson said.
Paul Merski, group executive vice president for congressional relations and strategy at the Independent Community Bankers of America, said community banks understand that PPP was intended to help lift up small businesses affected by the coronavirus pandemic.
“The explicit intent of Congress was for the PPP program to reach small businesses nationwide, especially given the minimum $60 billion set-aside for community lenders,” Merski said. “We will hold Treasury and SBA to that statutory responsibility.”
Sands said that the intent behind the $60 billion set-aside was "noble," but that a limit on loan size would likely have been a more effective means of funneling money to the smallest businesses.
As businesses begin submitting applications for new PPP loans after the second congressional authorization, the SBA has issued new guidance for banks’ lending decisions. The agency is capping the maximum dollar amount of loans each bank can issue at $60 billion, or 10% of the funding allocated in the first two rounds of the program.
And the Office of the Comptroller of the Currency encouraged banks last week to “prudently document their implementation and lending decisions.” Additionally, the OCC encouraged banks to identify and track the PPP loans made to small-business borrowers that have annual revenues of $1 million or less and are in low- and moderate-income areas.
But as agencies look to tweak the program to ensure that the right businesses receive PPP loans, some say the reports that banks prioritized wealthy clients over smaller businesses highlights a fundamental issue with the program's structure — that banks are involved in executing a government loan program.
“I think what this is pointing to is that the PPP is sort of fundamentally a mistaken approach,” said Marcus Stanley, policy director at Americans for Financial Reform. “Why are we having banks giving loans? … Why aren’t these direct grants to businesses instead of loans through banks?”
Representatives for small businesses said the original legislation authorizing the PPP failed to ensure equal treatment for firm seeking funds.
“Publicly traded companies did not access this money on their own. The legislation lacked strong guardrails, leaving an opening for big business, and allowing large financial institutions to help their bigger clients access money intended for real small businesses," said Brad Close, president of the National Federation of Independent Business. "Policymakers should put an immediate halt to this nonsense, prohibit financial institutions from prioritizing publicly traded clients, and should take great strides to ensure that every penny taken by publicly traded companies be returned and then provided to their intended recipients — small businesses.”
As more details come to light about the banks' lending decisions in the PPP, Petrou said banks could face significant political headwinds in the coming months.
“If this is validated, I think it is a significant political risk,” Petrou said. “I think it has the potential to become a significant political risk akin to the way Wells Fargo’s cross-selling risk was huge.”
However, Katz said banks could argue that they didn’t act improperly when prioritizing certain clients over others.
“If I were the big banks on the second go-around, I would want more clarity from the administration on what’s permitted and what’s not,” Katz said. “I think they can make a fair case that they’re not doing anything that’s not allowed.”