In surveys by the National Federation of Independent Businesses, a staggering 92 percent of small businesses report being negatively impacted by the COVID-19 pandemic. In April, the NFIB reported that at least 70 percent of the nation’s small businesses had applied for the Paycheck Protection Program financial assistance made available through the SBA as part of the CARES Act stimulus bill.
With so many businesses struggling with diminished or no revenue during forced closures, community-minded banks have stepped up to answer the calls for help and disburse emergency funding. Lenders everywhere have been under enormous pressure to meet the overwhelming demand – and meet it quickly.
But even amidst such challenging circumstances, banks’ burden to “get it right” still exists. Alongside the $349 billion in business funding were appropriations for oversight by the SBA’s Office of the Inspector General. Based on lessons learned from previous economic stimulus loans, the OIG plans to aggressively investigate allegations of fraud, waste, abuse, or mismanagement of COVID-19 loans.
Complicating the situation further for lenders is the evolving guidance surrounding the new programs. The SBA too has been under pressure to act quickly. New program rules were generated in short order, and guidelines continued to change in the weeks following the availability of funds.
As lenders prepare for the next round of PPP funding, remaining conscious of a few best practices will help them to avoid potential trouble down the road.
Conduct prudent due diligence. When working with businesses that are current bank customers, following the PPP document collection guidelines for information pertaining to payroll reports, health insurance premiums, retirement plan funding, and lease agreements should be sufficient.
But due to the overwhelming demand, many lenders are now serving businesses they aren’t familiar with. In those circumstances, lenders should follow standards from their primary regulator and FDIC for knowing your customer. This includes collecting additional personal verification documents such as a social security number and valid driver’s license, and business records such as operating agreements, articles of incorporation, and partnership agreements.
Don’t assume that responsibility ends with loan approval. Lenders that routinely make SBA loans are well-aware of the SBA’s prescriptive processes for each stage of the transaction. But the usual manner of detailed processes haven’t been articulated for PPP loans.
Continuing to follow best practices for closing and funding PPP loans in a commercially responsible manner can become critical further down the road – particularly if the bank finds itself needing to collect the guarantee. At that point, all details of the transaction will fall under scrutiny. The bank will need to show it conducted adequate due diligence, maintained proper documentation, and closed and funded the loan in a responsible manner like any other commercial loan.
It’s important to note that these best practices are not just for the benefit of the bank, but the borrower as well. Eight weeks after receiving PPP funding, proper documentation needs to be submitted in order for the borrower to obtain loan forgiveness. Without this, the borrower will be unable to get all or some of the loan forgiven, and forced to repay on an accelerated schedule.
Make sure borrowers understand the very narrow use of PPP loan proceeds. It is critical that borrowers understand that PPP funding can only be used for very specific purposes: payroll, rent, mortgage interest, and utilities. Nothing else.
Borrowers understand that the PPP loans are to keep their payrolls going, but they could misconstrue the applicability of PPP funds for this purpose. For example, if a bakery’s commercial oven goes out, the business cannot use PPP funds to replace the oven, even if that piece of equipment is central to running the business, and thereby maintaining payroll.
For any expenditure other than specifically making payroll or paying rent, mortgage interest, or utilities, other financing avenues must be used. If the SBA determines that PPP funding was used for ineligible purposes, the loan will not be forgiven. Worse still, the balance will need be repaid within 24 months, potentially placing a major financial strain on already struggling businesses.
Community lenders are answering the call to move mission-critical funding into the economy, and this is no small task. It’s stressful and demanding, and everyone is looking for the light at the end of the tunnel. Following a few best practices now will help to ensure that when we get there, lenders aren’t haunted by PPP missteps from the past.
Mike Slater is the president of VITAL Financial Services, a lender service provider specializing in SBA and USDA loans. More information can be found at www.vitalfs.com.