Fair Lending Pitfall #3: The CARES Act & PPP
Do you like your small business lending with a side of controversy? If so, you’ve probably been actively monitoring the Paycheck Protection Program (PPP), created when Congress passed the Coronavirus Aid, Relief, and Economic Security Act (more commonly known as the CARES Act) in March.
In this third blog in our series on the CARES Act and its potential fair lending pitfalls, we’re looking at the PPP program, which was designed to help small businesses weather the COVID-19 storm by keeping workers on payroll. (See previous stories on reporting and delinquencies and mortgage loan servicing.)
Key features of the loans include:
- 100% guaranteed by the SBA.
- Fully forgivable if funds are used for payroll costs, interest on mortgages, rent, and utilities. 75% of the loan amount must be used for payroll.
- Payments will be deferred for six months.
- No collateral or personal guarantee are required.
- Neither the government or lenders will charge small businesses a fee.
- Loan has a maturity of two years and an interest rate of 1%.
Fair Lending Pitfall: Short on details and time, lenders scrambled to prepare for implementation and meet ravenous demand for the loan. That effort should have included a review of policies and procedures to ensure adjustments were made to lending practices.
Most loan standards require things like guarantees, collateral etc. For the PPP, standard underwriting processes do not apply because lenders don’t have to assess creditworthiness.
What adjustments were made to policies and procedures and were they applied consistently to ensure equal treatment? Application processing times and requirements for receiving the loan are very important to help ensure there are no disparities. Failure to review and revise these practices could result in fair lending violations.
Application Standards: Whose Application Was Processed First?
With limited funding and huge demand, the borrowers whose applications were processed first were at a huge advantage. There may have been a temptation to move known businesses or good customers up the underwriting queue instead of strictly following first-in-first-out (FIFO) application standards when reviewing, underwriting, and submitting applications.
There are indications this may have occurred. Is it a coincidence that many large corporations were able to get PPP funding when so many small businesses were shut out? We may find out later.
Fair Lending Pitfall: Playing favorites is an easy way to create disparity, especially when there’s a lot of attention on who got loans and who didn’t. Using FIFO underwriting practices ensures that similarly situated applicants are treated consistently. Cherry picking is bad for fair lending.
How Did the Lakers End Up with a PPP Loan?
The intent of the PPP is to provide relief to America’s small businesses as quickly as possible. Additionally, it was to allow small business to immediately determine their eligibility and apply for a loan.
The PPP loans were designed to help small businesses utilizing existing SBA 7(a) lenders or any federally insured depository institution, federally insured credit union, and Farm Credit System institution that is participating. Additionally, the PPP required lenders to follow definitions and standards set forth in the PPP utilizing the fundamentals of the SBA programs.
SBA defines small businesses as follows:
- A business with a maximum of 250 employees or a maximum of 1,500 employees. They maybe privately owned corporations, partnerships, or sole proprietorships.
- The SBA has a comprehensive table of standards, breaking down the acceptable sizes of small businesses by industry (and sub-industries, even). Average receipts range from $750,000 - $38.5 million in average annual receipts.
The PPP’s definition of small business was focused to helping:
- Any small business concern that meets SBA’s size standards (either the industry based sized standard or the alternative size standard)
- Any business, 501(c)(3) non-profit organization, 501(c)(19) veterans organization, or Tribal business concern (sec. 31(b)(2)(C) of the Small Business Act) with the greater of:
- 500 employees, or
- That meets the SBA industry size standard if more than 500
- Any business with a NAICS Code that begins with 72 (Accommodations and Food Services) that has more than one physical location and employs less than 500 per location
- Sole proprietors, independent contractors, and self-employed persons
There were also other requirements, most notable:
- Loans were capped at $10 million.
- A borrower had to “certify in good faith that current economic uncertainty makes this loan request necessary to support the ongoing operations of the applicant.
Despite these requirements, huge companies were able to get PPP loans including Shake Shack ($10 million), the L.A. Lakers ($4.6 million), Ruth Chris’s Steakhouse ($20 million), J. Alexander’s ($15.1 million). Many of these companies are publicly traded with access to the capital markets. The L.A. Lakers are worth $4.6 billion. The average player makes $7 million a year, and the minimum salary for first-year players is $898,310, according to Fox Business News. Clearly the L.A. Lakers should not be taking $4.6 million intended for small businesses.
In some cases, companies got around the $10 million cap by having two subsidiaries apply.
Once the bad publicity hit, many returned the loans. Others, like Ruth Chris’s, waited until the Treasury Department issued guidance reminding borrowers that they must “certify that their PPP loan request is necessary.”
Fair Lending Pitfall: Financial institution PPP processes should include due diligence measures to verify the applicability of the businesses applying for the loan. While these businesses might have counted as small businesses under the liberal definition used by the PPP, there were other hurdles, including the fact that the loan was necessary to continue operations. While it’s on borrowers to certify eligibility on “good faith” a good lender should use common sense to recognize that a company like the L.A. Lakers isn’t dependent on the loan for survival. Failing to adhere to the requirements of the PPP program can have fair lending repercussions down the road.
To learn more about the impact on COVID-19 on fair lending, tune into our webinar Fair Lending & COVID-19: Strategies for Maintaining Fair Lending Compliance on May 13 at 2 p.m. CT.