Helping Commercial Clients Access New Tax Credit

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Helping commercial clients is also an opportunity for banks to increase fee income through a partnerships.

Commercial clients can access a payroll tax refund through the Employee Retention Credit (ERC); ERC providers that specialize in navigating the process can partner with banks to offer this service and increase their noninterest fee income and deposits.

The ERC was born out of the 2020 CARES Act, which is the same relief bill that created the Small Business Administration’s Paycheck Protection Program (PPP) loan. PPP clients may qualify for the ERC, which gives banks an opportunity to monetize their PPP client list. The ERC is easier for banks to implement than the PPP since it is not a loan: it is money that businesses are entitled to receive from the government. Once companies receive ERC funds from the U.S. Department of the Treasury, it’s the business owner’s money to keep.

Initially, the ERC tax credit was available to companies whose operations were fully or partially suspended from March 13, 2020, through Dec. 31, 2020. Back then, the maximum refund a company could receive was up to $5,000 per employee. Then, Congress made several modifications:

1. The Consolidated Appropriations Act extended the ERC to include wages paid before July 1, 2021. The maximum ERC amount was increased to $7,000 per employee and quarter.

2. The American Rescue Plan Act of 2021 included wages paid between July 1, 2021 and Dec. 31, 2021.

3. As of Sept. 30, 2021, the retroactive appeal of the ERC affected businesses that were originally scheduled to receive the ERC from Oct. 1 through Dec. 31, 2021.

Who Qualifies for the Payroll Tax Refund
Thanks to the payroll tax refund, banks that partner with an ERC provider can help their clients capture these rebates, benefiting from the higher deposits in their clients’ accounts. The IRS estimates that tens of thousands of businesses are eligible for the refund, which is available to both essential and non-essential businesses that were impacted by the pandemic. If a company experienced disruptions to commerce, travel or group meetings, it likely qualifies.

When banks empower their commercial clients with business opportunities they can take advantage of, both parties benefit in several ways, including:

Stronger relationships. Helping their commercial clients claim their payroll tax refund gives more trust and credibility.

Expanded services. Banks can set themselves apart from their competitors by offering assistance with navigating the ERC qualification and refund process.

Growth opportunities. With more noninterest fee income and deposits, banks can increase their budgets for other initiatives that help move their business forward.

While business owners may be tempted to go to their CPA to find out if they qualify, it’s recommended to go to an ERC provider that understands the intricacies and nuances involved in assessing eligibility. Choosing a highly qualified professional gives commercial clients a potentially higher refund amount than if they went to a general practitioner.

Banks that partner with an ERC provider can help their commercial clients navigate the payroll tax refund process easily and quickly. This partnership can then expand to additional services that allow banks to scale their commercial client base.

Proposed TDR Accounting Relief Will Miss Most Small Banks (For Now)

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Small banks may miss out on a new proposed accounting rule that frees banks from onerous accounting and reporting requirements following a loan modification.

In November 2021, the board that sets U.S. accounting standards issued an exposure draft that will remove the reporting guidance around troubled debt restructurings, or TDRs, for banks that have adopted the new loan loss standard, called the current expected credit loss model or CECL. Under the proposal, banks that have adopted CECL could continue reporting any modifications they offer borrowers and leave TDR accounting behind, but excludes the many small banks that have yet to adopt CECL.

The move has its fans.

“I’m all for it, and good riddance. There’s not a true credit guy I know who spends much time worrying about TDRs anymore,” says David Ruffin, principal at IntelliCredit, a division of QwickRate that helps financial institutions with credit risk management and loan review. “TDRs stayed around well beyond their usefulness.”

The change from the Financial Accounting Standards Board, or FASB, stems directly from the combination of the new loan loss standard and the banking industry’s experience during the coronavirus pandemic. TDRs occur after a bank offers a concession on a credit that it wouldn’t otherwise make, because of a borrower’s financial difficulties or hardship. The bank offers a modification and it reports the value of the impaired credit using a complicated accounting approach called discounted cash flow analysis. Under the current guidance, a credit classified as a TDR could never be reclassified even when the modification ended and the borrower returned to financial health, giving rise to the phrase “Once a TDR, always a TDR.”

CECL and the coronavirus pandemic changed all that. CECL requires banks to set aside a lifetime loss estimate when they make a loan, and then periodically update that expected loss as the borrower’s financial condition or the economy changes. TDR guidance conflicted with CECL in several ways. CECL gives banks the flexibility to select what method to use to calculate loan losses, based on factors like the portfolio or borrower characteristics; the proscriptive TDR approach seemed to violate that spirit. And after the standard went into effect, banks and those who prepare financial statements told the FASB that the new approach to allowances captured most of the impacts from loan modifications that would be included in the TDR calculation.

“TDRs no longer provide decision useful information,” the board noted in the project description for this proposal.

Then the pandemic hit, and Congress took the dramatic step of dramatic step of suspending the TDR reporting requirements to encourage banks to work with borrowers facing unexpected financial hardship. Banks were free to offer loan modifications that normally would’ve triggered TDR classifications but didn’t need to engage in the accounting and formal reporting requirement.

What they did do was better. Banks voluntarily provided information on the percentage of borrowers that had received a modification, the amount of loans under modification, the type of modification and sometimes the industry. This became somewhat of an industry standard, which observers praised as more useful and actionable. Quarterly updates showed that at many banks, the percentage of secondary or continued modifications was declining, boosted by government stimulus programs and the gradual return of economic activity.

All that was slated to revert to TDRs at the end of 2021 with the sunsetting of the CARES Act provision, until the accounting board took up the mantel. If the proposal passes, CECL banks that offer a loan modification to a borrower that is facing financial difficulty in 2022 will need to provide enhanced disclosures.

But the relief would only be for some banks. CECL went into effect for most public filers — mostly large banks — at the start of 2020. But private companies and those defined as “smaller reporting companies” by the Securities and Exchange Commission received a delay until the start of 2023 and can still use the incurred accounting method, setting aside a reserve when a loss becomes probable. The argument against eliminating TDR treatment for banks using the incurred method is that because the bank doesn’t assign potential lifetime losses to its loans on a quarterly basis, the TDR guidance isn’t redundant and still applies.

Although banks large and small showed they could manage both borrower modifications and appropriate allowances during the pandemic, community banks should expect to revert to the existing TDR guidance at the beginning of 2022 until they adopt CECL.

A Look at the Great Loan Modification Experiment

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After almost a year, Congress’ decision to suspend loan modifications rules was an unprecedented, unorthodox and, ultimately, effective way to aid banks and borrowers.

The banking industry is going on four quarters of suspended requirements for coronavirus loan modifications. Suspending the reporting rules around loan modifications was a creative way for regulators and lawmakers to encourage banks in the spring of 2020 to work with borrowers facing coronavirus-related hardships. The result is that the industry, and economy, had more time to reassess the rapidly uncertain environment before needing to process troubled credits.

“Standing here today, having completed most of my year in audit and having a pretty good idea of how things are panning out — I would call it a raging success,” says Mandi Simpson, a partner in Crowe’s audit group. She adds that the decision to pause loan payments may have helped avoid a number of business closures and foreclosures, which will help the economy stabilize and recover long-term.

Ordinarily, these modifications, like no payments or interest-only payments for a period of time before restarting payments and catching up, would have been categorized as troubled debt restructurings, or TDRs, under U.S. generally accepted accounting principles.

TDRs occur after a bank offers a concession on a credit that it wouldn’t otherwise make to a borrower experiencing financial difficulties or hardship. The CARES Act suspended the determination that a loan modified because of the coronavirus would count as a TDR, “including impairment for accounting purposes.” Banks could now offer deferments and modifications to borrowers impacted by the coronavirus without needing to record them as TDRs.

The suspension came as part of the Coronavirus Aid, Relief, and Economic Security Act of 2020, or CARES Act, and was extended in the stimulus bill passed before the end of the year. The move was supported by the U.S. Securities and Exchange Commission, the Financial Accounting Standards Board and bank regulators, who had encouraged banks to work with borrowers prior to the suspension. It is scheduled to be in effect through until Jan. 1, 2022, or 60 days after the termination of the national emergency, whichever is earlier.

“The regulatory community gets a high-five for that, in my opinion,” says Christopher Marinac, director of research at Janney Montgomery Scott. “Think about the accounting change in TDRs as another form of stimulus … For the companies and the clients that received deferrals – this pandemic is not their fault. … There was a recognition that this gave people a way to buy time. The one variable you can’t quantify in a crisis is time.”

The widespread forbearance allowed borrowers to adapt their businesses, get a handle on their finances or apply for Paycheck Protection Program funding from the Small Business Administration. It also gave banks a chance to reassess their borrowers’ evolving risk and offer new loan terms, if needed.

Reported Bank Deferral Data for 2020

Quarter Loans in deferral, median Low range High range Number of banks reporting
Q1’2020 11.1% 0.3% 38% 224
Q2’2020 15.3% 1.2% 46.4% 234
Q3’2020 3% 0% 21.5% 240
Q4’2020 1.4% 0% 14.5% 238

Source: Reports authored by Brad Milsaps, managing director at Piper Sandler & Co.

A number of institutions took advantage of the suspension to offer borrowers relief. Simpson remembers that many banks freely offered short-term forbearance in the second quarter, and panicked borrowers accepted. When those forbearance periods expired in the third quarter, borrowers had a better sense of their financial condition — aided by the PPP — and banks were better prepared to work with customers under continued pressure.

By the end of the second quarter, most banks “expressed optimism” about the direction of deferrals and reported “minimal” second requests, mostly related to restaurant and hotel borrowers, wrote Brad Milsaps, managing director at Piper Sandler & Co.

He expected deferrals to become “less of a focus going forward,” as those loans’ performance normalized or banks felt confident in marking them as nonaccruals. To that end, the median ratio of criticized loans to total loans, excluding Paycheck Protection Program loans, increased to 3.6% at the end of the third quarter, from 2.9% in the second quarter.

“Deferrals were an impactful tool utilized at the beginning of the pandemic, but have fallen to a very minimal level given the impact of PPP, the CARES Act, and improvement in the economy,” he wrote in a February 2021 report. “Although deferral data continues to be disclosed by most banks, the investment community has mostly moved on from deferrals as an area of primary focus.”

But the suspension of TDR guidance is not a green light for banks to wholly ignore changing credit risk. If anything, the year of deferrals gave banks a better sense of which customers faced outsized challenges to their businesses and whether they could reasonably and soundly continue supporting the relationship. Marinac points out that many banks have risk-rated loans that received modifications, set aside reserves for potential losses and migrated those that continued to have stress over time.

And as documented in Milsaps’ reports, a number of banks decided to share their modification activity with the broader public, with many including geography, industry and sometimes even the type of modification offered. These disclosures weren’t required by regulators but demonstrated the credit strength at many banks and reassured investors that banks had a handle on their credit risk.

The suspension of TDR reporting requirements through the end of 2021 gives the industry and stakeholders like FASB, the accounting board FASB, to consider the usefulness of the existing TDR guidance.

The reporting involved with TDRs involves an individual discounted cash flow analysis, which makes the accounting complicated and tedious. TDRs also can carry negative connotations that are impossible to shake: A modified TDR, even if it’s performing, is always recorded as a TDR. Simpson points out that the loan modification disclosures banks made in lieu of reporting TDRs was, in many cases, more useful and insightful than if the banks had just treated all modified loans as TDRs. And while mass loan modifications may have been a lot of work for banks in the midst of the pandemic’s most uncertain days, it would have been exponentially more complicated to do mass restructuring recordings and discount cash flow analyses over those four quarters.

“If you aren’t going to do TDR reporting at the time when — in theory — it would be the most valuable, doesn’t that call into question whether TDR identification is really that useful after all?” Simpson asks. “The standard-setters are doing some outreach and taking a second look with exactly that in mind.”

When it Comes to Loan Quality, Who Knows?

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Seven months into the Covid-19 pandemic, which has flipped the U.S. economy into a deep recession, it’s still difficult to make an accurate assessment of the banking industry’s loan quality.

When states locked down their economies and imposed shelter-in-place restrictions last spring, the impact on a wide range of companies and businesses was both immediate and profound. Federal bank regulators encouraged banks to offer troubled borrowers temporary loan forbearance deferring payments for 90 days or more.

The water was further muddied by passage of the $2.2 trillion CARES Act, which included the Paycheck Protection Program – aimed at a broad range of small business borrowers – as well as weekly $600 supplemental unemployment payments, which enabled individuals to continuing making their consumer loan repayments. The stimulus made it hard to discriminate between borrowers capable of weathering the storm on their own and those kept afloat by the federal government.

The CARES Act undoubtedly kept the recession from being even worse, but most of its benefits have expired, including the PPP and supplemental unemployment payments. Neither Congress nor President Donald Trump’s administration have been able to agree on another aid package, despite statements by Federal Reserve Chairman Jerome Powell and many economists that the economy will suffer even more damage without additional relief. And with the presidential election just two months away, it may be expecting too much for such a contentious issue to be resolved by then.

“We expect charge-offs to increase rapidly as borrowers leave forbearance and government stimulus programs [end],” says Andrea Usai, associate managing director at Moody’s Investors Service and co-author of the recent report, “High Volume of Payment Deferrals Clouds a True Assessment of Credit Quality.”

Usai reasons that if there’s not a CARES Act II in the offing, banks will become more selective in granting loan forbearance to their business borrowers. Initially, banks were strongly encouraged by their regulators to offer these temporary accommodations to soften the blow to the economy. “And the impression that we have is that the lenders were quite generous in granting some short-term relief because of the very, very acute challenges that households and other borrowers were facing,” Usai says.

But without another fiscal relief package to help keep some of these businesses from failing, banks may start cutting their losses. That doesn’t necessarily mean the end of loan forbearance. “They will continue to do that, but will be a little more careful about which clients they are going to further grant this type of concessions to,” he says.

For analysts like Usai, getting a true fix on a bank’s asset quality is complicated by the differences in disclosure and forbearance activity from one institution to another.  “Disclosure varies widely, further limiting direct comparisons of practices and risk,” the report explains. “Disclosure of consumer forbearance levels was more comprehensive than that of commercial forbearance levels, but some banks reported by number of accounts and others by balance. Also, some lenders reported cumulative levels versus the current level as of the end of the quarter.”

Usai cites Ally Financial, which reported that 21% of its auto loans were in forbearance in the second quarter, compared to 12.7% for PNC Financial Services Group and 10% for Wells Fargo & Co. Usai says that Ally was very proactive in reaching out to its borrowers and offering them forbearance, which could partially explain its higher percentage.

“The difference could reflect a different credit quality of the loan book,” he says. “But also, this approach might have helped them materially increase the percentage of loans in forbearance.” Without being able to compare how aggressively the other banks offered their borrowers loan forbearance, it’s impossible to know whether you’re comparing apples to apples — or apples to oranges.

If loan charge-offs do begin to rise in the third and fourth quarters of this year, it doesn’t necessarily mean that bank profits will decline as a result. The impact to profitability occurs when a bank establishes a loss reserve. When a charge-off occurs, a debit is made against that reserve.

But a change in accounting for loss reserves has further clouded the asset quality picture for banks. Many larger institutions opted to adopt the new current expected credit losses (CECL) methodology at the beginning of the year. Under the previous approach, banks would establish a reserve after a loan had become non-performing and there was a reasonable expectation that a loss would occur. Under CECL, banks must establish a reserve when a loan is first made. This forces them to estimate ahead of time the likelihood of a loss based on a reasonable and supportable future forecast and historical data.

Unfortunately, banks that implemented CECL this year made their estimates just when the U.S. economy was experiencing its sharpest decline since the Great Depression and there was little historical data on loan performance to rely upon. “If their assumptions about the future are much more pessimistic then they were in the previous quarter, you might have additional [loan loss] provisions being taken,” Usai says.

And that could mean that bank profitability will take additional hits in coming quarters.

Did the PPP Create Class Action Liability for Banks?

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The federal government has a history of assisting businesses when a crisis occurs, but one of its latest interventions may have created risk for bank partners providing aid.

Most recently, the CARES Act’s Paycheck Protection Program, commonly called PPP, helped businesses affected by Covid-19 by providing forgivable loans if, among other things, a company used the funds for “payroll costs, interest on mortgages, rent, and utilities” and used at least 60% of the amount forgiven on payroll. The program’s rocky rollout came during an extremely turbulent time, so it should surprise no one that disgruntled applicants and agents have filed a series of class action lawsuits with similar patterns of claims and allegations.

The first PPP class action lawsuits were filed against Bank of America Corp. and Wells Fargo & Co. in early April. In both cases — Profiles v. Bank of America Corp. and Scherer v. Wells Fargo Bank — the plaintiffs alleged the banks improperly restricted access to PPP loans to customers with a pre-existing banking relationship. Per this theory, the banks favored established, pre-existing clients in order to receive larger fees from larger loans at the expense of new customers.

Critically, in Profiles, the district court denied the plaintiffs’ motion to enjoin Bank of America from imposing eligibility restrictions. Specifically, the court held that no express or implied private right of action exists under the PPP, and that only the Small Business Administration could file a civil suit for alleged violations of the PPP. The district court determined the alleged conduct was allowed, stating “[t]he statutory language does not constrain banks such that they are prohibited from considering other information when deciding from whom to accept applications, or in what order to process applications it accepts.”

Recognizing issues with asserting claims directly under the CARES Act, another group of class action plaintiffs brought claims under state law theories in separate cases against Bank of America, JPMorgan Chase & Co, U.S. Bancorp and Wells Fargo in California federal court. These plaintiffs assert that the banks prioritized applications for large loans to generate higher fees in violation of California’s Unfair Competition and False Advertising Laws and engaged in common law fraudulent concealment. The law firms that led the California class actions have filed suits under similar theories in New York against JPMorgan.

Utilizing different theories, class plaintiffs in California argue lenders are failing to process PPP loan applications on a first-come, first-served basis, as purportedly expected by the SBA. In Outlet Tile Center v. JPMorgan Chase & Co, the plaintiffs claimed Chase solicited applications from more-favored clients, making it impossible for the others to obtain loans. Even though there is no express requirement applications be processed on a first-come, first-served basis, plaintiffs claim they gave up opportunities to get loans from institutions that took applications as they came because of their pending applications with Chase. Suits employing this theory were also filed in New York, Illinois and Texas. 

Espousing novel-market theories under the Sherman and Clayton Acts, plaintiffs in Legendary Transport v. JPMorgan Chase & Co. allege lenders conspired to only provide PPP loans to their larger clients as a way to “protect their market share and to limit competition” with respect to PPP funds. That suit also accuses JPMorgan of negligence and misrepresentation in connection with its PPP application process.

Finally, loan seekers are not the only class action plaintiffs seeking relief. Parties purporting to be agents assisting clients with applying for PPP loans are also seeking compensation. Cases in Florida and Ohio assert, despite CARES Act fee requirements, agents including accountants, attorneys, consultants and loan brokers who helped businesses prepare and submit applications are not being paid. These suits allege banks are not properly processing agent fees, intentionally failing to process loans that refer to an agent and/or directing applicants to online portals that do not allow customers to designate an agent.

All of these suits are still in their early stages, and some may be abandoned now that additional PPP funds have been made available and named plaintiffs may have received funds. Nonetheless, class action theories and new targets will evolve and emerge over time. In defending these suits, banks will likely rely upon “no private right of action” rulings, the lack of specific process requirements (as opposed to statutory guidance) and, in cases when only state law actions are pled, federal preemption. Importantly, financial institutions that evaded the first strike of class action litigation should prepare for future attacks utilizing the same or very similar theories of liability.

The CARES Act: What Banks Need to Know

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Banks will play a critical role in providing capital and liquidity to American businesses and consumers, and the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) includes several provisions that benefit depository institutions. The implications for bank directors and officers are significant; they may need to make major decisions quickly.

Expanded SBA Lending
The CARES Act appropriates $349 billion for “paycheck protection loans” to be made primarily by banks that will be 100% guaranteed by the Small Business Administration (SBA) through its 7(a) Loan Guaranty Program. The SBA issued an interim final rule on the program on April 2 and has issued additional formal and informal guidance since that date. Application submissions began on April 3. Banks and borrowers will want to move quickly, due to the limited funds available for the program.

Provisions Benefitting Depository Institutions Directly

Troubled Debt Restructuring Relief. A financial institution may elect to suspend the requirements under generally accepted accounting principles and federal banking regulations to treat loan modifications related to the COVID-19 pandemic as troubled debt restructurings. The relief runs through the earlier of Dec. 31 or 60 days after the termination date of the national emergency, and does not apply to any adverse impact on the credit of a borrower that is not related to the COVID-19 pandemic.

CECL Delay. Financial institutions are not required to comply with the current expected credit losses methodology (CECL) until the earlier of the end of the national emergency or Dec. 31.

Reduction of the Community Bank Leverage Ratio. Currently, a qualifying community banking organization that opts into the community bank leverage ratio framework and maintains a leverage ratio of greater than 9% will be considered to have met all regulatory capital requirements. The CARES Act reduces the community bank leverage ratio from 9% to 8% until the earlier of the end of the national emergency or Dec. 31. In response to the CARES Act, federal banking regulators set the community bank leverage ratio at 8% for the remainder of 2020, 8.5% for 2021 and 9% thereafter.

Revival of Bank Debt Guarantee Program. The CARES Act provides the Federal Deposit Insurance Corp. with the authority to guarantee bank-issued debt and noninterest-bearing transaction accounts that exceed the existing $250,000 limit through Dec. 31. The FDIC will determine whether and how to exercise this authority.

Removal of Limits on Lending to Nonbank Financial Firms. The Comptroller of the Currency is authorized to exempt transactions between a national bank or federal savings association and nonbank financial companies from limits on loans or other extensions of credit — commonly referred to as “loan-to-one borrower” limits — upon a finding by the Comptroller that such exemption is in the public interest.

Provisions Related to Mortgage Forbearance and Credit Reporting

The CARES Act codifies in part recent guidance from state and federal regulators and government-sponsored enterprises, including the 60-day suspension of foreclosures on federally-backed mortgages and requirements that servicers grant forbearance to borrowers affected by COVID-19.

Foreclosure and Forbearance on Residential Mortgages. Companies servicing loans insured or guaranteed by a federal government agency, or purchased or securitized by Fannie Mae or Freddie Mac, must grant up to 180 days of forbearance to borrowers who request and affirm financial hardship due to COVID-19 through the period ending on the later of July 25, or the end of the national emergency.

Servicers are not required to document the borrower’s hardship. The initial 180-day forbearance period must be extended up to an additional 180 days at the borrower’s request., Servicers of federally backed mortgage loans may not assess fees, penalties, or interest beyond the amounts scheduled or calculated during this forbearance period, as if the borrower made all contractual payments on time and in full under the terms of the mortgage contract. The law also imposes a foreclosure moratorium on federally backed mortgage loans of at least 60 days, beginning on March 18.

Forbearance on Multi-Family Mortgages. Multifamily borrowers with a federally backed multifamily mortgage loan that was current on its payments on Feb. 1, may request forbearance for a 30-day period with up to two 30-day extensions, during the covered period. Servicers are required to document borrower’s hardship. Borrowers must provide tenant protections, including prohibitions on evictions for non-payment and late payment fees, in order to qualify for the forbearance, and servicers are required to document the borrower’s hardship.

Moratorium on Negative Credit Reporting. Any furnisher of credit information that agrees to defer payments, forbear on any delinquent credit or account, or provide any other relief to consumers affected by the COVID-19 pandemic must report the credit obligation or account as current if the credit obligation or account was current before the accommodation.

Loan Modification Rules Suspended in Race to Minimize Pandemic Losses

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The suspension of accounting rules on modified loans is another dramatic measure that regulators and lawmakers have taken in the struggle to limit pandemic-related loan defaults.

The question of how — and increasingly, whether — to account for, report and reserve for modified loans has taken on increasing urgency for banks working to address borrowers’ unexpected hardship following the COVID-19 outbreak.

Regulators homed in on the treatment for troubled debt restructurings, or TDRs, in late March, as cities and states issued stay-at-home orders and the closure of nonessential businesses sparked mass layoffs. The intense focus on the accounting for these credits comes as a tsunami of once-performing loans made to borrowers and businesses across the country are suddenly at risk of souring.

“The statements from regulators and the CARES Act are trying to reduce the conversations that we have about TDRs by helping institutions minimize the amount of TDR challenges that they’re dealing with,” says Mandi Simpson, a partner in Crowe’s audit group.

TDRs materialize when a bank offers a concession on a credit that it wouldn’t have otherwise made to a borrower experiencing financial difficulties or hardship. Both of those prongs must exist for a loan to be classified as a TDR. Banks apply an individual discounted cash flow analysis to modified credits, which makes the accounting complicated and tedious, Simpson says.

“You can imagine, that could be pretty voluminous and cumbersome” as borrowers en mass apply for modifications or forbearance, she says.

Late last month, federal bank regulators provided guidance on TDRs to encourage banks to work with borrowers facing coronavirus-related hardship. Still, Congress intervened, broadening both the relief and the scope of eligible loans.

The Coronavirus Aid, Relief, and Economic Security Act, or CARES Act, which went into effect on March 27, suspended the requirements under U.S. generally accepted accounting principles for coronavirus loan modifications that would have otherwise been categorized as TDRs. It also suspended the determination that a loan that has been modified because of the coronavirus would count as a TDR, “including impairment for accounting purposes.” This applies to any loan that receives a modification that was not more than 30 days past due as of Dec. 31, 2019.

The law encourages banks to record the volume of modified loans. It also specified that bank regulators can collect data about these loans for supervisory purposes.

Bank regulators issued their revised interagency statement on April 7 to align with Congress’ rule. Bankers should maintain appropriate allowances and reserves for all loan modifications. It adds that examiners will exercise judgment when reviewing modifications and “will not automatically adversely risk rate credits that are affected by COVID-19.”

Importantly, the U.S. Securities and Exchange Commission’s chief accountant issued an opinion accepting the CARES Act treatment of TDRs as GAAP on April 3. The statement reconciled U.S. accounting policy and federal law, and spared auditors from issuing modified opinions for institutions that adopt the TDR relief.

But the accounting relief could create longer-term issues for banks, says Graham Steele, staff director of the Corporations and Society Initiative at Stanford Graduate School of Business. He previously served as minority chief counsel for the Senate Committee on Banking, Housing and Urban Affairs and was a member of the staff of the Federal Reserve Bank of San Francisco.

He understands the imperative to provide forbearance and flexibility, but he says the modifications and concessions could lead to diminished cash flows that could erode a bank’s future lending capacity. He points out that it’s also unclear what would happen to balance sheets once the national emergency ends, and how fast those modifications would be reclassified.

“This seems like an ‘extend and pretend’ policy to me,” he says. “Congress and regulators have offered forbearance, but they’re changing mathematical and numerical conventions that you can’t just assume away.”

Simpson says that as part of the tracking of modified loans, institutions may want to consider those credits’ risk ratings and how their probability of default compares to performing loans. She is encouraging her clients to consider making appropriate and reasonable disclosures to share with investors, such as the amount and types of modifications. The disclosures could also give bank executives a chance to highlight how they’re working with borrowers and have a handle on their borrower’s problems and financial stress.

“I think proactively helping borrowers early on is a good move. I know banks are challenged to keep up with the information, just I am, and the timing is challenging,” Simpson says. “They’re needing to make very impactful decisions on their business, and you’d like to be able to do that with a little bit more proactivity than reactivity. Unfortunately, that’s just not the place that we find ourselves in these days.”

Banks Brace for Exploding SBA Loan Demand

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It’s hard to run a small business in the best of times. Right now, it’s all but impossible.

“It took me 11 years to get comfortable and make enough money to create a cushion so I didn’t have to worry if the pub had a slow period,” wrote Natasha Hendrix in a recent Facebook post. Hendrix owns McCreary’s Irish Pub & Eatery in Franklin, Tennessee; she’s also my sister-in-law. Business was doing so well that she closed the restaurant to remodel its bathrooms in advance of St. Patrick’s Day — the Super Bowl for Irish pubs.

The complete evaporation of revenue for a small business like McCreary’s is mind-boggling. In 2016, a JPMorgan Chase & Co. study found that the median small business can survive without cash flow for a little less than a month; a quarter of them can make it just two weeks.

Small business owners are left questioning whether they can survive this severe and sudden downturn. “Everyone in this position has to START OVER. Build again,” wrote Hendrix. “Sure, people CAN do it but the real question I have for myself is … do I WANT to?”

“It’s a time for banks to be heroes,” said Curt Queyrouze, CEO of $827 million TAB Bank Holdings, during a recent digital conference hosted by MX.

A number of banks have announced deferrals on loan payments and are offering additional loans; Queyrouze tells me loan growth for term loans to small and mid-sized businesses had already tripled by late March at Ogden, Utah-based TAB, mostly to bridge expenses to weather the crisis.

But a lot of the relief — up to $349 billion — promises to come through the “Paycheck Protection Program,” a special Small Business Administration loan created through the Coronavirus Aid, Relief, and Economic Security (CARES) Act.

Small businesses can access PPP loans through existing SBA lenders and other participating financial institutions effective April 3; independent contractors and self-employed people can take advantage of the program beginning April 10. The terms are the same for all borrowers — two-year terms at 0.5% interest — and loan payments are deferred for six months. Use of the loans are restricted to payroll costs, including benefits; rent or interest on mortgage obligations; and utilities. The U.S. Treasury has supplied an information sheet for borrowers. (In a late press conference on April 2, Treasury Secretary Steve Mnuchin announced the interest rate on these loans would be raised, to a still-low 1%. The SBA then released an interim final rule with more information.)

Demand promises to be strong for these new SBA loans — many small businesses need cash now. But implementation is proving to be a challenge, and there’s a limited amount of time for small businesses to apply; June 30 is the deadline for the PPP loans. Additionally, there’s concern that the $349 billion in available funds won’t be enough.

At $239 million Farmers State Bank, Small Business Lending President Chris Healy has put in long hours to stay abreast of these changes and get information out to the small businesses in his markets, using email marketing, the bank’s website and videos on its social media channels.

The bank, based in Alto Pass, Illinois, is already an SBA lender and is familiar with the intricacies of the agency’s process. It has also shifted its technology to prioritize these new loans. The process has been iterative, with Healy uploading and sharing new requirements with customers as information provided by the SBA and Treasury evolves. The entire process is digital; Farmers was able to pivot quickly because it already had the technology in place.

Healy tells me roughly 300 small business customers started applications before April 3. That’s 12 times the volume in a normal year — the bank typically closes around 25 SBA loans. However, some worry the industry won’t be able to meet this influx of demand.

In a statement released April 2, the Independent Community Bankers of America cited key barriers for financial institutions. The low interest rate means banks won’t be able to break even on the loans, the two-year terms are incredibly short, and the guidelines are restrictive.

The low interest rate and abbreviated term could limit the availability of these loans, said Chris Hurn, the CEO of Lake Mary, Florida-based Fountainhead Commercial Capital, a nonbank commercial lender, in a recent webinar. Secondary markets won’t be interested in purchasing the loans. The U.S. Treasury has indicated it will purchase them, but a mechanism for doing so hasn’t been made clear.

“We’re still awaiting the final rules of how to do this, but being an experienced SBA lender already, we’re familiar with following their intricate procedures and guidelines and so forth, and this is going to be a significantly stripped-down version of that,” Healy says. However, “the Treasury did shock us … with laying out the terms on the two-year basis and a 0.5% interest [rate].”

A key provision for small businesses is that these loans can be forgiven under certain conditions: if the proceeds are used as required, and employee and compensation levels are maintained over the eight-week period after the loan is made. The intent is to ensure Americans still have jobs after nearly 10 million have filed for unemployment in the past two weeks alone. (Small businesses employ 47% of working Americans, according to the SBA.)

However, guidance is needed on the documentation and calculations that will be required to determine loan forgiveness, said Hurn.

But without the new SBA program, Healy says Farmers wouldn’t be able to support small businesses to the degree necessitated by the crisis. He expects the government to ultimately buy these loans back. “If we do a $5 million loan to help a small business, that’s a big loan for us but we can sell it back to SBA immediately, and they’ll buy it from us at the principal value of the loan,” says Healy.

Small businesses need relief. Long after this crisis has passed, those that survive will remember how banks helped them through it.

Coronavirus Underlines Digital Transformation Urgency

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The passage of the Coronavirus Aid, Relief, and Economic Security (CARES) Act means up to $350 billion in loans guaranteed by the Small Business Administration is set to flow to small businesses by the June 30 funding deadline.

Community and regional institutions are, of course, the logical partners for distribution of this capital. But a challenge remains: How will those financial institutions reach out to the market when their lobbies may not be open, and businesses may not be comfortable with face-to-face interactions?

Banks have done little to change the way they interact with their business customers in the digital age. In good times, this lack of transformation allowed large technology companies like Amazon.com, PayPal Holdings and Square to siphon customers away. The current environment complicates efforts for banks that have not already transformed to be responsive to their customers immediate needs.

Customers prioritized convenience — now banks will be forced to. Even prior to social distancing, consumers prioritized speed and convenience, whether it came to new technology or where they banked.

Winning at business banking was always going to require banks to offer business customers a frictionless experience. But the ability to operate business banking functions digitally has taken on new meaning — from defining quality service to becoming a necessity during a pandemic.

Three Critical Points of Friction in Business Banking
Now more than ever, it should be every institution’s goal to make working with businesses as easy as possible, especially when distribution of SBA dollars is at stake.

To meet this moment, banks need to remove three critical friction points from their business banking experience:

  • The Application: Paper applications are long and tedious, and the process is even more difficult for SBA 7(a) loans. To remove friction, institutions need to focus on data and access. They should use available data and technology to pre-fill applications as much as possible, and provide them digitally either for self-service or with banker assistance.
  • The Decisioning: Underwriting loans is a labor-intensive process that can delay decisions for weeks. An influx of Paycheck Protection Program loan applications will only compound the inefficiencies of the underwriting process. Banks need to automate as much of the underwriting and decisioning process as possible, while keeping their risk exposure in mind. It’s critical that banks select companies that allow them to use their own, unique credit policies.
  • The Account Opening: Banks also need to think about long-term relationships with the businesses they serve during this time. That means eliminating common obstacles associated with opening a business deposit account. For example: If a business has already completed a loan application, their bank should have all the information they need for a new account application and shouldn’t ask for it twice. They need to ensure businesses can complete as much of this process remotely as possible.

At Numerated, the sense of urgency we hear from bank leaders is palpable. Our team has been working overtime — remotely — to provide banks with a quick-to-implement CARES Act Lending Automation solution. Banks have been working just as fast to understand the current environment and build strategies that will help them meet their customers’ rapidly shifting needs.

In many ways, the COVID-19 pandemic has forced banks to consider digital transformation as a solution to this problem. Still, many firms have held off for any number of reasons. Institutions that have focused on digital transformation will be the most successful in improving the business banking customer experience and will lead the way during this pandemic as a result.

From Eastern Bank Corp. in Boston that used digital lending to become the No. 1 small to midsized business lender in their competitive market, to First Federal Lakewood, in Lakewood, Ohio, that is using digital experiences to retain and grow strategic relationships, institutions of all sizes have launched new digital capabilities, better positioning them to face what’s ahead.

As the nation’s businesses grapple with this new reality, these financial institutions are examples for others exploring how to serve business customers when they can’t see them face to face. Doing so will require a reimagining of the way we do business banking.