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.

On the Radar For the Pandemic’s Next Phase

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The banking industry must address and satisfy several competing interests as executives and the workforce adjust to the new normal of life during a pandemic.

Banks across the nation have stepped up as leaders in the fight against the Covid-19 pandemic. Now as the dust settles from the initial shock in mid-March, what are issues that your bank should be prepared to address looking forward?

When and how should we reopen our physical locations?

While banks have continued operations during the pandemic, many limited their services. It is not clear when these services will fully ramp back up. As your bank debates the best course of action for your circumstance, consider the following:

  • Prioritize health and safety by installing physical protection at branches and offices, including sneeze guards at teller windows, medical screening of employees, enhanced cleaning procedures and required use of personal protective equipment.
  • When considering return-to-work policies, be flexible and responsive to employee concerns and location-specific issues.
  • Apply the lessons learned during this period and embrace (or even improve) the technology for working remotely.
  • Task teams with understanding federal, state and local requirements related to the pandemic and the bank’s corresponding compliance obligations. These teams should meet regularly to ensure full compliance at all locations.

The ABA published a free matrix to assist banks in their reopening efforts.

We participated in the Paycheck Protection Program; now what?

There are some important post-lending matters for banks that participated in the Paycheck Protection Program to consider:

Brace for litigation. Some banks have faced lawsuits from applicants that failed to receive PPP funding. While your bank may not be able to avoid a similar lawsuit, it should avoid liability in these suits by following established procedures and demonstrating that your bankers did not deny applicants on a prohibited basis (race, religion, gender, age, among others).

Additionally, banks have encountered complaints filed by agents of borrowers seeking lender fees. You should not face liability in these suits if you did not execute a binding agreement with an agent before loan origination. Your bank’s defense will be even stronger if you mitigated this issue on the front end —for example by requiring borrowers to certify whether they used an agent, and if so, requiring the agent to complete a Form 159.

Stay current on loan forgiveness requirements. The Small Business Administration stated that it would review all PPP loans over $2 million following each loan forgiveness application submission. Thankfully for lenders, banks can rely on borrower certifications on loan forgiveness amounts. Nevertheless, agencies continue to release new guidance, and customers will rely on lenders to help them through the process.

Look for new opportunities to serve your customers and communities. There are rumors that Congress may issue a third round of PPP funding that will apply to more eligible borrowers. The Federal Reserve announced the expansion of its Main Street Lending Program, which can be a valuable source of liquidity as banks seek to meet customer needs. The SBA also released guidance on the sale of participating interests in PPP loans.

What regulatory or supervisory concerns should we be prepared to address?

Credit Decisions. Your bank must continue to balance meeting customer needs and making prudent credit decisions in the current economic environment. Many banks have started tightening credit standards, but this comes with a potential uptick in complaints about harmful lending practices. Regulators have indicated that they will scrutinize lending activity to ensure banks comply with applicable laws and meet customer needs in a safe and sound manner. The Office of the Comptroller of the Currency urged banks to “prudently document” their PPP lending decisions. The Consumer Financial Protection Bureau instructed small business owners “who believe they were discriminated against based on race, sex, or other protected category” to file complaints. Your decisions on credit parameters must be well thought out and applied uniformly.

Bank Secrecy Act/Anti-Money laundering Focus. Banks may face heightened risks from new customers or new activities from existing customers. For the first time since 2014, the Federal Financial Institutions Examination Council released updates to the Bank Secrecy Act/Anti-Money Laundering (BSA/AML) examination manual. While these updates are not directly related to the pandemic, regulators may scrutinize BSA/AML efforts at your next examination. Use this updated guidance as a springboard to assess your BSA/AML compliance program now.

IT and Security Concerns. Banks used technology enabling virtual or remote interactions during the pandemic, increasing risks associated with IT security. The regulators issued a joint statement addressing security risk management, noting that bank management cannot rely on third-party service providers and must actively ensure technological security. Expect this to be an area of focus at your next examination.

Coronavirus Ushers Banks Into New Digital Banking Era

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The Covid-19 pandemic has forced dramatic changes in the U.S. economy at a breakneck speed that seemed impossible only a few short months ago.

The banking industry has risen to the challenge, managing more than a million applications for the Small Business Administration’s Paycheck Protection Program, modifying countless loan terms, deferring payments and redesigning the customer experience to minimize in-branch foot traffic — all while shifting a significant portion of operations to employees’ home offices.   

We are in uncharted territory. The business decisions your bank is making now impact your institution’s ability to meet customers where they are today, but also where they expect you to be in the future. The digital bridge you build for online account opening can help take you there.

Even before most of us learned the term “coronavirus,” few banks would have disagreed with the need to automate digital account opening and invest in systems to support the online customer experience. Your institution may have already identified this as a strategic objective for 2020. And even if you already offer the service, shutdowns and closures stemming from Covid-19 may have highlighted friction in the account opening experience that either previously lacked visibility or was considered acceptable for the limited number of customers who took advantage of it. With customers now primarily directed toward a digital channel, you should reconsider the metrics used to define a satisfactory user experience.

The right channel. Online account opening may have been one of several customer channels your bank offered, but it may not have been marketed as the primary or best channel — especially when compared to the high-touch experience of in-person banking. It’s become clear, though, that a digital model that complements, and works cohesively with, a branch model is necessary to meet customers where they are. The steps you take to cultivate online account opening as the right channel for your bank should also establish the hallmarks of a preferred user experience.

An end-to-end strategy. Do your customers need to visit a branch or make a phone call to complete application paperwork? Does your solution provide for safe digital identity verification? Does it support electronic signing? Are your account opening documents optimized for viewing on mobile devices? An online account opening strategy that does not consider these questions will likely reduce efficiency, resulting in a poor user experience that may cause customers to abandon the account opening process before completing it.

Continuing the relationship. Online service must be full service and seamlessly dovetail with your in-person customer model. Offering an online account opening experience that then requires a phone call or a branch trip to manage name or address changes is the sort of partial digital transformation that unnecessarily complicates customer service. Online account maintenance must have the option to be fully driven by customers as an embedded component of your online account experience. Fully embracing a well-conceived online strategy will include opportunities for marketing and cross-selling as part of the digital maintenance experience. If your bank cannot fully service customer needs remotely, they may seek institutions that better address their banking usability preferences.

Continuing the investment. Investment priorities for your organization have undoubtedly been revisited two, potentially three, times in the last few months. Use these opportunities to reevaluate your digital delivery model and the technology that supports it. Technology that speeds up identity verification processes and solutions that support the digital signing of mobile-optimized documents are critical components of your digital architecture that will reduce friction for your customers as they move through the online process.

You have already made vast changes to your operating model to meet the needs of your customers during very trying times. Now is the time to maximize your return on those changes and continue developing your digital strategy.

How Peoples Bancorp Prevailed Through PPP

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“You only learn who has been swimming naked when the tide goes out,” wrote Warren Buffett in his 2004 annual letter.

He was referring to operations that trade derivatives. You don’t really know the value of what you hold in opaque markets, he explained, until it’s tested in hard times.

The same can be said about banking.

Rarely has the industry faced an environment as acute as today.

“The scope and speed of this downturn are without modern precedent,” said Federal Reserve Chairman Jerome Powell earlier this week. It’s “significantly worse than any recession since World War II.”

It’s hardly an exaggeration to say that bankers bear much of the burden of saving the economy from oblivion. “If doctors and nurses are first responders to those who are sick,” says Robyn Stevens, chief credit officer at Peoples Bancorp, “bankers are the first responders for businesses, communities and economies.”

Stevens would know.

Within its three-state footprint spanning Ohio, West Virginia and Kentucky, Peoples was the top-performing bank in the first round of the Paycheck Protection Program measured by dollars of PPP loans approved per assets.

“A culture is tested when times get tough,” says Ryan Kirkham, general counsel at the $4.5 billion bank based in Marietta, Ohio. “You find out whether it is real or just lip service. We passed the test.”

The success of Peoples in the first round of PPP reveals a flaw in one of the principal narratives that has emerged from the unfolding crisis — that banks with the most advanced technology were the ones best positioned to manage the onslaught of loan applications.

It’s not that Peoples Bank hasn’t invested in technology in recent years, because it has. But the secret to its success in the first round of PPP was simple elbow grease.

Personnel from the top of the bank to the bottom volunteered to enter data into the Small Business Administration portal to process customer loan applications.

“Banks had to decide whether they were going to do it automated or whether they were going to do it manually,” says CEO Chuck Sulerzyski. “Peoples tried an automated approach but then opted for manual.”

“Many of our most senior executives have done data entry until 8, 9, 10, 11, 12 at night,” he adds. “We did over 100 of these loans on Easter Sunday. And when they shut banks over $1 billion out from 6 p.m. to midnight one evening, we had a couple dozen people volunteer to work midnight to 4 a.m. putting in the entries.”

This success reflects a culmination of a decade’s worth of effort, spearheaded by Sulerzyski, who joined the bank from KeyCorp in 2011.

The 62-year-old CEO spent the previous four decades working up the corporate ladder at multiple prominent banks. He worked at Citibank during the Walter Wriston era. He was at Chemical Bank when Walter Shipley was CEO. And he spent eight years at Bank One, working closely with President Don McWhorter and CEO John B. McCoy.

Sulerzyski has been there and done that, in other words. One lesson he’s learned along the way has been the importance of culture and customer relationships. It’s a lesson that has paid off in spades over the past three months.

“From a competitive standpoint, a lot of the large banks struggled with PPP,” Sulerzyski says. “One of the large regionals couldn’t do any loans the first few days. Another one started, but then had to shut down. Each of the bigger banks we compete against had their own degree of difficulties with this. Because our customers were well taken care of, CPAs and attorneys started referring business to us and it kind of snowballed on itself.”

Sulerzyski’s team speaks in single voice on this.

“Our commitment to our communities and the importance that plays resonates with our employees,” says Thomas Frawley, senior vice president, consumer lending. “They start the call as a banker and end the call as a counselor, listening to the fears of our customers while assuring them that we are going to do our best to help them.”

“We have several associates who are working day and night,” says Ann Helmick, director of enterprise risk management. “They are doing this for the good of the client. For most, there will not be a personal gain.”

“It is easy to come up with a mission, vision and values. And when times are good, it can be easy to live by those values,” says Jason Phipps, regional president. “It is when a company or person faces adversity that you find out who a person or who an organization really is.”

One can argue all day long about the importance of scale and technology, and how it could soon be a principle competitive differentiator in banking. But technology is only a tool to help bankers ply their trade. The soul of any organization, and the true source of performance, lies instead in the people who run it.

“Bankers may have got a bad rap during the last crisis,” says Stevens, “but ours have been heroes during this one!”

Beyond PPP: Supporting Small Business Through the Covid Crisis

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In the first wave of the Small Business Administration’s Paycheck Protection Program, West Des Moines, Iowa-based Bank Iowa Corp. closed around 400 loans totaling $72 million, according to CEO Jim Plagge. When we spoke — just a few days before the SBA re-opened the portal for another $320 billion of PPP loans — the $1.4 billion bank was prepared to submit another 75 or so applications.

The bank’s branch teams — which are split to encourage social distancing and minimize the impact if someone were to get sick — have also taken to ordering takeout every day to support local restaurants that have been particularly hard hit. “[We’re] just trying to support them,” he says.

This desire to support the 23 communities it serves inspired Bank Iowa’s “Helping Hand” program, which is accepting nominations to assist local organizations, small businesses and nonprofits. The bank’s goal is to serve at least one need in each of its seven regions. “We’re only as strong as the communities we serve,” says Plagge. “So, we’re just trying to help where we possibly can.”

Banks play a vital role in supporting their communities, one we’re seeing played out across the country as bankers put in extra hours to help customers, especially small businesses that keep towns alive. Bank Iowa, like many financial institutions, recognizes that supporting small businesses can’t be limited to the SBA program — PPP loans have proved difficult to obtain, and they don’t make sense for some companies that still need help.

Bank Iowa reached out immediately to borrowers to understand the impact of the coronavirus crisis for each one, says Plagge. The bank has deferred loan payments, restructured debt and set up working capital lines. Bankers have also been a shoulder to cry on.

“[We’re] trying to be there to help our clients talk through the difficulties they’re facing,” says Plagge. “Hopefully we can offer some advice and encourage them along the way.”

Relationships matter. “We typically see that business banking account managers get good scores for being courteous, knowledgeable and responsive,” says Paul McAdam, a senior director, regional banking in the financial services practice at J.D. Power. Small business owners will be even more sensitive to their banker’s response in today’s desperate environment, asking: “‘Do I feel like I’m connecting with them? Do they understand my needs and what I’m going through right now?’”

In addition to building long-term relationships, supporting small businesses now could help banks reduce later damage to their loan portfolios. But unfortunately, tough decisions will be required in the coming months. Plagge says Bank Iowa has started stress testing various sectors. With agriculture comprising a significant portion of the loan portfolio, they’re examining the impact of a reduction in revenue for ag producers.

“Our goal will be to try to work with every borrower and see them through this,” Plagge says. “But we also know that may not be possible in every case.”

David K. Smith, a senior originations consultant at FICO, advises banks to segment their portfolio, so lenders understand which businesses they can help, and which pose too great a risk. Does the business have a future in a post-Covid economy? “You can only help so many without sinking your portfolio,” he says.

But banks should also look for ways to keep relationships alive. “As small businesses go out of business, there’s an entrepreneur there … that person who lost this company is going to be on the market creating another company soon,” says Smith.

After the crisis, this could lead to a wave of start-up businesses — which banks have typically hesitated to support. “They’re going to have to rethink policy, because [of] the sheer number of these that are going to pop up,” says Smith. Some businesses won’t fail due to poor leadership; they simply couldn’t do business in an abnormal environment, given shelter-in-place and similar orders issued by local governments. “Bankers will have to appreciate that to a certain degree and figure out a solution, because it will help bring the economy back faster,” he says.

Preparing to Be There for Your Community

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The fallout from COVID-19 will likely take some time to stabilize. The personal and social costs are already significant, and neither is independent of economic and business disruptions.

Especially impacted are the businesses on Main Streets everywhere that are served by community banks. Community banks will be essential to any recovery, so it is important that they take steps now to ensure they’re positioned to make a difference.

The Challenge Of A “New Normal”
Financial markets were in “price discovery” mode this spring, but that phase is unlikely to last for long. If Treasury rates rise from their current levels, banks are likely to do well with their traditional models. But if they remain low, and spreads eventually stabilize to 2019 levels, nearly every institution will encounter pressure that could undermine their efforts to be a catalyst for Main Street’s recovery.

Bank Director’s recent piece “Uncharted Territory” warned that the experience of past financial crises could mislead bankers into complacency. Last time, dramatic reductions in funding costs boosted net interest margins, which helped banks offset dramatically higher loan losses. The difference today is that funding costs are already very low — leaving little room for similar reductions.

Consider asset yields. Even without significant credit charge-offs, community bank profitability could face headwinds. Community banks entered 2020 with plenty of fuel to support their thriving Main Streets. Their balance sheets had been established for a Treasury rate environment that was 100 basis points higher than today’s. If rates settle here for the next couple of years and existing assets get replaced at “new normal” levels, yields will fall and net interest margins, or NIMs, could take a hit.

Banks could have trouble “being there” for their communities.

Where do the current assets on banks’ balance sheets come from? They were added in 2018, 2019 and the first quarter of 2020. If we assume a fixed rate loan portfolio yields somewhere around 300 basis points over the 5-year swap rate at closing (which averaged about 1.75% over 2019), and floating rates loans yield somewhere around 50 basis points over prime day to day, we can estimate banks’ first quarter loan yields at perhaps 4.75% fixed-rate and 5.25% prime-based.

Prime-based yields have already dropped for the second quarter and beyond: They are now earning 3.75%. Fixed-rate loans continue to earn something like 4.75%, for now.

Banks that can quickly reduce funding costs might, in fact, see a short-term bump in net interest margins. If they can stave off provision expenses, this might even translate into a bump in profitability. But it will not last.

If Treasury rates remain at these historic lows and spreads normalize to 2019 levels, current balance sheets will decay. Adjustments today, before this happens, are the only real defense.

Banks’ fixed rate loans will mature or refinance at much lower rates — around 3.50%, according to our assumptions. Eventually, banks that enjoyed a 3.50% NIM in 2019 will be looking at sustained NIMs closer to 2.50%, even after accounting for reduced funding costs, if they take no corrective steps today. It will be difficult for these banks to “be there” for Main Street, especially if provision expenses begin to emerge.

Every community bank should immediately assess its NIM decay path. How long will it take to get to the bottom? This knowledge will help scale and motivate immediate corrective actions.

For most banks, this is probably a downslope of 18 to 30 months. For some, it will happen much more rapidly. The data required may be in asset and liability management reports. Note that if your bank is using year-end reports, the intervening rate moves mean that the data in the “100 basis points shock” scenario from that report would represent the current rates unchanged “baseline.” Reports that do not run income simulations for four or more years will also likely miss the full NIM contraction, which must be analyzed to incorporate full asset turnover and beyond.

Times are hectic for community banks, but in many cases commissioning a stand-alone analysis, above and beyond standard asset-liability compliance requirements, is warranted.

Then What?
The purpose of analyzing a bank’s NIM timeline is not to determine when to start taking action, but to correctly size and scope the immediate action.  All the levers on the balance sheet— assets, liabilities, maybe even derivatives — must be coordinated to defend long-term NIM and the bank’s ability to assist in Main Street’s recovery.

The Small Business Administration’s Paycheck Protection Program lending is fully aligned with the community bank mission, but it is short term. Banks must also plan for sustainable net interest income for three, four and five years into the future, and that planning and execution should take place now. The devised NIM defense strategy should be subjected to the same NIM decay analysis applied to the current balance sheet; if it’s insufficient, executives should consider even more significant adjustments for immediate action.

The economic environment is out of bankers’ control. Their responses are not, but these require action in advance. Banks can — and should — conduct a disciplined, diagnostic analysis of their NIM decay path and then correct it. This interest rate environment could be with us for some time to come.