The CARES Act: What Banks Need to Know

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.

Banks Brace for Exploding SBA Loan Demand

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.

The Top SBA Lenders Fuel Small Business


SBA-loans-4-8-16.pngCalvin Coolidge once observed that “the business of America is business,” and if the 30th president of the United States were alive today, he would probably amend his statement to says “the business of America is small business.”

Indeed, small businesses—or companies with fewer than 500 employees—are the engine of the U.S. economy, accounting for 99.7 percent of all U.S. employee firms, 64 percent of net new private sector jobs and 49 percent of private company employment, according the the Small Business Administration’s Office of Advocacy. However, banking a small business can be an entirely different matter because as borrowers, they tend to fall into a high risk category. Only about half of all new businesses are still around after five years, according to the SBA, and only about a third survive 10 years or more. Most banks tend to be put off by markets where the likelihood of success or failure could be predicted by the flip of the coin.

Enter the SBA’s various loan guarantee programs, particularly its highly popular 7(a) program (named after a section of the Small Business Act passed by Congress in July 1953), which has been very successful in bringing much needed bank financing to the small business sector. In its 2015 fiscal year, which ran through September 30, the SBA approved 63,000 7(a) loans for a record $23.6 billion. In FY2014, the SBA approved 52,044 7(a) loans totaling $19.19 billion. While the 7(a) program’s annual loan totals are still well off their peak in 2007, when they approached 100,000, volume has been increasing since 2009, when demand dropped off sharply as the financial crisis and Great Recession caused many banks to pull back from most lending markets.

There are several SBA loan guarantee programs, including disaster recovery loans, microloans and financing loans for fixed assets like real estate and equipment. But the 7(a) program is the big daddy of them all, and can be used for a variety of purposes, including acquisitions, business expansion, working capital and debt refinancing. A regular 7(a) loan can be for as much as $5 million. Loans up to $150,000 can be guaranteed by the government up to 85 percent. For loans over $150,000, the guarantee limit is 75 percent. These are term loans with one monthly payment of principal and interest, with a maximum maturity of 10 years except for real estate. Real estate can be financed for a maximum term of 25 years.

The leading SBA 7(a) lender in FY2015 based on loan volume was San Francisco-based Wells Fargo & Co., which originated $1.9 billion in loans, followed by Live Oak Banking Co., U.S. Bancorp, JPMorgan Chase & Co. and Huntington Bancshares. Wells Fargo also originated the greatest number of loans in FY2015, at 7,254, followed somewhat surprisingly by Huntington, at 4,337. Wells Fargo—which is the third largest bank in the country with $1.78 trillion in assets—sources much of its 7(a) loan production through a coast-to-coast retail branch network, while $71 billion asset Huntington relies on a much smaller network of 750 branches in six upper Midwestern states, with additional loan production offices in Chicago, Wisconsin and Florida.

Top SBA Lenders in FY 2015
Lender State Approved Loans Approved Amount*
Wells Fargo & Co. CA 7,254 $1,918
Live Oak Banking Co. NC 966 $1,148
U.S. Bancorp MN 3,977 $776
JPMorgan Chase & Co. NY 4,040 $754
Huntington Bancshares OH 4,337 $673
Celtic Bank Corp. UT 1,586 $499
Ridgestone Bank WI 475 $474
SunTrust Banks GA 575 $365
Newtek Small Business Finance NY 391 $356
Seacoast Commerce Banc Holdings CA 325 $293
BBVA Compass AL 1,432 $269
Regions Financial Corp. AL 329 $247
BBCN Bank CA 315 $240
BankUnited Inc. FL 169 $207
Stearns Financial Services MN 490 $205

*Dollar amounts are in millions
Source: Small Business Administration

The top five 7(a) lenders in FY2015 carried their rankings through the first quarter of the SBA’s 2016 fiscal year as well, which ended December 31. Wells Fargo lead the group with 2,379 loans for total volume of $437 million.

Huntington SBA Group Manager Margaret Ference is a big proponent of the agency’s various loan guaranty initiatives, particularly the 7(a) program. “It allows us to invest in our communities and say yes” to small business borrowers who otherwise might be deemed too risky for a conventional commercial loan, she says. Whether the problem is a collateral shortfall, too much leverage or the need for a longer loan term than Huntington would normally provide, the SBA’s backing makes it possible for many small business borrowers to qualify for bank funding who probably wouldn’t be approved for a conventional business loan. “The SBA guaranty is used to mitigate risk, not to make a risky loan,” Ference says.

The 7(a) program is in fact Huntington’s primary small business loan, and the bank views it as an entry level product. The ultimate goal is to engage the borrower in a broader relationship that would include commercial deposit accounts, merchant services and cash management services. “That’s the start of a relationship,” she says.

How to Safely Generate Bank Income Through SBA Loans


sba-loans-8-19-15.pngSmall Business Administration (SBA) lending is one of the key lending activities that can quickly and dramatically improve the bottom line of a community bank. It is not that difficult for a bank to generate $20 million in SBA loans, which will earn the institution between $1.0 to $1.2 million in pretax net income, if the loan guarantees are sold. Some bankers get concerned because they have heard stories of the SBA denying loan guarantees and that the SBA loan process is too time consuming and complex.

Sourcing SBA Loans
The basic strategies that most successful SBA lenders use to source SBA loans are as follows:

  1. Hire an experienced SBA Business Development Officer (BDO), who can find loans that fit your credit parameters and geography.
  2. Source loans from brokers or businesses that specialize in finding SBA loans.
  3. Utilize a call center to target SBA borrowers.
  4. Train your existing staff to identify and market to SBA loan prospects.

I have put these in the order of which approach is likely to be the most successful. However, ultimately it is the speed of execution that enables one lender to beat out another in the SBA business. So if you want to hire that high producing SBA BDO, the bank needs to have a clear idea of the types of credits that they will approve and a process that can quickly get them approved.

This can create a catch 22 for the lender, since in order to justify hiring SBA underwriters and processing personnel, you have to make sure that you generate loans. But in order to recruit those top performing SBA BDOs, you will need to show them that you have a way of getting their loans closed quickly.

The most effective solution for solving these problems is to hire a quality SBA Lender Service Provider (LSP).  This is the quickest way to add an experienced SBA back shop that will warranty its work and handle the loan eligibility determination, underwriting, processing, closing, loan sale and servicing. This gives the bank a variable cost solution, and allows them to have personnel to process 100s of loans per year. While some of the better LSPs will help the lender with the underwriting of the loan, it is solely the bank that makes the credit approval decision. SBA outsourcing is very cost effective and allows a bank to begin participating and making money with these programs immediately, even if they only do a few loans.

Making a Profit
Let us look at the bank’s profits from a $1.0 million SBA 7(a) loan that is priced at prime plus 2.0 percent with a 25-year term.

Loan amount $1,000,000  
Guaranteed portion $ 750,000  
Unguaranteed portion $ 250,000  
Gain on the sale of the SBA guaranteed portion $ 90,000 (12% net 14% gross)
Net interest income(5.25%-0.75% COF = 4.5%) $ 11,250 (NII on $250,000)
Servicing Income ($750,000 X 1.0%) $ 7,500  
Total gross income $ 108,750  
     
Loan acquisition cost (assumed to be 2.5%) $25,000 (BDO comp, etc.)
Outsource cost (approximately 2.0%) $ 20,000 (per SBA guidelines)
Annual servicing cost (assumed to be 0.50%) $ 5,000  
Loan loss provision (2.0% of $250,000) $ 5,000  
Total expenses $ 55,000  
Net pretax income $ 53,750  
ROE ($53,750/$25,000 risk based capital) 215%  
ROA ($53,750/$250,000) 21.5%  

In this example the bank made a $1.0 million SBA loan and sold the $750,000 guaranteed piece and made a $90,000 gain on sale. The bank earned $11,250 of net interest income on the $250,000 unguaranteed piece of that loan that the bank retained. When an SBA guaranty is sold, the investor buys it at a 1.0 percent discount, so the lender earns a 1.0 percent  ongoing fee on the guaranteed piece of the loan for the life of the loan. This example  did not account for the amortization of the loan through the year.

I believe that the expenses are self explanatory, but you can see if the bank made $20 million of SBA loans using these assumptions, they would earn $1.075 million in the first year.

Conclusion
As you can see, SBA lending can add a substantial additional income stream to your bank; however, you need a certain amount of loan production and a high quality staff, or you need an SBA outsource solution to underwrite and process the loans. As you can see, the ROE and ROA for SBA loans is much higher than conventional financing, which is why you see community banks that have an SBA focus generate higher returns.

How Banks Can Profit from SBA Lending


4-7-14-SBA.pngAll community banks are looking for ways to leverage their staff, maximize profit, minimize expense and build flexibility into their loan portfolios.

One effective way to do this is to participate in SBA lending and to use an SBA outsource provider to provide your bank with a simple and cost effective way to offer this product.

The primary SBA lending program, the SBA 7(a) guaranty loan, allows the bank to make small business loans and receive a 75 percent guarantee from the U.S. government. The guaranteed portions of these loans can be sold in the secondary market, with current gain on sale premiums of 13.5 percent net to the bank. So if a bank makes a $1 million SBA loan and sells the $750,000 guaranteed portion, it will generate a premium or fee income of $101,250.

In addition, when the guaranteed portion of an SBA loan is sold, the investor buys the guaranty at a rate that is 1 percent less than the note rate. In this example, if you have a $1 million SBA loan at an interest rate of 6 percent and the bank sells the $750,000 guaranteed piece, the investor buys it at a 1 percent discount off the note rate and receives a yield of 5 percent. This means that the bank will earn 6 percent on the $250,000 portion that they retained and 1 percent on the $750,000 or $7,500 per year, not accounting for amortization of the loan. If you compare that $7,500 per year in servicing income to the $250,000 that the bank retains on its books, you can see that it represents an additional 3 percent yield on the retained portion. That 3 percent of servicing, plus the note rate of 6 percent, shows that the bank’s gross yield on the retained portion of the loan is now 9 percent. This additional yield is something to consider if your bank is competing for a loan with a larger bank that is trying to undercut your bank on pricing. The added servicing income will enable you to maintain your yield even on loans that have lower pricing.

While SBA lending can be very profitable, it should be viewed as more than just a profit center for your bank.

The SBA loan guarantee can be used to refinance existing loans to mitigate risk in your loan portfolio or to help retain clients who are close to the bank’s legal lending limits. Using SBA lending to refinance existing bank loans can be helpful in reducing real estate concentrations since properties like hotels, mini storage facilities and care facilities are included as investment properties by regulators. If a bank has these types of properties on their books, they can often refinance the loan and sell the guaranteed portion to reduce a concentration and free up capital. Using the SBA guaranty to make loans that fall into an investment property category is a good way of managing portfolio concentrations.

Why does SBA outsourcing make sense?
Outsourcing your SBA lending department eliminates the need to allocate resources and budget for an SBA department since there are no upfront or overhead costs associated with it. Outsourcing eliminates the risk of hiring an SBA team and then not generating sufficient loan volume to support the cost of that staff. SBA personnel costs are high, and it can be difficult to find qualified people. Also, without an experienced and dedicated SBA group, your loan officers will typically avoid handling SBA loan applications for fear of dealing with the complex SBA rules and process.

Outsourcing also enables a community bank to acquire, through the outsource provider, an experienced staff, which in turn enables it to provide an accurate and efficient process to its SBA borrowers. An SBA outsource provider can efficiently process, document, close, sell to the secondary market and service your loans. Typically these services charge between 0.6 percent to 2 percent of the loan amount.

Conclusion
In today’s competitive market, the SBA program offers too many profit enhancement and risk mitigation opportunities to simply ignore its value. In order to maximize success, bankers need to have every tool available to them.