From seeding new growth initiatives to funding expansion plans, small business lenders are always in search of opportunities where they can come through for their customers in times of need. But the coronavirus crisis is providing them with perhaps the ultimate moment of truth: facilitating tens of billions of dollars in emergency loans to keep their small business customers up-and-running.
With the $2 trillion landmark recovery bill known as the CARES Act, Congress has effectively enlisted the nation’s banks, fintech, and other commercial lenders as the frontline response to providing financial relief to small businesses. Through the Paycheck Protection Program (PPP), which takes effect this Friday, the U.S. government has designated $350 billion to guarantee special SBA loans extended to businesses with fewer than 500 employees.
The PPP relies on private sector lenders to originate and administer these special SBA loans. For their effort, the federal government will reimburse lenders on a sliding scale for between 1% and 5% of the principal balance on loans worth as much as $2 million. As long as the loans are prudently underwritten, they will purportedly be fully backed by the U.S. government – meaning that lenders do not have to take on any credit risk. So, it’s essentially between a $10 and $15 billion pool of fresh revenue that is up for grabs.
With millions of small businesses eligible to apply for PPP loans, the result is perhaps a once-in-a-lifetime opportunity for lenders to provide critical assistance to their existing small business customers and potentially introduce new ones to the bank. It also positions these institutions as a trusted funding resource and opens the door to potentially sell these small business customers other financial products down the road.
There is a mad rush and a lot of confusion over the details of the program, but what is clear is that the key to success will be implementing the program in the right way. After all, the government is expecting participants to ramp up quickly to handle the expected crush of applications. It also has participating lenders funding the loan at the same time that they make their underwriting decision, something that very few financial institutions do today. And adding to the complexity, lenders participating in the PPP will be doing it with a largely remote workforce and under intense scrutiny from media and regulators. One misstep could have outsized consequences.
That’s why it is critical for lenders to make sure they have the right infrastructure in place to handle the load. Even though lenders won’t be taking any credit risk, originating PPP loans is not without its complications.
For one, PPP’s guidance calls for lenders to collect and verify information from tax forms rarely used in making traditional small business loans. For example, to document their payroll, small business borrowers may be required to submit a Form 941, in addition to W-2 and 1099 forms that will be required for higher-earning employees. Because most traditional underwriting systems aren’t set up to analyze these forms, PPP may force lenders to hire small armies of workers to handle the volume of manual review work.
Secondly, PPP calls for lenders to award the loan so that it approximates two and a half months of the small business applicant’s monthly payroll. But this amount is driven by a mathematical formula that caps the amount of funding that covers the total compensation of employees that earn $100,000 or more. In other words, lenders cannot arrive at the payroll amount by simply plucking it off of a tax filing and multiplying by 2.5. Their loan underwriting systems will need to be reprogrammed to do this math.
Lastly, the program requires lenders to verify that its small business borrowers are really who they say they are. If lending participants don’t engage in some type of “third-party verification” program, their loans may not qualify for the government guarantee. As a first step, that means lenders will need to put every applicant through a verification process similar to the “Know Your Customer” analyses that most do today. Then, there may be another wave of verification should small business borrowers choose to take advantage of a unique feature of the PPP: the ability to request that their loan be forgiven, so long as they can certify that they have maintained roughly the same number of jobs as they had before they sought out the loan. Although the rules are still being sorted out, lenders will be responsible for verifying this step as well.
The good news is that cutting-edge lending infrastructure, like Ocrolus, can help lenders stay ahead of the expected flood of PPP applications. With Ocrolus, lenders can automate the document analysis process so that they can quickly process and digitize thousands of applications — all with incredible accuracy and speed. What’s more, Ocrolus has built-in verification tools that can corroborate the information that small business applicants submit – and a partnership with Plaid that allows for real-time verification with their existing financial institution. And it can package all of this information in a format that makes it easy for lenders to approve these loans in a timely fashion.
As Rahm Emanuel, the Illinois politico and former White House chief of staff, said during the throes of the market turmoil in 2008: “You never let a serious crisis go to waste.” PPP provides small business lenders with another potentially game-changing opportunity amid the current economic downturn. They just need to make sure they are prepared so they don’t miss out.
Ethan Schwarzbach leads business development at Ocrolus, including SBA PPP initiatives. In this role, Ethan helps lenders modernize their workflows so that they can better serve small businesses with fast, automated processing.