On March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act (the CARES Act) was signed into law, creating an unprecedented economic support program for businesses, individuals, and states impacted by the COVID-19 pandemic. Among other provisions, the CARES Act allots $349 billion to the Small Business Association (SBA) for a new Paycheck Protection Program (the Program), under which certain businesses are eligible for loans to cover payroll costs, fully guaranteed by the federal government and, if certain conditions are met, largely forgivable. Given the speed at which this money is to be deployed, the Program will be administered by lenders rather than the SBA. The Program is an unprecedented opportunity for banks to help American businesses, including both existing and new bank customers.
Previously, we published a client alert on the Program, available here. A Q&A section offers a comprehensive overview of the Program for small businesses.
In this client alert, we narrow our focus to help banks understand how the Program will operate from a lender’s perspective: which banks are eligible to participate, restrictions on loan terms, and how to comply with Program rules. We expect there will be extremely high demand to participate in the Program, and Michael Best has a streamlined loan documentation process and teams in place to assist our bank clients in meeting this demand.
Which banks are eligible to participate in the SBA’s new Paycheck Protection Program?
In order to participate, a bank must be an approved lender under the SBA’s 7(a) loan program, meaning it must meet the following requirements:
- Have a continuing ability to evaluate, process, close, disburse, service, and liquidate small business loans.
- Be open to the public to issue loans (and not be a financing subsidiary, engaged primarily in financing the operations of an affiliate).
- Have continuing good character and reputation, and otherwise meet and maintain the ethical requirements as identified in 13 CFR Part 120.140.
- Be supervised and examined by a state or federal regulatory authority, satisfactory to the SBA.
In addition, Congress authorized the SBA and Secretary of the Treasury to allow additional lenders to participate in the Program, so long as they have the necessary qualifications to process, close, disburse and service loans. Guidance on the criteria for these additional lenders is forthcoming, and we expect many more lenders will be able to participate in the Program as a result. Under the CARES Act, Congress authorized but did not mandate that the SBA and Treasury issue guidance on additional lenders, meaning that the timeline for expanding the scope of eligible lenders is unknown at this time.
I am not already an SBA-approved lender – how do I get approved?
If you meet the four criteria set forth above, contact a lender relations specialist at your local SBA district office to start the application process. Michael Best attorneys are available to assist with the application process, and for banks that are not currently approved SBA lenders, we will provide an update once the SBA issues guidance on the new, less stringent criteria for additional lenders under the Program.
When can I start making loans under the Paycheck Protection Program?
Within 15 days following the enactment of the CARES Act, the SBA is required to issue guidance and rules that implement the Paycheck Protection Program. These rules will not be subject to the standard notice and comment periods. Accordingly, SBA-approved lenders may begin accepting loan applications under the Program as soon as early April. Banks that are already SBA-approved lenders should be ready to act quickly to take advantage of the Program and to meet what is sure to be significant demand from existing and new customers.
Will I need to make underwriting decisions?
Under previously authorized SBA lending programs, approved lenders are generally required to obtain authorization from the SBA before lending to a borrower.
Now, in light of the urgency of this situation, so long as a bank is an approved lender as set forth above, it will be deemed to have delegated authority from the SBA to make and approve the guaranteed loans under the Program, meaning that it can skip the usual SBA eligibility determination process in favor of a much more streamlined process that will get cash to businesses as quickly as possible. It also means that lenders will need to ensure that the borrowers to which they lend under the Program meet all the eligibility requirements set forth below.
Under the Paycheck Protection Program, banks can provide government-backed loans to all eligible businesses under the SBA’s existing 7(a) program (including “small business concerns” such as restaurants, bars, hair salons, independent bookstores, etc.), as well as other businesses, 501(c)(3) non-profit organizations, 501(c)(19) veterans’ organizations, and tribal businesses that have no more than: (i) 500 employees, or (ii) if greater than 500 employees, the maximum number of employees for a particular industry as set forth in the SBA's size standards tool (which may be up to 1,500 employees). There is also an exception to the 500-employee limit for certain businesses that are assigned NAICS Code 72 (travel accommodations, food services, bar and restaurants) with fewer than 500 employees at each store/location.
The CARES Act also waives some of the SBA’s affiliation rules that would otherwise preclude certain businesses from meeting the Program criteria. Normally, a business would have to count an affiliate’s employees and annual receipts in determining whether it is a small business. Under the Program, the affiliation rules will not apply to: (i) businesses referenced above that are assigned NAICS Code 72, (ii) businesses that are assigned a franchise identifier code by the SBA, and (iii) businesses that receive financial assistance from a company licensed under section 301 of the Small Business Investment Act of 1958.
In making an eligibility determination, lenders are required to consider whether a potential borrower:
- Was in operation on February 15, 2020, and
- Had employees for whom the borrower paid salaries and payroll taxes, or paid independent contractors, as reported on IRS Form 1099-MISC.
Potential borrowers will also need to make a good faith certification when applying for a loan under the Program, stating:
- That the uncertainty of current economic conditions makes necessary the loan request to support the ongoing operations of the eligible recipient;
- Acknowledging that funds will be used to retain workers and maintain payroll or make mortgage payments, lease payments, and utility payments;
- That the eligible recipient does not have an application pending for another SBA 7(a) loan for the same purpose and duplicative of amounts applied for or received under a covered loan; and
- During the period beginning on February 15, 2020 and ending on December 31, 2020, that the eligible recipient has not received amounts under this subsection for the same purpose and duplicative of amounts applied for or received under a covered loan.
Borrowers that are seeking loan forgiveness (rather than a new loan) under the Program will also need to provide additional documentation and certifications, including a statement that the amount for which forgiveness is requested was used to retain employees, make interest payments on a covered mortgage obligation, make payments on a covered rent obligation, or make covered utility payments. The SBA is required to issue additional guidance and regulations implementing the loan forgiveness portions of the Program within 30 days of enactment of the CARES Act, and may add additional documentation and certification requirements at that time.
Will principal and interest payments be deferred under the Program?
During the covered period of February 15, 2020 to June 30, 2020, lenders under the Program will be required to provide “complete payment relief” for a period of 6-12 months for borrowers that (i) were in operation as of February 15, 2020 and (ii) have an application for a covered loan approved or pending as of the date of enactment (March 27, 2020). This means that borrowers will not be required to make any payments of principal, interest, or loan fees for Program loans during this period. The SBA is required to issue guidance and regulations implementing the loan deferment process under the Program within 30 days following enactment of the CARES Act.
We expect that these deferment terms will be hardwired into each lender’s documentation for loans under the Program.
How big are the loans under this Program, and what types of fees and interest can I charge? What other loan terms are required under the Program?
A bank may lend each potential borrower up to an amount that is the lesser of (i) 2.5x the average total monthly payments made by the applicant for payroll costs incurred during the one-year period before the loan is made, and (ii) $10 million. If a potential borrower was not in business from February 15, 2019 to June 30, 2019, a bank may lend up to an amount that is the lesser of (i) 2.5x the average total monthly payments made by the applicant for payroll costs incurred from January 1, 2020 to February 29, 2020, and (ii) $10 million. Interest rates on loans under the Program are capped at four percent.
Each eligible borrower may only receive one loan under the Program, and may only use such loan for payroll costs, insurance premiums, continuation of group health care benefits during periods of paid sick, medical, or family leave, salaries, commissions, or similar compensation, interest on mortgage obligations, rent, utilities, and interest on other outstanding debt.
Under the CARES Act, the SBA may not collect fees during the covered period (February 15, 2020 to June 30, 2020). In addition, the CARES Act dictates that there may be no prepayment penalty for any payments made on a covered loan under the Program. The Treasury Department will be issuing implementing rules setting forth additional terms and conditions for loans under the Program, including lender compensation, underwriting standards, interest rates and maturity, we will update this client alert once more information becomes available.
Otherwise, subject to additional guidance and regulations from the SBA and Treasury Department, banks are free to set their own terms and are not required to collateralize loan obligations under the Program.
May I use my own form loan documents?
The CARES Act does not require Program lenders to use any specific forms. That said, lenders will need to customize the loan documentation that they use with borrowers to ensure that such documentation includes specific covenants and representations in order to comply with the terms of the Program. Our firm is uniquely capable of drafting and scaling these documents so that your bank can participate in the Program and meet client demand in an efficient and timely manner.
We expect that the SBA will also publish a standardized application for potential borrowers to submit to lenders in order to participate in the Program.
Why should I participate in the Paycheck Protection Program?
As with any government-backed lending program, banks have an incentive to participate in the Paycheck Protection Program because of (i) greatly reduced credit risk and (ii) potential new revenue streams, including but not limited to substantial earnings from the secondary market and servicing fees. Banks also have an opportunity to support and improve local economies, which state and federal examiners may see as demonstrating a commitment to the bank’s community.
What about smaller, community banks that might not be sufficiently capitalized to participate in the Program?
Under the CARES Act, Congress also provided temporary relief for certain community banks from their capital and leverage requirements, in order to free up more cash for lending to small businesses. Specifically, the appropriate prudential regulators are required to issue an interim final rule providing for (ii) a Community Bank Leverage Ratio of eight percent, and (ii) any qualifying community bank that falls below such ratio shall have a “reasonable grace period” (as determined by the prudential regulators) to satisfy the eight percent requirement. This temporary relief will last until the earlier of (i) the end of the COVID-19 crisis and (ii) December 31, 2020.
Can I resell the loans under the Program?
Yes. Loans under the Paycheck Protection Program are eligible to be sold into the secondary market. However, the SBA may not collect fees for any Program loan guarantees sold into secondary market. In addition, if a covered loan is eligible for the payment relief discussed above, and a buyer in the secondary market does not agree to such deferral, then the SBA will purchase the covered loan so that the borrower will receive the benefit of six to 12 months of payment relief.
What about the loans that I already have in place with borrowers in retail, hospitality, and other industries impacted by the COVID-19 pandemic?
Many of our bank clients are now offering loan deferral programs, allowing an additional three to six months for certain borrowers to make principal and interest payments. We are working with many bank clients to document the deferral terms on a streamlined basis. On March 31, 2020, we will publish a client alert on loan deferral programs and key considerations for banks.
Do you have more questions? Are you prepared to receive numerous loan requests from potential borrowers under the Paycheck Protection Program? Michael Best’s Banking and Financial Services lawyers specialize in loan documentation solutions that are efficient and cost-effective, and we are here to help your bank meet your customers’ demands.