Lender Beware – Post-funding Risks to Paycheck Protection Program Lenders
Lender Beware – Post-funding Risks to Paycheck Protection Program Lenders
The Coronavirus Aid, Relief, and Economic Security (CARES) Act and the Paycheck Protection Program and Health Care Enhancement Act have together authorized a total of $660 billion for the Small Business Administration’s (SBA) Paycheck Protection Program (PPP), with the possibility that additional amounts may be authorized at a future date.
The PPP continues to garner significant media attention given its size, scope, and need for the funds. The coverage has highlighted issues concerning borrowers receiving loans and subsequently returning them, as well as allegations of lenders prioritizing larger, pre-existing clients ahead of new clients and smaller businesses, particularly those in underserved or rural markets.
In addition, the Justice Department has announced a preliminary inquiry into how PPP funds were disbursed, noting “…the review has already turned up several red flags in the data prosecutors have examined and issues were found in both approved and rejected applications.” Additionally, the SBA recently stated that it plans to audit all loans in excess of $2 million and will audit a sample of smaller loans. Finally, the CARES Act has established several bodies to oversee how relief funds were disbursed.
Together, these factors will challenge lending institutions moving forward. Accordingly, lenders should take this opportunity to re-examine control and compliance processes to mitigate risks and prepare for the inevitable government inquiries and audits. Lenders should also begin preparing for the loan forgiveness process now to mitigate challenges created as a result of the rapid implementation of the PPP. Risks that require focus include:
Improperly prioritizing loans based on the borrower’s size and nature and scope of the existing relationship with the lender;
Failing to identify situations where borrowers submitted multiple applications and /or obtained multiple loans through a single institution;
Providing loans to borrowers who were not entitled to receive loans or providing loans in amounts higher than they should be by:
Failing to conduct a good faith review in a reasonable time of borrower payroll calculations and supporting documentation regarding average monthly payroll costs; and
Failing to request that the borrower remedy calculation errors or material substantiation in supporting documentation.
Relying on borrower certifications that the lender knew or should have known, based on their relationship with the borrower, were false or misleading;
Failing to conduct adequate Know Your Customer, Customer Due Diligence and Enhanced Due Diligence and transaction monitoring;
Failing to prepare and submit a report containing a detailed narrative that adequately details the assumptions used by the lender in determining the borrower’s expected forgiveness amount; and
Failing to quickly and effectively react to new and constantly evolving rules and guidance set by regulators.
Risk Mitigation Strategies:
To effectively manage and mitigate these risks, lenders should consider performing the following activities:
Post-Funding Activities – What should lenders be focused on?
Quality Assurance/Quality Control (QA / QC) – Lenders should be hyperfocused on performing QA/QC to review amounts and calculations to protect themselves and their borrowers. Lenders should review loans to verify employees followed lending procedures, including reasonably relying on borrower attestations and reviewing the amounts and calculations. Amounts and calculations are critical because if amounts are not accurate, the borrower may not be able to substantiate loan amounts to obtain loan forgiveness. In such situations, lenders will have to service the loans for an additional two-year period and borrowers will have to pay it off – if they are even able to do so.
Regulatory Change Management – Lenders should implement a regulatory change management process that will capture, analyze, summarize, and communicate regulatory changes, guidance, and directives to relevant stakeholders. Lenders should document the decisioning process and be able to tie lending outcomes to the guidance available at the time. A well-managed process will likely require some level of technology to support it.
Documentation and Reporting – Lenders should have detailed and timely documentation describing the lending process and the business decisions they made to prioritize customers. They should also create detailed reporting to identify potential fair lending violations, discrimination, and other risks. Management can leverage quality reporting to help avoid future issues and influence the actions for future rounds of funding.
Fraud Reviews – Lenders should develop, implement, and execute processes to identify and remediate potential fraud within the lender organization, fraud perpetrated by borrowers, and fraud perpetrated by external parties.
Loan Forgiveness – How should lenders begin to prepare?
Loan forgiveness creates unique compliance and reputational risks for lenders. Small businesses will be looking to lenders to obtain forgiveness from the SBA for their loans, while lenders will need to make sure they are complying with the latest guidance. Discrepancies between borrower understanding and SBA guidance may result in customer dissatisfaction, thus adversely impacting a lender’s relationship with their customer. Lenders should consider implementing these processes to avoid risks, including:
Borrower communication – Lenders should consider communication plans that provide borrowers expectations around what is required for loan forgiveness. Although there has not been extensive guidance, we know that borrowers will need to substantiate their actions to rehire and compensate employees within prescribed thresholds. Lenders should begin to set these expectations with borrowers, including required types of documentation and the timing of that information.
Design and build a process with regulatory reviews and audits in mind – There will be extensive regulatory reviews, and audits. Lenders should have detailed policies, procedures, and training, including desktop procedures in place. Within their processes, they should implement preventive controls and be prepared to document any decision-making. Regulatory change or case management technology should be considered when designing and building the processes. These types of considerations will help manage the risks of future regulatory reviews and audits.
Complaint management – Capturing and analyzing complaints is an effective way to identify risks and unintended issues. Complaints can inform how the process can be adjusted going forward.
Reducing Lender Risk from COVID Fallout:
This is a critical time to review processes and controls with respect to loan processing and forgiveness. With heightened regulatory focus around these areas, lenders simply cannot have gaps in lending processes or their ability to explain decisions. Focusing efforts around quality assurance and quality control, regulatory change management, documentation and reporting, and fraud reviews is critical to shoring up operations and reducing risk in these uncertain times.
Guidehouse’s combination of public sector and commercial expertise provides a unique and complete perspective of the challenges associated with implementation of the PPP and other relief lending programs. Critical success factors that we bring to these projects include:
Guidehouse is actively supporting clients now with the PPP. Therefore, we have unique insights into the challenges that other lending institutions are encountering. You can benefit from the latest thinking and guidance.
The Guidehouse team has the relevant skills and qualifications to successfully execute these programs. We leverage the lessons learned from the financial crisis, recent natural disasters, and other regulatory lending activities. Our team is made up of bankers, compliance officers, lawyers, and data and technology specialists. This combination of backgrounds and our experience position us to recommend and execute a complete end-toend solution.
Guidehouse has technology tools that can be leveraged for this engagement. Our tools can help track regulatory and guidance changes and manage the loan forgiveness process. These tools have been successfully utilized at other clients with similar challenges.
Guidehouse utilizes a flexible delivery model that allows us to quickly scale up or down depending on the client’s specific needs. We have the ability to provide deep expertise and advisory-level services and the capability to provide staffing for outsourced solutions.