How Community Banks could be punished for Participating in PPP

COVID-19 and the resulting economic strains imposed by it required an unprecedented response by the U.S. government and federal banking agencies in order to get much needed emergency liquidity into the hands of small businesses. Unsurprisingly, to implement this response, the government turned to community banks, asking them to work with their customers in relation to new government policies designed to avoid economic catastrophe brought on by the pandemic. Community banks answered the call by participating in the Small Business Administration’s (“SBA“) Paycheck Protection Program (“PPP“), and distributing billions of dollars of loans to their customers. Now, however, community banks that participated in the PPP program face being unfairly penalized by potentially being subject to increased supervision, reporting, regulations, and costs.

The issue faced by community banks that participated in PPP is that the distribution of PPP loans caused these banks to see an unexpected and sharp rise in their assets and significant, unplanned growth in their balances sheets. In some cases, banks saw growth in their balance sheets of more than 25%. Much of this growth, particularly with respect to PPP participants, was (and still is) expected to be temporary. Banks reasonably assumed that PPP loans would be forgiven and written off their balance sheets by the third quarter of 2020. For a variety of reasons, most notably the SBA’s still evolving PPP loan forgiveness process, this has not been the case and community banks may end up with PPP loans on their balance sheets for an extended period of time.

The inflated balance sheets caused by PPP loans pose potential harm to community banks in that it may impact how they calculate various regulatory asset thresholds. In general, community banks face a wide range of statutory requirements predicated in large part on their risk profile and asset size. Including PPP loans in a bank’s asset threshold calculations, therefore, may well push a community bank over thresholds that will subject the bank to additional regulations and/or reporting requirements. Such a result was certainly not the intent of the PPP program and would unfairly punish banks that participated in the program with every expectation that PPP loans would be written off of their balance sheets in quick order.

Notably, banking agencies including the OCC, the Federal Reserve Board, and the FDIC, are taking action to ameliorate this unintended consequence of participating in the PPP program and have recently proposed a rule to exclude PPP loans from the asset calculations of community banks. Banks that participated in the PPP program should track the progress of this proposed rule to ensure that their threshold calculations include, or don’t include as the case may be, the appropriate assets.