On April 9, the federal banking agencies issued an interim final rule to encourage lending to small businesses through the Small Business Administration’s Paycheck Protection Program (“PPP”) established under the CARES Act. Specifically, the agencies are applying a 0% risk weight to PPP covered loans for regulatory capital purposes.
To help stabilize the financial system and assist with providing general economic relief to small businesses and the broader credit markets, the Federal Reserve Board (the “Fed”) authorized each of the Federal Reserve Banks to participate in the lending facility recently created by the Fed (the “PPPL Facility”). Under the PPPL Facility, each of the Federal Reserve Banks will extend non-recourse loans to eligible financial institutions, including banks subject to the Federal banking agencies’ regulatory capital rule, that are making PPP-covered loans. In turn, the PPP lender would pledge as eligible collateral only PPP-covered loans that are guaranteed under the PPP as to both principal and interest and that are originated by an eligible institution.
The Fed is encouraging the use of the PPPL Facility by permitting banks to neutralize the regulatory capital effects of participating in the PPPL Facility, which is consistent with Section 1102 of the CARES Act. As a general matter, guarantees under the PPP are backed by the full faith and credit of the U.S. government. The agencies’ regulatory capital rule requires a bank to apply a 0% risk weight to the portion of exposures that is guaranteed by a U.S. government agency for purposes of meeting its regulatory capital requirements. Further, because of the non-recourse nature of tapping into the PPPL Facility, the agencies have taken the position that a bank originating a PPP covered loan would not be exposed to credit or market risk on such loan. Accordingly, PPP covered loans pledged as eligible collateral to the PPPL Facility will receive a 0% risk weight under the agencies’ regulatory capital rule, which effectively removes PPP covered loans pledged as collateral to the PPPL Facility from a bank’s total leverage exposure, average total consolidated assets, and total risk-weighted assets.
As discussed in greater detail in a prior Waller posting (https://www.wallerlaw.com/news-insights/3523/What-small-businesses-and-lenders-need-to-know-about-the-final-details-of-the-SBA-7a-loan-program-expansion?gs=name&gk=sba), the PPP establishes a loan program to enable small businesses facing disruption caused by COVID-19 to keep workers on payroll during the pandemic. PPP-covered loans are fully guaranteed as to principal and interest. For borrowers, PPP loans afford them forgiveness up to the principal amount of the PPP-covered loan. Meanwhile, the Small Business Administration is to reimburse lenders for any amounts of the PPP covered loan that are forgiven. In addition, lenders are not held liable for representations made by PPP borrowers.
Please note that Waller expects the agencies to provide further, more specific guidance with respect to accessing the PPPL Facility and will update this posting accordingly.
For additional information, please contact Kevin Tran at (615) 850-8743.