Thorn Run Partners Financial Services Report (4/13)

April 13, 2020

House and Senate Leaders, along with Treasury Secretary Mnuchin will continue to negotiate around the so-called Phase 3.5 bill this week, driven initially by a belief that the fund was going to be entirely spent soon. As of this past Saturday, the Small Business Administration reported that banks had approved 725,000 loans totaling over $182 billion dollars. (slightly more than half of the $349b available). Increasing the pool of eligible lenders via the inclusion of fintech and other non-bank lenders last week my accelerate the PPPs burn rate.

However, it is unclear whether it will do so at a speed that forces Congressional Democrats and Republicans to finalize a deal this week. What we do know is that it is difficult to push a narrative that the fund is close to running out and needs to be replenished concurrently with a narrative that the PPP isn’t providing money to small businesses. However at some point the data supporting those two narratives will come close to intersecting, as the demand for the PPP is always unlikely to match the funds supply, but when it does, that will be the forcing action on Congress to pass Phase 3.5.

Last Week in Congress

On the Floor

On Thursday morning, Senators failed to pass a roughly $250 billion funding bill to bolster the Small Business Administration’s (SBA) Paycheck Protection Program, which is projected to run out of money due to overwhelming demand. Majority Leader Mitch McConnell (R-KY) attempted to pass the additional funding for PPP by voice vote during a pro forma session, but was blocked by Democrats seeking additional policy changes.

Democrats’ latest offer calls for additional funding priorities beyond the small business loan boost in the Republican “Phase 3.5” effort, most notably for health care providers and municipalities. In contrast with the Republican’s clean $250 billion increase, the Democratic small business proposal would boost PPP funding by $185 billion ($60 billion of which would be set aside for loans made by certain smaller and community-based lenders), provide $65 billion for Economic Injury Disaster Loans (EIDL) and grants, and make farms eligible for both programs.

Perhaps the most significant policy change in the Democratic bill is clarifying how PPP lenders can meet know-your-customer requirements, the challenge of which has driven many participating lenders to only accept applications from existing customers. The bill would also increase the maximum loan amount from 10 weeks of payroll to 12. While this change would not on its own not affect the statutory program’s 8-week forgiveness formula, the Administration at its own discretion capped non-payroll forgiveness at 25 percent based on this 8:10 ratio. Thus, it is plausible that SBA wold raise that cap should the maximum loan amount change in this way. This would allow a greater portion of forgiveness to go towards non-payroll costs.

Washington is currently at a crossroads with the Phase 3.5 measure as officials from both sides of the aisle continue to jostle for positioning. Speaker Nancy Pelosi (D-CA) emphasized that the Senate’s proposal cannot pass the House in its current state, and could ultimately be blocked by Rep. Thomas Massie (R-KY) who has expressed concerns about passing this funding package absent a quorum. Conversely, White House officials have stated that President Donald Trump will not sign a bill that includes priorities beyond PPP, saying that he prefers to handle additional funding for hospitals, state, and local governments in the “Phase IV” legislation. As such, timing for passage of the Phase 3.5 measure is in flux.

Looking ahead, it is highly unlikely that lawmakers return to Washington as scheduled next week. Members’ absence from the Capitol will complicate the development and passage of any “Phase IV” COVID response legislation.

Last Week in the House

HFSC Republicans Criticize Waters on COVID Response. On Monday, Ranking Member Patrick McHenry (R-NC) led senior Financial Services Committee Republicans sent a letter criticizing HFSC Chairwoman Maxine Waters (D-CA) for her “partisan” response to the COVID-19 pandemic. The letter accuses Chairwoman of using the public health crisis to promote unrelated Democratic priorities. The Republican authors are specifically critical of attempting to tie COVID-19 to broadening corporate disclosures and ESG investing, collecting diversity data, and instituting a $15 dollar minimum wage and permanent federal paid leave requirement.

Waters/Velazquez Letter to PPP Lenders. On Friday, Financial Service Committee Chairwoman Maxine Waters (D-CA) and Small Business Committee Chairwoman Nydia Velazquez (D-NY) sent a letter to four large banks inquiring into the problems with the implementation of the CARES Act’s Paycheck Protection Program. While acknowledging that inconsistent guidance and technical failures on the part of SBA have impeded PPP’s rollout, the letter expresses concern that “megabanks are favoring certain customers and shutting out others.” The letter calls on the institutions to do all they can to assist consumers and small businesses and poses several inquiries into the banks’ participation in the program thus far. The letter mirrored concerns expressed earlier in the week by Velasquez herself in a letter to Secretary Mnuchin and Administrator Carranza.

Last Week in the Senate

Crapo PPP Letters. Last week, Banking Committee Chairman Mike Crapo (R-ID) sent two letters to federal agencies calling for action to facilitate financial institutions’ origination of loans under the Paycheck Protection Program. While supportive of agency efforts thus far, the first letter to the Small Business Administration and Treasury called for additional guidance providing clarity to lenders, as well as a prioritization of agency portals facing a spike in traffic. Sent to federal banking regulators, the second letter calls on regulatory action to enable the offering of PPP loans, among other actions to encourage financial institutions to lend to consumers.

Brown Sends Series of Letters Highlighting Consumer Protection Issues. During the course of the week, Banking Committee Ranking Member Sherrod Brown (D-OH) engaged in a series of actions reiterating Democrats’ focus on the financial protection of consumers impacted by COVID-19. Some of these letters were sent individually, some with other members of the Senate, and one was even bipartisan.

On Monday, Ranking Member Brown and Sen. Dick Durbin (D-IL) sent a letter to federal financial regulators calling for additional action to prevent predatory lending during the public health crisis. Specifically, the letter calls for a 36 APR rate cap (though not specifically a Military Lending Act calculation of APR), stringent ability-to-repay standards, the prohibition of automatic enrollment in new loan products, and an end to balloon payments.

On Monday, Ranking Member Brown and Sen. Elizabeth Warren (D-MA) led a cohort of Senate Democrats on a series of letters to private student lenders calling on them to provide relief to private student loan borrowers consistent with relief that has already been provided to federal student loan borrowers impacted by the COVID-19 pandemic.

On Thursday, Ranking Member Brown and Sen. Josh Hawley (R-MO) sent a letter to the Treasury Department calling on the agency to prevent consumers’ $1200 stimulus checks from being garnished by private debt collectors.

Senate Dems CRA Letter. On Thursday, Banking Committee Ranking Member Sherrod Brown (D-OH) led 42 Senate Democrats on a letter to FDIC and OCC urging them to withdraw their proposed rule that would reform Community Reinvestment Act (CRA) regulations. The letter reiterates months-old Democratic criticisms that the rulemaking’s attempt to modernize and simplify CRA compliance would water down the country’s decades old signature anti-redlining law.

Last Week in the Administration

Main Street Lending Program Headlines Continued Central Bank response to COVID
Throughout the week, the Federal Reserve continued escalating its extraordinary 13(3) lending programs, among other actions to mitigate COVID-19’s impact on the economy.

Main Street Lending Program. Most notably among its actions taken last week, the Fed announced its long awaited Main Street Lending Program, which will support lending to small and medium-sized businesses with fewer than 10,000 employees or less than $2.5 billion in 2019 revenue. Using funds appropriated under the CARES Act, Treasury will make a $75 billion investment in the program, supporting to up to $600 billion in lending to distressed businesses.

Made directly by participating financial institutions, loans under this program would be almost entirely purchased by the Fed with the originating institution retaining 5 percent of each loan. Structurally, the program will consist of two separate vehicles respectively supporting new loans and the expansion of old loans. New loans will be capped at four times the borrower’s 2019 earnings maxing out at $25 million. Expansions of existing loans will be capped at the lesser of $150 million, 30 percent of the borrower’s existing debt, or six times the borrower’s 2019 earnings.

Loans made under either program will have a 4-year maturity, be deferred for 1 year, and have an adjustable interest rate of 250-400 basis points above SOFR. Borrowers are required to abide by the limitations on executive compensation, stock buybacks, and dividends outlined in the CARES Act and attest that the loan is necessary due to the public health crisis and will be used to retain workers.

The term sheet for the new loan program can be found here. The term sheet for the expanded loan program can be found here. Prospective borrowers should note that the program is still being finalized and that feedback can be submitted on the program until April 16.

Wells Fargo Growth Restrictions Loosened. On Wednesday, the Fed loosened growth restrictions on Wells Fargo in order to allow the bank to make additional loans through the Paycheck Protection Program and Main Street Lending program. The Fed has emphasizes that this relief is temporary and restricted to these specific lending programs, and that the bank will be required to transfer its benefits from the loans to either the Treasury or a non-profit benefiting small businesses. The move does not otherwise modify the Fed’s 2018 enforcement action against Wells Fargo, which restricted the banks growth amid numerous accusations of misconduct.

PPP Liquidity Facility. On Thursday, the Fed announced the creation of a facility intended to provide liquidity to lenders offering Paycheck Protection Program loans. Known as the Paycheck Protection Program Liquidity Facility (PPPLF), this facility will allow certain qualified PPP borrowers, which as of right now is just banks, credit unions and a few other federally backed lenders, to use the PPP loans they are making to serve as collateral for additional funds from the Fed. In addition, the Fed announced an interim rule to exlcude from its regulatory capital ratios all PPP loans pledged as collateral to the PPPL Facility; and that PPP loans originated will receive a zero percent risk weight under the federal banking agencies’ regulatory capital rules regardless of whether they are pledged as collateral to the PPPL Facility.

Expansion of Capital Market Facilities. On Thursday, the Fed announced the expansion of three facilities intended to support the supply of household and business credit through capital markets. The Primary and Secondary Market Corporate Credit Facilities and the Term Asset-Backed Securities Loan Facility will now support up to $850 billion in credit.

Municipal Liquidity Facility. On Thursday, the Fed announced a lending facility intended to provide up to $500 billion in liquidity to state and local governments facing cash-flow issues caused by COVID-19. The Treasury Department will provide $35 billion of credit protection to the Federal Reserve for the Municipal Liquidity Facility using funds appropriated by the CARES Act.

CFPB Takes Steps to Enable Remittance Transfers During Pandemic
On Friday, the Consumer Financial Protection Bureau announced that it will not take enforcement actions against financial institutions that provide estimates of exchange rates and fees for remittances after July 21 of this year, when the temporary exemption from the Remittance Rule’s requirement that institutions disclose the exact costs of a transfer expires. The policy statement is in effect through the end of the year and is intended to mitigate what CFPB anticipates could be adverse consequences on institutions that would have to begin calculating the exact costs of remittances during a financial and public health crisis. CFPB expects to finalize its ongoing rulemaking intended to address the impact of the exact cost exemption’s expiration in May.