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    Latest worry for PPP lenders: Liability for loans they didn't make

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    Spurred by complaints that the Paycheck Protection Program's initial phase failed to channel enough loans to small businesses, lenders have hustled to get money into the hands of more borrowers in the effort's second iteration.

    Lenders are on pace to make more than 4 million loans during PPP's second installment, which would more than double the numbers from the program's initial run, based on May 1 data from the Small Business Administration. The average loan size has fallen by 60%, to $80,000.

    While those results are dramatic, there are concerns that lenders will need to brace for fair-lending litigation and regulatory scrutiny for the loans they do not make. And there is potential reputational risk as small businesses that received funds navigate the murky process for loan forgiveness.

    Banking lawyers are already having conversations with nervous clients about the looming issue.

    "There's a significant possibility banks could face private lawsuits or regulatory action,” said Scott Pearson, a regulatory compliance attorney at Manatt in Los Angeles.

    Regulators have already dropped hints that they plan to examine PPP lending closely.

    The Office of the Comptroller of the Currency issued a bulletin on April 27 urging banks to “prudently document their implementation and lending decisions.” The agency also advised lenders to “identify and track the PPP loans made to small-business borrowers that have annual revenues of $1 million or less and are located in low- to moderate-income areas.”

    The Consumer Financial Protection Bureau published a blog post the same day, co-written by Fair Lending Director Patrice Alexander Ficklin, instructing small-business owners “who believe they were discriminated against based on race, sex, or other protected category” on how to file complaints online.

    For many if not most lenders, experiencing any adverse impacts from PPP participation would be a hard pill to swallow. Congress devised the program, part of the $2.2 trillion coronavirus stimulus package, to funnel money to small businesses and their employees as quickly as possible.

    Congress authorized $349 billion for the program. Lenders jumped in with both feet, exhausting the allocation in 13 days. Despite persistent problems accessing the SBA’s platform, nearly 5,000 lenders — often working around the clock — secured approval for nearly 1.7 million loans during the initial run that ended on April 16.

    Banks acted "as intended by the legislation and demanded by" the Treasury Department, Pearson said. “In the early stages of the program, [lenders] said they did not have enough guidance. They were told to stop complaining and make these loans. Banks did that.”

    The SBA and Treasury pushed lenders to make PPP loans as rapidly as possible, industry observers said.

    "The focus was speed, speed, speed — deploy the funds," said Brad Rustin, a lawyer at Nelson Mullins in Greenville, S.C.

    Even so, small-business owners complained about decisions by many lenders to prioritize existing clients. Bankers acknowledged such a focus, but they noted it provided them some protection from running afoul of Bank Secrecy Act and anti-money-laundering laws.

    “With little guidance whatsoever, banks jumped into the fray to try and help customers as best as they could, not knowing the terms and rules even up to the first day applications opened,” said Eric Corrigan, a managing director in the financial institutions group at Commerce Street Capital in Dallas.

    The SBA and some lenders are already dealing with litigation tied to the program.

    Payday Loan LLC, which engages in lending and check cashing in 22 stores in California, sued the SBA April 25 after its request for a $644,000 loan was denied. The application was rejected on the grounds that PPP funds could not be made to companies that profit mostly from making loans.

    Some small-business owners have filed lawsuits targeting big banks, claiming that they favored select, larger clients rather than processing applications on a first-come, first-served basis. Wells Fargo, Bank of America, JPMorgan Chase and U.S. Bancorp are all defending class-action lawsuits.

    The $96 billion-asset BBVA USA in Birmingham, Ala., and the $34 billion-asset Cullen/Frost Bankers in San Antonio are also dealing with legal challenges.

    It is unclear how much of a threat the lawsuits pose.

    A federal judge in Maryland threw out a lawsuit in mid-April, ruling that borrowers lacked a private right of action to sue under the stimulus law that created the PPP. But the decision might not shield banks from other types of litigation related to the program — including discrimination complaints.

    "There are some potentially nasty disparate-impact issues out there," Rustin said.

    Participation in the program has put lenders in unchartered territory.

    "Helping SBA and Treasury roll out a massive stimulus program is not something banks ever did before," said Craig Nazzaro, another Nelson Mullins lawyer. "Most didn't have the bandwidth or capacity to meet program demands and stay heavily focused on their fair- lending controls to safeguard against future allegations of unequal access to credit for women and minority borrowers.”

    Amid massive economic fallout from the coronavirus pandemic, banks assumed the PPP’s primary goal was to quickly put money into the hands of small business employees whose jobs were at risk. The ceiling for loans was set at $10 million and companies with up to 500 employees were eligible. Congress stipulated that funds spent on payroll and benefits, along with occupancy costs and utilities, would be forgiven.

    But several high-profile incidents where publicly traded companies, elite private schools and even the Los Angeles Lakers obtained loans, than agreed to return the funds, have galvanized lawmakers and government officials to press for more lending to smaller borrowers. That has contributed to the much smaller average loan size in PPP's second phase.

    The SBA and Treasury recently announced plans to review PPP loans exceeding $2 million in size when lenders submit borrowers’ applications for forgiveness. And the agencies have yet to release overdue guidance on the specific requirements for loan forgiveness.

    The result is persisten confusion for bankers and borrowers, said Brad Bolton, president and CEO at the $153 million-asset Community Spirit Bank in Red Bay, Ala.

    Larger borrowers with a legitimate need for funding “are scared to death,” said Bolton, who is also vice chairman of the Independent Community Bankers of America. “They want to know if they should access their loans. … They’re having to pay a penance for things they didn’t do.”

    "Regulators have a habit of changing the rules along the way,” Corrigan said. “Now they're reviewing loans over $2 million. They could also change the terms of forgiveness. ... Any bank holding this paper, even for a moment, is subjecting themselves to unknown risks.”

    For lenders, the best way to protect against legal and regulatory scrutiny lies in documenting every step of the decision-making process, Nazzaro said. The sooner they start, the better, he added.

    "You don't want to be reconstructing all this a year from now," Nazzaro said. "Document the discussions you had, what was presented to the board. If you did an outsize number of Paycheck Protection loans relative to your portfolio, document why."

    With PPP's phase two still in full swing, and with a possible third installment being discussed, lenders should expand their outreach to more underserved communities and groups “to make sure they get the opportunity to apply," Pearson said.

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