Assessing the PPP as the Application Window Closes
Date August 12, 2020
In Gordon Brothers’ newest article, Alex Sutton, Gordon Brothers Managing Director and Head of Research, provides perspective on the Paycheck Protection Program (PPP) and how its expiration will impact business operations.
- Survey data on Gordon Brothers’ transactions conducted from April through June indicates that the PPP has affected the asset-based lending (ABL) market.
- The PPP provided liquidity support for companies that may have otherwise shuttered their doors during the COVID-19 pandemic, providing them with a longer runway before implementing layoffs or closures.
- Going forward, asset-backed lenders will need to ask deeper questions about the state of borrowers’ collateral, as lenders will be tasked with determining the ability of businesses to rightsize and continue operating without interruption over the term of any new debt.
Assessing the PPP as the Application Window Closes
As of August 8, companies were no longer able to apply for Paycheck Protection Program (PPP) loans, the U.S. Small Business Administration (SBA) loans that were put in place to help individuals and firms stay afloat amid the COVID-19 pandemic. Given that the loans constituted the government’s largest COVID-19 relief program to date (Figure 1)1,2,3,4,5,6, it is worth considering whether the program met its goals and how the end of the application period will impact business operations.
PPP was successful in saving jobs and providing a lifeline for small businesses7, two of the main goals of the program8. However, the timeframe for requesting a loan has ended well before pandemic-related struggles conclude for many industries, such as restaurants, hospitality, and retail.
The PPP also had an impact on asset-based lending (ABL) deals, as many current ABL borrowers have tapped into the program to access additional availability.
Gordon Brothers Survey Findings: PPP Preserves Operating Capabilities for Some Distressed ABL Borrowers
In a survey of 74 Gordon Brothers’ transactions conducted in April through June, 32.4 percent of borrowers had been granted PPP funds. The PPP loan amounts aggregated to 15.3 percent of their total outstanding financing debt. In one respect, this can be looked at as a positive for ABL deals, as the additional funding provides liquidity to an ABL borrower without diminishing the security position of the lender. That being said, the very need for these companies to access these loans indicates that, to one degree or another, they were impacted by COVID-19 and were likely incurring operating losses as a result.
Of the companies surveyed, average sales in March and April declined by 16.0 percent and 35.8 percent, respectively. The PPP loan amounts granted replaced over 100 percent of the lost sales amounts for these two months. By contrast, in May, the lost sales amounts exceeded the amounts granted under the PPP loans. Since loan eligibility did not take a borrower’s credit health into account, some weaker companies were able to continue operating despite having sharp declines in profitability and an inability to service their existing debt. However, as the PPP liquidity source dries up, expenses funded by the loans will begin to accumulate again, and ABL lenders will need to take a closer look at the strength of the collateral and overall credit standing for small-business borrowers.
Impact on Small Businesses
The program, which began April 3, aimed to help small businesses and incentivize them to keep employees on the payroll, providing relief to employers that wanted to pay and retain staff who could not come to a work site. SBA loans will be forgiven if loan proceeds back payroll, insurance premiums, mortgage, interest, rent or utility costs, and if employees are retained under specific rules, among other criteria9. In addition, the interest rate for the PPP loans is 1 percent (deferred for six months), with the loans ultimately being forgiven if you used for payroll, rent, mortgage payments, and other select uses10, allowing most businesses the opportunity to average down their aggregate cost of capital.
The program achieved widespread distribution across the U.S. Within all 50 states, 72 percent to 96 percent (varied by state) of estimated small business payroll was approved for PPP loans. In aggregate, the PPP supported as much as 84 percent of small business employees11. However, as of August 6, only $523 billion of PPP loans had been disbursed, which was short of the $659 billion allocated to the program.
The highest percentage of loans went to the Health Care and Social Assistance, and Professional, Scientific and Technical Services sectors, which are also the sectors with the highest and second-highest proportion of payroll expenses for U.S. small businesses, respectively (Figure 2). Less relief went to sectors with a high proportion of employees and labor costs, but lower wage levels. Retail - one of the hardest-hit sectors in the pandemic - received 7.7 percent of the total PPP loans. While the Retail sector has the highest proportion of labor costs and employees, it has the second-lowest hourly median wage.
According to the Gordon Brothers survey data for transactions in April through June, the Manufacturing sector received the highest percentage of PPP loans, followed by Retail (Figure 3).
Data also shows that the PPP boosted liquidity for small businesses. Statistical analysis using instrumental variables indicated that if the share of firms receiving a PPP loan increased by 10 percent, the share of firms reporting at least two months of cash to cover business operations would rise by 3 percent, and the share of firms reporting missing loan payments would fall by 1.7 percent, per a July 3 academic study released by the University of Chicago12. Gordon Brothers’ internal study of companies impacted by the PPP concurred with this finding, showing that the program effectively covered at least two months’ worth of cash flow deterioration.
By design, the PPP funds were largely used to meet loan, payroll, and other spending requirements, which has kept businesses open that may have otherwise shuttered during the pandemic. In a Goldman Sachs survey of over 1,500 PPP loan recipients conducted July 7-8, 77 percent said they had been able to maintain 75 percent to 100 percent of payroll, despite material and negative pandemic-related pressures13. More than 80 percent of the businesses said their PPP funding would be exhausted by the first week of August, and only 16 percent said they were “very confident” that they could maintain payroll with no further government stimulus going forward, according to the survey.
Results for Individuals
Focusing on individuals, the fall in the unemployment rate from its peak of 14.7 percent in April to 10.2 percent in July helped improve confidence in the economy following dire periods in April and May. It is clear that the PPP is responsible for some of this improvement in employment data despite PPP funds being allowed for expenses other than payroll. However, the extent of the program’s support of the job market is open to debate. S&P Global Ratings' chief U.S. economist, Beth Ann Bovino, estimates the program saved 13.6 million jobs, significantly below the SBA’s estimate of 51 million jobs supported. Notably, at the state level, Massachusetts, New Jersey, and New York had the highest unemployment rates in June14, but two of those states - New York and New Jersey - had among the lowest fraction of small businesses receiving PPP and the lowest allocation of PPP per small business15. The University of Chicago paper posited that this is partly due to fewer small-business-focused banks with a heavy presence in those states. The paper further notes that congressional districts with the least drops in hours worked and the lowest rates of business shutdowns had a larger fraction of their small businesses receive PPP funds.
Even without a clearly defined correlation between the PPP and unemployment, the program has provided liquidity support for small businesses across industries, which has indirectly helped employees whose companies received a necessary lifeline and a longer runway before implementing layoffs or closures.
Considerations for Lenders
Origination fees for banks providing PPP loans have provided a windfall for revenues, leading to total payments that exceed revenues for all of 2019 for some community banks, according to a report from S&P Global Market Intelligence16. By allowing banks to earn these fees on loans regardless of the borrower’s ability to service the debt (Figure 4), the PPP eased banks’ ability to underwrite these loans at an attractive fee structure and near-zero risk. It also enabled banks to grant additional leeway to existing borrowers, allowing them the opportunity and time to recover and/or restructure their businesses.
As the program winds down, lenders will need to ask deeper questions about the state of each company’s collateral and closely analyze impairment levels of both long-term and current assets. The SBA loans may have curbed some use of revolving credit facilities or other lending mechanisms, and companies are now seeking these additional liquidity sources. Small businesses may need more working capital to reopen their doors, increasing their need for a new loan that can fund all types of expenses.
Lenders will be tasked with determining the ability of businesses to rightsize and continue operating without interruption over the term of any new debt. Borrowers will surface that have been able to use the PPP as a bridge for several months, but now face liquidity pressures without those funds. Banks may need to be cautious about giving these companies deferrals on non-PPP loans that could morph into nonperforming loans in the near- to medium-term.
Importantly, the expiration of the PPP program is occurring when tariffs on European goods are rising, the $600-per-week unemployment insurance bonus has been cut to $400-per-week, state reopenings are at risk, and consumers, businesses and municipalities remain concerned about a second wave of the virus. While it is clear that the PPP was in no small measure a success, lenders will need to closely monitor their portfolios and understand what their customers’ credit outlook looks like without the PPP program standing behind it.