When we have “Black Swan” events, such as a worldwide coronavirus pandemic that throws the world’s financial markets into a tailspin, the investment advisory business becomes more challenging. But meeting those challenges by managing clients’ investments and expectations can be wonderfully satisfying. Part of the challenge is knowing where and when to find resources to help us accomplish our goals.
Most small businesses were affected when states announced COVID-19 coronavirus lockdowns in March for all businesses not deemed “life-sustaining.” Meanwhile, the market was tanking on wave after wave of selling, resulting in what was nearly a straight-line fall from a high on February 12 at 29,551 to a low on March 23 at 18,591 for the Dow.
Along with the precipitous market crash driven by the COVID-19 pandemic came government aid focused on getting money to small businesses such as ours—specifically, the part of the Coronavirus Aid, Relief, & Economic Security (CARES) Act relief package known as the Paycheck Protection Program (PPP).
How It’s Supposed to Work
The PPP is intended to bolster small businesses such as ours by helping to secure employee payroll expenses and cover applicable overhead such as mortgages, rent, and utilities. The $349 billion program is administered by the Treasury Department through the Small Business Administration (SBA), offering a two-year loan with an interest rate of 1%, as stipulated in the legislation. The law allows for forgiveness of the loan provided certain conditions are met.
The Small Business Administration was chosen to administer the loans and distribution of the funds because the agency was already helping to fund small businesses across the country through a network of loans underwritten by the government but issued by banks.
The PPP provides a loan (which, as will be explained, can eventually turn into a grant if certain conditions are met) limited to eight weeks of wages paid to W2 employees, part-time “gig” employees, or 1099 employees. Normally smaller firms impacted by a pandemic would rush to cut costs; in a service business, generally, the largest costs are wages. The PPP small business loans help to keep a skilled employee base in place, with employers awaiting some return to normalcy. In addition, those employees kept on payroll would not be filing for unemployment and draining public funds; if the businesses survive the lockdown, they could then bring their pre-pandemic workforce back to work at a faster rate than if those employees had to search for and start new jobs.
The program infuses cash into small businesses such as ours (defined by the Small Business Administration as having fewer than 500 employees). As of 2019, there were 30.7 million such small businesses in the U.S., accounting for 99.9% of businesses in the nation, according to the SBA. Firms with fewer than 500 workers employed 46.8% of private-sector payrolls as of 2016.
Normally when things go bad, governments court the larger firms and ignore the plight of the smaller firms. What made PPP different was the recognition that an increasing number of people are either self-employed (independent contractors, sole proprietors, and “gig” workers), have more than one job to get by, and may string together a series of part-time jobs to make ends meet. A Pew Research Center report said that self-employed Americans (found at both ends of the education spectrum) and the people working for them together accounted for 30% of the nation’s workforce, or 44 million jobs in total in 2014.
While these employees have permeated the entire economy, the economic safety net still has not kept up in recognizing this workforce change. Congress redefined eligibility for unemployment within the CARES Act to include the increasing number of “gig” and self-employed workers. However, in most cases, the state unemployment claims process has not been able to process these claims and most of these workers have not received any payments.
Bowen Asset Management employs two principal partners and three 1099 employees (contract workers), making our firm eligible for the PPP supplement; we decided to apply for the loans for our 1099 employees.
There are a few restrictions on the funds disbursed, but they include:
- The loan is needed to continue operations during the COVID-19 pandemic.
- Funds will be used to retain workers and maintain payroll or make mortgage, lease, or utility payments.
- The applicant does not have any other applications pending.
- The bulk of the funds are to be used for related payroll costs, including salary, wages including commissions, and any expenses that total less than $100,000 per year in compensation.
The delineation of funding restrictions is how businesses were operating on February 15. The amount of the loan available is 2.5 times the monthly wages of qualified workers that were being paid at that time. If the company taking part in PPP maintains the workers it had on February 15 for a specified period after receiving the funds, then the loan amount becomes a grant to the lender. If not, it must be repaid.
On one hand, this can be looked upon as free money for the borrower, as a loan that does not have to be returned; however, the loans do not cover even a full three months of payments, only 2.5 months of payroll expenses.
How It Worked for Us
We began researching the PPP application process immediately after the legislation’s congressional approval on March 19.
Applicants could only get into the program by applying through a bank. One of the first issues we encountered is that the banks have a natural tendency to first take care of their current, most active customers. A company borrowing from a bank and using a lot of bank services is considered to have a strong banking relationship.
The issue for Bowen Asset Management is that many small businesses such as ours have no debt outstanding and strive for timely payment of our bills. We have virtually no extensive business banking relationship beyond a checking account. Under normal conditions, we would be considered a financially conservative company with a strong likelihood of survival. As such, for the purposes of the distribution of the PPP loan/grant, we appeared to be virtually invisible to those distributing the funds.
After the program was announced, we received a barrage of emails from well-intentioned attorneys and accountants offering advice on how to apply for the program. We consulted our trusted contacts in the industry who urged participation in PPP but using a smaller community bank. However, we had no corporate relationship with any of the community banks, so we took the route of our primary banker: PNC, a super-regional bank.
It soon became apparent that our corporate bank was not structured to handle a PPP loan to a firm such as ours. We were directed to the bank’s website, but it was not yet up and running. We went back online daily to check the status of the site. On April 3, we were finally able to log into the bank’s PPP application website. On the site, were able to indicate our interest in the PPP program to PNC for further correspondence. We were told via form email that PNC would update their website as soon as they were able to begin the application process.
Meanwhile, the site generated a checklist of required documents needed to complete the application. Finally, on April 8, PNC provided a link to a Small Business Administration online application that was to be electronically completed and submitted, which we did. We received a note back from PNC on April 9 thanking us for our interest in the program.
We heard nothing back for over a week.
Then, on April 18, we received our formal application, but before were unable to complete the electronic form and register it online, the Small Business Administration announced that it was not accepting new applications because it had run out of money. However, PNC shortly thereafter posted through their portal that they intended to keep working on our application for future registration should the Small Business Administration begin accepting applications again. Furthermore, PNC was requesting proof that we were still paying employees as of February 15, which we provided immediately through billing invoices. Since that time, all communications have been through the PNC Portal for the PPP.
The first round for the PPP from the government was $350 billion and was exhausted as of April 16. The second round of $310 billion was approved on April 23. All the following communications were from the log-in site at PNC. On April 28, we were informed that our loan was in a queue for submission to the Small Business Administration. On May 1 at 3:47 p.m. we were informed that our application had been submitted to the SBA and was awaiting registration. On May 1 at 4:13 p.m. we were informed that the application had been registered with the SBA and PNC was preparing for closing; any further contact would be through email.
We were applying for less than $5,000 through the PPP program; of that, 75% was required to be used for payroll and no more than 25% could be used for mortgage interest, rent, or lease payments, utilities, and interest or debt accumulated since February 15.
The application process was relatively easy and straightforward, though it involved several brief conversations with our corporate accountant concerning the eligibility of our 1099 employees. We were receiving mixed advice from PNC and our accounting firm as to whether 1099 employees were included in the program. The advice seemed to change daily; however, news reports were consistently indicating that 1099 employees were eligible as part of the program, which turned out to be the case.
On May 21, we finally received our loan documents and signed the loan to begin the processing; by the end of the day we received a $4,200.00 deposit in our corporate checking account.
On June 8, we received notification from PNC that the CARES Act had been changed to extend the loan expenditure period to December 31 in the case of loans issued before June 5 and broadening the non-payroll costs to 40% if at least 60% of the loan was used to meet payroll. In addition, it also allows us to apply for forgiveness if we are unable to rehire former employees before December 31, 2020, or if our level of business does not return to what it was before February 15, 2020. In addition, the loan repayment forgiveness portion of the application time period was extended to 10 months.
In short, the loan program appears to work; it pushed money out to where it was needed, even in the case of micro loans, such as ours, where there were fewer banking relationships between the applying companies and the approved banks.
Any issues we had with the program related to the speed of the fund distribution. Considering the magnitude of the program, the results are not unexpected. There were likely some businesses that could not wait as long as we did; but the second round of distribution (in which we participated) seemed to work. In addition, considering the higher-profile larger businesses also getting PPP loans, we were not sure we would get anything all. That turned out not to be the case, and several of the larger businesses ended up returning the PPP funds following a spate of bad publicity.
One reason for the loans going to where they shouldn’t was that bankers prioritized existing customers because they did not require additional paperwork to verify a customer’s identity. As a result, some bankers walked their customers through the first tranche of lending with a virtual consigliere service while other relatively unknown customers (such as Bowen Asset Management) were left to fend for themselves.
We found that PNC really walked a fine line here. The bank had developed a way to handle their lesser-priority customers such as Bowen Asset without having to devote human resources to walk through the application process; we experienced the development of that outreach in real time. We were on their books and hence they had some evidence of our legitimacy, but we did not have in-depth files with them because we did not have the need to borrow money up until then.
Distribution of these funds through this program was a massive undertaking and despite our misgivings, it was successful even for a small firm like ours.
We took these funds for two main reasons. With an imminent financial and economic collapse possible, it appeared as if our business was going to be affected at the time either by a drop in assets driven by the market or by clients who needed to make unusually large, unplanned withdrawals from their account; either would have caused us to reassess and cut our operating budget. Also, and less pressing, we felt that going through the application process would give us an opportunity to assess the program from the inside.
What’s Next
On July 1, Congress passed an extension to the PPP; President Trump signed the legislation on July 4. The bill extends the deadline for businesses to apply for PPP loans until Aug. 8. The program had been set to expire on June 30 with roughly $130 billion left unused from the $2 trillion coronavirus stimulus package agreed to in March. But the Senate, in a surprise, passed the legislation by unanimous consent late in the evening of June 30, extending the program hours before it was set to expire.
Though the data is still coming out and the program has not yet completed, we will have to wait to see if it is regarded as a success. There was, however, not much other choice in executing a program of this size and scope. The shortfall in using the Small Business Administration for PPP is that not all small businesses use traditional banking lending relationships. The program misses the very small businesses and conservatively managed business which have not borrowed against their balance sheet.
For the banking industry, the institutions charged with administering the SBA loans are fully backed by the federal government for the loans made in this program. A PPP loan will be assigned a risk-weight of 0% under the risk-based capital-ratio rules of the federal banking agencies and it is deemed as not having an effect under the facility on leveraged capital ratios.
In short, it is a unique program because it does not count against the bank’s credit or its capital ratios. The fear for the banks, however, is that in the aftermath of the program, they will become responsible for any extra money lent out through paperwork errors or any changes to the program that made on the fly to accommodate political realities. For the banks, speed creates a propensity for errors, and they are afraid of having to eat those errors in the aftermath of the program.
One advantage of our dealing with a larger bank was that many small community banks (assets of less than $1 billion) had a difficult time getting their loans processed with the SBA. On April 29, the SBA dedicated an eight-hour window to banks with less than $1 billion in assets. It seemed to work, though not as well as Congress had originally intended.
Considering the size and scope of the program, and the public shaming of the large companies that were still able to get into a program intended for small businesses, the PPP ended up working well.
As always, if you have any questions about this article or any financial questions in general, please reach out to Bowen Asset at info@bowenasset.com or (610) 793-1001.
Disclaimer
While this article may concern an area of investing or investment strategy in which we supply advice to clients, this document is not intended to constitute a complete description of our investment services and is for informational purposes only. It is in no way a solicitation or an offer to sell securities or investment advisory services. Any statements regarding market or other financial information is obtained from sources which we and/or our suppliers believe to be reliable, but we do not warrant or guarantee the timeliness or accuracy of this information.
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