PPP Loans: Modeling the Madness

By Dale Sheller and Matt Harris

As summer winds down, the same goes for the Payroll Protection Program (PPP) as August 8 was the final day for application. This critical but controversial component of the $2 trillion CARES ACT passed in March this year created over $525 billion in loans with over five million applicants. The program was necessary to keep millions of American workers on company payrolls as the US Economy suffered one of the worst quarters in history. Community banks were critical in the PPP loan process. Banks with total assets less than $10 billion were responsible for over half the loans created (2.7 million) to an impressive total $233 billion! Now as Congress readies for a second round of fiscal stimulus, bankers across the country are analyzing the short- and long-term implications of their balance sheets and earnings projections.

When reviewing June 2020 call report data, bank loan balances are up significantly from the previous quarter as well as overall deposit growth when tracking both quarterly and annualized changes. On top of this, there have been additional deposit flows with the personal savings rate at historic levels and a continued shift of certificates of deposits back into non-maturing demand products.

2020-07 Charts for PPP Article

Key risk managers within Asset-Liability Committeemen (ALCO) members should consider the following when analyzing these loans impact on Asset-Liability Management (ALM) and Interest Rate Risk (IRR) profile of the bank.

PPP Loan Data – How does it come into your interest rate risk model?

  • Ensure that the loan tape reconciles to the total balance sheet and the loans are being modeled properly with a 1% rate. Some banks have the PPP loan data in a different source.

Setting Up the PPP Loan Account – Do you break them out?

  • Most institutions will break out the PPP loans from the rest of their loan portfolio to allow model flexibility.

Once They Are Set Up – How are you modeling the cash flows?

  • Most of these are set for a two-year (and in some cases five) maturity. As we know, the expectation at the start was that a vast majority of these loans would be forgiven and converted to a grant. Congress has debated legislation that would provide for blanket forgiveness for all loans less than $150,000. If passed, a large percentage of these loans would be forgiven causing further increases in liquidity. Some of these funds will be used to pay off borrowings used to fund the loans and others into new loans or securities.

Fee Income?

  • Given the straightforward breakdown of the fees, (1% > $2MM, 3% $350M-$2MM and 5% < $350M) most banks are able to incorporate their projections of income on these balances and incorporate into their ALCO results. Also be sure to incorporate agent fees and if you are backing those out.

What else should we be thinking about?

  • What if interest rates turn negative? What does are margin look like if short-term assets and liabilities have negative returns? As we’ve seen in Europe and Asia, negative interest rates can be punitive for bank earnings.
  • Prepayment Risk! Take time to increase your prepayment projections in the model by increasing speeds up to 10 to 15 CPR in the various interest rates scenarios modeled for the bank.

The impact of PPP on community banks has been significant. Because of this risk managers must take the additional time to ensure these loans are being modeled properly. While the list above is by no means exhaustive, it is a great place to get started when reviewing the ALCO reporting. Taking the time today to improve the assumptions and data inputs will save a lot more later when having to unwind bugs and re-run multiple reports. Also, be sure to consult with your asset-liability provider for any new model updates or changes to the system calculations. Remember, the old GIGO adage goes with any model: Garbage in, garbage out!

Dale Sheller is Senior Vice President in the Financial Strategies Group at The Baker Group. He joined the firm in 2015 after spending six years as a bank examiner with the Federal Deposit Insurance Corporation. Sheller holds a bachelor’s degree in finance and a master’s degree in business administration from Oklahoma State University. He works with clients on interest rate risk management, liquidity risk management, and regulatory issues. Contact: 800-937-2257, dsheller@GoBaker.com.

Matt Harris, CFA, is Senior Vice President at The Baker Group. He started with the firm in 2007 as an intern while attending the University of Texas-Austin, where he earned a Bachelor of Arts degree in government and economics. In 2010, he joined the firm’s Financial Strategies Group at the home office in Oklahoma City, where he works directly with bankers, examiners, and auditors regarding fixed income portfolio analysis and asset/liability management. Harris is also involved in the development and testing of Baker ’s proprietary bond accounting and interest rate risk software. Contact: 405-415-7251, mharris@GoBaker.com.

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