Community banks are getting too little credit for PPP loans

Never have community banks rallied to do so much for their communities in as short a period as was the case during the pandemic with their Paycheck Protection Program lending and loan modifications. Unfortunately, far too many community banks are not getting their deserved credit from regulators, Congress and community groups.

Rather, many of them are being criticized for taking PPP fees,disproportionate lending to larger firms and failing to lend enough to minority businesses. Other community banks are spending time with Small Business Administration audits and government agencies investigating PPP fraud, with one study estimating that 15% of all PPP lending involved fraud.

Big banks have the compliance and legal staff, including many revolving-door regulators, to deal with these issues. Community banks, however, are struggling with an increased and costly regulatory burden as well as record-low net interest margins.

Yet, most studies show that community banks, generally those under $10 billion in assets, did a far better job of helping their communities during the pandemic than the big banks. For example, the Fed’s 2021 Small Business Credit Survey found that community banks were not only the most common source for PPP loans but also had the most satisfied customers compared with big banks (61% vs. 41%).

In order to quantify the extent to which different banks were responsive to their communities during the pandemic, I created a PPP Loan Community Responsiveness Index in July 2020 after the first SBA PPP disclosure data were released. This index measured the market share of a bank’s PPP loans in a given area relative to its market share of deposits in that area. This index was replicated by numerous business journals in major banking markets.

An index of 1.00 indicated a bank responded satisfactorily to PPP loan needs, while an index of 2.00 or higher represented the most responsive banks. Indexes of 0.50 or lower represented the opposite.

Only three of the 10 largest banks operating in my home state of Florida had indexes over 1.00. Our two biggest banks, Bank of America and Wells Fargo, with a combined deposit market share of nearly one-third of the state, had the lowest indices at just 0.40 and 0.18, respectively. Citibank was not much better at 0.19, although Chase ranked at 0.72. By comparison, most community banks had much higher ratios, several over 2.0.

Putting on my Community Reinvestment Act professor hat, I found it disturbing that regulators are not giving many community banks proper CRA credit for their PPP loans or loan modifications, unless it is specifically asked for and documented. Déjà vu CRA in the 1990s, “If it wasn’t documented, it wasn’t done.” This is not a problem for big banks, as they make sure they get credit for — and let everyone know about — every single thing they do to help their communities.

For example, one large bank, with a more than $40 billion loan portfolio, got CRA “extra credit” for “flexible and innovative” lending programs, not just for its PPP loans but also for more than $7 billion in loan modifications, nearly one-fifth of its portfolio. These modifications included any credit accommodation with an interest-only period, deferral of principal and interest payments, deferral of escrow payments, waiver of certain loan payment late fees or the use of an interest reserve to make partial or full payments.

Community banks, in addition to their PPP loans, made these same modifications, but far too many of them are not getting basic or extra CRA credit. I reviewed all CRA exams issued this year with a focus on the 8% receiving “outstanding” ratings — those most likely doing the best job of meeting community credit needs. While virtually all of those banks made PPP loans, every large bank with an outstanding rating received explicit credit, compared with only half of the outstanding community banks. Nearly three times the number of large banks received explicit credit for pandemic loan modifications compared with community banks.

The incidence of offering PPP loans and modifications at outstanding-rated community banks and large ones was probably very similar, but the fact that the large banks are explicitly given credit in their CRA exams at the rate of two to three times that of community banks is troubling.

This suggests that regulators, but especially the Federal Deposit Insurance Corp., must do a better job in their CRA exams to give credit where credit is due. Virtual compliance exams, especially those being rushed within a few weeks at community banks, are no excuse for the failure to provide deserved credit for both PPP loans and modifications. It may be important to get virtual exams done quickly, but it is more important to get them done right since banks must live with their public CRA ratings and performance evaluation for three years or longer.

There is really no excuse for failing to provide CRA credit for PPP loans as all of this information is public and should be analyzed by regulators and banks in advance of an exam. These same data can be a valuable source of competitive intelligence for banks because they show which local businesses are banking with which of their competitors, since most businesses approached their primary bank or credit union first for PPP loans.

While it is easy to fault regulators, CRA officers at banks not getting proper credit also deserve blame. Examiners have a list of exams that must be done each quarter, and each bank is just another CRA brick in their compliance exam wall. That is why we recommend CRA officers provide their examiners at the start of the exam with a detailed spreadsheet of all PPP loan and especially loan modifications, even for the same loan more than once, made since March 2020.

If the rushed or sometimes unfortunate “rogue examiner” fails to give CRA credit to a bank that has helped its community during the pandemic with PPP loans, modifications or other activities, we further recommend that the bank submit a public comment into its own CRA Public File detailing those activities. That way, the inquiring public and the next examination team will hopefully give CRA credit where it is due.