The Small Business Administration’s (“SBA”) Paycheck Protection Program (“PPP”) guarantees loans from qualified lenders to small businesses impacted by the COVID-19 pandemic so that those businesses can keep workers employed.  In the Third Interim Final Rule issued on April 20, 2020 (see 85 Fed. Reg. 21747), the SBA cleared the way for members of Federal Reserve Banks (“FRB”) and Federal Home Loan Banks (“FHLB”) to pledge PPP loans to secure borrowings by excluding the FRBs and FHLBs from the pledge requirements typically applicable to SBA 7(a) loan pledges.  The exclusion of such pledges from the otherwise applicable requirements means that the SBA does not have to provide prior consent to such pledges nor will it have to approve the FRB and FHLB loan documents or require a multi-party agreement among SBA, the lender, and others.

COVID-19, FHLB

As a result of the SBAs action, members of FRBs and FHLBs are provided with another source of liquidity for PPP loans in addition to the Paycheck Protection Program Lending Facility (“PPPLF”).  Through the PPPLF, Treasury extends credit to financial institutions that make PPP loans, using the PPP loans as collateral for non-recourse loans.  Notably, although the FRB and FHLB loans to its members are full recourse loans, the member loans are not subject to the transparency requirements and other restriction applicable to the PPPLF and the other liquidity facilities established by the Federal Reserve under the authority of Section 13(3) of the Federal Reserve Act.

In an April 23, 2020 letter from FHFA to the FHLB Presidents (link below) responding to requests from the FHLBs for action by the SBA to confirm the pledges of PPP Loans, the FHFA specified the conditions (see below) under which the FHLBs can accept PPP loans as collateral for advances.  In the letter, the FHFA recognized the limitations on collecting on the SBA guaranty due to the fact that FHLBs are not SBA approved lenders.  However, the FHFA stated that it had determined that the SBA should treat FHLBs in the same category as “any federal or state banking regulator or any receiver or conservator”, and allow FHLBs to liquidate PPP loan collateral by selling PPP loans to another SBA lender, with SBA’s consent.

The FHFA specified a number conditions that must be satisfied for FHLBs to accept PPP loans as collateral, including:

  1. Members must have minimum CAMELS ratings of “3”, or a minimum credit rating in the top 60%, or top three quintiles, of the FHLBs member rating system.
  2. A member downgrade will result in increasing collateral discounts if the PPP collateral is not replaced.
  3. Minimum collateral discount of 10% of UPB (capped at 100%).
  4. Collateral value of PPP loans cannot exceed 20% of member’s lendable pledged collateral (after applying collateral valuations).
  5. FHLB must limit the dollar amount of PPP loans that a member may pledge to no more than $5 billion in lendable collateral.

https://www.fhfa.gov/Media/PublicAffairs/PublicAffairsDocuments/PPP-Loans-as-Collateral-for-FHLBank-Advances.pdf

The Federal Reserve issued a release on April 23, 2020 stating that it is working on expanding the list of eligible borrowers under PPPLF to include non-depository institution lenders, such as some Community Development Financial Institutions. Currently, only depository institutions are eligible to participate in the PPPLF, and over 1000 have already been approved to access the program.

Members of the Firms Emergency Relief Task force continue to monitor the roll-out of Federal programs to support the liquidity and capital needs of businesses, financial institutions and others during the Covid 19 pandemic.

As you are aware, things are changing quickly and there is no clear-cut authority or bright line rules.  This is not an unequivocal statement of the law, but instead represents our best interpretation of where things currently stand.

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*This alert is provided for information purposes only and does not constitute legal advice and is not intended to form an attorney client relationship.  Please contact your Sheppard Mullin attorney contact for additional information.*