With income derived from facilitating Paycheck Protection Program loans likely to fade as the next few quarters wear on, some community banks will have to look for ways forward.

With the recent extension of the Paycheck Protection Program through May 31, banks could continue to see the lending program boost their balance sheets for several more quarters. 

But with likely a majority of the PPP lending taking place last year, many banks will see those effects, including a boost in their net interest margins, start to diminish in the coming quarters as more loans are forgiven. While the vaccine rollout and upcoming summer season have raised hopes that the economy will continue to reopen, banks will still face questions about how to manage their balance sheets and generate revenue.  

“What’s difficult right now is just trying to figure out how to play the uncertainty going forward,” said Jeffrey Reynolds, a managing director at the Newburyport-based Darling Consulting Group. 

Fee Income Boosted 2020 Figures 

Reynolds said the PPP has had a key role in supporting banks and the economy.  

“When you look at the potential for credit losses in an economy that was just in effect unplugged for the better part of three months and then restricted afterwards, PPP probably did a lot for banks by thwarting a number of bankruptcies, foreclosures and things of that nature,” Reynolds said. 

Nationwide, nearly 4 million loans worth $223.57 billion have been approved through April 4 of this year, including both first-time loans and second-draw loans for the businesses most affected by the pandemic. The program saw 5.2 million loans worth $525 billion from April 3 through Aug. 8 last year.  

Massachusetts businesses have received more than 73,000 loans for almost $6 billion in 2021 compared to about 118,000 loans for $14.3 billion last year. 

Banks receive loan origination fees from the U.S. Small Business Administration, and Reynolds said this fee income has helped improve lenders’ net interest margins.  

“When you tack on the fee income that comes from the origination, [PPP] really has been one of the better asset classes that community banks have been able to partake in over the last year,” Reynold said. 

The fees banks receive from the SBA are amortized over the life of the loan, along with deferred costs associated with originating loans. When the SBA forgives a loan, the amortization period is adjusted and the fees, less the origination costs, are recognized.  

Navid Abghari, a senior portfolio manager at Angel Oak Capital Advisors, said the PPP has provided banks with a strong fee-generating business.  

“The PPP program has really been a positive for banks as they’ve generated a healthy amount of fee income by both originating and servicing these loans,” Abghari said. 

In its annual report filed with the SEC, Eastern Bank, which had approximately 8,900 loans worth $1.2 billion, said that it received approximately $37.1 million of PPP loan origination fees in 2020 from the SBA and had deferred PPP loan origination costs totaling $4.2 million. By the end of the year, the bank had recorded net interest income related to PPP fees of $13.9 million out of $401 million in all net interest income. Lowell-based Enterprise Bank, which processed 2,700 loans worth $510.1 million, said in its annual report that it had recognized $7.2 million in net interest income related to PPP fees out of $130 million in all net interest income.  

Because banks have already factored this income into the models they create around interest rate risks, Reynolds said, they will see the boost from these PPP fees start to drop off. While the 2021 round of PPP funding will provide banks with more fees, the lower volumes will mean the new round of loans will have less of an effect. Banks have seen PPP loan volumes in 2021 between 25 to 50 percent of what they had in 2020, Reynolds said.  

Balance Sheet Dilemmas 

The fall-off in income from PPP loans presents challenges to bank balance sheet managers. After businesses received PPP proceeds, the proceeds went into deposit accounts, but not all businesses have had to spend down their PPP loans, Reynolds said. As PPP loans are forgiven, they are removed as a loan, and the bank receives a payment from the SBA for the amount of the loan – as cash.  

Diane McLaughlin

Community banks that typically have as much as 85 percent or more of their total revenue come from their net interest margin will need to rely on what they have on their balance sheets to generate more income, Reynolds said. He added that those banks sitting on a lot of cash will be pressed to look for more permanent solutions, including loans or buying bonds, solutions which come with risks. 

“This is where you start to see risk management questions come up,” Reynolds said. “Murphy’s law says all of a sudden the deposits are going to start to move away from me as soon as I do that.” 

Abghari said stock banks will have opportunities to increase shareholder dividends, buy back shares and look for merger and acquisition opportunities. He added that banks looking to grow their loan portfolios could see a positive effect from the steepening yield curve. 

“As the yield curve flattened and overall rates lowered, that really put a strain on spread margins at banks,” Abghari said. “As we’re seeing that effect reverse and interest rates normalize both through an increase in overall rates and a steepening of the curve, you expect that would be a positive for banks as it would allow for spread expansion and potentially increase the profitability of banks broadly.”