PPP FRAUD: HOW FINANCIAL INSTITUTIONS CAN MITIGATE ONGOING RISK

The COVID-19 pandemic challenged communities and businesses nationwide, and financial institutions were no exception. As part of the $2 trillion coronavirus stimulus bill, Congress authorized Paycheck Protection Program (PPP) funding. Under the PPP program, the Small Business Association (SBA) rolled out two relief rounds for certain small businesses. These funds were intended for new and smaller borrowers and borrowers in low- and moderate-income communities.

How PPP funding led to fraudulent loans

While individual stimulus checks and PPP funding helped many businesses during the crisis, a Government Accountability Office report concluded that the SBA’s organizational structure and priorities during the pandemic contributed to conditions that led to increased fraud. For example, the PPP applicants simply needed to self-certify information—the SBA did not have policies or methods to verify borrower information before funds were disbursed or forgiven. The Secret Service has estimated that $100 billion was illegally obtained from the relief programs.

COVID-19 relief fraud has been uncovered for some time, but the devastating numbers and impact are still being realized. According to The New York Times, more than 15% of PPP loans were potentially fraudulent, and financial institutions continue to discover fraudulent loans in their PPP portfolios today.

The U.S. Department of Justice continues to pursue charges against large companies that received multimillion-dollar PPP loans. It has also charged individuals accused of obtaining six-figure PPP loans to finance lavish personal expenses such as luxury vehicles, mansions, private jets, high-end jewelry, expensive vacations, and even plastic surgery.

The Biden administration has taken a hard stance to hold criminals accountable for COVID relief fraud. President Biden stated, "We must prosecute serious offenders and go after those who have the largest amount of stolen funds to recapture.”

How financial institutions can help track down PPP fraud

It’s not too late for financial institutions to review their remaining PPP portfolio for any indication of fraud. The following red flags are indicators of fraudulent PPP applications:

• Misuse of proceeds

• Unqualified borrowers

• New Employer Identification Numbers (EIN)

• Shell corporations/dormant EINs

• Recent business incorporations

• Inflation of payroll

• Large loan amounts

• False statements on applications

• Fraudulent supporting documents (e.g., payroll, tax forms)

• Employee/employer collusion

• Newly created and multiple bank accounts with abnormal transaction activity

• Consumer accounts rather than business accounts

• Rapid movement of money in and out of accounts

• Withdrawals made via cash or apps (i.e., Cash App, Zelle, Venmo)

• Abnormal transaction activity for the client

• Transfers to overseas accounts known for poor antimoney laundering controls

• Crime rings - multiple applications are submitted using phishing information

The fast rollout of the PPP program meant that financial institutions were under pressure to issue loans quickly and may have missed some of these signs. With all types of fraud on the rise, now is the time to include lenders in fraud training, including what to look out for when checking for PPP fraud.

Conducting due diligence after the fact

To detect any lingering fraud within a PPP portfolio, a financial institution should review the PPP loan documentation to ensure that the application and attestation are fully completed with no evident red flags. Be sure to:

• Ensure that current anti-money laundering (AML) procedures were followed

• Conduct negative news searches on an entity and all principals and beneficial owners

• Review public records for the existence and filing date of the entity (was it a viable business before the pandemic?)

• Complete a credit check if not done at onboarding. Is there evidence of “loan stacking”?

• Check that all related tax identification numbers (TINs) are valid and were obtained before SBA imposed deadlines

• Check that all borrowers are related to the business

In addition to these customer due diligence (CDD) procedures, financial institutions should conduct a complete relationship enhanced due diligence (EDD) review on PPP loans. This will require them to:

• Follow the use of loan proceeds from funding to the current date

• Review payroll expenditures and taxes. If funding account elsewhere, consider this a red flag and submit a 314(b) request if warranted

• Balance the borrower’s anticipated payroll costs with the number of employees

• Review for thorough financial institution records of loan decision-making and spending of proceeds

• Update policies & procedures to show enhanced due diligence for PPP loans

Financial institutions are required to follow Bank Secrecy Act (BSA) requirements and perform proper due diligence. Financial institutions should follow all Suspicious Activity Report (SAR) requirements for fraud reporting and start the 30-day SAR clock when fraud is detected. If a borrower does not comply with the PPP criteria and the loan is not forgiven, a SAR may be warranted for loans that are termed out.

In addition to filing a SAR, the federal government has asked that the following agencies be contacted immediately upon detecting PPP fraud:

• SBA at www.SBA.gov

• Local Secret Service field office at www.secretservice. gove/contact/field-offices/

• Other local federal offices (FBI, IRS, etc.)

AML/CFT units should work closely with lenders and senior management to ensure all relevant staff receive training, including PPP portfolio review and monitoring. It is equally important to perform CDD and transaction monitoring of these businesses. Regulators will expect enhanced due diligence since financial institutions know that PPP fraud has been widespread, so be proactive and weed out any PPP fraud in your institution’s portfolio before someone else does.

Terri Luttrell CAMS-Audit Abrigo

WHERE ARE YOUR BALANCE SHEET BLIND SPOTS?

Stress testing your institution’s liquidity is no longer an academic exercise! Recent bank failures of Silicon Valley Bank and Signature Bank shocked the banking sector, and the fallout continues to ripple through the industry and the economy. Liquidity and Contingency Funding Plans have taken center stage, and regulators will be ultra-focused on liquidity risk management practices. Given the unprecedented uncertainty in the banking sector, we must fortify our liquidity risk management practices and prepare our balance sheet for a challenging environment.

Liquidity Assessment

The events of the past few weeks have certainly forced executives to dust off Contingency Funding Plans and assess the importance of having a robust approach to liquidity management. Beyond strengthening your current on-balance sheet liquidity, the following are key questions to ask as you prepare for tomorrow’s risks:

• Federal Reserve’s Bank Term Funding Program – Have you set up access and identified eligible collateral? How quickly can you access this funding source?

• Have you identified additional eligible collateral (loans and investments) to pledge to the FHLB or the Fed Discount Window?

• Have you tested all lines of credit?

• Are you monitoring Reg F exposure for counterparty risk?

• Do you stress test your Tangible Equity Capital falling below zero and are you familiar with the resulting liquidity implications of this?

• Have you assessed your institution’s reliance on uninsured deposits?

• Can you offer reciprocal deposits to your large depositors?

• Could our institution withstand a significant deposit outflow?

Executive teams need to ask themselves some additional important questions. Is our Liquidity Management and Continency Funding Plan up-to-date and reflective of the current economic environment? Are we overly reliant on funding sources that may not be available under a time of stress? How do our funding sources behave during periods of stress? Knowing the ‘breaking points’ within your current liquidity positioning and working to rectify any gaps will serve your institution well for your Board and especially the regulators.

Capital Assessment

The Capital position and stress testing should not be ignored in favor of a hyper-focused approach to liquidity. Stress testing your capital position is equally important today as liquidity access and capital are very much intertwined. We have a saying at Taylor Advisors’: “Capital Erosion Leads to Liquidity Evaporation” and, historically, capital erosion stems from asset quality and loan impairment. While credit quality remains favorable today, the long and variable lags of Federal Reserve Monetary Policy can most certainly impact asset quality in the future.

Furthermore, some institutions have chosen to materially impair capital today by selling securities and realizing unrealized losses in investment portfolios (i.e. Silicon Valley Bank). Knowing the breaking points of your capital by comprehensively stress testing helps reinforce confidence in your liquidity risk management practices and your ability to implement your Contingency Funding Plan.

HUB | Taylor Advisors’ Take:

Checking boxes and going through the motions at ALCO is never sufficient!

The liquidity assessment and management processes continue to evolve for the Board, management, and regulatory perspective. The liquidity crises during the Great Recession stemmed from asset quality and capital issues. Fallout from recent liquidity failures could spread to even the most conservatively run financial institutions. Silicon Valley Bank converted interest rate risk into credit risk, eroding regulatory capital ratios.

Evaluating strategies in isolation can expose blind spots on other parts of the balance sheet. This is why a wholistic approach to balance sheet management is critical when evaluating each of your major ALCO positions: Capital, Liquidity, Interest Rate Risk, and Investments.

Have you considered reimagining your ALCO process? You can start with upgrading your tools and policies, improving your ability to interpret and communicate the results, and helping implement actionable strategies.

HUB |Taylor Advisors, an Affiliate Member of OBL, helps banking executives by providing strategies and expertise to effectively manage the balance sheet and maximize Net Interest Margin.

Todd Taylor Managing Partner HUB |Taylor Advisors

Omar Hinojosa Managing Partner HUB |Taylor Advisors