Many banks expect the Paycheck Protection Program to act as a major revenue source over the coming months while also helping existing borrowers who are at risk of defaulting and driving up already heavy credit costs.

PPP fees range from 1% to 5%, depending on loan size, and will largely be recognized as interest income in the next quarter or two as amounts borrowers use on payroll and other expenses are forgiven by the government and disappear from banks' books.

Based on loan size data released by the government to date, aggregate fees have averaged 3.1%. That would represent $20.3 billion in total fees based on the full federal authorization for the program so far, and a far better return than securities yields across a yield curve pinned close to the zero lower bound. Some banks say participation in the program, while requiring long hours and a Herculean mobilization of staff, involves modest direct costs, and that they are not concerned about potential liabilities. Some banks also hope to use PPP loans with new clients to peel relationships away from large competitors that angered borrowers with long processing delays.

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In an environment marked by weak loan demand across many sectors, PPP lending stands as one of the few near-term opportunities. In its Form 10-Q on May 5, PNC Financial Services Group Inc. projected that its average loans would increase 10% to 15% in the second quarter from the first quarter, reflecting $14 billion of lending under the small business rescue program, up from "high-single digit" growth it forecast just three weeks earlier. During its first-quarter earnings report April 24, Synovus Financial Corp. said that the program will become its "primary engine for loan growth." On its first-quarter earnings call April 29, BankUnited Inc. Chairman, President and CEO Rajinder Singh said his company could be renamed "Bank of PPP" for the month of April.

"That's like all we've been doing," Singh said.

The earnings math

PPP loans have two-year terms, but loan amounts are set according to how much borrowers spend on two months of employee compensation, and are forgivable in their entirety eight weeks after funding if borrowers do not cut their payrolls. Building in some time for processing, banks expect most of the loans to be paid off over the next two quarters, triggering the recognition of most fees as interest income.

First Interstate BancSystem Inc. President and CEO Kevin Riley projected that his bank's net interest margin could increase modestly in the second quarter as PPP loans begin to be repaid. By the third quarter, however, "it probably could go north really fast because of all those fees being recognized," he said during a May 1 conference call on first-quarter results.

The Billings, Mont.-based bank, with $14.41 billion in assets, funded about $1 billion of PPP loans in the first round of the program — the government added another $310 billion after the initial authorization of $350 billion was used up in about two weeks in the first half of April — which it said generated $35 million in fees. That figure is equivalent to 7% of the bank's net interest income over the year through the first quarter.

The interest rate on PPP loans is 1%, which produces a modest spread against funding available at a rate of 0.35% through a special facility offered by the Federal Reserve, which many banks have said they plan to use. Still, banks have emphasized that the loans, since they are fully backed by the government, carry a zero risk weight for measures of regulatory capital, and some have described that core spread as an attractive source of revenue.

"We will get the funding [from the Fed] and a spread of 65 basis points, and it has no impact whatsoever on our capital," Chairman and CEO Jay Sidhu said on Customers Bancorp Inc.'s May 4 first-quarter earnings call. "So over the next two years, if 25% are not forgiven and they stay on our balance sheet, you would expect to see approximately $8 million more in annual...interest income."

The Wyomissing, Pa.-based bank, with $12.03 billion in assets, said it had originated $5 billion of PPP loans directly and in partnership with financial technology companies. It said the lending would generate about $85 million in fees, which would equate to 28% of the net interest income it posted over the year through the first quarter. Overall, Customers Bancorp estimated its PPP operation would add about $2.50, or more than 10%, to its tangible book value per share. "There is no lender liability because we are an approved [Small Business Administration] lender," Sidhu said. "We know how to do this business."

Banks have acknowledged that the program, and the revenue it generates, will be short lived, sometimes framing the earnings they anticipate as an offset to mounting credit costs. Prosperity Bancshares Inc. said PPP lending will be "very accretive" to EPS, but that some of the money will be channeled into loss reserves. "I wouldn't want you to count it just extra found money," CEO David Zalman said on the bank's first-quarter earnings call.

"PPP fees should be viewed as a positive earnings offset and source of capital at a time when provisions are building," analysts at Keefe Bruyette & Woods said in a May 5 note. They estimated that the fees would represent more than 30% of provision expenses over two years at more than a dozen banks, including Republic First Bancorp Inc., Customers Bancorp, Level One Bancorp Inc., Orrstown Financial Services Inc., First of Long Island Corp., Meridian Corp., Peapack-Gladstone Financial Corp. and OceanFirst Financial Corp.

Modest direct expenses, help for stressed borrowers

While banks have built new platforms and enlisted employees in all-hands-on-deck efforts as part of their PPP campaigns, some said that direct costs have been moderate. Synovus CFO Andrew Gregory Jr. said they "are fairly minimal." Grand Rapids, Mich.-based Mercantile Bank Corp. said that it had "direct loan origination costs" of $1 million on $14 million of fees for about $500 million of PPP loans. Chicago-based First Midwest Bancorp Inc. said it partnered with a third party for "origination and processing and execution," and that its fees on about $1.2 billion of PPP loans averaged 2% net compared with 3% gross.

Banks also said PPP served as a way to deliver aid to many struggling borrowers who had been granted payment deferrals. Ruston, La.-based Origin Bancorp Inc. said the vast majority of its borrowers who have received loan forbearance, which account for 17% of its total loan portfolio, have also gotten PPP loans.

Houston-based Cadence Bancorp. disclosed that borrowers representing about half the balance in its troubled restaurant portfolio asked for restructurings or forbearance, and that 90% had applied for PPP loans through various banks, including $147 million that Cadence processed. Chairman and CEO Paul Murphy Jr. said on an April 29 call that the bank sees the PPP loans "as immediate credit support in the near term."

The extent to which payment deferrals and federal assistance bridge businesses past shutdowns and stay-at-home orders will be critical in determining the ultimate level of bank charge-offs.

Kalispell, Mont.-based Glacier Bancorp Inc. said that within a $700 million portfolio it is monitoring because of exposure to pandemic-related stress, 25% of loans have been modified and 15% have PPP loans. "Both the PPP loans and the modifications help customers maintain and build their balance sheets while businesses wait to reopen," President and CEO Randall Chesler said.