Fed Study Shows Healthy Small Businesses Benefited Most From PPP Loans

Policymakers are tapping PPP loan lessons for future-fit insights into keeping Main Street businesses healthy.

Researchers say that analyzing the legacy and impact of the U.S. government’s extraordinary $800 billion Paycheck Protection Program (PPP) loan initiative, an emergency response to the COVID-19 pandemic, can help inform future efforts to assist otherwise healthy small and vulnerable businesses during times of dramatic and damaging economic upheaval.

With Main Street increasingly bracing for a recession, now is the time to understand how successful the PPP loans were in preserving jobs and keeping small businesses afloat in the face of rising liquidity constraints and historic macroeconomic headwinds.

Winning Strategies

PPP loans significantly improved their recipients’ financial condition. On average, companies receiving loans reduced their credit risk by nearly one-fifth (18%) relative to non-PPP participating peers in the four quarters after receiving their government allocation.

Across companies studied, smaller businesses saw a more pronounced, and persistent, impact on their financial health after receiving a loan than did their larger peer organizations.

By assessing the financial health of a business before allocating funds, those funds can be better and more efficiently allocated in the future. Smaller, more vulnerable businesses in good health, when excluding macroeconomic factors, stand to benefit most from outside support, and should be targeted explicitly.

That’s according to a newly published research paper from the Federal Reserve Bank of Boston, which looked at the effect of PPP loans across nearly 25 million business.

The report revealed how federal assistance affected business health over the short and medium term, while studying what overall implications the billions of dollars in taxpayer-funded allocations hold for shaping future federal support on Main Street.

Only small businesses with 500 or fewer employees were eligible for the COVID-era PPP program, and maximum loan amounts were 2.5 times the company’s average monthly payroll costs, capped at $10 million.

Banks across the nation were made responsible for approving the loans and allocating the money, which did not affect banks’ own capital requirements as the funds were fully guaranteed by the government.

The paper, published last week (Dec. 23) by Boston Fed economists Gustavo Joaquim and J. Christina Wang, builds on the findings of two previous studies by Joaquim titled, “Bank Incentives and the Effect of the Paycheck Protection Program,” and “Optimal Allocation of Relief Funds: The Case of the Paycheck Protection Program,” respectively.

The Boston Fed’s earlier research found that while PPP loans reduced job losses at eligible firms by 12.9 percentage points, or roughly 7.5 million jobs at an estimated average cost of $70,000 per job, they were not as effectively allocated as they could have been, and more governmental targeting of smaller businesses would have significantly increased the program’s positive results.

The PPP disbursed $800 billion in two separate rounds. The first round, which ran from April 3 through Aug. 8, 2020, allocated $525 billion across more than 5 million loans.

Because of the longer timeline its subsequent affects could be studied over, the first initial phase was the focus of the Boston Fed’s latest research.

Businesses that received loans in the later months of the first PPP phase exhibited greater improvement in their financial condition compared with earlier recipients.

The more creditworthy a business was, the earlier and more likely it was to receive a PPP loan the research found, even when compared to similar peers.

While the research did not establish a causal relationship between being creditworthy and having banks extend PPP credit, it can be inferred that creditworthy businesses were likely operating with more internal controls and oversights than less creditworthy peers, which in turn alerted them first to the advantages of applying for and receiving PPP loans.

Implications of the Boston Fed’s research show how the financial health of a business prior to government assistance is a significant factor in both its selection for allocation and the later, positive effects of that capital injection.

Avoiding Future Red Flags

Critics of the program allege that the funds distributed through the PPP initiative were shared unevenly and disproportionately benefited a tiny fraction of the companies in need.

A congressional report published earlier this month has separately blamed FinTech companies for causing tens of billions of dollars in losses due to their inadvertent enablement of widespread fraud, giving taxpayer-funded loans to companies that included fake farms, among other instances.

PYMNTS previously reported that one of the main reasons traditional banks didn’t take on new PPP business at a larger scale was because their due diligence and internal fraud prevention controls preempted the possibility. This left the door open for FinTechs to disburse the PPP allocations to businesses.

As policymakers move forward, being able to pinpoint the extent to which the PPP loans were mere transfers from taxpayers to small businesses, versus the way they successfully helped maintain job stability and economic viability for those firms and their employees, will be crucial to future considerations around deploying government-led assistance to businesses.