A Surprise Win for the Brazilian Small Business Underdog
Comparing Brazil’s PEAC Program to the U.S. PPP Program
Brazil’s Small Business Aid Gap
Over the past year, governments around the globe have focused on supporting small businesses as a way to sustain their economies and create jobs. The U.S. led this effort with the first Payroll Protection Plan (PPP) which closed in August of this year after distributing $525 billion in forgivable loans. A second relief package will add another $284 billion for a total of $809 billion in forgivable loans for U.S. small businesses.
In Brazil, by contrast, the National Bank for Economic and Social Development (Portuguese: Banco Nacional de Desenvolvimento Econômico e Social, abbreviated: BNDES) ran an Emergency Credit Access Program (Portuguese: Programa Emergencial de Acesso a Crédito, abbreviated: PEAC) which distributed R$91.7 billion (17.4 billion USD).
The U.S. economy is clearly larger than the Brazilian economy, but that difference still does not explain the aid gap. In 2019, the U.S. economy had a $21.43 trillion GDP versus $1.84 trillion for Brazil. In other words, the U.S. economy is 11.6 times larger than Brazil’s economy, but it distributed 47 times more aid for small businesses. On an “apples to apples” basis, the U.S. distributed over 420% more aid for small businesses than Brazil!
Understanding PPP versus PEAC
PPP loans are forgivable and 100% backed by the U.S. government. Calling PPP a “loan” program is a misnomer. It’s not loan, it’s a grant! Most of the PPP “loan” originators that I spoke to in the U.S are not worried about collections, they’re worried about processing an extremely large volume of forgiveness applications. The U.S. Small Business Association (SBA) will forgive PPP grants as long as the funds are used for the appropriate purpose.
[PPP] borrowers may be eligible for loan forgiveness if the funds were used for eligible payroll costs, payments on business mortgage interest payments, rent, or utilities during either the 8- or 24-week period after disbursement.
PEAC, by contrast, is a real loan program. The loans are not forgivable. Banks distributing PEAC loans can receive reimbursement from BNDES for the first 20% of credit defaults, but beyond that level, the issuing bank must carry the losses. This type of partial guarantee enabled Brazilian banks to partially relax their underwriting criteria, but there were no “free rides.” PPP was a grant program that almost any company could qualify for including an unfortunate number of fraudsters. PEAC, on the other hand, is a real loan program for real companies with funds that will need to paid back by borrowers over the next few years.
Which Companies Received The Funding?
The SBA has been extremely transparent about the distribution of PPP Grants, and it seems clear from their data that the grants reached smaller companies that were most in need.
BNDES has not had the same level of transparency with respect to the distribution of PEAC loans. In a public statement in October, BNDES claimed that that funds had been distributed “primarily to micro-, small- and medium-sized enterprises.” My own back of the envelope analysis shows that the PEAC loans skewed towards larger companies that qualified for larger lines than on PPP.
It’s not at all surprising that PEAC loans skew towards larger companies. A 20% guarantee does not provide lenders a great deal of flexibility to experiment. In order avoid deep losses, PEAC loan originators needed to limit their distribution to relatively larger, more established companies.
Surprise Win
If you were brave enough to read this far, you’re probably thinking that the future picture for Brazilian small businesses looks bleak, but I think this cloud has a bright silver lining for Brazilian small businesses.
The bad news about PPP that very few experts have been willing to discuss is that it distorts the critical payment data that lenders rely on for their credit models. I’ve written about this in previous articles, but it’s worth repeating here again. Sudir Jha, senior vice president and head of Brighterion, the artificial intelligence company owned by Mastercard, told PYMNTS:
How up-to-date you are on the payments plays a very big role in the models … and that data may not be very useful.
Jha’s statement makes a lot of sense in a world where “zombie companies” are being held up by PPP grants.
We can see this data distortion very clearly when we analyze U.S. delinquency rates on credit cards which are at an all-time low despite record unemployment and overall GDP contraction.
After all of the dust settles, U.S. lenders will have a very big challenge when they try to return to “business as usual” in a Post-Covid world. How will U.S. lenders discriminate between real COVID survivors and zombie companies that survived on PPP grants? U.S. lenders have a massive data challenge ahead of them. They will not be able to rely on traditional methods for credit decisioning, and I believe that lenders will need to tighten criteria for many quarters until they collect sufficient new data or develop new techniques. Ultimately, these massive data distortions will impede the pace of the U.S. economic recovery.
The story in Brazil is a lot different. There was no “free money.” No grants and no zombie companies. PEAC loans were distributed to real companies that passed a relaxed, but overall standard, bank underwriting process. In 2021, when Brazilian lenders return to “business as usual,” they will be able to rely on their 2020 payment data and traditional underwriting tactics. They will also benefit from new insights and learnings from the partial experiments fueled by PEAC.
Brazil’s aid gap created a big challenge for small businesses in the short term, but I believe that the continuity of lending as usual during COVID via PEAC will enable Brazilian lenders to return to “business as usual” faster and will help to accelerate the Brazilian economic recovery.
Epilogue: What About the Little Guys?
One thing that became clear to me from this analysis is that micro enterprises in Brazil were hit disproportionately hard during COVID. PEAC did not create enough incentives to encourage lending for this segment of this economy, and the lack of a government safety net left many of these companies stranded.
Now, more than ever, small businesses need our help. Over the next few months, I am proud to report that WEEL will be focused on conducting the largest study of small and micro enterprises in Brazilian history to generate new mechanisms to help this segment access credit. If you would like to discuss how you can collaborate in this study, please contact me on LinkedIn.
