The April 30 changes to the Federal Reserve’s Main Street Lending Program (MSLP) broaden the Federal Reserve’s backstop for loans to small and medium-sized enterprises (SME), but also impose new non-credit-related restrictions on borrower eligibility. While these program changes may facilitate the provision of bridge loans to some businesses, the MSLP continues to be challenged by its structure (the intermediation role of private banks and credit unions) and by the increasing politicization of the government’s COVID-19 recovery programs.
The MSLP now consists of three separate credit facilities, which collectively will lend up to $600 billion to SMEs using $75 billion from the Treasury Department’s Exchange Stabilization Fund (appropriated under the CARES Act) as collateral. A newly created facility, the Main Street Priority Loan Facility, will complement the pre-existing Main Street New Loan Facility to make four-year secured or unsecured loans between $500,000 and $25 million at 300 bps over LIBOR to borrowers whose debt-to-EBITDA ratio, net of the Main Street loan, does not exceed 6:1. Terms of these programs vary slightly, such as the amortization schedule and the required risk retention by originating lenders. The Main Street Expanded Loan Facility, originally announced on April 9, will now provide credit support to upsized tranches of revolvers as well as term loans (previously only term loans qualified) in principal amounts between $10 million and $200 million. In all facilities, the Federal Reserve will permit the use of “adjusted” EBITDA, defined by reference to pre-existing contractually defined EBITDA or, for borrowers without term loans, what a typical EBITDA definition would be for “similarly situated” borrowers.
While the MSLP’s credit terms may have expanded, newly announced eligibility rules that have nothing to do with credit quality restrict which borrowers qualify for the MSLP. For all three credit facilities, a borrower must have either fewer than 15,000 employees or less than $5 billion in 2019 revenue. New in the April 30 announcement (FAQs) is the requirement that these conditions be measured using the Small Business Administration’s “affiliation” rules, see 13 C.F.R. § 121.106, which were also used in the administration of the CARES Act’s Paycheck Protection Program (PPP). Moreover, a business does not qualify for a MSLP loan if it would be ineligible for a SBA 7(a) loan, see 13 C.F.R. § 120.110, except that, per footnotes in the MSLP term sheets, changes to these eligibility rules announced in connection with the PPP through FAQs or interim final rules are honored in the MSLP (e.g., for religiously affiliated borrowers, small businesses with legal gambling revenue, etc.). For many businesses, including standalone operating subsidiaries of holding companies and those with private equity investment, the effect of these non-credit-related eligibility rules is to render businesses ineligible for any government-backed loan (PPP and Main Street loans) to help them through the crisis.
A borrower that is both eligible and has room in its capital structure for a Main Street loan is not guaranteed help by the MSLP. Each of the three credit facilities requires a bank or credit union to originate the loan; an eligible borrower must therefore meet the specific underwriting criteria of its lender, which may be more scrupulous than the Federal Reserve's MSLP conditions. One challenge will be how to address a simmering reputational conundrum for lenders, some of which already have received intense scrutiny for their administration of PPP loans. On the one hand, if lenders’ prudent underwriting guidelines result in the origination of relatively few Main Street loans, rhetoric about the “ineffectiveness” of the MSLP may involve questions about why lenders are not doing more to “help” Main Street borrowers. On the other hand, if lenders originate a high volume of loans and a fair number of them default, there will be intense scrutiny by inspectors general and congressional committees of whether lenders’ underwriting guidelines were up to par (note that lenders receive a fee for originating Main Street loans, regardless of whether the loans perform). Some lenders may also experience issues with regulatory capital requirements. The use of private banks and credit unions as the delivery model for the MSLP may be the optimal construct (neither the Treasury nor the Federal Reserve is set up to make thousands of business loans directly), but it presents a unique set of challenges for institutional lenders already under a fair amount of public and congressional scrutiny, and consequently for putative MSLP borrowers.
The good news is that the Federal Reserve and Treasury can and likely will adjust the MSLP in the weeks ahead to respond to evolving program conditions. The program is very nimble; no further congressional action is needed to make program changes. One dynamic we are watching is whether Treasury elects to move from a “risk off” to a “risk on” position. The Treasury secretary recently stated that the department is not planning to lose any of the CARES Act money in the MSLP and other Federal Reserve lending programs. Lending programs designed to minimize credit loss are by definition more conservative than the programs would be if they were designed to “spend” the $454 billion in CARES Act money in the form of credit loss absorption. If the MSLP and other programs fail to deliver meaningful relief broadly across the country, pressure may mount on Treasury to reconsider its investment strategy.
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