The Federal Reserve's unprecedented Main Street Lending Program (MSLP) is set to kick off any day now. The program is designed to provide financial support to companies that have been hurt by the coronavirus pandemic but were too big to qualify for loans in the Paycheck Protection Program (PPP).
Essentially, the Fed is trying to directly reach middle-market companies -- eligible borrowers in the program are businesses that have 15,000 employees or fewer, or that earn annual revenue of $5 billion or less. Eligible borrowers will be able to obtain four-year loans ranging from $500,000 to $200 million -- far larger than PPP loans, which did not exceed $10 million. The program is set to run until Sept. 30 and has the ability to fund up to $600 billion in loans, a little bit smaller than the $660 billion collectively authorized for the PPP to date.
Here's how it works
Similar to the PPP, the Fed plans to do the actual lending through the banking system. All U.S. federally insured depository institutions, including banks and credit unions, are eligible to participate. The Fed is currently not allowing non-banks such as fintechs to participate, but said it is "considering options to expand the list of eligible lenders in the future."
The actual issuing of the funds is where things get slightly complicated. A lender such as a bank will issue the loan and then sell the majority of that loan to a special purpose vehicle recently set up by the Federal Reserve. Banks will use their own underwriting standards when processing MSLP loans, but the Fed has set up three separate lending facilities for the three different types of MSLP loans. They are all similar, but each have slightly different requirements:
- Main Street New Loan Facility (MSNLF): Loans range from $500,000 to $25 million. The loan amount cannot be more than four times the borrower's adjusted 2019 earnings before interest, taxes, depreciation, and amortization (EBITDA), when added to borrower's outstanding and undrawn available debt. The lender can sell 95% to the Fed's special purpose vehicle and must retain 5% of the loan.
- Main Street Priority Loan Facility (MSPLF): Loans range from $500,000 to $25 million. The loan amount cannot be more than six times EBITDA when added to borrower's existing outstanding and undrawn available debt. The lender can sell 85% of the loan to the special purpose vehicle and must retain 15%. Lenders of these loans must retain more of the loan than for MSNLF loans because these loans are more leveraged than MSNLF loans and therefore more likely to default.
- Main Street Expanded Loan Facility (MSELF): Loans range from $10 million to $200 million. The loan amount can be either 35% of the borrower's existing outstanding and undrawn available debt, or an amount that is no more than six times the borrower's adjusted 2019 EBITDA when added to existing outstanding and undrawn available debt. The lender can sell 95% of the loan to the special purpose vehicle and must retain 5%. Even though these loans are also six times EBITDA and a lot larger than MSPLF loans, lenders only must retain 5% because of the 35% test that is not part of the MSPLF loan requirements.
Terms of the loan
These loans have very different terms from PPP loans, the biggest being that they are not forgivable. Under the PPP, if borrowers used the funds to cover certain expenses such as payroll, they would not have to repay that portion of the loan. MSLP terms state that borrowers "should make commercially reasonable efforts to maintain its payroll and retain its employees during the time the eligible loan is outstanding." But the terms do not require the loan to be spent on specific expenses and do not say any part of it can be forgiven.
The interest rate is also not as friendly for businesses as that of PPP loans. While chunks of PPP loans could be completely forgiven, banks did actually collect 1% interest on the loans from either the borrower or the Fed. MSLP loans will come with an adjustable rate of the one- or three-month LIBOR plus 3%.
Similar to PPP loans, banks will also be able to collect fees. Lenders can collect up to a 1% origination fee from borrowers on the principal amount of the loan, and another 25 basis points (0.25%) of the principal amount of its participation from the Fed. For example, if a lender issues a $25 million loan, that means it can collect a $250,000 fee from the borrower, and another $3,125 from the Fed ($25 million, times 0.05 for the part of the loan it will have to retain, times 0.25), totaling $253,125 in fees.
Will there be demand?
Unlike the PPP, which had small businesses flooding banks with applications, it is unclear whether there will actually be demand from businesses for the MSLP. Multiple media outlets that have surveyed lenders have reported very little interest, or uncertainty about whether or not customers will use the program, which has been extremely difficult for the Fed to set up.
"We will definitely be involved in the program [and will be] providing those loans," Jim Mack, head of commercial lending at the Michigan-based Independent Bank Corp. (NASDAQ:IBCP), told S&P Global. "But as of yet, we don't have a great feel for where the demand will be." Various executives and consultants told the Minneapolis Star-Tribune that potential problems include the fact that companies must borrow at least $500,000, and that the loans must be repaid in four years.
I am also guessing that many companies have somewhat found their footing after the initial shock to the economy in March. In just a few months, there has been lots of government intervention, including $1,200 stimulus checks and PPP loans; the Fed has done a lot to stabilize markets and many businesses pivoted to find new ways to make money during lockdowns.
One indication that companies may be doing better is the fact that demand for the PPP program has recently slowed. The Census Bureau has polled businesses requesting and seeking assistance from the PPP since March 13. While the number of businesses requesting assistance has remained steady between the last week of April and the week ending May 23, the number of companies receiving PPP loan assistance in that time frame has risen from 38% to 69%.
I am sure that plenty of companies are still struggling right now, but it's likely that we'll have a better idea regarding the effectiveness of MSLP once the intervention from the Fed and government completely runs out, or if there is a second flare-up of coronavirus cases, forcing areas to once again close non-essential businesses or take other stay-at-home measures.