June 26, 2020

Video: Main Street Lending Unpacked


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In this video, Partner Bruce Klein discusses the latest in financial support for businesses during the COVID-19 crisis, the Main Street Lending Program.

Watch here, or continue for the full transcript.

BRUCE KLEIN: Hello. We’re here today to talk about Main Street Lending.

Main Street Lending is one of the government’s programs to help businesses survive during the COVID-19 slowdown. It is not as well known as PPP, the Paycheck Protection Program, which has gotten a lot of press over the last few months, but it is rolling out in the next few days. And it is going be an important source of funding for many businesses.

It’s really a novel program. The Federal Reserve is going to be lending directly to businesses through banks. And that has never been done before, even in the 2008 financial crisis. So this is charting totally new territory.

Now, what is the Main Street Lending program? Again, it’s intended to assist small but also medium-sized and relatively large businesses who are not having financial trouble but just need some extra cash to get them through the pandemic and the slow down. Any bank can lend – U.S. bank, or a foreign branch, or even the U.S. branch of a foreign bank. And it has a wide range of borrowers.

So, if you have less than 15,000 employees or your revenues were less than $5 billion, you’re eligible to borrow under this program. And the loans are all the way from $250,000 at the low end, up to $300 million at the high end. So really, a large group of borrowers can benefit from this program.

Now, there’s three types of loans that have been created under Main Street. One is called the New Loan Facility, the Priority, and the Extended. And they’re similar but with some important differences.

The New Loan Facility and the Priority Loan Facility are basically similar except Priority Loan Facility is eligible to be given to borrowers who have greater debt. Under the New Loan Facility, if your existing debt is four-times your earnings, four-times EBITDA, that’s the maximum allowed to get a loan under the New Loan Facility. But under Priority, it goes up to six-times EBITDA.

And the more interesting feature is that the Priority Loan Facility can be used to refinance an existing loan. So for instance, let’s say you have a high-interest loan with one bank, you can’t refinance it under the New Loan Facility. But under the Priority Loan Facility – for example, if you’re currently with Wells Fargo at 7 percent, you can go to you know Bank of Main Street and say, “I want a Priority Loan Facility.” You can get it at LIBOR or plus 3 percent. Use the money to pay your Wells Fargo loan and you’ve all of a sudden cut your monthly principal and interest payment.

And speaking of payment, there actually is no principal repayment needed in the first two years for any of these loans. So you’re paying interest only. After the two years, the three later years, you’re paying off the loan at 15 percent per year until year five, where there’s a balloon payment of 70 percent. So you would need to refinance at that point. But the idea is the economy will be better by then and it will be easier to refinance.

So in terms of the difference between New and Priority, the thing to remember is Priority can be used to refinance debt and it can be used for borrowers who have more debt on their balance sheet right now.

The Expanded Loan Facility is sort of what it sounds like; it is if you have an existing loan or line of credit and you want to upsize it, make it a larger amount, draw a larger revolving line of credit, for example, you use the Expanded Loan Facility, which has the same generous terms as the first two.

Now, banks are going to be originating these loans but the Fed is going purchase 95 percent of them. So really, a bank is only keeping 5 percent just to have some skin in the game. But really the government’s taking 95 percent of the risk, and that is meant to make it attractive for lenders to go into this.

So how is it going to work? You could see in the diagram basically the relationship is between a borrower and a lender, just like a regular loan. The borrower is going to make an application; they’re going to enter into a loan agreement. The borrower is going to certify that they need this money, that they’re going to try to retain their workers, etc. And they’re going to send those certifications to the lender.

The lender is going to follow their standard process. They don’t have to make the loan; they’ll underwrite it. They will look at the financials. They will make a credit decision. They will close it and fund it. And at that point, they’ll sell 95 percent of it to the Fed.

Now, the Fed doesn’t want to be in the business of collecting payments and servicing, so the bank’s going to do that on behalf of the Fed. And they are required to send annually a healthy, very robust set of financial reports to the Fed that they’re going to get from the borrower.

So really all of the work is happening at the bank side. The Fed is sort of a silent partner, taking most of the risk, getting some reporting. But really, you don’t notice the Fed in this scenario. This all changes, though, if there is a default.

Now, you could imagine – the feds, the junior partner, but they have taken 95 percent of the risk. They’re junior in the sense that they’re not really involved in the loan, but if there’s a problem, they want to have a voice. So they’ve built in this mechanism that in the case of default, lets them elevate their position from a mere participant, which is sort of a backseat junior position. And once a default happens, they become a co-lender, equal in power to the bank. And not only equal, but because they are a 95 percent holder, if there’s something to vote on or a decision to be made about restructuring, they actually have the majority of the power due to their size of their position.

So in a default domain, the Federal Reserve now becomes the main player and the banks, the junior player. The problem is, or the interesting scenario, is going to be what if they don’t agree on what to do? You can think of two scenarios. What if there is a borrower with very little public sympathy, and maybe it’s a private equity firm that goes into default. Now, the lender says, “Hey, we can restructure this debt. Let’s work with them.” Maybe the Fed will say, “Hey, I don’t want to work with them. Why should we bail out a private equity firm?”

Now, the SPV says in there, the Federal Reserve in their Frequently Asked Questions, says they’re not going to be influenced by factors outside of economic ones, which means they’re not supposed to play politics. But you know, in the end result we’ve seen in the PPP, politics always comes into play. So there could be a difference of opinion between the bank and the lender on that front.

And then there’s a second scenario where maybe the Fed wants to restructure the debt because it’s a company that is politically sensitive, maybe it’s somebody who provides manufactured housing to poor communities, so they don’t want to default on that borrower. But the lender says, “Hey, this is not a good creditor anymore. I want it to fall and take the collateral.” So you could see scenarios where their interests are not aligned. And it’s going to be very interesting to see what happens.

Again, this type of lending has never occurred before. We’re really in new unchartered territory. And the program is going to roll out in the next week or so. And you know, these things will play out over the next two to five years and we’ll have to watch and see how they go.

But if you’re a Main Street lender, just know that you’re going to be joined at the hip with the federal government, and that’s a commitment that you have to just go in eyes wide open and know that situations may arise in the future where having the government as your partner just leads to some sticky situations.

We may come back and do a follow up on this, but that is Main Street Lending Unpacked for now.