Federal Reserve Announces Changes to Main Street Lending Program

Yesterday, April 30, 2020, the Board of Governors of the Federal Reserve System announced important changes to the Main Street Lending Program (the “Program”) that it had introduced on April 9, 2020. The changes reflect further information and clarification with respect to the terms and conditions of the Program and address, at least in part, feedback that the Federal Reserve received in response to the term sheets for the Program released on April 9, 2020. The changes include the creation of a new facility, the Main Street Priority Loan Facility, which would support loans to more leveraged borrowers while requiring lenders to retain a greater portion of credit risk. We have prepared blacklines reflecting the changes made to the two term sheets previously issued on April 9 (linked here for the Main Street New Loan Facility and Main Street Expanded Loan Facility). In addition to updated term sheets for the facilities, the Federal Reserve published a lengthy set of frequently asked questions that provide clarity and detail on a range of important topics. While yesterday’s announcement contains considerably more detail about the Program, many questions remain. The Federal Reserve has not provided a launch date for the Program.

Overview of the Program

The overall economics of the Program remain the same: as described in our previous client alert, the U.S. Treasury Department will make a $75 billion capital investment into a special purpose vehicle (“SPV”) that will be used to support small and medium-sized businesses by purchasing up to $600 billion of participations in eligible loans made by eligible lenders to eligible borrowers (each as defined below), with eligible lenders retaining the remaining portion of each such loan. Although the Federal Reserve suggested an allocation of the $600 billion between the two facilities unveiled on April 9, there appears to be no specific allocation among the now-three facilities. The Federal Reserve Bank of Boston will administer the Program.

The three lending facilities are:

• The Main Street New Loan Facility (the “MSNLF”), which was previously announced on April 9, will purchase 95 percent participations in qualifying new loans originated after April 24, 2020.
• The Main Street Priority Loan Facility (the “MSPLF”), which was announced for the first time yesterday, will purchase 85 percent participations in a broader range of qualifying new loans originated after April 24, 2020.

• The Main Street Expanded Loan Facility (the “MSELF”), which was previously announced on April 9, will purchase 95 percent participations in new upsized tranches of existing, outstanding loans or revolving credit facilities – specifically, the upsized tranche of qualifying loan increases that are granted on or after April 24, 2020.

All three facilities will cease purchasing participations on September 30, 2020, unless the programs are extended by the Federal Reserve and the Treasury Department.

The three facilities have many elements in common, and the term sheets released by the Federal Reserve yesterday preserve many of the components of those announced on April 9.

Eligible Lenders 

Criteria

For all three facilities, eligible lenders include U.S. federally insured depository institutions and U.S. bank holding companies and savings and loan holding companies, as described in the April 9 term sheets. The updated term sheets now also include, as eligible lenders, U.S. branches and agencies of foreign banks, U.S. intermediate holding companies of foreign banking organizations, and U.S. subsidiaries of any entity otherwise eligible to act as lender under the facilities.

Lender Risk Retention

Eligible lenders must retain at least a 5 percent participation in any eligible loan under the MSNLF and the MSELF. A significantly higher 15 percent participation is required under the MSPLF. As provided for in the April 9 term sheets, the SPV and an eligible lender will share risk in the eligible loan on a pari passu basis. The updated term sheets clarify that an eligible lender must retain its share of the eligible loan (or upsized tranche) until it matures (in the MSELF, the maturity is that of either the underlying loan or the upsized tranche) or the SPV sells all of its participation, whichever comes first. The sale of a participation in the eligible loan to the SPV will be structured as a “true sale” and must be completed expeditiously after the eligible loan’s origination.

Origination and Servicing Fees Paid to Lenders

Eligible lenders will be paid an origination fee by the borrower in an amount equal to 100 basis points of the eligible loan principal amount at the time of origination from the eligible borrower under the MSNLF and MSPLF. The MSELF origination fee is up to 75 basis points of the upsized tranche at the time of upsizing, which reflects a reduction from the 100 basis point fee provided for under the April 9 term sheet.

The annual servicing fee paid to the lender by the SPV is an amount equal to 25 basis points of the principal amount of its participation in the eligible loan (or, for the MSELF, 25 basis points of the principal amount of its participation in the upsized tranche of the eligible loan).

Transaction Fees Paid by Lenders

Eligible lenders will pay a transaction fee (formerly referred to as a “facility fee”) in the amount of 100 basis points of the eligible loan principal amount that is purchased by the SPV under the MSNLF and the MSPLF; this amount is consistent with the April 9 term sheets. The updated term sheets also impose a transaction fee for MSELF participations of 75 basis points; the April 9 term sheets contained no such requirement. An eligible lender may pass this fee on to the eligible borrower; the updated term sheets do not expressly address whether the eligible borrower may pay the fee out of the proceeds of the eligible loan.

Eligible Borrowers 

U.S. Nexus, Employees and Revenue

For all facilities, eligible borrowers must be businesses created or organized in the United States with significant operations in and a majority of employees based in the United States, consistent with the April 9 term sheets.

Eligible borrowers must also have either (i) not more than 15,000 employees or (ii) not more than $5 billion in 2019 annual revenues. These ceilings are a substantial increase from the thresholds in the April 9 term sheets, which were 10,000 employees and $2.5 billion, respectively. In a highly impactful change, the updated term sheets also introduce new affiliation principles that apply for purposes of counting both employees and revenues. A prospective borrower must now aggregate these numbers with those of its affiliates, using the same rules that the Small Business Administration (“SBA”) uses for its section 7(a) loans as specified in 13 C.F.R. § 301(f). These SBA rules, which are different from the “control” principles typically employed by the Federal Reserve under the Bank Holding Company Act, are broad, complex, and require significant interpretation in application, and will significantly reduce the number of eligible borrowers under the Program relative to the April 9 term sheets.

Interaction with Other Forms of CARES Act Financial Assistance

Consistent with the April 9 term sheets, eligible borrowers that have taken advantage of the Paycheck Protection Program may also participate in one of the facilities, but may not (i) participate in the Federal Reserve’s previously announced Primary Market Corporate Credit Facility (which purchases qualifying bonds as sole investor, or purchases portions of syndicated loans or bonds at issuance from investment-grade U.S. corporate debt issuers) or (ii) participate in more than one of the three facilities in the Program. On their face, these restrictions apply only to the borrower, but not to affiliates of the borrower.

The updated term sheets also impose a new requirement that prohibits any borrower that has “specific support” under section 4003(b)(1)-(3) of the CARES Act (which provides for direct U.S. Treasury loans to certain air carrier, national defense, and related companies) from participating in the Program. On its face, this restriction applies only to the borrower, but not to affiliates of the borrower.

Other Eligibility Criteria

The updated term sheets also introduce three new eligibility criteria applicable to borrowers:

• An eligible borrower must be a “Business” as defined under the updated term sheets, which includes partnerships, corporations and a range of other corporate forms, as well as joint ventures “with no more than 49 percent participation by foreign business entities.”  Non-profit organizations are not eligible to participate in the Program, but the FAQs state that the Federal Reserve and Treasury Department are evaluating how to adjust eligibility criteria to include these borrowers as well.
• An eligible borrower must not be an “ineligible business” as defined in certain provisions of an SBA regulation at 13 C.F.R. § 120.110 and modified in regulations implementing the Paycheck Protection Program, which include financial businesses, speculative businesses, and certain related parties of the lender.

• If the lender had one or more other loans outstanding to the eligible borrower on December 31, 2019, those loans must have had an internal risk rating on that date that was equivalent to a “pass” in the Federal Financial Institutions Examination Council’s supervisory rating system.

Finally, while the EBITDA-based requirements do not accommodate asset-based borrowers, the Federal Reserve and Treasury Department are evaluating how to adjust eligibility criteria to include these borrowers in the Program.

Eligible Loans and Loan Terms 

Eligible loans under all facilities will have similar, but not identical, terms, many of which have been revised relative to the April 9 term sheets.

Term and Prepayment

Under all three facilities, eligible loans have a term of four years and may be prepaid without penalty, consistent with the April 9 term sheets.

Rate

In a significant change, eligible loans under all three facilities will have an adjustable interest rate equal to LIBOR plus 300 basis points, which is different in both form and amount than the amount specified in the April 9 term sheets (i.e., the Secured Overnight Financing Rate plus 250 to 400 basis points). This change removes any lender discretion in pricing a loan, which could affect the underwriting process.

Amortization

Consistent with the April 9 term sheets, amortization of principal and interest will be deferred for one year. However, the updated term sheets provide greater detail regarding amortization thereafter. MSNLF loans will amortize on a straight-line basis in the second, third, and fourth years, while the MSELF and MSPLF amortization schedule provides for (i) payment of 15 percent of the principal amount in the second and third years and (ii) a 70 percent balloon payment in the final year.

Minimum Loan Amounts

• Under the MSNLF, the minimum loan amount is now $500,000, down from $1 million.
• Under the MSPLF, the minimum loan amount is also $500,000.

• Under the MSELF, the minimum loan amount is now $10 million, significantly higher than the $1 million minimum amount described in the April 9 term sheets.

Maximum Loan Amounts

• Under the MSNLF, the maximum loan amount is the lesser of (i) $25 million or (ii) an amount that, when added to the eligible borrower’s existing outstanding and undrawn available debt, does not exceed four times the eligible borrower’s 2019 adjusted EBITDA. With the exception of the new reference to adjusted EBITDA, this is consistent with the April 9 term sheets.
• Under the MSPLF, the maximum loan amount is the lesser of (i) $25 million or (ii) an amount that, when added to the eligible borrower’s existing outstanding and undrawn available debt, does not exceed six times the eligible borrower’s 2019 adjusted EBITDA.
• Under the MSELF, the maximum loan amount is the lesser of (i) $200 million (up from $150 million), (ii) 35 percent (up from 30 percent) of the eligible borrower’s existing outstanding and undrawn available debt, or (iii) an amount that, when added to the eligible borrower’s existing outstanding and undrawn available debt, does not exceed six times the eligible borrower’s 2019 adjusted EBITDA.
• The FAQs clarify that maximum loan amounts are calculated based on adjusted 2019 EBITDA. For the MSNLF and MSPLF, an eligible lender must use a methodology for calculating an eligible borrower’s adjusted EBITDA that it used when extending credit to the borrower or similarly situated borrowers on or before April 24, 2020. For the MSELF, an eligible lender must use the methodology previously used when originating or amending the underlying loan on or before April 24, 2020.

• Under all three facilities, total debt calculations appear to continue to be gross measures, not net of cash.

Seniority

The term sheets for the three facilities now contain seniority requirements for eligible loans, which vary by facility; the April 9 term sheets were silent on seniority. In the MSNLF, an eligible loan must not be, at the time of origination and at any time during the term of the loan, contractually subordinated in terms of priority to any of the eligible borrower’s other loans or debt instruments. The MSPLF and the MSELF are a little more forgiving: an eligible loan or upsized tranche must, at the time of origination and at all times the loan or upsized tranche is outstanding, be senior to or pari passu with, in terms of priority and security, the eligible borrower’s other loans or debt instruments, other than mortgage debt.

Security and Remaining Maturity

The updated term sheets clarify that a loan under the MSNLF or MSPLF may be either secured or unsecured; the April 9 term sheets only referred to unsecured loans.

The updated term sheets also clarify that whether and to what extent an upsized tranche of an existing loan under the MSELF is secured will depend on the terms of the existing loan. The updated term sheet also now specifies that to be eligible for the MSELF, the existing loan that is being upsized must have a remaining maturity of at least 18 months (taking into account any adjustments made to the maturity of the loan after April 24, 2020, including at the time of upsizing).

Lender Underwriting

Lenders are now expected to conduct an assessment of each potential borrower’s financial condition at the time of the potential borrower’s application; although such an assessment is inherent in the underwriting process, this expectation was not stated in the April 9 term sheets.

Certifications and Covenants

Eligible lenders and eligible borrowers must make numerous certifications and commitments to participate in any of the facilities.

Lender Certifications and Commitments

In order to participate in any of the facilities, an eligible lender must commit that it:

1. Will not use eligible loan proceeds to repay debt extended by the eligible lender to the eligible borrower or to pay interest on such obligations until the loan or upsized tranche is repaid in full, unless payments are mandatory and due or in the case of default and acceleration; and
2. Will not cancel or reduce any existing lines of credit to the eligible borrower, and the eligible borrower may not seek such cancellation or reduction.

For all three facilities, an eligible lender also must certify that its methodology for calculating an eligible borrower’s adjusted EBITDA is consistent with the methodology described above under “Maximum Loan Amounts.”

Borrower Certifications and Commitments

In order to participate in any of the facilities, an eligible borrower must commit that it:

1. Will refrain from repaying the principal balance of or paying interest on any debt until the eligible loan is repaid in full, consistent with the April 9 term sheets. However, the updated term sheets make clear that a borrower may make debt or interest payments that are “mandatory and due.” Additionally, the term sheet to the MSPLF (but not the other two facilities) states that “an Eligible Borrower may, at the time of origination of the Eligible Loan, refinance existing debt owed by the Eligible Borrower to a lender that is not the Eligible Lender.”   
2. Will not seek the cancellation or reduction of any existing lines of credit with the eligible lender or any other lender.
3. Will follow compensation, stock repurchase, and capital distribution restrictions that apply to direct loan programs under the CARES Act. (Under the relevant CARES Act provision, these restrictions remain in place for 12 months after a loan is no longer outstanding.)  The updated term sheets clarify that an S corporation or other tax pass-through entity may nonetheless make distributions to the extent reasonably required to cover its owners’ tax obligations in respect of the entity’s earnings.

In a change from the April 9 term sheets, an eligible borrower must also now certify that it has a reasonable basis to believe that, as of the date of origination of the eligible loan and after giving effect to such loan, it has the ability to meet its financial obligations for at least the next 90 days and does not expect to file for bankruptcy during that time period.

The term sheets released on April 9 also required two attestations from a borrower that (i) participation in a facility was required by the exigent circumstances of the COVID-19 pandemic and (ii) it would make commercially reasonable efforts to maintain its payroll and retain its employees during the time the eligible loan is outstanding. These elements have been revised in the updated term sheets and FAQs:

• In a change from the April 9 term sheets, neither condition is a required attestation.
• The condition that a borrower use commercially reasonable efforts to retain its work force is now a formal requirement. The FAQs note that “commercially reasonable efforts” to retain employees during the term of the loan means that the borrower “should undertake good-faith efforts to maintain payroll and retain employees, in light of its capacities, the economic environment, its available resources, and the business need for labor. Borrowers that have already laid-off or furloughed workers as a result of the disruptions from COVID-19 are eligible to apply for Main Street loans.”

• The updated term sheets are now silent on exigent circumstances.

Finally, both the eligible borrower and eligible lender must also certify that the eligible borrower is eligible to participate in the facility, including in light of section 4019 of the CARES Act, which prohibits participation by “covered entities” that are controlled by the President, Vice President, a Member of Congress, or a related individual.

Lender Obligations with Respect to Borrower Certifications

The updated term sheets now clarify that “[a]n Eligible Lender is expected to collect the required certifications and covenants from each Eligible Borrower at the time of upsizing of the Eligible Loan,” but “may rely on an Eligible Borrower’s certifications and covenants, as well as any subsequent self-reporting by the Eligible Borrower.”

Regulatory Capital Treatment

The FAQs specifically address the regulatory capital treatment of loans made under the facility, as follows:

• The interest in the portion of a Main Street loan that is retained by an Eligible Lender should be assigned the risk weight applicable to the counterparty for the loan (e.g., a 100 percent risk weight for a corporate exposure under the standardized approach).
• For purposes of risk-based capital rules and leverage rules, the exposure amount is the amount of the loan retained by the lender (i.e., 15 percent of the outstanding MSPLF loan balance for MSPLF loans, and 5 percent of the MSNLF loan balance or MSELF upsized tranche balance for MSNLF Loans and MSELF upsized tranches, respectively).

• Secured Main Street loans are eligible for the credit risk mitigation treatment in the standardized approach provided that any collateral securing the loan is eligible financial collateral. Eligible lenders are not permitted to recognize collateral attributable to the Main Street SPV’s interest for purposes of the credit risk mitigation treatment under the capital rule.

Public Disclosure of Information Regarding the Facilities

The FAQs identify what information the Federal Reserve will disclose regarding the three facilities, as follows:

• The Federal Reserve will disclose information regarding the MSNLF, MSPLF, and MSELF during the operation of the facilities, including information regarding names of lenders and borrowers, amounts borrowed and interest rates charged, and overall costs, revenues, and other fees. An April 23, 2020, press release from the Federal Reserve indicates that it will report this information on a monthly basis.
• Balance sheet items related to the MSNLF, MSPLF and MSELF will be reported weekly, on an aggregated basis, on the Federal Reserve’s H.4.1 statistical release, and the Federal Reserve will disclose to Congress information pursuant to Section 13(3) of the Federal Reserve Act and the Federal Reserve Board’s Regulation A.

• Under section 11(s) of the Federal Reserve Act, the Federal Reserve also will disclose information concerning the facilities one year after the effective date of the termination by the Federal Reserve Board of the authorization of the facilities. Importantly, disclosure under section 11(s) includes names and identifying details of each participant in the facilities, the amount borrowed, the interest rate or discount paid, and information concerning the types and amounts of collateral pledged or assets transferred in connection with participation in the facilities.

Covington & Burling LLP’s Financial Services attorneys have deep experience guiding U.S. and non-U.S. financial institutions through the most challenging circumstances, including the 2008–09 financial crisis. Our team, which includes former senior federal regulators, stands ready to advise financial institutions as they navigate the impact of COVID-19 on the economy and the financial markets.