On April 30, 2020, the Federal Reserve released updated details of the Main Street Lending Program (the “Program”) in response to substantial input from market participants, industry groups and other stakeholders on the initial terms of the Program, which the Federal Reserve had announced on April 9. The updated terms are described in a Locke Lord QuickStudy, available at this link. While the Federal Reserve’s updated terms are responsive to many of the issues raised by the commentary on the initial terms, the updated terms still leave many unanswered questions and unsolved problems. This alert outlines key issues that may hinder the Program’s ability to effectively fulfill its goal of facilitating access to credit for small and medium-sized business in the midst of the economic dislocations related to the COVID-19 pandemic.
Scope of Eligible Borrowers
The increase in the maximize size of businesses eligible to participate, from 10,000 or fewer employees or $2.5 billion or less in 2019 revenues to 15,000 or fewer employees or $5 billion or less in 2019 revenues, and the reduction in the minimum loan size under the Main Street New Loan Facility (the “MSNLF”) and Main Street Priority Loan Facility (“MSPLF”) from $1 million to $500,000, provide the appearance of expanding access to the Program for a wider range of companies. However, the application of SBA affiliation rules, which require a business to aggregate its employees and revenues with those of its affiliates for purposes of determining eligibility, will preclude certain companies, including many private equity and venture capital-backed businesses, from accessing the Program. Moreover, the omission of exceptions from the affiliation rules for SBIC-funded businesses and certain franchises and business in the restaurant and hospitality sector – exceptions which made the Paycheck Protection Program accessible to certain businesses – will further narrow the availability of the Program for certain potential participants.
Scope of Eligible Lenders
The Federal Reserve has expanded the types of lenders eligible to provide Main Street loans (“Eligible Lenders”) to include U.S. branches and agencies of foreign banks and U.S. intermediate holding companies of foreign banking organizations. Eligible Lenders do not, however, include non-bank financial institutions such as direct lenders and private debt funds, which provide a significant portion of existing credit facilities to small and medium-sized U.S. companies. Federal Reserve guidance has clarified that, for purposes of the Main Street Expanded Loan Facility (the “MSELF”), an Eligible Lender may provide an MSELF loan as an upsized tranche of an existing multi-lender credit facility which includes lenders that are not Eligible Lenders, but that flexibility only applies to the extent the Eligible Lender was an existing lender under the credit facility at the time the MSELF loan is made. This restriction, and the exclusion of direct lenders and private debt funds, raises substantial practical problems for any company with existing credit facilities that are provided exclusively by direct lenders and/or private debt funds. The restriction would preclude such a company from borrowing under the MSELF, as it would be unable to add a new lender that is an Eligible Lender to its existing facility to provide an MSELF. Instead, such a company would need to look beyond its existing lending relationships to access the Program using the MSNLF or the MSPLF.
Narrow Prescribed Terms for Main Street Loans
One significant criticism with respect to the initial terms provided for the Program was that the proposed structure of Main Street loans would require that most companies obtain amendments or waivers under their existing debt agreements to accommodate the proposed tenor, structure, interest and principal payment and other terms of the facilities. For instance, given that the terms of many credit facilities require new debt to mature outside the maturity of the existing debt and have a weighted average life to maturity that is longer than that of the existing debt, the required 4 year tenor and amortization schedules for the Main Street loans will likely require many borrowers to obtain amendments or waivers under their existing facilities. Critics suggested that changes to afford lenders and borrowers flexibility to negotiate structures and interest and amortization terms that made sense for an individual borrower and fit within such borrower’s existing debt structure would better facilitate the Federal Reserve’s goal of providing access to credit for small and medium-sized companies. Although the updated terms of the Program clarify that lenders must apply their own underwriting standards in evaluating a borrower’s financial condition and creditworthiness, the terms do not provide flexibility to tailor the basic parameters of the loans, such as tenor, interest rate, amortization schedule and certain structural elements, to the circumstances of individual borrowers.
Leverage Test Issues
The Federal Reserve’s use of an Adjusted EBITDA metric as a basis for the cap on the size of eligible loans and a leverage test for borrowers, relying on a lender’s methodology previously used for a particular borrower or similarly situated borrowers, will likely enable access to the Program for many potential participants for which the previously-proposed, narrowly defined EBITDA metric would have precluded participation. However, the updated terms do not appear to permit an alternative creditworthiness metric for early growth stage companies, which may have negative adjusted EBITDA and be unable to satisfy the required leverage test. In addition, the measure of “debt” for purposes of the leverage calculations continues to include most undrawn commitments, an atypical method for calculating a leverage test, and one which will inflate leverage for most companies, thereby prohibiting many from accessing the Program. In addition, the Program’s terms do not permit the netting of unrestricted cash in the leverage calculation, a term that has become prevalent in recent years throughout the middle market. Finally, while the addition of the MSPLF may provide an option for companies that seek to borrow smaller amounts but that would not have met the required 4 times pro forma leverage ratio for the MSNLF, it is likely in certain industries that, even with the Federal Reserve’s adjustments to the terms, the proposed leverage tests of 4 times for the MSNLF and 6 times for each of the MSPLF and the MSELF will be too restrictive for many otherwise eligible borrowers. Allowing lenders to use their credit judgment to apply tests consistent with a borrower’s existing debt agreements or market standard for the borrower’s industry would make the Program available to a broader set of companies.
Restrictions on Prepayments of Other Debt
The Program restricts borrowers from voluntarily prepaying other existing debt during the term of a Main Street loan. The Federal Reserve has clarified that this restriction would not prohibit a borrower from refinancing maturing debt, but it is not clear how far in advance of a loan’s maturity date such a refinancing transaction would be permissible. This restriction will complicate a borrower’s task of managing its balance sheet in an efficient manner as it seeks to replace more expensive existing debt.
Restrictions on Payment of Dividends and Share Repurchases
The Federal Reserve has clarified that the restrictions on dividends and capital distributions that apply during the term of a Main Street loan and the period of 12 months following its repayment will not restrict S corporations or other tax pass-through entities from making distributions to the extent reasonably required to cover their owners’ tax obligations in respect of the entity’s earnings. This exception will help a large number of businesses, but it is narrow and may not allow other types of required dividends such as REIT distributions, distributions that are incidental to the structure of a transaction such as an acquisition or a sale, or distributions to fund customary ordinary course operating expenses of an entity’s direct or indirect parent. In addition, the restriction on share repurchases by a borrower during the term of a Main Street loan and the period of 12 months following its repayment may have implications on a borrower’s ability to retire convertible debt during that time period, depending upon the treatment of convertible debt for purposes of the restriction. Finally, the restrictions on dividends and share repurchases, as well as the corresponding restrictions on executive compensation, are not currently structured to terminate upon a repayment in full of a Main Street loan due to a change of control transaction. The continued application of these restrictions to a business following a change of control transaction may make a Main Street loan borrower less attractive to a prospective acquirer and have a chilling effect on acquisition activity involving Program participants.
Locke Lord team members are closely following further developments with respect to the Program and expect to publish additional guidance as further information from the Federal Reserve and/or the Department of the Treasury, including a proposed start date for the Program, becomes available.
Your regular Locke Lord contact and the authors of this article would be happy to help you navigate the CARES Act and associated guidance as they relate to or otherwise affect small and mid-sized businesses and their lenders.
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