Thoughts on the Main Street Lending Program

by Michael Odom

Relying on the CARES Act, the Federal Reserve Board (Fed) established the Main Street Lending Program (MSLP) to facilitate lending to small and medium-sized businesses in order to help maintain operations until conditions normalize. The program provides a relatively low-risk mechanism for banks to stretch beyond their traditional credit boxes and make funds available to borrowers struggling with the effects of the COVID-19 pandemic. And while MSLP is totally different and far more restrictive than its cousin the Paycheck Protection Program (PPP), like the PPP, used appropriately, MSLP may benefit borrowers and lenders alike.

Program Overview

Under the MSLP, a Fed-established special-purpose vehicle (SPV) will purchase a 95% interest in qualifying loans made by participating lenders. MSLP borrowers must have been in sound financial condition prior to the COVID-19 outbreak, and must otherwise meet program criteria. The SPV will purchase up to $600 billion in MSLP loan participations from participating lenders, with qualifying loans ranging from $250,000 to $300 million. Qualifying borrowers may have up to 15,000 employees and up to $5 billion in annual revenue, and include not-for-profit organizations.

Loan Terms

The MSLP is made up of five facilities, each with similar terms: 5-year term, interest at LIBOR plus 3%, 2 years’ deferred principal, and one year’s deferred interest. Principal must be reduced by 15% at the end of years three and four, and the balance must be paid at the end of year five. The loans may be repaid early without penalty, and may be secured or unsecured (depending upon the MSLP facility).

Loans are subject to full underwriting by the lender, and are documented on the lender’s standard terms and conditions. In addition, however, borrowers must agree to certain program restrictions established by the CARES Act, including, among other things: enhanced financial reporting, limitations on distributions to owners, headcount reduction, and utilization of foreign supply chain. As a trade-off for these additional burdens and limitations, however, borrowers may achieve more leverage than they might under traditional loan facilities (in most cases, up to 6 times Adjusted EBITDA).

Program Fees and Mechanics

MSLP-participating lenders must pay a per-loan “transaction fee” of 1% of the principal loan amount at the time of origination, which fee may be passed on to the borrower. However, lenders may also charge and retain an origination fee of 1% of the principal loan amount at the time of origination.

Participations will be sold to the SPV at par value, and the lender will retain servicing. Unlike the 100% SBA guaranty under the PPP, Fed will only take 95% of the exposure on any given MSLP loan; the lender must retain 5% of the loan until it matures or the SPV sells all of its participation, whichever comes first. The SPV and the lender will share any losses on a pari passu basis. For servicing the loan, the SPV will pay lenders an annual fee of .25% of the SPV’s participation amount.

The lender is expected to service MSLP loans in accordance with the terms of Fed’s standard servicing agreement, which generally requires the lender to exercise the same duty of care it would exercise had it retained ownership of the entire loan.

Program Risks

One of the primary program risks – apart from the increased risk of default due to enhanced borrower leverage – is the relationship risk posed by the SPV. That is, under the terms of the MSLP Participation Agreement, the SPV has a multitude of opportunities to transfer its participation to a third-party without the lender’s consent. Lenders should expect to have no control over the selection of co-lenders or subsequent participants. Similarly, the terms of the Participation Agreement limits the lender’s ability to exercise ordinary servicing discretion. Whether to grant a covenant waiver, for instance, is generally reserved to the SPV, and failure to obtain consent may trigger the SPV’s right to transfer its interest. This approach may subject borrowers to stricter compliance than that to which they are used to lenders imposing, or even to which they may be subject on other loans with lender.

Does MSLP Make Sense For You?

The MSLP is not the PPP; MSLP loans are “real” commercial loans.  They require traditional underwriting and an ongoing commitment by the lender to service the credit.  In exchange, however, the MSLP allows lenders to extend emergency funding to needy borrowers while transferring 95% of the credit risk.  Whether the benefits offset the burdens is – of course – a case-by-case decision, but this new Fed program could be just the lifeline needed for the present time.

Michael Odom is Of Counsel in McGlinchey’s Birmingham office, where he provides a full range of industry-leading real estate finance, litigation and transactions counsel to banks, other lenders and title insurance companies.