On April 30, 2020, the Board of Governors of the Federal Reserve updated the proposed terms of the Main Street Lending Program by publishing three term sheets and frequently asked questions (the “FAQs”). The updated terms of the program will have an impact on how useful this program may be to portfolio companies owned or controlled by private equity firms and other middle-market companies.
The basic structure of the program remains the same. A special purpose vehicle (the “Main Street SPV”) will be formed; the Treasury Department will invest $75 billion made available under the CARES Act into the Main Street SPV; and the Federal Reserve, under the Section 13(3) powers of the Federal Reserve Act, will loan up to $525 billion to the Main Street SPV. The Main Street SPV will use the proceeds of those investments to purchase participations in new or additional extensions of credit made by “Eligible Lenders” to “Eligible Borrowers.”
The program previously comprised two facilities, the Main Street New Loan Facility (the “New Loan Facility”) and the Main Street Expanded Loan Facility (the “Expanded Loan Facility”). A third facility, called the Main Street Priority Loan Facility (the “Priority Loan Facility”), has been added, the terms of which are discussed below, together with various other changes that were made to the program.
One of most significant unanswered questions is what the terms of the participation agreement are pursuant to which the Main Street SPV will purchase its interest in a new or additional extension of credit from an Eligible Lender. The terms of that agreement will be a major factor in determining whether Eligible Lenders will participate in the Main Street Lending Program. If the Main Street SPV is taking a significant majority of the risk in the new loan or additional extension of credit, then it would follow that the Main Street SPV would want appropriate representations regarding the loan, covenants regarding the administration of the loan, and the right to put the new loan or additional extension of credit back in the event of a material breach of the obligations of the Eligible Lender.
Definition of Eligible Lenders Expanded
The Eligible Lenders now include, in addition to US federally insured depository institutions, bank holding companies and S&L holding companies, the US branches or agencies of foreign banks, US intermediate holding companies of foreign banks, and any US subsidiaries of any of those entities.
The term sheets for the Main Street Lending Programs provide that for each of the facilities, an Eligible Borrower must be a business that meets the following criteria:
- Established before March 13, 2020.
- Not “ineligible” under SBA regulations as modified by the Payroll Protection Program.
- Either (i) has 15,000 employees or less or (ii) had 2019 annual revenues of $5 billion or less.
- Was created or organized in the US or under the laws of the US, with significant operations and a majority of its employees based in the US.
- Does not participate in another Main Street Lending Program of the Primary Market Corporate Credit Facility.
- Has not received specific support pursuant to the CARES Act. It should be noted that participation in the Payroll Protection Program would not render an otherwise Eligible Business ineligible to participate in the Main Street Loan Program.
Although not in any of the Facility term sheets, the answer to FAQ E.3. expressly states that factor 3 above is to be measured based on both the number of employees and the revenue of a business and its affiliates. The answer to FAQ E.5. states that the determination of whether an entity is an affiliate of a business is made in accordance with the tests set forth in 13 CFR 121.301(f), which applies to most SBA loan programs. Under that provision, various forms of actual or potential control over the various entities by a single person or entity, such as a private equity firm, could require the aggregation of the number of employees and 2019 annual revenue for purposes of determining whether any one of the businesses is eligible to participate in the Main Street Loan Program.
Main Street Expanded Loan Facility
Since it is highly likely that a middle-market company and the portfolio companies of a private equity firm have existing credit facilities, the most likely facility that such an entity would use under the Main Street Lending Program is the Expanded Loan Facility, under which an Eligible Lender would provide an “upsized tranche” as part of an underlying Eligible Loan. On the one hand, the minimum amount of the upsized tranche is $10 million (increased from $1 million). On the other hand, the maximum amount of the upsized tranche is now the greatest of $200 million (increased from $150 million), 35% of existing “outstanding and undrawn available” debt of equal priority, or an amount that when added to existing outstanding and undrawn available debt does not exceed six times the Eligible Borrower’s “adjusted” EBITDA. Adjustments to EBITDA must be consistent with the adjustments used when originating or amending the underlying Eligible Loan on or before April 24, 2020. The amortization is now set at 15% at the end of the second and third years, and a balloon payment due at the end of four years. There is a new requirement that the underlying Eligible Loan have a remaining maturity of at least 18 months.
In the case of a syndicated loan facility, not all lenders need be Eligible Lenders, but only Eligible Lenders may provide the upsized tranche. This is a favorable change since it is not unusual for there to be lenders in a syndicated loan that do not fit the criteria of “Eligible Lender.” However, the burden and risk of providing 5% of the upsized tranche will fall on the regulated lenders. In addition to taking the marginal risk, an Eligible Lender that provides an upsized tranche must continue to hold its 5% interest in the upsized tranche and the underlying Eligible Loan until these debts mature or the Main Street SPV sells off its 95% interest in the upsized tranche. Finally, the Eligible Lender that provides the upsized tranche must commit to not allow repayment of the debt it has extended unless such payments are mandatory. None of those burdens appear to be applicable to the members of a syndicate that do not provide the upsized tranche.
In addition to paying interest, a borrower under the Expanded Loan Facility will undoubtedly need to fund a fee payable by an Eligible Lender to the Main Street SPV in the amount of 0.75 percent of the amount of the upsized tranche together with a fee to the Eligible Lender of 0.75 basis percent of the upsized tranche. This is a change from the first iteration of the program, which only provided for a 100 basis point fee to the Eligible Lender.
Main Street New Loan Facility
Although the Expanded Loan Facility seems like the most likely mechanism for obtaining financing under the Main Street Lending Program, the April 30 version of the New Loan Facility may be more attractive in certain circumstances than the April 8 version. The new loan can be secured or unsecured. The minimum amount of the loan has been reduced to $500,000. The maximum amount is the lesser of $25 million or an amount that when added to existing outstanding and undrawn available debt does not exceed four times the Eligible Borrower’s adjusted EBITDA. Payment of interest and principal is deferred for a year, after which one-third of the principal is paid at the end of each year thereafter. The only limitation with respect to priority of existing debt is that it cannot be contractually subordinate to the borrower’s other debt. That means that an Eligible Lender that already has already made a secured loan could make a new unsecured loan, and the new unsecured loan would be structurally but not contractually subordinate to the existing secured loan. This potential advantage to an Eligible Lender is tempered by the requirement that the Eligible Lender agrees not to cancel any existing committed lines of credit or request the early repayment of debt. The New Loan Facility requires the payment of 100 basis points to the Main Street SPV (which the Eligible Lender can require be paid by the borrower), and allows the Eligible Lender to charge the borrower 100 basis points for its own account.
While the economics of the New Loan Facility remain relatively unattractive to Eligible Lenders without a prior relationship to a borrower, the revised terms present its possible use by an Eligible Lender to provide needed working capital to an existing borrower at a lower risk.
Main Street Priority Loan Facility
The Priority Loan Facility is new. It is similar to the Expanded Loan Facility in the requirement that if an Eligible Lender is lending new money to an existing borrower, the priority and security must be the same as the other debt already owed to the Eligible Lender and as to the term of repayment. It is similar to the New Loan Facility as to its minimum and maximum size. However, unlike either the Expanded Loan Facility or the New Loan Facility, it may be used to refinance existing debt owed to a lender other than the Eligible Lender making a loan under the Priority Loan Facility. Also, the Main Street SPV will purchase only 85% participation as opposed to the 95% participation purchased in credit extended under the Expanded Loan Facility or the New Loan Facility.
It is not clear what the advantages of the Priority Loan Facility are except in certain circumstances where it makes sense to take out the obligations owed to another lender. In order to gain that flexibility, the Eligible Lender must increase the amount of risk it retains to 15% as opposed to 5%. So under the Priority Loan Facility, it is the Eligible Lender that pays the price for potentially rationalizing the borrower’s debt structure.
Additional Requirements for All of the Facilities
Many of the characteristics of an Eligible Loan remain unchanged. The term is four years. No prepayment premium is permitted. The borrower must agree to comply with the CARES Act requirements regarding compensation, stock repurchases and capital distributions, though pass-through tax entities may now make tax distributions. In addition to the differences between the Facilities outlined above, the April 30 term sheets set out additional requirements for all extensions of credit made under the Main Street Loan Programs.
Pricing of each of the Facilities is based on London Interbank Offered Rate (“LIBOR”) plus 300 basis points, as opposed to Secured Overnight Financing Rate (“SOFR”) plus 250 to 400 basis points. This change was apparently needed because many potential Eligible Lenders have yet to operationalize SOFR. The FAQs provide that lenders will need to include fallback contract language that can be used when LIBOR becomes unavailable.
A new requirement is that in order to provide the upsized tranche, the Eligible Lender must have given the underlying Eligible Loan a minimum “internal risk rating” as of December 31, 2019, and the Eligible Lender is expected to conduct an assessment of the financial condition of the Eligible Borrower at the time of application. It is unclear how this requirement will work given the sensitivity that lenders will have regarding any internal ratings and the question of whether the adequacy of the assessment could give rise to any rights on the part of the Main Street SPV under the participation agreement.
As a condition to closing, the Eligible Borrower must now certify that it has a reasonable basis to believe that as of the date that the upsized tranche is provided, 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. This is not the normal formulation required from a borrower with respect to its solvency. Given the specificity of the statements, borrowers will want to document their reasonable basis for their belief about their ability to meet financial obligations. The good news for borrowers is that the time period during which they believe they will have such ability is limited to 90 days.
To be eligible, a borrower cannot be an “ineligible” business under the SBA rules and the CARES Act.
Conclusion Although there are a number of limitations on its usefulness, the changes in the Main Street Lending Program make it more likely that Eligible Lenders will choose to participate. The most significant unanswered question is what the required terms of the participation agreement between an Eligible Lender and the Main Street SPV will be. Stay tuned.