Locke Lord QuickStudy: Main Street Lending Program Updates Respond to Market Input but Leave Unsolved Problems

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.‎

Visit our COVID-19 Resource Center often for up-to-date information to help stay ‎‎informed of the legal issues related to COVID-19.‎