Federal Reserve Expands Main Street Lending Program

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Introduction

The Federal Reserve Board (the Board) announced on April 30 that it is expanding the scope and eligibility for the Main Street Lending Program adopted pursuant to Section 13(3) of the Federal Reserve Act. The Board developed the Main Street Lending Program to help credit flow to small and medium-sized businesses that were in sound financial condition before the pandemic. After receiving public comment on its initial proposal, it made a number of changes, including:

• Creating a third loan option, with increased risk sharing by lenders for borrowers with greater leverage;
• Lowering the minimum loan size for loans under two of the programs from $1,000,000 to $500,000; and
• Expanding the pool of businesses eligible to borrow to include businesses with up to 15,000 employees or up to $5 billion in annual revenue.

The Main Street Lending Program now includes the following three facilities:

• The Main Street New Loan Facility (the MSNLF) is the basic program available to small and medium-sized businesses;
• The Main Street Expanded Loan Facility (the MSELF) provides for larger loans to supplement an existing lending facility from the applicable lender; and
• The Main Street Priority Loan Facility (the MSPLF) is a new program similar to the MSNLF, but permitting Eligible Lenders to offer higher principal balances relative to the borrower's 2019 Adjusted EBITDA in exchange for retaining a higher share of the resulting loan.

The three programs have many common features, including the categories of institutions eligible to lend (Eligible Lenders) and borrow (Eligible Borrowers), and the feature that a participation interest (95% for the two original programs, and 85% for the new MSPLF) would be purchased by a special purpose entity (the Main Street SPV), with the remaining "risk retention" participation interest to be retained by the Eligible Lender. The Eligible Lender is required to retain its "risk retention" participation interest until either the Eligible Loan (or, in the case of the MSELF, the upsize tranche) matures or the Main Street SPV sells its participation interest. In the case of the MSELF, the Eligible Lender must also retain its interest in the existing loan facility to which the upsize tranche is added until the upsize tranche matures or the Main Street SPV sells its participation interest in the upsize tranche.

The Treasury Department will fund $75 billion in equity to the Main Street SPV, and it is anticipated that the three programs taken together will involve purchases of participation interests of up to $600 billion. The Main Street SPV will stop purchasing such participation interests on September 30, 2020, unless the program is extended by the Board and the Treasury Department.

The Board indicated that it is evaluating a separate approach for non-profit organizations.

Common Features

Eligible Lenders. For each program, Eligible Lenders include a U.S. federally insured depository institution (including a bank, savings association, or credit union), a U.S. branch or agency of a foreign bank, a U.S. bank holding company, a U.S. savings and loan holding company, a U.S. intermediate holding company of a foreign banking organization, and a U.S. subsidiary of any of the foregoing.

Eligible Borrowers. For each program, Eligible Borrowers include any "Business" that:

• was established prior to March 13, 2020;
• is not an Ineligible Business (as defined below);
• meets at least one of the following two conditions: (i) it has 15,000 employees or fewer, or (ii) it had 2019 annual revenues of $5 billion or less;
• is created or organized in the United States or under the laws of the United States with significant operations in, and with a majority of its employees based in, the United States;
• does not also participate in either of the other two Main Street Lending Program facilities or the Primary Market Corporate Credit Facility; and
• has not received specific support pursuant to Subtitle A of Title IV of the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act), other than under the Paycheck Protection Program established under Section 1102 of the CARES Act (the PPP).

For purposes of each program, a Business is an entity that is organized for profit as a partnership; a limited liability company; a corporation; an association; a trust; a cooperative; a joint venture with no more than 49 percent participation by foreign business entities; or a tribal business concern.

In counting the number of employees, a Business is required to apply the standards of the Small Business Administration (the SBA), which provide that Businesses should count as employees all full-time, part-time, seasonal, or otherwise employed persons, excluding volunteers and independent contractors. Businesses must count their own employees and those employed by their affiliates. In order to determine the applicable number of employees, Businesses are required to use the average of the total number of persons employed by the Eligible Borrower and its affiliates for each pay period over the 12 months prior to the origination or upsizing of the loan under the Main Street Lending Program.

To determine its 2019 annual revenues, Businesses must aggregate their revenues with those of their affiliates. Businesses may use either of the following methods to calculate 2019 annual revenues for purposes of determining eligibility:

• A Business may use its (and its affiliates') annual "revenue" per its 2019 audited financial statements prepared in accordance with generally accepted accounting principles (GAAP); or
• A Business may use its (and its affiliates') annual receipts for the fiscal year 2019, as reported to the Internal Revenue Service.

For both the employees test and the annual revenues test, affiliates whose employees or 2019 annual revenues must be included are determined by the SBA's affiliation test, which states that entities are affiliates of each other if one controls or has the power to control the other, or a third party controls or has the power to control both. Affiliation can be established through (i) ownership (generally on the basis of ownership of over 50% of voting equity), taking into account stock options, convertible securities and agreements to merge, (ii) management control, or (iii) identity of interest among close relatives.

An Ineligible Business is defined as a type of business listed in 13 CFR 120.110(b)-(j) and (m)-(s), as modified by regulations implementing the PPP on or before April 24, 2020. The result is that significant categories of Businesses are excluded from the Main Street Lending Program, including the following:

• Financial businesses primarily engaged in the business of lending, such as banks, finance companies, and factors (pawn shops, although engaged in lending, may qualify in some circumstances). This will generally operate to exclude specialty finance companies, but not loan originators who promptly sell the loans they originate, or who are primarily engaged in loan servicing;
• With certain exceptions, passive businesses owned by developers and landlords that do not actively use or occupy the assets acquired or improved with the loan proceeds;
• Life insurance companies;
• Businesses located in a foreign country, though businesses in the U.S. owned by aliens may qualify;
• Government-owned entities (except for businesses owned or controlled by a Native American tribe) ;
• Loan packagers earning more than one third of their gross annual revenue from packaging SBA loans; and
• Certain other Borrowers based on the nature of their activities.

The application of these restrictions may be further modified at the discretion of the Board.

Loan Terms. The variations in the three facilities are primarily reflected in the terms of loans that qualify for the respective facilities (Eligible Loans), though they all have certain features in common, as follows:

• Unlike loans under the PPP, Eligible Loans under the Main Street Lending Program are not forgivable;
• Eligible Loans will have a 4-year maturity;
• Principal and interest payments on Eligible Loans will be deferred for one year (but unpaid interest will be capitalized);
• Eligible Loans will bear interest at an adjustable rate of LIBOR (1 or 3 month) plus 300 basis points; and
• Eligible Loans may be prepaid at any time without penalty.

The Board had originally contemplated having Eligible Loans bear interest based on the Secured Overnight Funding Rate (SOFR), but concluded that a number of Eligible Lenders had not yet implemented systems to charge interest at such rate, and accordingly would be restricted in their ability to offer loans bearing interest based on a SOFR index. Given that LIBOR is not expected to be available for the full 4-year term of Eligible Loans, the loan documents will need to provide for an appropriate transition from LIBOR.

Remaining loan terms vary as described for each facility below.

Other Common Requirements. For Eligible Loans under all three facilities,

• Eligible Lenders are expected to conduct an assessment of each potential borrower's financial condition at the time of the potential borrower's application;
• Any other loan from the Eligible Lender to the Eligible Borrower (including the underlying loan for the Main Street Expanded Loan Facility) must have had an internal rating equivalent to "pass" in the supervisory rating system of the Federal Financial Institutions Examination Council as of December 31, 2019;
• Both the Eligible Lender and the Eligible Borrower are required to make certain certifications as described below; and
• Each Eligible Borrower that participates in the Facility is expected to make commercially reasonable efforts to maintain its payroll and retain its employees during the time the Eligible Loan is outstanding.

Each Eligible Lender will be required to pay the Main Street SPV a transaction fee of 100 basis points (or 75 basis points, in the case of the MSELF) of the principal amount of the Eligible Loan at the time of origination. The Eligible Lender may require the Eligible Borrower to pay this fee.

An Eligible Borrower will pay an Eligible Lender an origination fee, as determined by the Eligible Lender, of up to 100 basis points of the principal amount of the Eligible Loan (or 75 basis points of the upsize tranche, in the case of the MSELF) at the time of origination.

The Main Street SPV will pay an Eligible Lender 25 basis points of the principal amount of its participation in the Eligible Loan per annum for loan servicing.

Main Street New Loan Facility

An Eligible Loan under the MSNLF must have the following features:

1. A loan size of between $500,000 and $25 million; provided that the maximum loan amount may not exceed an amount that, when added to the Eligible Borrower's existing outstanding and undrawn available debt, is equal to four times the Eligible Borrower's adjusted 2019 earnings before interest, taxes, depreciation, and amortization (Adjusted EBITDA);
2. Principal amortization of one-third at the end of the second year, one-third at the end of the third year, and one-third at maturity at the end of the fourth year; and
3. It is not, at the time of origination or at any time during the term of the Eligible Loan, contractually subordinated in terms of priority to any of the Eligible Borrower's other loans or debt instruments.

Adjusted EBITDA is to be determined using a methodology previously used by the Eligible Lender to calculate Adjusted EBITDA when extending credit to the Eligible Borrower or similarly situated borrowers on or before April 24, 2020. In the original proposal, the test was based on EBITDA alone without adjustment to conform to the Eligible Lender's methodology.

Note that the MSNLF is the most conservative of the three facilities, in that it limits the loan size (together with other specified debt) to 4 times the Eligible Borrower's 2019 Adjusted EBITDA, while the other two facilities permit a loan size which (together with other specified debt) is up to 6 times the Eligible Borrower's 2019 Adjusted EBITDA.

Main Street Expanded Loan Facility

The MSELF is designed to supplement an existing loan facility (the Eligible MSELF Loan) from the Eligible Lender. The Eligible MSELF Loan must be a secured or unsecured term loan or revolving credit facility originated on or before April 24, 2020, with a remaining term to maturity of at least 18 months (taking into account any extensions made in connection with the upsizing of the Eligible MSELF Loan).

The MSELF provides for an additional tranche of the Eligible MSELF Loan that must have the following features:

• A loan size of between $10 million and $200 million; provided that the loan size may not exceed the lesser of (i) 35% of the Eligible Borrower's existing outstanding and undrawn available debt from banks, non-bank financial institutions and private lenders (a change from the original proposal, which referenced only bank debt) that is pari passu in priority with the Eligible MSELF Loan and equivalent in secured status (i.e., secured or unsecured), and (ii) an amount that, when added to the Eligible Borrower's existing outstanding and undrawn available debt, is equal to six times the Eligible Borrower's 2019 Adjusted EBITDA;
• Principal amortization of 15% at the end of the second year, 15% at the end of the third year, and a balloon payment of 70% at maturity at the end of the fourth year;
• At the time of upsizing and at all times the upsize tranche is outstanding, the upsize tranche is 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; and
• Any collateral securing the underlying loan must equally secure the upsize tranche.

Adjusted EBITDA is to be determined using a methodology previously used by the Eligible Lender to calculate Adjusted EBITDA when originating or amending the Eligible MSELF Loan on or before April 24, 2020.

Main Street Priority Loan Facility

The MSPLF is similar to the MSNLF, but is designed to allow Eligible Lenders to offer a higher loan balance relative to the Eligible Borrower's 2019 Adjusted EBITDA, so long as the Eligible Lender believes that the Eligible Loan is still of acceptable credit quality. The Eligible Lender is asked to stand behind its judgment of credit quality, despite the higher loan balance, by retaining a 15% participation interest, rather than the 5% participation interest retained pursuant to the other facilities.

An Eligible Loan under the MSPLF must have the following features:

• A loan size of between $500,000 and $25 million; provided that the loan amount may not exceed an amount that, when added to the Eligible Borrower's existing outstanding and undrawn available debt, is equal to six times (as compared with four times under the MSNLF) the Eligible Borrower's 2019 Adjusted EBITDA;
• Principal amortization of 15% at the end of the second year, 15% at the end of the third year, and a balloon payment of 70% at maturity at the end of the fourth year; and
• At the time of origination and at all times the Eligible Loan is outstanding, the Eligible Loan is 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.

Adjusted EBITDA is to be determined using a methodology previously used by the Eligible Lender to calculate Adjusted EBITDA when extending credit to the Eligible Borrower or similarly situated borrowers on or before April 24, 2020.

Certifications

Each Eligible Lender must provide a certification containing the following:

• It will not request the Eligible Borrower to prepay existing debt or interest until the Eligible Loan (or the upsize tranche, in the case of the Main Street Expanded Loan Facility) is paid in full;
• It will not cancel or reduce eligible committed lines of credit absent an Event of Default;
• Its calculation of the Eligible Borrower's Adjusted EBITDA was the same as for prior credit extended by it to the Eligible Borrower or similarly-situated borrowers (or, in the case of the MSELF, was the same as used when originating or amending the Eligible MSELF Loan) on or before April 24, 2020; and
• It is eligible under the CARES Act (including in particular the conflict of interest provisions thereof).

Each Eligible Borrower must provide a certification as follows:

• It will refrain from prepaying principal or interest on any debt until the Eligible Loan (or the upsize tranche, in the case of the Main Street Expanded Loan Facility) is paid in full (except under the Main Street Priority Loan Facility, where proceeds of the Eligible Loan may be used to prepay debt to a lender other than the Eligible Lender making the Eligible Loan);
• It will not seek to cancel or reduce outstanding committed lines of credit;
• It expects to be able to meet financial obligations over the next 90 days and does not expect to file for bankruptcy in that period; and
• It will follow compensation, stock repurchase and capital distribution restrictions of CARES Act (except Subchapter S corporations may distribute enough to allow owners to pay taxes).

The Board clarified in its FAQs that an Eligible Borrower would not be prohibited from making payments under a line of credit that are consistent with the Eligible Borrower's ordinary course of business.

Conclusion

The result of the Board's announcement is that the Main Street Lending Program will be accessible by a broader range of Businesses, both by allowing more medium-sized Businesses to utilize the program by increasing the eligibility thresholds, and by enhancing its utility to smaller Businesses by allowing a smaller loan size. In addition, the modifications to the program reflect a greater reliance on the credit analysis and criteria of Eligible Lenders, including allowing higher leverage pursuant to the MSPLF in circumstances where such Eligible Lenders believe such higher leverage is justified, and are prepared to stand behind that analysis by retaining a larger participation interest.

© Arnold & Porter Kaye Scholer LLP 2020 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.