For over 100 years, the Federal Reserve has acted as a liquidity facility for the banking industry, meaning that the Federal Reserve lends money to banks when they need it. With the advent of the COVID-19 pandemic and the CARES Act stimulus program, Congress provided a budget authorization that allows the Federal Reserve to make or purchase interests in loans to “Main Street” businesses. The Federal Reserve’s resulting “Main Street Lending Facility” has been gradually rolled out since early April, and it is about to reach the point where borrowers can begin submitting loan applications.

Although there are three “Main Street” lending programs, this blog will concentrate on two of them, the “Main Street New Loan Facility” (referred to below as a “New Loan”) and the “Main Street Priority Loan Facility” (referred to below as a “Priority Loan”).  Although these two programs had substantial differences when first proposed, the terms have now converged, making some bankers wonder why the two programs have not been combined. This blog is based upon the most current term sheets issued by the Federal Reserve Bank of Boston on June 8. The Federal Reserve Bank of Boston is the lead Federal Reserve Bank responsible for implementing the Main Street program.

Who is eligible to borrow? Existing small and medium-sized businesses (those with less than 15,000 employees or less than $5 billion in annual revenue) are eligible so long as they are not excluded based upon a list created by the SBA. Although Main Street is not an SBA program, the Federal Reserve has piggybacked on the SBA ineligibility rules, with minor exceptions. Sixteen types of businesses are excluded, varying from banks and insurance companies, to passive businesses, casinos, businesses engaged in presenting live performances of a sexually prurient nature and speculative businesses like oil wild-catting. Illegal businesses are excluded, so even though medical marijuana may be legal in New York, it is illegal under federal law, and thus medical marijuana businesses are among the class of borrowers that may not participate. Not-for-profit corporations are eligible only if approved on a case-by-case basis. For-profit corporations principally engaged in religious teaching and indoctrination are eligible.

How will the program work? The lender will be a bank, but the lender will sell a 95% participating interest in the loan to an entity (known as a Special Purpose Vehicle, or SPV) created by the Federal Reserve Bank of Boston. The lender must retain 5% of the loan and will service the loan. The lender will make a credit judgment regarding whether it believes that the borrower will be able to repay the loan. The lender’s credit judgment will include a credit quality analysis that will go beyond the simple question of whether the borrower satisfies the technical eligibility requirements to participate in the program. In contrast to the PPP loan program, there is no forgiveness of the loan. The borrower must certify that it has the ability to meet its existing financial obligations for the next 90 days and does not expect to file for bankruptcy in the 90 days after the loan closes. The Federal Reserve anticipates that the SPV will purchase up to $600 billion of loan participations.

Who may be a lender? All FDIC-insured banks, savings banks, and savings and loan associations and NCUA insured credit unions are eligible to participate, but the program is still developing, so very few lenders have announced that they will accept applications. However, some lenders are already processing applications and the scuttlebutt is that some loans have already closed.

What are the terms of the loans? The principal terms are:

1. Loans will have a 5-year maturity.
2. No interest payments will be required for one year and no principal payments for two years (although the schedule of principal payments discussed below seems to allow a three-year principal moratorium), but interest during the first year will be capitalized and added to principal.
3. The interest rate will be an adjustable-rate equal to 300 basis points (3.00%) over either one-month or three-month LIBOR.
4. 15% of the principal amount must be repaid on the third anniversary; 15% on the fourth anniversary; and the remaining 70% on the fifth anniversary. We have asked the attorneys at the Federal Reserve whether the word “on” is intended to mean “on or before,” and we are awaiting a response.
5. Loans must be for at least $250,000 (this is a substantial reduction - the original minimum was $1 million, reduced to $500,000  in May and to $250,000 on June 8).
6. The maximum New Loan is four times the borrower’s adjusted 2019 earnings before interest, taxes, depreciation, and amortization (“EBITDA”), minus existing outstanding and undrawn available debt, but in no event more than $35 million (an increase over the $25 million maximum previously announced). For Priority Loans, the EBITDA multiple is six times, with a $50 million maximum loan amount.
7. At origination and during the term of the loan, a New Loan must not be contractually subordinated in terms of priority to any of the borrower’s other loans or debt instruments. Both New Loans and Priority Loans are subject to collateral priority and subordination requirements discussed in detail below.
8. There is no prepayment penalty.

Does my company financially qualify? Only companies that were financially sound before the pandemic and who satisfy the lender’s credit underwriting standards will qualify. This is an important difference from the PPP loan program, in which a 100% SBA guarantee causes most lenders not to review the applicant’s financial condition. For Main Street loans, the lender will retain the risk associated with owning 5% of the loan amount, so the lender will want to underwrite the borrower’s credit worthiness. Although the Federal Reserve has publicly stated that cash flow difficulties caused by the pandemic will not disqualify a company from participation, financial soundness after the pandemic is required.

What origination fees will a borrower have to pay? The lender may charge a 1% origination fee plus a 95 basis point fee for the participation purchased by the SPV. Other normal minor closing costs, such as lender’s attorney’s fees and appraisal fees, may also be charged.

How does this affect my existing loans?

• For Priority Loans, you may not have any pre-existing secured debt unless the lender of the pre-existing debt agrees that the lender of your Main Street loan will have an equal priority claim to the collateral. That rule does not apply to mortgage debt, which is defined as debt secured by real estate and certain limited recorded debt secured by equipment. We are seeking a clarification from attorneys at the Federal Reserve as to whether a mortgage loan which also includes personal property collateral other than equipment is a disqualifying debt. You may not have an unsecured Priority Loan unless all of your other loans, except for mortgage debt, are also unsecured.
• For New Loans, you cannot by contract agree that the rights of the lender under your Main Street loan are subordinate to the rights of any other lenders. This means that the New Loan must be equal in priority to other unsecured debt, but may have secondary priority in collateral. However, you may obtain an unsecured New Loan even though you have existing secured debt.
• Remember that your existing loans may have covenants prohibiting additional debt. Whether and to what extent there may be a clash between your existing loans and either a Priority Loan or a New Loan depends upon the specific facts and your existing loan documents will have to be reviewed carefully before you proceed with a Main Street loan.
• You may pay principal and interest on your existing loans when it is due under the existing loan documents, but you may not prepay any existing loans before they are due except as described below regarding use of proceeds.

How may I use the proceeds? You may use the proceeds of a Priority Loan for any business purpose other than specifically prohibited items. You may use proceeds to repay pre-existing debt to another lender, but not to the lender who is making the Priority Loan, but you must do this when the loan is funded, not afterwards. The proceeds of a New Loan may not be used to repay any existing debt.

What other rules are there? The principal rules include a prohibition on repaying other debt except on currently scheduled payment due dates and limits on officer salaries, stock repurchases and capital distributions. A borrower must make commercially reasonable efforts to retain its employees and maintain its payroll. A borrower is permitted to obtain a New Loan or a Priority Loan only if other adequate credit accommodations are not available. This is less stringent than a “lender of last resort” standard, but if a borrower has multiple loan commitments, and the others are commercially reasonable, the borrower should accept one of the other commitments.
There are many other rules and specifications applicable to Main Street loans that are beyond the scope of this blog. However, they may be important to individual companies, depending on the facts. We would be happy to discuss all the rules applicable to Main Street loans with any business interested in borrowing or any bank interested in being a lender. Call your attorney at Gallet Dreyer & Berkey, LLP for assistance.