ABA Letter to FRS re: The Main Street Lending Program

Board of Governors of the Federal Reserve System
20th Street and Constitution Avenue, NW
Washington, DC 20551

Ladies and Gentlemen:

The American Bankers Association (ABA) appreciates the opportunity to offer feedback on the Federal Reserve’s proposed terms for the Main Street Lending Program (MSLP) which are found in the Main Street New Loan Facility (MSNLF) and the Main Street Expanded Loan Facility (MSELF). ABA supports the Federal Reserve’s expansive efforts to partner with banks of all sizes to assist our nation’s small and medium-sized businesses as they grapple with the many challenges that accompany our collective effort to stem the COVID-19 pandemic.

The Federal Reserve’s action to develop the MSLP through its Section 13(3) emergency lending authorities has been swift by necessity. After previewing the development of the MSLP in a late March press release, the Federal Reserve announced the MSNLF and MSELF term sheets on April 09, 2020.5 ABA’s feedback is intended to support the MSLP, recognizing that the details and incentive structures that flow from the MSLP must be well designed and calibrated to ensure that the program’s $600 billion in loans backstopped by $75 billion in funds from the U.S. Treasury flow quickly to the businesses that need it most.

I. Overview

ABA believes that the rapid development and launch of the Federal Reserve’s lending program is critical to reducing the COVID-19 pandemic’s economic damage. However, to help ensure that the U.S. banking industry can effectively deploy MSLP to assist small and medium-sized businesses in need, we offer suggestions and seek clarifications below.

a) Affirm the essential role of bank underwriting;
b) Provide greater reference rate flexibility;
c) Allow a range of tenors for MSLP loans;
d) Reduce the minimum permitted loan size;
e) Provide greater flexibility in setting the maximum loan size and other loan terms;
f) Allow greater flexibility in the required attestations;
g) Clarify the future supervisory treatment of MSLP loans;
h) Clarify and expand the scope of Eligible Lenders; and
i) Preserve pre-COVID regulatory tailoring categorizations.

II. Discussion

Below, we further elaborate on the positions outlined above. We believe these suggestions will strengthen the MSLP by increasing bank and lender participation, which will assist in the national effort to reduce the COVID-19 pandemic’s economic damage.

a) Affirm the Essential Role of Bank Underwriting

The MSLP was developed after many healthy small and medium-sized businesses were required to cease operations temporarily to combat the spread of a deadly pandemic. The MSLP is designed to encourage banks to increase lending to new and existing customers. However, the MSLP is also structured to ensure that participating banks assess the creditworthiness of businesses seeking to become new borrowers or current bank customers looking to increase their borrowings.

To align incentives and minimize unnecessary loss, the MSLP requires banks to retain a portion of the risk for each loan extended. Designed properly, this requirement can help ensure that credit flows to well-run businesses facing temporary hardship. Banks are well suited to assist in that effort, as measuring and assuming risk is central to the business of banking. The MSLP’s risk retention features have the potential to provide greater protection to the Federal Reserve as a loan participant and as a lender backstopped by taxpayer funds. However, these protections are premised on participating banks being thoughtful risk underwriters that make sound lending decisions.

In this respect, the MSLP is distinct from other programs launched to address the economic impact of the COVID-19 pandemic, such as the Paycheck Protection Program (PPP). Under PPP, the banking industry has played a key role in distributing government guaranteed forgivable loans. However, by its terms, PPP does not expose participating banks to credit risk and PPP does not ask banks to make underwriting decisions or similar judgments.

The risk retention aspects of the MSLP reflect different considerations and objectives than PPP. The Federal Reserve should promote public understanding of this important distinction.

ABA suggests that the Federal Reserve publicly and clearly acknowledge the role of banks as underwriters of MSLP loans.

b) Provide Greater Reference Rate Flexibility

Both the MSNLF and MSELF require banks to set an adjustable rate tied to the Secured Overnight Financing Rate (SOFR). However, the transition away from the London Inter-Bank Offered Rate (LIBOR) and toward a different reference rate such as SOFR was not expected until LIBOR’s publication ceased after December 2021.

Lenders and borrowers already faced the need for an orderly transition to a different reference rate such as SOFR, but necessary borrower analyses and lender systems adjustments are still underway. In the midst of a pandemic, with diverse demands on finite management resources, such an abrupt transition to SOFR would deter participation in the MSLP.

The Federal Reserve is familiar with the operational challenges that a transition from LIBOR to SOFR presents, and it has played a leading role, along with the Alternative Reference Rates Committee (ARRC) in addressing these complex issues.

The Federal Reserve’s deep involvement in this transition has illuminated the need for lenders and borrowers to have sufficient time to make necessary adjustments. Transitions within loan administration, servicing, and risk management are necessary to successfully execute and administer a large program of SOFR-based commercial loans. Furthermore, until there is a robust and liquid market for hedging instruments tied to SOFR, risk management strategies for banks and borrowers will be hampered. The market for these hedging instruments is progressing, but at present it remains relatively unfamiliar to many small and medium-sized businesses.

The ARRC has recommended robust contract language to address the risks of LIBOR termination in new commercial loans based on LIBOR. The Federal Reserve should affirm the ARRC’s recommended language and attendant transition timeline, while permitting immediate implementation of SOFR for prepared borrowers and lenders.

However, it is also true that community banks need further reference rate optionality under the MSLP. Often, community banks lend to small and medium-sized businesses at rates tied to a publicly available version of a base or prime rate, such as that published in The Wall Street Journal. Community bank customer familiarity with this rate will be particularly useful in facilitating MSLP loans and should bolster participation. We do not believe that the use of such a rate would increase systemic risk, which the Federal Reserve and other supervisors have rightfully sought to mitigate in promoting an orderly transition away from LIBOR.

ABA suggests that the Federal Reserve permit the initial, short-term use of LIBOR so long as the lending agreements contain fallback language consistent with either of the two transition approaches recommended by the ARRC. Furthermore, the Federal Reserve should also permit other rates, such as a publicly-quoted prime or base rate, when that alternative best fits the borrower’s needs.

c) Allow a Range of Tenors for MSLP Loans

Both the MSNLF and MSELF facilities contemplate loans with a fixed four-year maturity, which do not reflect the tenor needs of all borrowers. At the outset, some borrowers may simply be unable to service a loan of the size their business needs over a three-year amortization period (taking into account the one-year deferral of principal and interest). Though flexibility in amortization terms (e.g., less than full amortization based on level payments through maturity) could solve this problem in some cases, other borrowers would face the risk of refinancing in market conditions that are now impossible to predict. More broadly, full participation in the MSLP’s two facilities could lead to considerable future loan refinancing demand over a short period if all MSLP loans mature four years from now.

Other borrowers will face different concerns that could be mitigated by a shorter maturity loan. For instance, the MSLP’s required attestations limiting payments on other debt will inevitably require borrowers with other debt to negotiate concessions with their other lenders. These borrowers will have to convince their other lenders that the benefits of new MSLP funds outweigh any perceived increased risk from concessions borrowers need to comply with the MSLP’s restrictions on debt repayment. A shorter tenor for the MSLP loan may present an acceptable risk to other lenders who are unwilling to limit payments for four years. The option for a shorter tenor for MSLP loans could facilitate some borrowers’ participation, and in many cases may prove essential.

ABA suggests adjusting the MSNLF and MSELF to permit lenders to negotiate any tenor that matches their borrower’s needs, allowing any tenor that does not exceed six years.

d) Reduce the Minimum Permitted Loan Size

In setting a minimum loan size of $1 million, both facilities may prove inaccessible to many small business borrowers in need. In the markets that community banks serve, small businesses often have borrowing needs far below $1 million, even in healthy economic conditions. Many potential borrowers with a desire to obtain MSLP funds will have needs well below the current minimum level. Accordingly, many community banks that are prepared to extend loans to customers with borrowing needs of less than $1 million would find themselves unable, or less able, to participate in the MSLP.

ABA suggests that the Federal Reserve reduce the minimum size for Eligible Loans to $50,000.

e) Provide Greater Flexibility in Setting the Maximum Loan Size and Other Terms

The MSLP’s use of a borrower’s 2019 EBITDA to limit the maximum loan size for both the MSELF (6x EBITDA) and MSNLF (4x EBITDA) sets parameters that are not appropriate for many types of businesses. In the hospitality industry, which has been particularly hard hit by COVID-19, normal EBITDA calculations are often not the right measures for operating condition and performance. A test setting maximum loan size based on net operating income would better fit some business models. In other cases, such as restaurants, use of lease-adjusted leverage would be more appropriate. In still other cases, a debt-service coverage ratio or (in the case of loans under the MSELF, which may be secured) loan-to-value ratio, would be best.

Consideration of these different approaches, which are familiar to lenders and borrowers working with these business types, will significantly facilitate participation in the program by making it easier to calculate the proper maximum loan size. Any calculation difficulty or uncertainty in setting the proper loan size will reduce program accessibility or slow the distribution of funds. Using standardized EBITDA multipliers for borrowers across every industry will necessarily reduce MSLP lending to industries that do not rely on EBITDA measures or whose credit suitability is not accurately captured by EBITDA.

Moreover, even when EBITDA is an appropriate high-level measure to apply in loan size calculations, different “add-backs” to EBITDA are customary in different industries. Both the MSELF and MSNLF should reflect these add-backs. If the MSLP terms do not take account of these variations and apply a common EBITDA formula in calculating maximum loan size, some industries may be significantly and unnecessarily disadvantaged in their access to the program.
As noted above with respect to bank underwriting, banks’ credit decisions in connection with MSLP loans will require careful analysis. Though use of 2019 EBITDA (to the extent EBITDA is appropriate, as discussed above) will help focus on businesses that were demonstrably healthy prior to the pandemic’s onset, it may also present an incomplete picture of the borrower’s current credit condition. Greater flexibility in the calculation of maximum loan size will avoid inappropriate or excessive reliance on measures that do not reflect a borrower’s current condition, demand for funds, or ability to repay.

Finally, the terms of the MSELF provide that an Eligible Loan is an existing term loan. Many small and medium-sized business borrowers have existing revolving credit facilities for working capital and other purposes, but do not have existing term financing. Such borrowers otherwise suitable for the MSELF, and needing the amounts of credit it permits, would effectively be excluded from the program, or at least would receive significantly reduced funding.

ABA suggests greater flexibility in calculating EBITDA to accommodate the adjustments and add-backs appropriate to borrowers, including any present in existing lending agreements. In addition, the Federal Reserve should include existing revolving credit facilities within the MSELF.

f) Allow Greater Flexibility in the Required Attestations

The MSLP’s term sheets detail highly restrictive attestations concerning repayment of borrowers’ other debt of equal or lower priority, both to the Eligible Lender and to other creditors. In addition, the terms require restrictions on cancellation or reduction of other committed credit lines. These terms will obviously require the cooperation of an MSLP borrower’s other creditors, as well as changes to the Eligible Lender’s credit exposure. As noted above, a tenor as long as four years will likely cause heightened concerns among other lenders from whom borrowers require concessions in order to participate in the program.

Even with increased flexibility in MSLP loan tenors, however, the Federal Reserve should address other concerns such restrictions will raise. First, all lenders will monitor borrower financial condition and compliance with loan terms on an ongoing basis. Typical commercial loan terms provide for suspension of access to credit lines when the borrower’s financial condition deteriorates and options for declaring defaults under more extreme circumstances. The MSLP terms should make clear that when such terms are triggered, lenders’ options under the terms of existing credit agreements will not be constrained. The MSNLF and MSELF exceptions to permit “mandatory principal payments” are insufficient to resolve this concern.

The Federal Reserve’s debt repayment restrictions appear designed to encourage small and medium-sized businesses to access new credit under MSLP while ensuring that this extraordinary support does not enable a borrower’s existing lenders to withdraw from their exposure. Recognizing those aims, the Federal Reserve still needs to clarify that the attestations do not constrain the exercise of remedies under existing contracts, including those of the Eligible Lender. Any other result would effectively require subordination of all the borrower’s other debt to the MSLP loan. It is not clear that the MSLP intends that result, but a lack of clarity here could severely inhibit MSLP participation.

Finally, these required attestations appear to limit dividends and similar distributions to equity holders. Though intended to maintain healthy equity levels while MSLP financing remains outstanding, such blanket limitations will impose serious hardships on owners of small and medium-sized businesses organized as partnerships, Subchapter S corporations, limited liability companies, and other pass-through structures. Owners of these businesses incur current tax liability for the entities’ earnings, whether or not dividends or other distributions are declared.
Typical pass-through entity documents provide for cash distributions sufficient to permit the owners to pay these taxes, which they otherwise must cover from other funds.

Because many small and medium-sized business owners depend upon their business for their livelihood, they would face hardship by being prevented from receiving the cash distributions necessary to meet their tax obligations. It is common for dividend restrictions in credit agreements to include exceptions for such tax distributions, and allowing exceptions will further the MSLP’s objective of stabilizing small and medium-sized businesses as they cope with the COVID-19 pandemic. Otherwise, businesses organized as pass-through entities may effectively be excluded from the program.
ABA suggests clarifying that the required attestations concerning debt repayment do not impair existing remedies under loan contracts while also ensuring that the MSLP permits non-discretionary distributions (e.g. tax distributions) to enable broad participation for businesses that take different legal forms.

g) Clarify the Future Supervisory Treatment of MSLP Loans

Given the rapid deterioration in general economic and business conditions, some banks are concerned that any loans made in good faith to support borrowers in these particularly uncertain times will be subject to ex post criticism from bank examiners. This concern exists for both existing loans and MSLP loans, which will benefit borrowers facing clear pandemic-related stresses. The federal banking agencies have recognized this concern in other steps to address the economic hardships of the pandemic. Banks are ready to play their critical role in making MSLP funds available to their customers and communities, but they, like the supervisory agencies, recognize borrower needs will challenge many traditional supervisory practices.

ABA suggests that the Federal Reserve lead an effort to establish a public joint agency position emphasizing that loans under the MSLP will receive supervisory treatment that embraces the MSLP’s policy objective of providing emergency support to borrowers as they cope with the impact of the COVID-19 pandemic.

h) Clarify and Expand the Scope of Eligible Lenders

The language of the term sheets appears to limit participation in the MSLP to U.S.-chartered depository institutions and their holding companies. Experience with the PPP demonstrates that access to the MSLP through existing bank customer relationships will be critical to swift loan funding. Many small and medium-sized businesses have extensive relationships with foreign banking organizations operating in the United States through branches and agencies. Exclusion of these institutions from the scope of “Eligible Lenders” will disadvantage these businesses and frustrate the objective of the MSLP.

ABA suggests clarification or expansion of the scope of “Eligible Lenders” to ensure that U.S. branches and agencies of foreign banking organizations qualify as “U.S. businesses” and are able to act as intermediaries for their customers with regard to these facilities.

i) Preserve Pre-COVID Regulatory Tailoring Categorizations

Banks participating in the MSLP will retain new credit exposures on their balance sheets. This balance-sheet growth is an essential aspect of the program, but it will have potential regulatory consequences beyond credit exposure. In the past two years, the federal banking agencies have taken a number of important steps to implement the “tailoring” provisions of the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA). This important legislation made significant improvements to the regulations applicable to a variety of banking institutions, including fitting regulatory requirements to financial institutions of various classes based on size, complexity, and business model. 

The supervisory agencies have recently taken a number of positive steps to facilitate banks’ participation in programs to relieve COVID pandemic distress, such as neutralizing the capital impact of program participation. As banks extend credit under the MSLP, additional loans and retained interests will have further effects on their balance sheets, which, if unaddressed, may cause a change in the applicable category under the various tailoring rules adopted pursuant to the EGRRCPA. These category changes would be unwelcome and unnecessary complications for banks that choose to support the relief effort by underwriting loans through the MSLP. Similarly, participation in any other Section 13(3) programs could lead to this same unwelcome result. 

ABA suggests that the Federal Reserve and its federal banking agency counterparts confirm that balance sheet increases resulting from participation in any of the Federal Reserve’s Section 13(3) programs will not trigger changes in the applicable categories under the final tailoring rules mandated by EGRRCPA. 

III. Conclusion

ABA appreciates the opportunity to share our views on your laudable efforts to date in constructing the Main Street Lending Program. If you would like discuss further, please contact Shaun Kern at (202) 663-5253 ([email protected]) or Hu Benton at (202) 663-5042 ([email protected]).

Very truly yours,

Shaun Kern
Senior Counsel
American Bankers Association

Hu A. Benton
Vice President
American Bankers Association