4 Risks of the Fed’s Main Street Lending Program
The program, first announced on March 27 as part of the $ 2.3 trillion Coronavirus Aid, Relief and Economic Security Act (CARES), aims to provide loans at relatively low interest rates to businesses with up to 10,000 employees. The program is expected to support up to $ 600 billion in new loans.
Despite the favorable terms, these are still loans, so they require careful consideration before applying. Here are four things you should know:
1. They are not forgivable.
Unlike the loans backed under the $ 349 billion PPP, the Main Street loans must be repaid in full. The loans have a four-year term and variable interest rates which currently vary between 2.5% and 4%. Main Street loan borrowers can defer their principal and interest payments for one year.
2. Loans are big, maybe too big.
The amount of debt that businesses are allowed to take on under the Main Street loan program is much higher than usual, says Chuck Morton, partner and co-chair of the Venable Group of Companies, a firm of attorneys based in Washington, DC. Banks typically prefer to lend about two and a half or three times a borrower’s profit before interest, taxes, depreciation, and amortization (EBITDA).
Under the Main Street program, the maximum loan amount is four times EBITDA or six times EBITDA, depending on the facility chosen. (The program supports two – one for new loans and one for borrowers who have an existing loan from a particular lender. It is not clear whether a borrower who has an existing loan should resort to the last one. of both facilities.) company had EBITDA of $ 2 million in 2019 and no debt, a lender would normally approve a loan of $ 5 or $ 6 million. A Main Street loan could be as high as $ 8 million or even $ 12 million.
Historically, banks have been reluctant to let companies become so in debt for fear of not getting their money back, Morton says. So, just because you can take out such a large loan doesn’t mean you should. Think carefully about what your business will be able to handle. “The decision for any business to take on the amount of debt possible under the Main Street program, which you have to pay off in four years at interest rates not much better than what they could get commercially,” is a very different decision. calculation, ”Morton says.
3. Some lenders might not like them.
Even though borrowers have existing loans, the way the advice is worded suggests that they will have to pay off their loans on Main Street first, notes Ami Kassar, founder and CEO of MultiFunding, a small business loan adviser based. in Ambler, Pa. Although you are specifically prohibited from using the loan proceeds to repay or refinance existing debt, you must also first repay your Main Street loan before repaying other loan commitments that have equal priority or lesser. There is an exception for mandatory capital payments.
It’s unclear what level of priority these Main Street loans will be given over a borrower’s existing loans and the ambiguity of the terms doesn’t help that issue, Morton notes.
4. Compensation and distributions will be limited.
According to the termsheets, Main Street loan borrowers must adhere to all PPP restrictions on compensation, share buybacks, and capital distributions for the life of the loan, plus one year. This means that borrowers cannot pay dividends or other distributions of capital during this period. This should not affect payments to owners of flow-through entities who might be able to increase their wages with dividend payments, says Morton, who notes that the dividend clause applies to common shareholders and, presumably, holders of dividends. ‘other shares considered to be equivalent to ordinary shares.
There are, however, compensation restrictions to note: Main Street loan holders are required to freeze the salaries of employees who earn between $ 425,000 and $ 3 million in total annual compensation. According to Morton’s reading of the CARE Act, they cannot receive, over a 12-month period, total compensation greater than their 2019 total compensation. For employees who earn more than $ 3 million, their compensation is capped. at $ 3 million plus 50% of their 2019 compensation over $ 3 million. So if an employee earned $ 7 million last year, depending on the loan terms, that employee cannot receive more than $ 5 million in total compensation.