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April 10, 2020

Stroock Special Bulletin

By: Quyen T. Truong

On April 9, 2020, the Federal Reserve Board (FRB) announced major expansions of its corporate lending programs to address the needs of businesses, cities and states during the COVID-19 crisis. These measures include expanding the size and scope of the Primary and Secondary Market Corporate Credit Facilities to purchase certain debt issuances of highly rated firms, and establishing a Municipal Liquidity Facility to offer up to $500 billion in short-term loans to U.S. states, the District of Columbia, and eligible counties and cities. To increase liquidity for consumers and small to midsize businesses, the FRB is utilizing three primary avenues: the Term Asset-Backed Securities Loan Facility (TALF), the Paycheck Protection Program (PPP) Lending Facility, and the Main Street Lending Program. This bulletin discusses key aspects and implications of these latter facilities.

The TALF was created in the 2008 financial crisis and restarted on March 23, 2020, for the FRB to lend money to investors to buy securities that were newly issued from that date and collateralized by eligible servicing advance receivables, credit card receivables (both consumer and commercial), auto loans and leases, student loans, equipment loans and leases, floorplan loans, leveraged loans and certain loans guaranteed by the Small Business Administration (SBA). The FRB yesterday revised the terms of the $100 billion TALF to include triple-A rated tranches of both legacy commercial mortgage-backed securities and newly issued collateralized loan obligations, but to remove servicing advance receivables.

The removal of servicing advance receivables from the list of eligible debts at first glance may appear to be a blow to loan servicers, on the heels of Federal Housing Finance Agency Director Mark Calabria’s April 7, 2020, statement that a liquidity facility for servicing advances is unnecessary given an alleged lack of evidence of widespread forbearance on loans backed by Fannie Mae and Freddie Mac. Rather than signaling an abandonment of loan servicers, however, we anticipate that the FRB ultimately will provide more focused relief for servicers, after further observation of the scope and impact of debtors’ utilization of the expansive forbearance options provided by the CARES Act.

Focusing on small businesses, the PPP Lending Facility enables the FRB to extend credit on a non-recourse basis to depository institutions that originate PPP loans guaranteed by the SBA, taking the loans as collateral at face value. Based on its recent statements, the FRB will extend eligibility to other PPP lenders in the near future. There are no fees associated with the Facility, but these loans will have a rate of 35 basis points. The FRB did not state the size of this Facility, which will remain open until September 30, 2020. Although the FRB’s promised extension of credit provides additional support for the PPP, potentially expanding lending availability for small businesses, the continuing lack of adequate government guidance regarding the PPP is likely to be a persistent drag on implementation and present litigation liability exposure beyond the scope of the FRB’s Lending Facility to address.

While the forgiveness components of the PPP essentially offer small businesses (generally with up to 500 employees) “free money” to meet their payroll, mortgage, rent and utilities needs during the COVID-19 crisis, the Main Street Lending Program is a $600 billion traditional lending program for small to midsize businesses (up to 10,000 employees or 2019 annual revenues up to $2.5 billion).  Moreover, the FRB’s current term sheets for the Main Street Lending Program do not contain the affiliate limitations of the PPP, thus potentially opening the door to a larger range of businesses, including portfolio companies of private equity firms and holding companies. Companies that receive PPP loans also can obtain additional credit under the Main Street Lending Program. Under current schedules, PPP loans can be made through June 30, 2020, while the FRB will continue to purchase loans under the Main Street Lending Program until September 30, 2020, and will continue funding until the underlying assets mature or are sold.

Loans under the Main Street Lending Program have four-year terms, with principal and interest payments deferred for one year and no penalty for prepayment. The minimum loan size is $1 million. The maximum amount for a new loan is the lesser of (i) $25 million or (ii) an amount that, when added to the borrower’s existing outstanding and committed but undrawn debt, does not exceed four times the borrower’s 2019 EBITDA.  The maximum amount for expansions of an existing term loan is the lesser of (i) $150 million, (ii) 30% of the borrower’s existing outstanding and committed but undrawn bank debt, or (iii) an amount that, when added to the borrower’s existing outstanding and committed but undrawn debt, does not exceed six times the borrower’s 2019 EBITDA.

Borrowers must pay the lenders a 100 basis points origination fee and likely also will be required to pay the 100 basis points Facility fee for new loans. The special purpose vehicles (SPVs) created under the Main Street Loan Program facilities will pay banks a 25 basis points servicing fee. The adjustable interest rate will equal the Federal Reserve’s Secure Overnight Financing Rate plus 250-400 basis points.  (PPP lenders receive a 5% fee for loans under $350,000, 3% for loans between $350,000 and $2 million, and 1% for loans of $2 million or more – thus collecting higher fees on smaller balances for the shorter one-year term, as compared with the four-year loans under the Main Street Loan Program.) The FRB’s term sheets leave uncertainty regarding how the adjustable interest rate will be set, highlighting future litigation risks and the need for significant additional government guidance on this and other issues of program implementation (although the threat of confusion and delay is significantly lower under the FRB’s facilities than under the PPP).

Borrowers and lenders considering participating in the Main Street Loan Program will need to scrutinize their other credit arrangements carefully in light of the Program’s attestation requirements. Among other items, borrowers must attest that they require financing to maintain payroll and retain employees during the term of the loan, will not use the proceeds to repay other loan balances, and furthermore will not repay other debt of equal or lower priority, except for mandatory principal payments. Borrowers also would be subject to restrictions on stock buybacks, dividends and executive compensation. The lender must attest that “it will not cancel or reduce any existing lines of credit outstanding to the borrower.”

Besides the Main Street New Loan Facility, banks may use the Main Street Expanded Loan Facility to increase the size of existing loans to businesses. Banks must retain a 5% share of the loan, while selling the remaining 95% to the SPV at par value with risk shared on a pari passu basis. The 5% retention requirement increases incentives for banks to focus lending on their existing customers, particularly those with lending relationships, to limit underwriting risks. At the same time that this approach raises risks of enforcement actions or private litigation (like the class action filed on April 4, 2020, against one bank for limiting its PPP loans to existing borrower customers), the retention requirement provides business justification for banks to focus lending under this program on its existing customers.

We will be discussing litigation and enforcement risks to the financial industry flowing out of the COVID-19 crisis in the coming week, in addition to continuing our close monitoring of legal and market developments.


For More Information

Quyen T. Truong

This Stroock publication offers general information and should not be taken or used as legal advice for specific situations, which depend on the evaluation of precise factual circumstances. Please note that Stroock does not undertake to update its publications after their publication date to reflect subsequent developments. This Stroock publication may contain attorney advertising. Prior results do not guarantee a similar outcome.