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The Fed makes improvements on Main Street
admin | May 1, 2020
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
The Fed has taken another step toward setting up shop for the first time as a direct lender to business, and markets in high yield debt, leveraged loans and CLOs should get a lift from the effort. The central bank widened the scope of its Main Street New Loan Facility and its Main Street Expanded Loan Facility and introduced a new Main Street Priority Loan Facility designed to let the Fed lend to smaller but more highly leveraged businesses. The facilities together allow the Fed to buy up to $600 billion of participations in bank loans to businesses with debt of as much as four times to six times annual gross earnings. The Fed still has yet to buy its first loan, but it seems determined to get money to a distressed sector, and that is a big plus for leveraged credit.
Among some of the more notable changes announced by the Fed on April 30:
- Eligible lenders expanded beyond banks and savings and loans to include holding companies and the US arms of foreign banks
- Eligible companies expanded beyond those with up to 10,000 employees or up to $2.5 billion in 2019 revenues to include companies with up to 15,000 employees or up to $5 billion in 2019 revenues
- The Fed lowered the minimum loan size in the MSNLF and MSPLF from $1 million to $500,000, keeping the maximum loan size at $25 million; the Fed kept the MSELF minimum loan size at $1 million and raised the maximum from $150 million to $200 million
- The Fed set the cost of funds at 1- or 3-month LIBOR + 300 bp
- The Fed clarified that loans could be secured or unsecured as long as the Fed’s loan did not end up contractually subordinated to other debt in bankruptcy
- Loan originators have to retain their participation in the loan either until it matures or the Fed sells its participation, whichever comes first
- If borrowers had existing loans with the lender at the end of 2019, the loans had to have a “pass” rating under bank regulations, and
- Borrowers under the MSPLF, but only under the MSPLF, can use loan proceeds to repay debt owed to an entity other than the lending bank
Yesterday’s announcement included other changes designed to broaden eligibility and clarify terms (Exhibit 1).
Since the average leveraged loan made in 2018 and 2019 had a ratio of debt to EBITDA of slightly more than 5x, a majority should fit at least the leverage requirements of the Fed’s program. Some borrowers may find the Fed’s loan helps bridge temporary earnings shortfalls brought on by local or national limits on public gatherings or other factors. Other businesses may still face persistent earnings shortfalls, but the requirement that loan originators retain risk should limit lending to the weakest prospects. The Main Street programs will not rescue businesses with little prospect of returning to sufficient profitability.
The Fed still faces execution risk. That includes challenges in getting banks to originate the loans, in getting existing creditors to allow borrowers to add debt and in setting terms that will encourage borrowers to take the loans (see Execution on Main Street). Main Street has potential to help many although not all and still looks like a broad positive for credit.
The Main Street facilities are the first foray for the Fed into territory normally served by banks and the high yield debt and leveraged loan markets. Before the COVID-19 crisis, the Fed had only invested in Treasury or agency debt, in agency MBS, in other highly rated securities, had made loans against highly rated securities or had made loans to banks or foreign central banks.
The facilities target a corner of the economy that has become steadily more important. Outstanding leveraged loans have doubled from $600 billion in 2008 to $1.2 trillion today. As a share of GDP, the market has gone from 4.0% to 5.5% and provides funding across a wide range of industries to companies from the obscure to the internationally known.
A link to a summary description of all Fed efforts to address the COVID-19 crisis is here. An excerpt summary of the Main Street facilities is below.
Exhibit 1: The Fed’s new businesses on Main Street
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