Leveraged loan issuers see little love for the Fed’s Main Street lending program

The Federal Reserve last week offered two credit facilities that will provide nearly $ 600 billion in loans to small and medium-sized businesses under the Main Street Lending Program. But a number of rules that limit the maximum leverage for companies that borrow under the program prohibit a large number of leveraged loan issuers from participating, a study by LCD found.

With a $ 75 billion Treasury Department investment in stocks, the Federal Reserve is committing up to $ 600 billion through the new Main Street loan and existing Main Street lending facilities. Under the new loan facility, a borrower can take a maximum of $ 25 million, and under the extension facility, an existing borrower can take a maximum of $ 150 million.

However, the new loan facility stipulates that a borrower cannot subscribe for any amount that would increase its debt to EBITDA ratio above 4: 1, in combination with debt outstanding and committed but not used.

The same rules apply to the existing credit facility, which caters to existing loan issuers looking to increase their transactions, except that the new debt-to-EBITDA ratio cannot be greater than 6: 1.

These leverage caveats will effectively limit many existing leveraged loan issuers from participating in either of the Main Street programs, based on a review of LCD data.

For example, the average pro forma debt / EBITDA ratio for M&A-related transactions in 2019 was 5.9x at the end of 2019, up slightly from 5.8x at the end of 2018. Thanks to synergies, the average leverage has slightly increased. decreased, to 5.5x. 5.6x, but synergies and additions will not be considered for the terms of the Main Street programs.

Some 51% of 2019 M&A loans had a pro forma debt-to-EBITDA ratio of 6x or more, based on unadjusted numbers, while the share of M&A transactions with a leverage of 7x or more increased at 24%, based on unadjusted EBITDA.

SNL Image
SNL Image

In addition, these EBITDA figures measure the total debt on the issuer’s balance sheet at the close of the loan. Typically, this does not include revolving lines of credit that are typically not used at close, which the Fed will include as part of the debt-to-EBITDA ratio measure, which will likely increase the ratio.

“From a borrower’s perspective, there are a number of challenges in the way the program has been structured, which makes it difficult for a typical American business to access, especially in terms of leverage. and determination, ”said Sartaj Gill, Chief Financial Officer. partner at Davis Polk. “My feeling is that many companies that are supposed to benefit from the program are out of the box based on the current program parameters. “

Other terms of the program

While regulated banks will make the qualifying loans, they will keep only a 5% share, selling the remaining 95% to the Fed’s Main Street facility. Only deposit-taking institutions, bank holding companies and savings and loan banks are designated as eligible lenders, which means direct lenders could not participate.

The unsecured loans under the programs will have a term of four years, and despite the title of the program, the loans are not designed exclusively for small businesses. The conditions allow borrowers to have up to 10,000 employees and a maximum of $ 2.5 billion in annual income in 2019.

Based on 2019 M&A deals, around 80% of leveraged loan issuers would qualify on income alone, but a much smaller percentage could ultimately qualify for Main Street liquidity due to leverage requirements.

“The eligibility criteria are broad, so the program should encompass a large portion of US businesses,” said Gill of Davis Polk. “But when you go into the details, you realize that if you haven’t met the myriad requirements for taking out a new loan, it’s unlikely that many businesses will be able to access the facility.”

The exclusion of some leveraged companies from the program is consistent with other concerns that privately funded companies will not receive public support for the current economic crisis. Recent news articles have highlighted how the private equity industry continues to pressure the US government to amend the Coronavirus Aid Relief and Economic Security Act after it emerged that many companies were wallet will not be able to access the Paycheck Protection for Small Businesses program of the law.

Yet others believe there should be a limit to government support for the economy, especially when high leverage investments are considered.

“Markets work best when participants have a healthy fear of losing,” Howard Marks, co-founder of Oaktree Capital Management, wrote in a note to clients on April 14. “It shouldn’t be the role of the Fed or the government to root it out. Some people argue these days that there is no way that those who have taken on leverage that has proven to be excessive could have anticipated a pandemic and the resulting damage to the economy. But unlikely (and even unpredictable) things do happen from time to time, and investors and businessmen alike need to heed this possibility and expect to bear the consequences.

The Federal Reserve is accepting comments on the Main Street loan facility and other programs related to COVID-19 until April 16.

This analysis was written by Alexander Saeedy, who covers CLOs and leveraged finance for LCD.

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