MNI EXCLUSIVE: Take-Up on Fed's 'Main Street' May Fall Short

By Jean Yung

     WASHINGTON (MNI) - The Federal Reserve's USD600 billion Main Street lending

facility might attract only modest take-up because the current loan terms are

burdensome and unattractive to banks, former Fed officials told MNI, adding that

they expected significant changes to the program by the time it is rolled out.

     Its USD1 million minimum loan amount would exclude a slew of small

businesses, while its EBITDA-based credit metric would be inappropriate for many

borrowers including nonprofits and start-ups, they said. The interest rate of

2.5% to 4.0% above benchmark SOFR is high relative to other small business

loans, and borrowers must agree to restrictions on compensation, stock

repurchases and dividends.

     More importantly, the facility offers no downside protection or added

leverage for banks, serving only to amplify credit actions a lender would

already make based on its own risk appetite and assessment of customer finances.

That offers little new incentive to facilitate the flow of much-needed credit to

smaller businesses hurt by the COVID-19 pandemic.

     "I thought the terms of the program would be more favorable to borrowers,"

Nellie Liang, a former financial stability director at the Fed, told MNI.

     The Fed has launched a public consultation on the design of the program,

which the former officials expected to be significantly modified by the time it

is rolled out in early May.

     But, while more flexible and concessionary loan terms could encourage

higher participation, they would also increase government exposure to risk and

potentially require more loss-absorbing equity from Treasury, the ex-officials

said.

     "If Treasury provides USD75 billion in capital, the Fed has a legal

obligation to secure loans to its satisfaction, and will assess risks to

minimize its losses. I thought Treasury would have a higher risk tolerance for

the use of capital and they could offer more to small and mid-size firms," Liang

said.

     --RISK SHARING

     In contrast to the Paycheck Protection Program for distressed small

businesses, the Main Street facility is designed to dole out loans, not grants.

Thus banks play a crucial role in deciding how the money is allocated, based

largely on existing knowledge of their customers.

     "This program is designed from the get-go with the idea that the criteria

for borrowers and loans are just minimum requirements. Banks are not only

expected, but desired, to say no to some business applicants. That's an

important way to protect taxpayers," Bill Nelson, chief economist at the Bank

Policy Institute and a former deputy director of monetary affairs at the Fed

Board, told MNI.

     "It's a loan, not a grant, so they have to find a balance between offering

debt to companies that will actually benefit, versus situations where it will

just turn out to be a burden," Liang said.

     The Fed's proposed risk-sharing arrangement, in which banks retain 5% of

loans they make, sell the rest to the Fed and split gains and losses

accordingly, is designed to give banks some skin in the game. But for the

program to succeed, loan terms must work a bit to banks' advantage.

     --CHANGES EXPECTED

     Among potential modifications mentioned by former officials would be to

offer banks the option to wait before transferring the 95% share of a Main

Street loan to the Fed. This would create a powerful put that could incentivize

a higher volume of lending. Lenders would also be more willing to participate if

they are afforded some protection from default.

     The Fed could also voluntarily take on a structurally subordinate position

among a business's many creditors, for example by writing longer-maturity loans

that come due last. But that would increase the risk to taxpayers.

--MNI Washington Bureau; +1 202-371-2121; email: jean.yung@marketnews.com

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