William B. English
Professor in the Practice of Finance - Yale School of Management
Former Director of Division of Monetary Affairs - Federal Reserve
The Main Street Lending Program (MSLP), authorized by the CARES Act, provides loans to small and mid-size firms and large below-investment-grade firms that were financially sound before the onset of the pandemic. Extending credit can help some of these businesses manage the near-term drop in revenues, prevent unnecessary failures, and so support a recovery once the pandemic eases. The MSLP is a big step for the Federal Reserve and Treasury, given the risk of these loans and the legal constraints on Fed lending.
Domestic borrowers with fewer than 15,000 employees and less than $5 billion in 2019 revenues are eligible to apply; they account for a significant share of aggregate employment. Loans will be made by banks, who will retain 5 percent of the loan and sell the remaining 95 percent to one of three Main Street facilities. All Main Street loans have a five-year maturity, defer interest payments for one year, defer principal payments for two years, and have a loan rate of LIBOR plus 3 percentage points. Borrowers have limits on executive compensation, shareholder distributions, and employment.
The program has been revised twice in response to feedback. Still there are features that may limit take-up. We believe the current program would be more attractive and, thus, more effective if loan terms were more tailored to the characteristics of borrowers, the rigidity of fixed debt repayments was reduced, and lenders received more compensation for taking additional risks. We recommend the following:
- Loans to borrowers with higher credit quality should have a lower spread than loans to more-leveraged borrowers.
- Loans should have maturities of more than 5 years and more delayed repayments, but incentives for firms to repay earlier should be added.
- The minimum loan size for the New Loan facility should be reduced to reach smaller borrowers and encourage smaller banks to participate in the program. Loans to smaller and less risky borrowers also should have lower spreads and streamlined paperwork requirements.
- Banks should be allowed to extend loans to riskier borrowers if they retain a larger share of the loan to demonstrate their confidence in the credit.
- The condition that the borrower make “commercially reasonable efforts to maintain its payroll and retain its employees” should be clarified, so that uncertainty about it does not limit take-up, or eliminated altogether to make it easier for borrowing firms to reorganize their businesses.
- Compensation to banks should be increased to encourage their participation given the risk that new loans will be correlated with risks of existing loans, and to encourage more efficient loan workouts if there is a high level of delinquencies.
These changes would pose additional risk to the $75 billion that the Treasury has provided to cover any losses. However, it is critical to support businesses now. The downturn is very deep, and the risk of permanent harm to labor markets because of protracted high unemployment is large. Thus, the Fed and the Treasury should move quickly to adjust the terms of the program if take-up is low. Even with the recommended changes, however, the program may have limited demand because many businesses need equity, not more credit. Congress should be prepared consider other types of programs, such as loan guarantees or insurance, which, combined with lending, would promote a more rapid recovery in employment and limit long-run damage to the economy.
The authors did not receive financial support from any firm or person for this article or from any firm or person with a financial or political interest in this article. Neither is currently an officer, director, or board member of any organization with an interest in this article.
Report Produced by The Hutchins Center on Fiscal and Monetary Policy