The Federal Reserve launched its $600 billion Main Street Lending Program on Monday to provide bridge financing to midsize firms that have been hurt by the COVID-19 pandemic.
In our estimation, the program over time will turn into an extraordinary opportunity for middle-market firms that seek to finance restructuring, innovation and growth in the post-pandemic economy.
For many midsize firms, the program will level the playing field to obtain financing that supports their revitalization.
Initially, the U.S. Treasury expects that roughly 30,000 firms meet the revenue and employee criteria to participate in the program. We think the recent expansion of the program will bolster participation of middle-market firms.
While we understand that the MSLP comes with conditions – which we view as too strict for some of our clientele — we think that this initiative will result in an extraordinary opportunity. For many midsize firms, it will level the playing field to obtain financing that supports their reinvention, revitalization and recovery.
We strongly urge our clients to follow this one-of-a-kind lending program for further changes to the term finance or broader participatory framework that underscores the program.
To be sure, the launch of the MSLP will be the most scrutinized initiative by the federal government to put a floor under the economy since the introduction of the Small Business Administration’s Paycheck Protection Program on April 3 as part of the CARES Act.
Should the uptake not be what the central bankers want, there is ample room for reform of the program’s basics: term finance of 3% plus LIBOR; timing of repayment; limits on executive pay, dividend payments and stock buybacks; and a minimum loan application of $250,000 ($300 million maximum).
Liberalization of the basic terms would surely result in greater demand for access to what we believe is a nascent financial market for firms previously shut out of capital markets. Midsize firms typically have a difficult time borrowing at anything less than 15% that reflects a risk premium that is often not in touch with the financial condition and economic prospects of rock solid middle-market firms.
Basic proposition: Financing without punishing risk premiums
One of the more interesting points of feedback we have received from middle-market clients is that they can get better terms on lending from the shadow market. We would seriously doubt that the median midsize firm could actually obtain such financing. Why is that?
First, that most likely pertains only to a small circle of firms with revenues in excess of $1 billion or a small circle of middle-market financial services firms with revenues near $2 billion. It is hard to take seriously that the vast majority of smaller firms that are in need of either bridge financing or that are looking to restructure can find terms better than three percentage points plus LIBOR.
A typical midsize firm that could be financed in the shadow market would face a significant risk premium for any type of lending, much less over a five-year term with no repayment of principal for the first two years and interest for the first year. One gets the notion that when the financial media discuss term financing surrounding the program, that the media will not fully understand the terms that the traditional midsize firm faces.
Second, we think that statement of “better terms” is directly linked to the conditionality surrounding program participation. Yes, an opportunity for the “free money” that some small firms could obtain inside the Paycheck Protection Program would be optimal. But that is not in the cards here. Some of the conditions attached to lending are likely to change as the program evolves. We are less than three months into the crisis and it is natural that there will be further policy improvisation going forward.
Bridge financing: Impaired firms and the economy
During the most intense period of the economic free fall between March and May, it was clear that there was a desperate need for bridge financing at terms favorable to what one can find on the market. That is still clearly the case. More than 44 million individuals have lost employment and income in less than three months. Income growth in May excluding government transfers collapsed by a record 6.3%. Unemployment insurance that provides an extra $600 per week to those who have recently lost their job runs out at the end of the July.
While the free fall of the economy ended in mid-April, the economy and the middle market will remain impaired for some time. It is critical that midsize firms know have a legitimate and sound series of potential lenders to turn to during the extended period or reconstitution and recovery that will define the economy in coming years.
There are clearly impaired midsize firms given the carnage across all industrial ecosystems. Many will need bridge financing that the banks would not make without the $600 billion Federal Reserve backstop and its commitment to purchase 95% of the loans made by participating lenders. Most important, the risk premiums on those loans are far superior to anything that will be found in the shadow financial market.
The long term: A financial market for midsize firms
Middle market firms have traditionally been prevented from obtaining capital in the bond market for a host of reasons. The creation of the Main Street Lending Program represents the first modern attempt to create a market for firms that constitute the beating heart of the real economy.
The Federal Reserve is acting in its own enlightened self-interest to create such a market. The policymakers at the central bank clearly understand that the magnitude of the shock that is still reverberating through the economy will result in an unnecessary explosion of bankruptcies of firms that comprise the real economy.
Moreover, this is the first time that the federal government during either the financial crisis or the pandemic has attempted to put forward direct major financial support for Main Street. This program was designed and constructed to last more than one year.
This program will most likely play a major role in the post-pandemic economy and will provide a unique opportunity for firms to fund the type of innovation and reinvention that will be necessary to thrive in an American economy that is experiencing a fundamental structural transformation.
For more information on how the coronavirus is affecting midsize businesses, please visit the RSM Coronavirus Resource Center.