"I remember standin’ on the corner at midnight, Tryin’ to get my courage up."
-Bob Seger, "Down on Main Street"
With the stress and lingering fallout from PPP still fresh on their minds, bankers must now decide how (or if) they will use the next round of federal help: the Main Street Lending facilities. In our daily conversations with them, bankers have expressed some reluctance about signing up for another round of government forms and potential public backlash.
But if bankers can “get their courage up,” we believe there are some compelling reasons why the Main Street program is worth participating in.
First, Some Details
We’ll start with a brief description, for a somewhat surprising reason; lots of bankers are telling us they haven’t even taken the time to review the Main Street Lending term sheets. That’s understandable, given the overwhelming PPP volume and the fact that the Fed just released an updated set of term sheets on April 30. But no matter how busy you’ve been, and no matter how frequently the government changes the rules, the time to prepare is now. Your bank must be ready to participate in this program, taking steps to prepare systems and prioritize customers - starting yesterday.
The short version is that like PPP, the Fed is relying on banks to operate the program, but this time without the SBA. Banks will make four-year loans to businesses that had up to 15,000 employees or $5 billion in revenues in 2019. The banks will then sell from 85% to 95% of each loan to the Fed and keep the remainder on their own balance sheets.
The biggest differences from PPP:
- The loans are actually loans, that must be fully repaid.
- All details of the program (including borrower names, amounts, and pricing) will be made transparent to the public.
This table from the Fed’s April 30 press release
is a great summary of the three Main Street options and their high-level terms:
With that background out of the way, let’s turn to the reasons why Main Street should matter to your bank.
It May Be the Only Game in Town
The markets are frozen, and there is now no such thing as a “business as usual” loan. The reason is simple. We have never faced a credit event quite like this before. Borrowers are asking for help and additional funding, but this crisis has unfolded in a matter of a few chaotic weeks, and it is still far from clear how the economy will bounce back in the coming months.
It is impossible for banks to tell the difference between a borrower facing a liquidity crisis and one facing a solvency crisis. Banks are understandably reluctant to extend their balance sheets into that degree of uncertainty. The Main Street program will serve as the only viable option until markets return to a level of normalcy, or additional government programs are announced.
Your Customers Still Need Help
Most of the country remains in lockdown orders, more than 30 million Americans have lost their jobs, and we are seeing frightening delinquency and forbearance rates across all asset classes. There are implosions happening with your customers right now. They need relief, and the Main Street options, with one year of deferred payments and reasonable rates, can offer some.
It’s an Opportunity to Mitigate Risk
While your customers are in a precarious position, your “pristine as of two months ago” middle market credit portfolio is likely no different right now. Main Street loans offer your best chance at a workout.
The following example illustrates why we believe the Main Street program will be widely used.
A Main Street Use Case
Let’s assume you have an existing middle market customer that is in good standing, and currently has total loan balances of $10 million with the bank. This borrower has now approached the bank saying they need significant liquidity ($3 million) to continue operations.
Let’s further assume, to be conservative, there are no obvious assets to use as collateral. The bank has three obvious options: do nothing, advance them funds in the usual way, or use the Main Street Facilities to advance funds.
The diagram below outlines the expected loss under each scenario. It assumes the borrower has a probability of default of 20% now, and assumes the new funds reduce that probability to 15%:
This simplified example shows that using the Main Street facilities can both drastically improve the odds your customer survives AND limit the bank’s exposure.
There are two key questions to answer: How much additional funding does the borrower need, and by how much will that change their probability of default? Running the above scenario through some stress testing yields this chart:
It is possible, of course, that adding to your customer’s debt burden will actually increase their probability of default. That is the impact you see on the left side of the chart; higher probability of default leads to higher expected losses when using the Main Street program.
However, most of the scenarios show an improvement in outcome. In fact, the breakeven change in probability is to reduce it by just 4.25%. Put another way, a loan with a 20% probability of default would only need to be dropped down to 19.15% probability to break even. It doesn’t take much to be money good with these programs.
How likely are the funds to reduce probability of default? That is for the bank to determine, but in general they’ll be looking at any business that was in a strong position before the pandemic, and that should remain solvent after the things return to some level of normalcy. Again, all payments on Main Street loans are deferred for one year, so you should be able to provide enough liquidity to get through the worst economic fallout, and then have a viable business on the other side.
The Loans Can Be Booked with Positive Returns
To be clear, the Main Street Lending program is not designed to be a money-making scheme for banks. You are taking on real risk, and you are expected to underwrite and process these just like any other loan, so there will also be real overhead involved.
However, the terms are such that even when unsecured, the loans should generate positive risk-adjusted income. As you can see from our example below, you won’t get rich doing Main Street loans, but it is a reasonable deployment of the bank’s capital, when you will need all of the earnings help you can get.
Get Going, Now
If you think there’s a compelling case for your bank to participate in the Main Street Lending programs, there’s no time to waste. While we don’t expect the same “land rush” scenario as PPP, the program does have finite funds available and a ticking clock.
Take a proactive approach by identifying your customers that are likely candidates for one of the Main Street funding options. Focus on these two questions.
- How much cash is needed and can be supported by the EBITDA requirements (which are more generous than a typical bank credit policy)?
- How much does that cash + 1 year of deferred payments reduce the probability of default?
Once you’ve compiled your list of likely options, begin reaching out to them. While it’s a stressful time, there’s never been a greater opportunity for banks to fill the role of trusted advisor for their clients.
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