A midsize manufacturer forced to shut down production for two months. A regional restaurant chain surviving on takeout service and sharply lower revenue. A hotel struggling to stay afloat until Americans start traveling again.
Tens of thousands of midsize businesses left out of massive government rescue programs for small and large companies amid the COVID-19 pandemic are finally getting their lifeline.
The Federal Reserve’s Main Street Lending Program for small and midsize companies battered by the outbreak got off to an encouraging start last week after months of delays, with more than 200 banks registering.
“We’re seeing a steady stream of lenders signing up,” Boston Fed President Eric Rosengren, who is overseeing the initiative, said in an interview. Responding to critics who fear lukewarm interest in the program from banks and borrowers, he added, “We wouldn’t be seeing them sign up if they weren’t planning on lending.”
The $600 billion initiative, announced in March, is intended to fill the gap between the wildly popular Paycheck Protection Program (PPP), which provides forgivable loans to small businesses, and the huge bailouts and corporate bond markets available to large companies.
But the program puts the Fed in the unprecedented and daunting role of a lender, prompting the agency to establish standard loan criteria for thousands of borrowers and manage risk so it doesn’t suffer big losses.
“This is an extraordinary action reflecting the nature of the pandemic,” Rosengren says.
Some economists, however, criticize the program’s cookie-cutter approach and say it should be better tailored to businesses based on their needs and creditworthiness.
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Filling the gap
Firms with fewer than 15,000 employees or less than $5 billion in revenue are eligible for a Main Street loan. A bank makes the loan and then sells 95% of it to the Fed, reducing its risk during a highly uncertain crisis and removing the loan from its books so it can lend to other companies.
The Fed recently lowered the minimum loan amount to $250,000 and raised the maximum to $35 million to open the program to more firms. To reduce monthly payments, loan terms were extended from four to five years and principal payments now can be deferred for two years, up from a year.
The slightly more than 3% interest rate, however, may not be a bargain. By comparison, PPP loans carry a 1% rate, cover eight weeks of payroll and other expenses, and are forgivable as long as the business keeps or rehires its workers. That $660 billion program has been geared to businesses with fewer than 500 employees, many of which had enough cash to survive just a few weeks.
The Main Street program is aimed at mostly midsize companies that presumably have more financial resources. Yet many, especially those with little or no revenue, have struggled to obtain loans from banks that are wary of defaults with the economy mired in one of the deepest recessions in history, marked by more than 40 million layoffs and furloughs, and a 13.3% unemployment rate.
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There are 110,000 firms with 100 to 10,000 employees, according to a Brookings Institution analysis of Census Bureau data. They employ about 50 million workers, or about 40% of U.S. payrolls. The loans could allow many to avoid bankruptcy and hold onto their workers as states gradually let businesses reopen, helping minimize long-term damage to the economy. The economy is expected to rebound quickly the second half of the year but experts say it will take a few years to recover all the lost jobs.
Loans may not attract some firms
But a loan that must be repaid may not cut it for a business that doesn’t know how quickly its revenue will return and worries about a second coronavirus wave in the fall, some experts say.
“The hole is too big to cover with a loan” for many companies, says Nellie Liang, a former Fed economist and a senior fellow at Brookings.
In a recent Brookings paper, Liang and former Fed economist William English argue the Fed should:
• Allow loan terms of more than five years to further trim monthly payments.
• Offer lower interest rates to borrowers with better credit.
• Let banks lend to riskier borrowers if they hold onto a larger share of the loan.
• Ease or possibly scrap a requirement that businesses make “commercially reasonable efforts” to keep employees. Some may need to cut staff amid lower sales but then hire again after sales rebound.
• Offer banks higher fees to make the loans.
“If you want to help some firms, you probably need to be more generous,” Liang says. “Why isn’t the program more tailored? Why does the firm with 100 employees have the same terms as the firm with $5 billion in revenue and 15,000 in employees?”
Even with those modifications, bank and borrower response to the program could be tepid, Liang says. Banks may lend to solid borrowers anyway and avoid risky ones even with the Fed’s aid, she says, though the program could become more appealing if the recovery is weak or there's a second wave of the virus. If demand stays sluggish, she says, Congress should consider allowing portions of some loans to be forgiven.
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Boston Fed chief Rosengren, however, says, “The changes we made ... address many of those concerns,” citing longer loan maturities, for example.
Trying to limit risk
“The only solution can’t be free money,” he adds. “It’s a lending program and there’s a trade-off in how much Congress gave us to potentially lose against how we can structure it to help as many businesses” as possible avoid layoffs. “I think we set a reasonable balance.”
The Fed, he says, is targeting financially solid firms that are going through a temporary disruption and are likely to bounce back as the economy thaws from its deep freeze. Even so, he said, "If there's a bad outcome in the economy we may ... have very substantial losses."
The Treasury Department is providing the central bank $75 billion to cover possible losses.
Rosengren also said the Fed can’t customize the program for different borrowers because for the first time it will be partnering with banks in overseeing thousands of loans. The large volumes demand uniform terms. “It’s trying to standardize a nonstandard product,” he says. “We are doing this in a very automated way. We’re not hiring thousands of people to underwrite and close loans.”
For other emergency programs, the Fed has purchased securities made up of loans, or announced its willingness to buy loans, but not purchased loans directly.
“I’m highly confident that we will do plenty of lending,” he added. “It is risky lending. It is a nontraditional role for the Fed. But, I think given the pandemic, it is an important role.”
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