September 4, 2020 – Joseph Heim was recently quoted in an article published by S&P Global Market Intelligence about the Federal Reserve’s Main Street Lending program.
Asset-based borrowers mostly shut out of Fed’s Main Street program
By: Polo Rocha
The Federal Reserve’s Main Street Lending Program is shutting out a significant chunk of U.S. mid-sized companies, excluding some whose pre-coronavirus business models make them appear too indebted.
The program’s restrictions have largely excluded companies that rely on asset-based borrowing, a financing method prominent in real estate but also used in a variety of other industries, including retail and manufacturing.
Those firms often borrow based on the value of collateral such as property, inventories, and other assets, but the measures used in asset-based lending do not fit neatly into the Fed’s Main Street program. Even if they did qualify for Main Street loans, companies looking to borrow from the program would face a major obstacle: Their existing lenders would be hesitant to dilute any claims they have on the company’s collateral if it goes bankrupt.
Those two reasons help explain why the take-up on the Fed’s $600 billion business loan program has been limited in its first two months, with only about $1.2 billion in loans made so far.
New Orleans-based HRI Properties LLC is among those left out under the program’s current terms. The company renovates historic warehouses and office buildings across the U.S. and turns them into hotels and apartments. It laid off approximately 1,000 employees after the pandemic caused a sharp drop in hotel bookings.
“I think it’s a great program, a great attempt, but it doesn’t really help industries that have been severely impacted,” President and CEO Tom Leonhard said.
‘Asset-rich but EBITDA-poor’
Leonhard’s company has been unable to take out a five-year Main Street loan due to the current eligibility criteria, which limits the program based on a company’s debt when compared to its EBITDA, a measure of pretax earnings. The restrictions ensure borrowers’ debt cannot be more than four or six times greater than their 2019 adjusted EBITDA when combined with a Main Street loan, depending on which loan option a company seeks.
Those safeguards are meant to shut out overly indebted companies, given that the Fed is limited in the losses it can absorb and has therefore focused on lending only to creditworthy borrowers. But debt-to-EBITDA measures are not commonly used in the real estate industry, where firms’ hefty property loans are paid off with several years’ worth of earnings.
Fed officials have said they are looking at ways to better capture the credit risks of asset-based borrowers. Examples of such borrowers might include a manufacturer financing its operations by using machinery as collateral; a clothing retailer borrowing based on its inventory; or a raw goods distributor taking out a revolving loan based on its accounts receivable.
Those borrowers are often “asset-rich but EBITDA poor,” said Richard Gumbrecht, CEO of the Secured Finance Network, which represents banks and nonbanks that engage in asset-based lending.
“Finding the right borrowers under the program as it’s structured today is a little like threading the needle,” Gumbrecht said.
Some asset-based borrowers are indeed too risky to meet the Fed’s mandate to lend to healthy companies, according to corporate finance lawyers and advisers. But others are healthy and prefer the flexibility of asset-based loans, including revolving credit lines that can be adjusted up or down throughout the year, said Joseph Heim, a partner at the accounting firm Dopkins & Co.