By Jon Hill

Law360 (September 9, 2020, 11:05 PM EDT) -- The Federal Reserve's Main Street Lending Program is falling short in its mission of providing support for financing to midsized businesses that are struggling during the coronavirus pandemic and needs urgent changes, members of the U.S. Senate Banking Committee heard Wednesday.  

A trio of representatives from industry, labor and academia told senators that the emergency lending program's design is overly risk-averse, with the result that only a little more than $1 billion of its $600 billion lending capacity has been tapped after two months in operation. Unless the rules surrounding the program are relaxed, countless companies could be shut out and wind up having to shut down, the witnesses warned.

"These Main Street businesses need assistance," Jeffrey DeBoer, president and CEO of the Real Estate Roundtable, said. "They are risky, but not because their product or their business line is risky. They're bearing a huge, somewhat immeasurable new risk, and it is based on governmental policy, the ability to keep clients, customers and guests healthy, and in particular, the timing of finding a vaccine."

"These are the businesses that Congress wanted the Main Street Lending Program to serve," DeBoer continued. "They can't get capital elsewhere. They are disproportionately minority-, women- and veteran-owned businesses, and they are increasingly running out of options."

The Main Street Lending Program is one of an array of Fed initiatives intended to help mitigate financial strains created by the COVID-19 pandemic and is backed with a $75 billion equity investment from the U.S. Treasury, drawing on funding authorized by the Coronavirus Aid, Relief and Economic Security Act.

The program, which consists of several individual loan facilities and has been tweaked several times since it was unveiled in the spring, generally aims to facilitate the flow of credit to nonprofits and for-profit companies by purchasing qualifying loans from participating lenders.

To qualify, a borrower must meet certain eligibility requirements, like having no more than 15,000 employees or $5 billion in 2019 revenues. A loan must also fit within certain size parameters, ranging from $250,000 to up to $300 million, depending on the facility, and it must have certain features, like a five-year maturity, two-year principal deferral and an adjustable interest rate of Libor plus 3%.

In addition, participating lenders must hold on to a small piece of each loan they sell to the program, ostensibly helping to promote discipline on the part of lenders by ensuring they shoulder some of the credit risk.

But with the program off to a relatively slow start, witnesses at Thursday's hearing called for the Fed and Treasury to broaden its eligibility rules, make its loan terms more attractive to potential borrowers and scrap its risk retention requirement, arguing that such reforms are need to maximize its impact before it is set to stop purchasing loans at the end of the year.

"These facilities were not designed to take on credit risk," testified Hal Scott, emeritus professor at Harvard Law School and president of the Committee on Capital Markets Regulation. "If you say the banks have to take 5%, they're going to apply normal credit standards and needy businesses are not going to get the money."

DeBoer echoed Scott's point, saying that the program's risk retention requirement acts as a disincentive for participating lenders to extend credit to the borrowers that need it the most.

"Traditional underwriting criteria would say these are risky loans," DeBoer said. "[Banks] get criticized by regulators for doing that ... so we share the view that 100% of the loan should move to the Fed facility."

Other changes DeBoer recommended included expanding borrower eligibility to include real estate companies and adjusting the metrics used to determine a borrower's maximum eligible loan size.

"We need to deal with inappropriate leverage limits that hamper the usefulness nearly to all retail stores and restaurants," DeBoer said. "The underwriting rules that are in place now simply do not work for any asset-based borrower, whether that's a manufacturer, restaurant, retail, commercial or multifamily owner."

William Spriggs, a Howard University economics professor and chief economist of the AFL-CIO, agreed that the program's design has made it "unable to absorb the risk that was needed in a time of high uncertainty."

Concerns about the effectiveness of the Fed's emergency lending efforts have been shared by lawmakers including Sen. Mike Crapo, R-Idaho, chairman of the Senate Banking Committee, who last month proposed legislative language that would clarify those efforts should prioritize helping eligible borrowers "even if ... such loans, loan guarantees or investments may incur losses."

That proposal got a boost Wednesday from Scott, who singled it out as a way to set the stage for looser Main Street Lending Program rules because it would "remove any doubt Congress's intent in enacting the CARES Act was for the Treasury to take credit risk."

Short of that, Scott said Crapo's committee should consider sending a letter to that effect directly to Treasury Secretary Steven Mnuchin. Uncommitted CARES Act funds could also be redeployed as additional cushion against potential losses, according to Scott.

"There is no guarantee that our recommendations will succeed in saving American small- and medium-sized businesses," Scott said. "But the current approach has been tried and found wanting. Our recommendations would give many of these businesses a fighting chance. The time to act is now."

--Editing by Breda Lund.

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