Fed’s Expanded Lending Plan Leaves Private Credit in the Cold

(Bloomberg) -- The Federal Reserve's expanded Main Street Lending Program will do little to help private credit firms step in as lenders to some of Americas small and mid-sized companies.

The Fed expanded the scope of the program Thursday to enable firms with higher revenues and more employees to access financing, while a third loan option was added that will allow companies with higher debt loads to be eligible. A start date for the $600 billion plan will be announced soon, the Fed said in a statement.

But the support doesn't apply to the $800 billion private credit industry, including direct lenders and business development companies, because they don't fall under the Fed's regulatory purview. Some had hoped that the Fed might incorporate the lenders after receiving feedback from businesses since the initial plan was rolled out earlier this month.

“It has to be disappointing to that industry, but not entirely surprising,” said James Kaplan, partner at law firm Quarles & Brady LLP. “They're not regulated by the Fed, they're not familiar to the Fed and the Fed seems confident it can do this through the traditional financial institution lenders.”

It's not a disaster for shadow banks as they're sitting atop nearly $300 billion in cash, and have shifted their focus away from financing buyouts to a more patient approach amid havoc caused by the coronavirus pandemic.

Yet the companies they lend to still need help. To that end, a new option available to small and mid-sized firms under the wider Fed program is getting additional loans from banks to help see them through the pandemic that has shuttered businesses and sent revenues into freefall.

Borrowers will now be able to count adjusted earnings, which they've been using in droves and make profits look rosier. That will make it easier to meet criteria under a new loan option whereby lenders would retain a 15% share of loans that when added to existing debt do not exceed six times earnings adjusted for interest, taxes and depreciation.

Many mid-sized companies may qualify for that option as well as the previously announced expanded loan facility. In 2019, middle-market borrowers on average carried net total leverage of 5.25 times, according to Covenant Review.

As companies consider that a recovery may be a long haul, more borrowers may seek the Fed's help.

“We're looking at more of a U-shaped recovery, so companies have started to look at borrowing more, realizing it could be an extended rough spot of a very challenging six months or more,” Kaplan said.

But there's one major drawback: The loans carry restrictions on business activity including layoffs, executive compensation and dividends.

“Some companies will choose not to take advantage of these programs because of that, but this is an emergency situation and there are a lot of companies that will have to bite the bullet because they need the money,” said Scott Pearson, a partner at Manatt, Phelps & Phillips.