Lessons from the Fed’s lending programme for small- and mid-sized businesses

The US Federal Reserve, on Wednesday, reiterated its commitment to use a range of tools to support the economy that has been hit by the pandemic. From an unlimited bond-buying programme, establishing facilities to ensure credit flow to large corporates, to setting up a Main Street Business Lending Programme to support small-and-medium sized businesses, the US Fed has been going all the way to support the battered economy.

Taking cognizance of the fact that small- and mid-sized businesses create jobs for a large share of the US workforce and face huge financial strain, the Fed has been expanding the scope of its Main Street Lending Programme to support more small- and-medium-sized businesses. The programme is supported by the Department of the Treasury providing capital (equity) of $75 billion in a Special Purpose Vehicle (Main Street SPV) that can essentially purchase up to $600 billion of eligible loans, thanks to the multiplier effect (essentially allowing multiple times lending, akin to a bank leveraging its capital manifold).

Deferral of principal payment for two years with a chunk of the repayment due at the end of five years (tenure of the loans), deferral of interest for one year (capitalised), and low-risk retention by lenders on such loans (lenders sell 95 per cent participation in such loans to the Main Street SPV) are some of features that stand out in the lending programme.

While the emergency credit line announced by the Centre in India for MSMEs is not strictly comparable with the US lending programme, looking at certain features such as interest, principal payments, risk transfer, and loan limit can help fill the gaps in the Centre’s ₹3-lakh crore credit guarantee scheme.

The credit guarantee scheme in India carries one-year moratorium period on the principal amount. Also, interest is payable during the moratorium period, which can be a burden for many MSMEs, and can lead to defaults in the coming months. Also, the risk in such loans is not transferred to the Centre at the start. Rather, only at the time of a default, the guarantee is invoked. Given the past experiences under similar schemes, some banks remain wary of the possible delay with claim approvals and lag in recovery of full dues. This may prevent banks from reaching out to vast set of MSMEs and limit their scope to select larger and well rated businesses.

Scores better

The Main Street Lending Programme includes three facilities – Main Street New Loan Facility (MSNLF), Main Street Priority Loan Facility (MSPLF), and the Main Street Expanded Loan Facility (MSELF). Each of the facilities, carry a similar loan tenure (of 5 years), risk retention of 5 per cent by the lender, deferment of interest for one year, and principal deferment for two years.

Essentially no principal is paid in the first or second year. The loan is amortised over the remaining term of the loan, with 15 per cent of principal due at the end of 3 years, another 15 per cent of principal due at the end of fourth year, and a balloon payment of 70 per cent of principal due at maturity at the end of fifth year. The principal includes unpaid capitalized interest.

This, essentially, gives ample time for businesses to recover from the pandemic crisis and repay their loans.

On the other hand, the credit guarantee scheme in India offers only a 12-month moratorium on principal payment and borrowers have to continue to pay interest during this period. With many small businesses facing acute cash crunch, servicing the interest on these loans may be an issue. Non-payment of interest could lead to defaults in the coming months, putting both the borrowers and banks in a spot.

The other aspect on which the Fed’s lending programme scores is that any business established prior to March 13, 2020, that meets at least one of the following two conditions: (i) has 15,000 employees or fewer, or (ii) had 2019 annual revenues of $5 billion or less (among other conditions) can avail loans under the Main Street Programme.

But under India’s credit guarantee scheme, the credit is available only to businesses that have already borrowed from banks. This is because the scheme stipulates that credit is available up to 20 per cent of the borrower’s total outstanding credit as on February 29, up to ₹25 crore. Hence, businesses that may not have borrowed so farare not eligible under the scheme.

Also, the US Fed programme rather than putting a blanket fixed cap on the maximum loan that a business can avail, links it to the credit risk of the borrower. For instance, in the case of the first facility MSNLF, while the minimum loan amount is $250,000, the maximum loan amount is the lesser of $35 million, or an amount when added to outstanding and undrawn available debt does not exceed 4.0x adjusted 2019 EBITDA of the borrower. Similarly, for the MSPLF facility, the maximum loan amount is the lesser of $50 million, or an amount when added to outstanding or undrawn available debt, does not exceed 6.0x adjusted 2019 EBITDA. In case of the third expanded loan facility (MSELF), the maximum loan amount is the lesser of $300 million, or an amount when added to outstanding or undrawn available debt, does not exceed 6.0x adjusted 2019 EBITDA.

Hence, a business’ financial performance and credit risk determines the maximum loan amount it can avail under the programme.

In India, the credit guarantee scheme caps the total amount of loan at 20 per cent of the borrower’s loan outstanding as of February 29 (both working capital and term loans) across lenders. This one size fits all approach may not meet the requirements of many businesses stuck with stocks and unable to realize their receivables.