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Coffee chain reveals flaws in Fed plan to save Main Street

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WASHINGTON – La Colombe, a Philadelphia-based fancy coffee and canned latte supplier, saw its business drop sharply in 2020 as the coronavirus pandemic closed its cafes and shut down the high-end restaurants that serve its beer. But the company has fallen through the cracks when it comes to government aid.

La Colombe did not believe she qualified for the government’s repayable small business loan program given its size and canned coffee business. It’s too small to have easy access to the debt markets that big corporations use to raise funds – markets that move with the help of the Federal Reserve’s safety nets.

Company executives believed that another Fed program, meant to help midsize businesses by providing loans, would be their best way to get help. But when the central bank announced the details in early April, it was clear that La Colombe would not qualify. The company has too much debt relative to earnings to meet the Fed’s debt restrictions.

“It just doesn’t make sense for companies like La Colombe, because we’re growing so quickly,” said Aren Platt, who heads special projects for the company.

The Fed’s Main Street loan program for midsize businesses was meant to be a challenge. The central bank had never tried to lend to midsize companies before, and it is difficult to help a very diverse group of companies without putting taxpayer dollars at risk. The Fed, the Treasury Department, and members of Congress also sometimes seemed to be on different pages on what they wanted the program to achieve.

The central bank and the Treasury, which provide money to cover any loans that go wrong, have spent months designing the program, negotiating credit risk, and controlling terms. Many Fed officials wanted to create a program that companies would actually use, but some at the Treasury saw the program as an absolute safety net for companies that had run out of options. Steven Mnuchin, the Treasury secretary, refused to take too many risks, saying at one point he didn’t want to waste money on programs as a baseline scenario.

What has come out after three months, two overhauls and over 2,000 comments filed with the Fed is a program that seems unable to please much.

First announced on March 23, the Main Street program finally allowed banks to register as lenders in mid-June, but only 450 of the nation’s eligible banks have registered so far. Banks have signaled that many customers are unwilling to use the program, Fed Chairman Jerome H. Powell admitted to relevant lawmakers in testimony in late June.

Small town bankers say some clients have been frightened by the heavy paperwork involved in using the program. Large companies often have more attractive options elsewhere in the market. Some, like La Colombe, are too much in debt to apply. This problem is reflected in letters of comment from companies that were expanding their footprint before the pandemic.

It will be difficult to declare the program an outright failure, even if few companies use it, as the Fed and Treasury have set limited – and often unclear – goals for themselves. Officials say they want to give healthy businesses an option to access credit if market conditions deteriorate, but they want to be responsible for the loans they make.

“Success would be if we have broad national coverage,” said Eric Rosengren, chairman of the Federal Reserve Bank of Boston, which is overseeing the effort. “It’s for companies that have a good business model, that have been disrupted by the pandemic, and who will be able to recover from it in order to be able to repay the loan.”

The program is intended to help a small number of businesses, especially given its stringent conditions, experts said.

The Fed assumes 95% of the risk, but banks must keep 5% of any loan they take out under the Main Street program, a stipulation intended to dissuade them from getting rid of bad debts on the Fed. Because they need to have their “skin in the game,” they are likely to avoid taking out loans if the economy is in crisis and it looks like a large chunk of borrowers could default.

The program also comes with reporting requirements and other restrictions, including limitations on executive compensation and distributions of capital, such as dividends, which Congress has set out in relief legislation. If the economy gets confused and credit is practically available, some businesses will find borrowing through the Main Street program unattractive because of the terms attached to it.

It’s a Goldilocks design: businesses won’t use it if credit conditions are good, and banks won’t use it if they’re too bad. It could help businesses access credit if the going is right – for example, if credit conditions tighten with a second wave of viruses in the fall, but banks and borrowers expect the economy will recover before long.

“There are tough conditions in taking this money,” Bruce Winfield Van Saun, CEO of Citizens Financial Group, said at an investor conference on May 27. “So I think a lot of companies will look for other financing from banks or asset lenders if they can get it.” He added that “if the situation remains difficult or worsens, then I think you will see more businesses taking advantage of Main Street loans.”

The program opened on Monday, and Rosengren said banks had already offered loans to hard-hit businesses, such as movie theaters. He declined to say how much and said he expected demand to increase over time. The Boston Fed’s disclosures show that virtually none of the biggest banks, other than Bank of America, are prepared to say publicly that they will make loans to new customers through the program.

An analysis by economists at Goldman Sachs found that there are potential borrowers for whom the terms of the program would be attractive given current funding conditions and to whom banks could lend money profitably – for most businesses. smaller and riskier. But they expect little use due to the conditions of the program. Large, risky companies might also find the facility attractive, but the program’s limitations would likely exclude them.

Another incentive for the program – removing loans from bank balance sheets to make room for more loans – also seems not to be a priority now, JP Morgan economist Michael Feroli wrote in a research note. He pointed out that a separate Fed program that takes small business loans from bank balance sheets has seen fairly limited use, suggesting that banks aren’t very concerned about freeing up space on their balance sheets.

Lawmakers have repeatedly pushed policy makers to make the program more inclusive and widely available. But Mr Mnuchin has been relatively cautious about taking credit risk, sometimes describing the Main Street program as a backup option that could succeed without ever being used by providing the market with certainty that credit would remain available.

“In the Perfect World, we’ve announced all of these facilities, the markets are working and we don’t need to use them,” he told CNBC in May. “But they’re there and they’re going to be ready and they’re going to serve as backstops.”

Criticism of the terms of the program prompted the Fed and the Treasury to make several revisions to make it more attractive to borrowers and lenders.

Banks can now provide smaller loans of as little as $ 250,000, and borrowers can have up to five years to repay the loan.

Despite this, Mr Powell told lawmakers on June 30 that banks “are not getting much interest from borrowers,” adding that they expect demand to increase. “We remain open to play with the formula and make adjustments going forward.”

Mr Powell signaled that the minimum loan amount could drop further, and Mr Mnuchin said the Treasury and the Fed were considering asset lending – which could allow more indebted companies to borrow using their stores. and factories to guarantee loans. . This is what La Colombe advocates, sometimes through its local legislators.

It is unclear how useful edge adjustments will be, even as the economy deteriorates and credit availability dries up. The Fed can only offer loans, not grants, so companies that use the program will end up with more debt to pay off.

“There are limits to the quality of the program because it is a loan,” said Nellie Liang, a former Fed official now at the Brookings Institution. Still, she said, policymakers “should err on the side of being generous, especially for small businesses,” adding: “If the program is too small to start with, the economy can get worse, more so. ‘businesses fail and even more support would be needed. “