SBA PPP and FRB Main Street Program – Good Friday Update

I hope everyone had a nice evening, whether celebrating the end of Lent or a Passover seder  or simply taking a break from working (from home).   The update from our policy team on today’s developments is below and here are a few other items of note:

  • Independent contractors and sole proprietors may begin applying for PPP loans today (Friday). 
    • The American Banker reported that out of 25 million small businesses in the US, nearly 20 million have no employees.  Thus, the ranks of independent contractors and sole proprietors could potentially quadruple the number of PP applicants, putting more strain on a system that already seems well beyond capacity, despite Herculean efforts by the banks and SBA.  This is not likely to go smoothly and may increase pressure on both parties in congress to find a compromise solution to upsize the program, to ease the fears of so many people who are worried the money will run out in a few days.   
    • Vice President Pence had mentioned that we might see updated guidance on independent contractors on Thursday, but it does not appear to have been posted. We will be on the lookout for it tomorrow as well as the promised guidance on forgiveness and will update you if/when we see it.
  • As you know, the Fed announced several new liquidity facilities, including two “main street” facilities, the Main Street NEW Loan Facility (MSNLF) and the Main Street EXPANDED Loan Facility (MSELF). I have attached a redline comparing the two pdf term sheets released by the Fed yesterday, as well as our summary term sheet, which we hope is in a user-friendly format for those accustomed to middle market financing term sheets.
    • The main difference between the programs is that the MSNLF is for new loans of up to the lesser of $25m or a total of 4X 2019 EBITDA to borrowers who do not already have loans from the lender bank, while MSELF is intended to allow borrowers to upsize existing credit facilities by up to $150m, 30% of the borrower’s aggregate bank debt or a total of 6X 2019 EBITDA.   
    • We await further guidance and details from the Fed, including whether borrowers, especially under MSNLF, can use the EBITDA measure from their existing credit facility to calculate the 6X limit (aka the Fed’s “red line”).  Most debt covenants are currently based on “adjusted” EBITDA, so the Fed may be reluctant to allow that — especially because the starting point is already 2019 EBITDA, which is almost surely higher than TTM Q1 2020 EBITDA for most borrowers, and in many cases significantly higher.  Stay tuned.
    • The CARES Act imposed limits on executive comp, stock buybacks and dividends for the Fed direct-lending and “mid-sized” facilities, but not require that such limits apply to the Main Street facility.  Many had hoped that the Fed would use the Main Street facility precisely to avoid those limits, but instead, the Fed has incorporated them to both MSNLF and MSELF.  We likely will need further guidance from the Fed as to whether and, if so how, these limits apply to pass-through and other non-corporate entities and their owners.
    • Both MSNLF and MSELF are available only to support loans made by banks and S&Ls (and their holding companies). This leaves private non-bank lenders out in the cold somewhat, but they also will not be constrained by the red-line or 4X leverage limit, and are not required to impose the exec comp and equity limits. Thus, they likely will remain attractive borrowing options for many middle market companies and PE sponsors, especially if BDCs, private credit funds and other non-bank lenders are able to take advantage of the additional Fed liquidity facilities for their own balance sheets and liquidity.  (Keeping in mind the SEC relief noted below providing borrowing flexibility for BDCS).
  • We are aware that many sponsors and SBICs are working to close transactions to finance a portfolio company in part to help it obtain an exemption from the PPP affiliation rules.   From what we are seeing and hearing, it seems that all parties are working in good faith to structure legitimate arm’s-length transactions designed to help the small business and its employees while following this helpful guidance from our friends at SBIA. 

That’s it for tonight.  This is a long weekend for many, and I hope all of you are able to enjoy a break and some time with your families and loved ones, whether in person or virtually.  Stay safe (and sane).

Congressional Response

Phase 3.5: Interim Coronavirus Relief Measure

This morning the Senate failed to pass an interim coronavirus relief measure aimed at increasing the funding available for the Small Business Administration’s Paycheck Protection Program under the Coronavirus Aid, Relief, and Economic Security Act (H.R. 748). Senate Majority Leader Mitch McConnell (R-KY) tried to pass the Senate Republicans’ proposal, a clean increase in funding available for the Paycheck Protection Program of $251 billion, through unanimous consent.

Senator Chris Van Hollen (D-MD), however, objected to the unanimous consent request and presented Democrats’ own proposal. According to the attached summary released today, the proposal would provide $250 billion for small businesses, $100 billion for health care providers, $150 billion for state and local governments to fight the pandemic, and a SNAP benefit increase. Leader McConnell blocked Democrats’ proposal and the chamber adjourned without reaching a compromise on the interim relief measure.

At this point it is unclear whether the Senate may take the bill up again during its next pro forma session, which is scheduled for Monday. In the meantime, congressional leaders are likely to continue negotiations. Even if a deal is reached in the Senate, its prospects in the House are unclear. House Speaker Nancy Pelosi (D-CA) warned that the Senate proposal was unlikely to pass by unanimous consent in the House.

It is important to note that neither party has expressed fundamental disagreements with each other’s proposals. Their disagreement has focused on timing, with Republicans supporting addressing Democrats’ policy priorities as part of a potential fourth coronavirus relief package (Phase IV). Democrats, however, have an increased sense of urgency to act on several of their priorities as Republicans express their preference for waiting until Phase III is implemented before they proceed to Phase IV.

Meanwhile, stakeholders continue to advocate for relief as part of the next relief package. America’s Health Insurance Plans and the Blue Cross Blue Shield Association are advocating for market stabilization measures, as outlined this week. They reported that health insurers’ costs for testing and treating could reach $556 billion in 2020 and 2021. Postmaster General Megan J. Brennan also warned policymakers during a briefing that the Postal Service will “run out of cash this fiscal year” without help from Congress.

Congressional Oversight

Senate Health, Education, Labor, and Pensions Committee Chairman Lamar Alexander (R-TN) and Senator Roy Blunt (R-MO) sent a letter to Department of Health and Human Services Secretary Alex Azar asking him to clarify that the coverage of testing requirements recently enacted apply to both the diagnosis of COVID-19 or SARS-CoV-2 as well as the detection of antibodies to SARS–CoV–2.

A bipartisan group of Members of Congress sent a letter to the Federal Emergency Management Agency expressing concerns about the allotment of emergency medical supplies to the Washington, D.C. region, citing recent remarks by Dr. Deborah Birx, White House Coronavirus Response Coordinator, that D.C. is on track to become one of the next coronavirus hotspots.

In that regard, House Energy and Commerce Committee Chairman Frank Pallone (D-NJ) and House Armed Services Committee Chairman Adam Smith (D-WA) sent a letter to President Trump requesting a clear and coordinated strategy to produce and acquire necessary medical supplies. The letter comes as the House Oversight and Reform Committee released a report on “the insufficient distribution of personal protective equipment and critical medical supplies to states.”

Agency Response

Federal Reserve

Today the Federal Reserve announced several actions to provide up to $2.3 trillion in loans to support the economy. This includes bolstering the effectiveness of the Paycheck Protection Program through the Paycheck Protection Program Liquidity Facility; ensuring credit flows to small and mid-sized businesses with the purchase of up to $600 billion in loans through the Main Street Lending Program; and helping state and local governments by establishing a Municipal Liquidity Facility that will offer up to $500 billion in lending to states and municipalities.

Treasury and Internal Revenue Service

Treasury and the Internal Revenue Service issued Notice 2020-23 extending the filing, payment, and administrative deadlines to provide relief to taxpayers affected by COVID-19. This includes postponement of due dates with respect to certain tax returns and federal tax payments; relief with respect to specified time-sensitive actions, including time for filing certain petitions to Tax Court; and administrative deadlines.

Department of Labor

The Department of Labor (DOL) announced today that, in the week ending on April 4, unemployment claims reached 6.6 million. DOL issued corrections to the temporary rule issued on paid leave under the Families First Coronavirus Response Act. The Occupational Safety and Health Administration expanded temporary guidance regarding supply shortages of N95s or other filtering facepiece respirators due to the pandemic.

Health and Human Services

The Centers for Disease Control and Prevention (CDC) issued interim guidance on safety practices for critical infrastructure workers who may have been exposed to COVID-19. CDC advises that “critical infrastructure workers may be permitted to continue work following potential exposure to COVID-19, provided they remain asymptomatic and additional precautions are implemented to protect them and the community.”

In addition, the Centers for Medicare and Medicaid Services announced workforce flexibilities aimed at reducing supervision and certification requirements so that practitioners can perform work to the full extent of their licenses in certain settings, including rural hospitals, skilled nursing facilities, and others.

Finally, the Office of Civil Rights announced that it will exercise its enforcement discretion and will not impose penalties for violations of the HIPAA Rules against covered entities or business associates in connection with good faith participation in COVID-19 community-based testing sites.

White House Guidelines

We understand the White House is considering creating a task force that would focus on efforts to reopen the U.S. economy. Dr. Birx and Dr. Anthony Fauci, director of the National Institute of Allergy and Infectious Diseases, have been in discussions regarding the medical criteria for the guidance. Dr. Fauci indicated yesterday that the number of COVID-19 cases in the country could plateau in the next week.

Please do not hesitate to let us know if you have any questions. The K&L Gates COVID-19 resource center, which includes a variety of updates from across the firm’s platform, can be found here. Thank you.

Best,

K&L Team

DC Updates – Watching for New Government Funding

The main updates this morning are a bit speculative.  Fed Chairman Powell is expected to announce more details around the “main street” liquidity facility in a speech today and the Senate may act by unanimous consent today on the attached proposal for the PPP upsize.  It’s short and sweet.  Below is an analysis from our Policy team in DC.  We will, of course, provide an update once we know more.  Out of respect for your inboxes, I won’t send that before tonight or tomorrow morning, but if you’d like a more real time update, please let me know.

On the SBA front, the only material updates were applications forms for new bank (etc.)  and non-bank lenders and an updated FAQ that didn’t do much:

  • reiterated that lenders are to use their own form of note; and
  • clarified that loans are to be disbursed within 10 days of approval and the 8-week clock starts on the date of disbursement.

Anticipating your question, nothing in here seems to help with the PE/VC affiliation analysis. 

As for the size of the stimulus and our original comment that “We’re gonna need a bigger boat,” we looked at the Census bureau data for 2017 (the most recent I could find) which shows that:

  • Employers with less than 500 employees (excluding employers with only one employee) had total payroll of $2.7 trillion.
  • That’s a monthly average of ~$225B.
  • Multiplied by 2.5x, that would yield a hypothetical total PPP borrowing capacity of $564B if every such employer (all 6 million of them) applied for the maximum amount. 

The census payroll measure and the PPP “payroll costs” don’t match up for several reasons, but some of those differences would at least directionally cancel each other out.  For instance the census includes all comp above $100k, but also excludes some benefits that are includable under the PPP, and we know that many employers with more than 500 employees can obtain a PPP, but that’s still probably at least a directional estimate.  Well, it is until you factor in the single-employee employers, which the census shows as having a 2017 payroll of $6.7 trillion, which would alone have borrowing demand of $1.2 TRILLION, but there is a lot of noise in those numbers so that number needs to be taken with a large grain of salt.

From Senate Majority Leader McConnell’s office:

Paycheck Protection Program Funding

The Majority Leader seeks a unanimous consent agreement that would allow the Senate to break in to the Pro Forma session scheduled for Thursday, April 9th, to introduce, call up and pass, by voice vote, a bill that would provide an additional $250 billion for the paycheck protection program.

  • Tomorrow morning, I’ll ask unanimous consent to pass standalone emergency funding for the hugely popular Paycheck Protection Program that is saving small-business jobs as we speak. As the rest of the CARES Act continues to come online, this key part is already low on funds.
  • Nobody thinks tomorrow will be the Senate’s last word on COVID-19. Other crucial parts of the CARES Act, like its historic funds for hospitals and healthcare providers, are still coming online and have not yet been exhausted. The PPP is where the lights are already flashing red.
  • If we want to act fast, Congress has to focus. There is no realistic chance that another sprawling bill which allocates half a trillion dollars to a number of priorities, even important ones, will be able to pass the Senate or the House by unanimous consent this week.
  • Ten million Americans were laid off in just the last two weeks. Tomorrow morning will likely bring another historic unemployment figure. This is urgent. If Senators delay this urgent paycheck support to insist on a broader bill, more Americans will lose their jobs unnecessarily.
  • I hope none of my colleagues object to my request for these urgently-needed funds. There is no reason why this bipartisan job-saving program should be held hostage for other priorities. Let’s re-fund the only program that’s already running dry and keep moving forward together.

While there is bipartisan consensus that more funds are needed for PPP due to popular demand, Democrats want accountability about how the funds are being used and will be used.  In response, Speaker Pelosi and Leader Schumer released a joint statement calling for the following conditions on the new package:

·      $250 billion in assistance to small businesses, with $125 billion channeled through community-based financial institutions that serve farmers, family, women, minority and veteran-owned small businesses and nonprofits in rural, tribal, suburban and urban communities across our country, and improvements to ensure all eligible small businesses can access this critical funding and are not turned away by banks;

·     $100 billion for hospitals, community health centers and health systems, providing desperately needed resources to the frontlines of this crisis, including production and distribution of national rapid testing and Personal Protective Equipment (PPE);

·    $150 billion for state and local governments to manage this crisis and mitigate lost revenue, doubling down on the investment secured in the CARES Act;

·    Strong additional support for families with a 15 percent increase to the maximum SNAP benefit to help put food on the table.

While it appears very likely that more assistance will be authorized and appropriated, the timing is less clear.  Even if the Senate were to work out a compromise in terms, we can’t forget the House.  The House also doesn’t want to have to physically return to DC, and getting 435 Members to agree to unanimous consent is never an easy lift.  There could be snags both on policy and procedures.  You will recall that for Stimulus 3, there was one House Member who effectively forced as many Members as practicable to return to DC for a vote.  It’s very possible the chambers will be seeing some weekend work. 

Note that this is not Stimulus 4, but rather Stimulus 3.5.  Pelosi and Schumer said they view this package as “interim emergency legislation,” and added that Congress “will move to pass a CARES 2 Act that will extend and expand the bipartisan CARES Act to meet the needs of the American people”. 

PPP Application Issues; Updated PPP Volume

Good morning.  No meaningful updates overnight.  Treasury and SBA did again update their FAQ at some point late yesterday, but the changes are only in FAQ #1, which was originally posted on April 3, and mainly reinforce the point made yesterday that it is the responsibility of the borrower and not the lender, to get the calculations right (in this case re payroll).   

Some interesting information in a report in the American Banker (behind a paywall, sorry):

  • Lenders have submitted* 266,000 applications for $71B in loans
  • SBA indicates that lenders are required to provide borrowers with funds with five days of receiving an SBA loan number, which is issued when a loan application is submitted* to the SBA;
  • SBA also said that it will not promulgate a form of PPP note and that each bank may use its own form, which will likely be the next frantic action item as lenders must prepare and circulate forms of notes within that 5-day window; and
  • As you no doubt saw elsewhere, Congress and Secretary Mnuchin are working to add another $200-250M to the PPP fund, perhaps as early as Thursday. 

*I believe that when SBA says an application is “submitted”, it means that the application has been properly submitted and thus effectively approved for a loan.

A few updates on what we are seeing in the market and questions that we are getting:

  1. Most importantly, we are getting questions from borrowers who are not planning to use the loan proceeds for “payroll costs”.   That is NOT PERMITTED under the IFR.  Although the CARES Act provides that loan forgiveness is conditioned on using proceeds only for permitted purposes, the IFR goes further and requires that Borrowers use 75% of the loan proceeds for payroll costs.  See page 16 of the IFR:

“However, at least 75 percent of the PPP loan proceeds shall be used for payroll costs. For purposes of determining the percentage of use of proceeds for payroll costs, the amount of any EIDL refinanced will be included. For purposes of loan forgiveness, however, the borrower will have to document the proceeds used for payroll costs in order to determine the amount of forgiveness. While the Act provides that PPP loan proceeds may be used for the purposes listed above and for other allowable uses described in section 7(a) of the Small Business Act (15 U.S.C. 636(a)), the Administrator believes that finite appropriations and the structure of the Act warrant a requirement that borrowers use a substantial portion of the loan proceeds for payroll costs, consistent with Congress’ overarching goal of keeping workers paid and employed. As with the similar limitation on the forgiveness amount explained earlier, the Administrator, in consultation with the Secretary, has determined that 75 percent is an appropriate percentage that will align this element of the program with the loan amount, 75 percent of which is equivalent to eight weeks of payroll.”

  • We know of at least one lender who has interpreted this to mean the borrower must certify that it will use the funds for permitted  purposes within the first 8 weeks after closing.  We understand that some borrowers are looking to borrow a PPP loan without necessarily having it forgiven and plan to  spend the funds for permitted purposes after the 8-week period.  The CARES Act says that “during the covered period [Feb 15 – June 30] an eligible recipient mayuse” the proceeds for the permitted purposes, and then the IFR imposes the 75% requirement above. 
    • It does not appear that there is a strict requirement that all proceeds be spent during the covered period.  It likely would be a strained (but not impossible) interpretation to read the nonrecourse exception to apply where a borrower uses the loan for permitted purposes beyond the covered period.  (The CARES Act says the PPP loan is nonrecourse “except to the extent that such shareholder, member, or partner uses the covered loan proceeds for a purpose not authorized under clause (i)”.)
    • However, borrowers who are intending to borrow a PPP loan while keeping operations shuttered or at greatly reduced levels may run a real risk of challenge to the certification that the loan is “necessary .. . to support the ongoing operations” of the borrower.  At the risk of stating the obvious, ongoing operations likely means what it says.   In light of the high demand for, and likely inadequate supply of, PPP financing, borrowers should tread carefully here.
  • Despite the guidance in yesterday’s FAQ, many lenders continue to insist on borrower ownership information for owners who aggregate to at least 51%, or for one lender 90%, of a borrower’s equity.  Some lenders are saying that this is being required by SBA.  Our Policy team is trying to gain insight and possibly assist on this.
  • A few of you have asked about “irrevocably” waiving control rights merely for the duration of the PPP loan.  Unfortunately, we believe that by analogy to SBA interpretations in other contexts, “irrevocably” means “permanently” without any sort of right (express or via “handshake”) to reinstate the control right in the future.   For investors not wanting to give companies unfettered rights, it may be possible in deals with multiple investors to amend the charter or agreement to lower the voting threshold so that no single investor (or group of affiliated investors) controls the vote.
  • Finally, we understand some companies are suggesting that because the “alternative size standard” (of $5M NI and $15M TNW) is not expressly mentioned in 121.301(a) that means that borrowers need not apply the affiliation rules to the that standard.  While the alternative standard is not mentioned there,  SBA SOP 50 10 5(K) in Section B.II.D.4 (page 92) captures it:

“4. The Applicant business may qualify under either the industry small business size standards or the alternative size standard. To qualify under the alternative size standard, the Applicant (including affiliates) must meet the following:

a. The maximum tangible net worth may not exceed $15 million; and

b. The average net income after Federal income taxes (excluding any carry-over losses).”

That’s all for this morning.  Please let us know what you are seeing and hearing from lenders and, as always, let us know if we can help. 

We hope that all of you are safe and healthy and for those of you celebrating Passover today, Chag sameach

PPP Demand to Dwarf 2019 SBA Loan Volume

You’ve probably seen these numbers from SBA. 

SBA FY19 total loan volume reaches over $28 billion with more than 63,000 approved loans.”

Now SBA needs need to pump out 12x the FY 2019 dollars ($349B). Even if every were $10B (and they won’t be anywhere close to that), that’s at least 60% of the FY volume/number of loans in a matter of weeks. 

We’re gonna need a bigger boat.  

The Hilarious Way Jaws Came Up With Its Most Famous Line - CINEMABLEND