Federal Reserve seeks banks’ advice on direct lending

The Federal Reserve has reached out to investment and retail banks for feedback on its Main Street lending program ahead of its formal launch, according to people familiar with the matter.

The central bank earlier this month laid out in broad strokes its plans for the program, which is aimed at creating up to $600 billion in loans for companies with up to 10,000 employees or up to $2.5 billion in 2019 sales.

Since then, the Fed has solicited a wide range of feedback as it formulates more details around the program. In addition to speaking to investment and retail banks, it has also talked to its reserve banks and received more than 2,200 pieces of feedback online.

It is not clear when the program will officially launch. The Fed has said it will roll out more detailed guidelines pertaining to its Main Street program “soon,” but not yet given an official time frame. It is expected to introduce them in the next few weeks, the people said. The people requested anonymity because the conversations are confidential.

Lael Brainard, a member of the Federal Reserve Board of Governors, is helping to lead the program, one of the people said. Her role in the program, which is being conducted under a Republican administration, is notable given her Democratic ties. Brainard previously served as an economic advisor to former President Bill Clinton. Under former President Barack Obama, she was undersecretary of the Treasury for international affairs.

Yet her involvement in the Main Street program may help soothe some partisan tensions as there is heightened scrutiny of loans being given to larger companies. Democrats pushed to add oversight to the programs that rolled out business loans during negotiations on the $2.2 trillion relief bill President Donald Trump signed in late March.

The Fed is asking a wide range of questions, including ones geared toward understanding what loan requirements make sense for specific industries, the people said. Lobbyists for various industries and sectors have pushed to ensure the companies they represent will be able to access the funds. Retail and hospitality lobbyists, for example, have expressed concern that requirements around debt are too restrictive. 

Investment professionals, likewise, have sought more clarity around certain details in the program, like how the Fed will calculate a company’s earnings before interest, taxes, depreciation and amortization, or EBITDA. They also are seeking answers about the rate the Fed plans to charge on the loans, bankers and private equity investors told CNBC.  

The dialogue between the Fed and bankers of several stripes underlines the unique position in which the central bank finds itself. In its response to the coronavirus‘s devastating impact on the economy, the Fed has been blurring the lines of its mandate of maximizing employment and stabilizing the economy into the uncharted territory of lending to companies directly.

Federal Reserve Board Chair Jerome Powell, however, has said the Main Street program is not a divergence from its mandate, but a broadening of its efforts under unprecedented circumstances to maintain the flow of credit to households and businesses. 

“The Fed’s role is to provide as much relief and stability as we can during this period of constrained economic activity, and our actions today will help ensure that the eventual recovery is as vigorous as possible,” he said when announcing initial details of several of the programs earlier this month. 

The central bank has already announced updated guidelines on another program it rolled out, saying Monday it will expand its municipality fund scope to support smaller cities than originally outlined.  

As the Fed has stretched itself, it has looked to banks for an assist and the Treasury for support on loan losses. 

“The Fed doesn’t have the capacity to do credit underwriting, so they are dependent on banks to do that,” said Chris Whalen of advisory firm Whalen Global Advisors, who previously worked at the Federal Reserve Bank of New York.

“In all cases, the Fed does not take credit risk. They want the Treasury standing in front of them. The Treasury has got to take the first loss.”

The Main Street lending program will rely on banks to help screen applicants and maintain 5% of the loans on their balance sheets. The Treasury, meantime, will offer up $75 billion in cash for the program, and take the first hit on any losses. Those funds are part of a $500 billion pot established by the $2.2 trillion CARES Act passed last month. 

“The bigger question is whether the Fed will be willing to make modifications in the terms across different sectors,” said Kathryn Judge, a professor at Columbia Law School and an expert on financial markets.

Banks, which are already seeing clients rush to draw down their credit lines, must manage their own balance sheets. 

“If the Fed learns that banks are likely to extend qualifying loans only to certain industries (because they are relatively less risky or there is less uncertainty about how Covid-19 will impact the sector’s viability), the Fed and Treasury then must decide what to do with that information,” Judge said in an email.

The Treasury could, for example, provide a thicker equity cushion for certain industries potentially seen as more vulnerable, such as retail or energy, said Judge. Treasury Secretary Steven Mnuchin, though, has implied the Treasury will use its funds with restraint, with an eye toward minimizing losses. He has also, though, told Bloomberg News that the administration is weighing creating a program through the Federal Reserve to support the ailing oil and gas industry. 

If the Treasury opts not to offer a buffer against vulnerable industries or companies, some may be left behind. Already, smaller companies have been shut out of the government’s program aimed at businesses with less than 500 employees, as requests have flooded in. Banks, meantime, have been criticized for allegations they prioritized existing clients.

“The reason [the banks are] lending to the bigger businesses is because they see them as more likely to survive,” Whalen said.