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| Keith Durkin |
The Federal Reserve requested comments on the original term sheets. On April 30, the Federal Reserve released new term sheets containing substantive changes to the Main Street Lending Program.
The new term sheets allow borrowers to utilize adjusted earnings before interest, taxes, depreciation and amortization, or EBITDA, in determining their borrowing base.
This is an important change as the original term sheets required borrowers to use the traditional definition of EBITDA. Utilization of adjusted EBITDA will increase the maximum loan amount available to borrowers and also allow more borrowers to qualify for the Main Street Lending Program.
Background
The Main Street Lending Program is a $600 billion fund designed to encourage commercial lenders to (a) make eligible new loans, commonly known as a new loan facility; (b) increase an eligible amount of existing loans, commonly known as an expanded loan facility; and (c) refinance existing loans, commonly known as a priority loan facility.[1]
Put simply, the new loan facility is designed to facilitate new loans. The expanded loan facility is designed to upsize existing loans. The priority loan facility will allow borrowers to refinance existing loans as part of the Main Street Lending Program.
The priority loan facility was not part of the initial term sheets, but is a new facility announced via the new term sheets. The Federal Reserve will create a special purpose vehicle, or SPV, and the U.S. Department of the Treasury will fund the SPV with $75 billion.
The SPV will be leveraged to provide $600 billion in liquidity for Main Street loans. Accordingly, the new loan facility, expanded loan facility and priority loan facility will cumulatively provide up to $600 billion in loans.
The three types of Main Street loans contain similar terms with substantive key differences. One of the key differences is the maximum loan amount available to borrowers. The maximum loan amounts set forth in the original term sheets and the new term sheets for the Main Street loans are as follows:
Allowing borrowers to use adjusted EBITDA rather than EBITDA will open the Main Street Lending Program to borrowers who would not be able to participate if the program were based on EBITDA.
Additionally, qualifying borrowers under the original term sheets will likely be able to borrow more because of an adjusted EBITDA standard.
EBITDA and Adjusted EBITDA Calculations
EBITDA is a popular metric to determine a company's financial performance by removing certain expenses that can be controlled by business owners, such as depreciation methods, debt and capital structure. EBITDA is a non-GAAP measurement and a deviation of net income[2] that adds back expenses such as interest, depreciation, taxes and amortization.
Typically, EBITDA is seen as a useful metric to (a) assess business performance without the effect of noncash expenses, such as depreciation; (b) assess a business's ability to service or incur debt; and (c) better understand a business's operating performance both internally and compared with competitors.
Adjusted EBITDA is a variation of EBITDA and is derived by adding back in certain expenses. Adjusted EBITDA results in a larger number than EBITDA.
Adjustments to EBITDA are industry-specific and can typically include certain nonoperating income, acquisition costs, development costs, litigation expenses, nonrecurring costs and various other industry-specific adjustments. Adjusted EBITDA is normally calculated to delineate information about operating performance and growth.
For example, a business heavily expanding in a new territory may show a negative EBITDA but a positive adjusted EBITDA because the acquisition costs for the expansion would be an adjustment difference. Lawyers typically view both EBITDA and adjusted EBITDA as malleable concepts allowing clients and their accountants to develop custom formulas for various transactions.
The Federal Reserve's revision to the new term sheets allowing adjusted EBITDA will likely increase a borrower's maximum loan amount. For example, consider the following hypothetical restaurant chain with the following simplified net income statement:
The hypothetical restaurant chain's EBITDA would be calculated as follows:
Traditional EBITDA Calculation
Under the original term sheets, if this borrower had no existing debt, then the maximum amount the borrower could obtain pursuant to the new loan facility would be $16,160,864 because the new loan facility maximum amount is the lesser of (a) $25 million or (b) a loan amount that when added to the borrower's existing outstanding and undrawn debt does not exceed 4 x EBITDA.
In this case, the borrower has zero existing outstanding and undrawn debt, so the maximum loan amount is 4 x EBITDA (4 x $4,040,216 = $16,160,864).
If the borrower had $8 million of loans outstanding at the time, then under the Original Term Sheets, the borrower's maximum amount pursuant to the New Loan Facility would be $8,160,864 ($8,000,000 + $8,160,864 = 4 x $4,040,216).
The new term sheets allow a borrower to use adjusted EBITDA. Allowing borrowers to utilize adjusted EBITDA will increase their borrowing bases.
Calculating adjusted EBITDA will be highly borrower-specific and industry-specific, and could include a multitude of adjustments.
In addition, the Federal Reserve Main Street Lending Program new term sheets require lenders to use the methodology lenders previously used in a borrower's credit agreement, or if there was none, then to use the adjusted EBITDA methodology for similarly situated borrowers.
A simplified adjusted EBITDA calculation for the hypothetical restaurant chain could be as follows:
Adjusted EBITDA Calculation
Under the new term sheets, if the hypothetical restaurant had no existing debt, then the maximum amount the borrower could obtain pursuant to the new loan facility would be $25 million because the new loan facility maximum amount is the lesser of (a) $25 million or (b) a loan amount that when added to the borrower's existing outstanding and undrawn debt does not exceed 4 x adjusted EBITDA.
In this case, the borrower has zero existing outstanding and undrawn debt, and 4 x adjusted EBITDA exceeds $25 million (4 x $8,194,409 = $32,777,636).
If the borrower had $8 million of loans outstanding, then under the new term sheets, the borrower's maximum loan amount pursuant to the new loan facility will equal $24,777,736 ($8,000,000 + $24,777,736 = 4 x $8,194,409).
Borrowers with negative EBITDA would not qualify for any loans pursuant to the original term sheets because the maximum loan amount would be four times a negative number, resulting in a negative borrowing amount. The new term sheets may allow those borrowers with negative EBITDA,[3] but positive adjusted EBITDA, to qualify.
For example, assume a borrower with the following net income statement, traditional EBITDA calculation and adjusted EBITDA calculation:
Traditional EBITDA Calculation
Adjusted EBITDA Calculation
In this hypothetical scenario, the restaurant chain borrower would not be entitled to receive any of the Main Street loans pursuant to the original term sheets because of its negative EBITDA.
Under the new term sheets, however, the restaurant chain borrower could, for example, receive a loan equal to four times its adjusted EBITDA pursuant to the new loan facility, which equals $24,537,636.
The new term sheets issued by the Federal Reserve for all Main Street loans require participating lenders to assess a borrower's financial condition and certify the adjusted EBITDA methodology is the same methodology previously used by the lender to extend credit to the borrower, or if no existing methodology was used, then that it is the same methodology being used for similarly situated borrowers.
The borrower must also certify, as of the date of loan origination, that it has a reasonable basis to believe it has the ability to meet its financial obligations for at least 90 days after loan origination, and it does not anticipate filing for bankruptcy during that 90-day period.
These requirements were not included in the original term sheets and were likely included to mitigate extending loans to financially risky borrowers.
Conclusion
The revision allowing adjusted EBITDA in the new term sheets issued by the Federal Reserve for the Main Street Lending Program is a significant benefit for many borrowers as it will likely increase borrowing bases and also allow more businesses to qualify for a loan.
Borrowers should begin reviewing their existing loan documents to determine the methodology that was used for calculating adjusted EBITDA and determining their maximum loan amount.
Borrowers without an adjusted EBITDA methodology in their credit agreement should begin lobbying their lenders for a favorable adjusted EBITDA methodology based on the methodology being used for similarly situated borrowers.
Keith C. Durkin is a partner at BakerHostetler.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
[1] The Main Street Lending Program also includes facilities for asset-backed securities and bond facilities. Those facilities are not discussed in this article.
[2] Typically, EBITDA can be calculated using operating income or net income. This author prefers using net income as a starting point because it more thoroughly measures financial performance.
[3] The subset of companies qualifying in this category is likely to be small.
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