Findings from a new Federal Reserve Bank of Boston report indicate that businesses borrowing from the Federal Reserve’s Main Street Lending Program had higher credit risks compared with similar-sized businesses in the same state and industry. However, MSLP borrowers may have shown greater potential to overcome the economic impact of the COVID-19 pandemic.

“Our findings suggest that these firms borrowed from the MSLP because their greater growth or survival potential, and hence relationship value, made lenders willing to lend to them, and their higher credit risk made the MSLP attractive, as it enabled the borrowers to pay a lower price or obtain more credit than they would have otherwise,” the report’s authors write.

The report is titled “How Did the MSLP Borrowers Fare Before and During COVID-19?” It was written by Boston Fed senior economist and policy advisor J. Christina Wang, data analyst Joshua Ballance, and senior research assistant Melanie Qing.

The report uses data from the business-information company Dun & Bradstreet to compare the financial health of MSLP borrowers with that of their peer businesses – companies of a similar size in the same state and same industry – that did not apply for MSLP credit. The D&B database includes information on businesses’ number of employees, credit-risk level, payment history, and business-to-business spending before and during the pandemic.

“This information can provide useful clues to the factors that influenced the firms’ and banks’ decisions,” the authors write. “It can also help evaluate whether the program reached the subset of businesses its design was meant to target. Such understanding can in turn help suggest changes to the parameters that would make them more suitably tailored should a similar program be called for in the future.”

MSLP approved 1,830 loans totaling $17.5 billion

The MSLP was one of several emergency credit and liquidity facilities that the Federal Reserve launched in response to the pandemic. The Boston Fed operated the MSLP from July 6, 2020, until it closed on Jan. 8, 2021.

The program was designed to assist small and mid-sized businesses – those with as many as 15,000 employees or as much as $5 billion in annual revenue. It was the largest of the Federal Reserve credit facilities by total principal of purchases, as it approved 1,830 loans totaling $17.5 billion. The program initially grew at a moderate pace but experienced a large acceleration toward the end of its operation.

The MSLP could purchase 95% of a loan from the lending bank, with the bank retaining the remaining 5% of the balance. The loan amounts available ranged from $100,000 to $300 million, depending on, among other factors, the type of loan and the financial condition of the business.

The MSLP’s leverage ratio limit was either 4 or 6, meaning a borrower could have a maximum of four or six times as much debt to earnings, depending on the size and type of loan. (In this case, the leverage ratio was the adjusted debt-to-EBITDA ratio for 2019. EBITDA stands for earnings before interest, taxes, depreciation and amortization. The ratio may be adjusted to account for extraordinary expenses, for example.)

Most loans were much larger than the $100,000 minimum requirement. However, the minimum loan amount was $250,000 until October 2020, which may have left little time for smaller loans to be underwritten before the program closed. The loans also were generally concentrated in amounts substantially below the program’s maximum limits. For example, in the category of loans where borrowers could access as much as $300 million, the median loan was $40.5 million.

Credit went to smaller businesses and to areas hit hardest by COVID-19

The latest report is the third in an ongoing series of studies of the MSLP authored or coauthored by Boston Fed economists and researchers. The first, titled “Uptake of the Main Street Lending Program” and released in March, found that 99% of the MSLP borrowers were smaller businesses with less than $50 million in annual revenue, and more than 70% were in the industries hurt most by the pandemic. It also found that the amount of credit extended by the MSLP equated to about 60% of the volume of loans made by large banks to borrowers of comparable size and leverage. The report was authored by Boston Fed senior economist and policy advisor Falk Bräuning and Board of Governors principal economist Teodora Paligorova.

The second report, “A Helping Hand to Main Street Where and When It Was Needed,” was released in May and written by Bräuning, Wang, senior economist and policy advisor José L. Fillat, and research assistant Frankie Lin. It concluded that more MSLP loans went to businesses located in states hit hardest by the pandemic, and more credit was issued when the infection rate in a state rose.

As the authors of the latest report note, the purpose of these and forthcoming studies is to evaluate whether the MSLP’s design enabled the program to serve its purpose of supporting the flow of credit to small and mid-sized businesses. The studies also indicate what, if any, changes would be in order if future circumstances call for the Fed to introduce a similar credit-purchase program.

MSLP borrowers had higher credit risks than their peer businesses

The latest report looks at various credit-risk scores that D&B calculates. It concludes that, compared with their peers at the start of the pandemic, businesses that borrowed from the MSLP tended to be more at risk of going out of business, becoming delinquent on their bills, or experiencing other forms of financial distress. Once the pandemic began, each of the D&B risk scores deteriorated more on net among the MSLP borrowers than among their peers.

The report also looks at payment records compiled by D&B and finds that the MSLP borrowers did a better-than-average job of paying their bills on time over the two years preceding the start of the pandemic, but they fell behind on their payments in the three months immediately before its onset. After the start of the pandemic, their payment records deteriorated more than those of their peers.

“These findings can help explain why these firms applied for credit from the MSLP,” the authors write. “Their worse-than-average conditions would have made it more expensive for them to obtain credit in the private market, or they would have faced constraints on the amount of credit available.”

Spending patterns indicate MSLP firms maintained business activities better than peers

The report finds that just before the onset of the pandemic, nearly half of MSLP borrowers were ranked higher than the median by their number of employees but below the median by age. According to the authors, this suggests a large share of the MSLP borrowers may have experienced faster growth relative to their peers before the pandemic hit.

The authors also look at companies’ business-to-business spending, using that figure as a measure of business business activity. According to the authors, the data indicate that MSLP borrowers as a whole had higher-than-average spending in March 2020. The data also suggest that among MSLP borrowers reporting positive spending for March 2020 and for the month of their loan submission, spending was sustained more than it was among their peers.

According to the authors, these spending patterns suggest that some MSLP borrowers maintained their level of business activity better than their peers did. But, the authors write, some of those companies may have done so at the expense of making payments, which would have hurt their risk scores.

“The high activity level is consistent with the intuition that MSLP borrowers had good growth prospects, and thus the lending banks, which still would have to bear a portion of the loss should the borrower default, would have expected the firms to return to adequate profitability once the pandemic is over,” the authors write.

Read the full report.

J. Christina Wang is a senior economist and policy advisor in the Research Department at the Federal Reserve Bank of Boston. Her email is christina.wang@bos.frb.org.

Joshua Ballance is a data analyst in the Boston Fed’s Research Department.

Melanie Qing is a research assistant in the Boston Fed’s Research Department.