CARES Act: Why Quality Screening Is Now More Important Than Ever

The U.S. stimulus bill (the CARES Act) enacted on March 27, 2020, received significant attention for its support payments to individuals. However, it also has a significant impact on large corporations (see Exhibit 1).

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This blog will take a closer look at two lending programs and their market impact within their respective segments.

CARES Act: Liquidity Where It’s Needed

The first program[i] is for loans and guarantees made through the U.S. Treasury or Federal Reserve for up to five years, at prevailing market rates prior to the outbreak. While this is welcome liquidity, it comes with a few restrictive covenants.

  • Companies must maintain 90% of their pre-virus employment and may not pay dividends or repurchase stock until 12 months after the loan terminates.
  • Only companies with “significant operations” and a “majority of employees” in the U.S. are eligible.

This means that companies that change their finance policies to access these loans may signal they have no other funding options available.

The U.S. Treasury will also provide financing[ii] to lenders to make direct loans at rates of 2% or less to businesses with 500-10,000 employees. Furthermore, for the first six months (or longer, at the Treasury’s discretion), no principal or interest shall be payable, though restrictions like those mentioned above remain in place here too. However, the distinction here is that the second program could significantly enhance the borrowing capacity of high-quality mid-sized companies, without needing to change their financing policies or signaling distress (given its accessibility through lenders or intermediaries).

This leads us to the following considerations.

  • First, below-market rates are welcome from a liquidity perspective.
  • Second, as we go down the market-cap scale, companies are more likely to have more than 50% of their employees based in the U.S., which would qualify them for this program.
  • Lastly, most of these qualifying companies with 500-10,000 employees are well represented across the core U.S. size indices.
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