The U.S. Federal Reserve's $600 billion Main Street Lending Facility will base its loan criteria on adjusted Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA ) instead of GAAP figures, with the rates set according to the London Interbank Offering Rate (LIBOR), both a reversal of previous Fed positions.

Previously, the Federal Reserve had criticized banks that approved highly leveraged loans based on adjusted EBITDA to make them appear more credit-worthy than they actually were. The reasoning was that relying on EBITDA could distort market information, leading financial institutions to fear regulatory scrutiny. The Fed's sudden about-face on the matter, said Bloomberg, represents a tacit endorsement of the metric that earlier had been losing credibility in the financial world.  Bloomberg said that this reversal increases the risk of moral hazard, as poorly performing companies will come to believe that the central bank will back them up in any situation. However, it would appear that the Fed is willing to take risks in the face of the COVID-19 pandemic, as it is also preparing soon to make the unprecedented move of directly purchasing high-risk corporate debt, or junk bonds.

The Fed, like other central banks around the world, had also been previously trying to get away from using the LIBOR, one of the most widely used benchmark rates used by financial institutions for short-term loans to each other in the international market. That's because the metric lost much of its credibility during the financial crisis, when it was found that, for years, currency brokers at major banks had been coordinating with each other over instant messaging to fix the rates in order to boost profits and obscure financial difficulties. The scandal rocked the LIBOR's previously sterling reputation as a reliable rate. In response, central banks across the world began searching for an alternative to replace it. While many alternatives have been proposed, such as the Fed's Secured Overnight Financing Rate (SOFR), none has gained the market traction that LIBOR had. Despite the lack of a replacement, regulators had been proceeding with a plan to ditch the metric anyway. New York's Department of Financial Services, in fact, had only recently demanded that banks provide a plan for how they planned to transition away from the LIBOR. Yet now the Fed said that loan rates from the Main Street Lending Facility will be "LIBOR + 3%." Bloomberg said this risks lending  credibility to the beleaguered metric, imperiling plans to eventually move away from it, as its use highlights the inadequacies of alternatives developed thus far.

While the Fed might be aware that its moves are sudden reversals, its priorities right now have been to keep lending markets stable and mitigate a growing credit crunch. Moody's has predicted a wave of corporate bond defaults as the crisis continues, particularly among the junk bond sector that the Fed is now dipping into. In a more recent report (you'll need a free account to view) it predicted that, in particular, speculative-grade retailers and apparel companies will be a major source of these defaults, estimating a default rate of 12.4 percent, nearly twice that of the 6.34 estimate it had just a month before; by next April Moody's expects this rate to rise even higher, to 17.4 percent.

Banks themselves are bracing for huge credit losses as a result of widespread business shutdowns, which have led many to sharply increase allowances for loan losses, as borrowers' credit ratings sink like a stone, though larger, more diversified banks will likely come out of this in better shape than smaller ones with high exposures to sectors heavily affected by the pandemic.