Small Business Financing July 17, 2009, 12:00AM EST

ARC Loans' Weak First Month

The SBA loan program is meant to help viable small businesses survive "immediate financial hardship." So far, it seems inadequate for the scope of the problem

By John Tozzi

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Diego Iorio's SIRS Electronics had been profitable through last year

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Diego Iorio sounds like the kind of small business owner the government's new ARC loans are made for. His two-employee audio gear retailer, SIRS Electronics, had been profitable through last year, with 2008 revenue nearing $500,000, but his projections for this year are down 40% to 50%. Although he has not missed any payments yet, SIRS, based in McAllen, Tex., has $140,000 in debt split among credit cards and payments owed to vendors. "We are in a very delicate situation right now," the 41-year-old Iorio says.

He prepared 200 pages of paperwork, including financial statements and tax returns going back three years, and applied for an ARC loan through Wells Fargo (WFC) just after the program launched June 15. The loans, made by banks and fully guaranteed by the government, give small businesses up to $35,000 interest-free to pay off other debts for up to six months, with repayment deferred for a year after that. But Wells Fargo rejected Iorio's loan application because his personal credit score, at 649, was below the 680 the bank requires. To Iorio, it's a catch-22: His score had been above 700, but it suffered when he took on debt to support the business.

The Small Business Administration's ARC loan program, funded through $255 million from the stimulus package passed in February, is intended to buoy viable small businesses that face "immediate financial hardship," not to prop up zombie companies. But a month into the program, ARC looks like weak medicine for ailing firms like Iorio's.

Projected Default Rate Scares Lenders

It's early days, to be sure, but even ARC's stated goals are meager. The program aims to guarantee 11,000 loans worth $340 million through 2010, saving some 55,000 jobs. By contrast, loans made through the SBA's main 7(a) guarantee program have declined by $2.3 billion in the first half of 2009, a drop of more than one-third from the same period last year.

In the first four weeks of the program, ARC funded $12 million in 371 loans through 178 lenders. But some business owners are unclear about which banks are participating. The SBA is not tracking it centrally, though local offices may be able to refer borrowers. Some of the biggest lenders such as Citi (C) are not participating, and others, including Bank of America (BAC), haven't decided yet. [Update: While a Citi spokesperson originally told BusinessWeek Citi is not participating in the ARC loan program, after this story was published she said the bank is evaluating the program.] Many are lukewarm on the plan because defaults are expected to be high: The Office of Management & Budget has projected a staggering 56% default rate on ARC loans. "This is a different and riskier program than traditional SBA loan programs, designed to meet the unique challenges the recession has placed on small businesses," OMB spokesman Ken Baer says in a statement.

Even though the SBA guarantees every penny, such a high default rate scares away lenders because it can be costly to collect, says Tony Wilkinson, president of the National Association of Government Guaranteed Lenders, a trade association of 650 SBA lenders. Banks earn interest of 2% above prime (the prime rate is currently 3.25%), paid by the SBA—borrowers pay no interest. That's a relatively small return for loans with a high default rate.