An ARC To Nowhere? Yet Another Lending Plan Failure

By Marc Tracy

A couple of weeks ago, we talked about how private lenders might not be willing to play ball with the Small Business Administration's America's Recovery Capital microlending program. The program, you'll recall, would see the SBA backing interest-free loans of up to $35,000 100% for small businesses with outstanding bank debt--the idea being that they use the extremely cheap and favorable credit to pay down what they owe. The lenders were worried about the particulars of the plan, and whether participating would make business sense for them. (And who can blame them? Not us.)

Well, the particulars have now been codified, and the lenders remain skeptical--bad news.

Fortune provides a nice primer on the program. In essence:
-The loans are available to businesses that have been around for two years or more (so no start-ups).
-Borrowers must thread the needle of being both under duress and "viable". For the former, sales should be down 20% or payments should be difficult; for the latter, cash flow projections should indicate promise.
-The loans that the ARC loans would pay down must not be more than 60 days overdue.
-Though SBA-backed loans prior to February '09 are ineligible to be paid down with ARC loans, the overdue loans can be used to pay down pretty much anything else business-related: mortgages, non-SBA bank loans, even personal credit-card debt that involved business expenses.

Sounds great, right? Yup, and $255 million has been allocated for it; the SBA guesses that 10,000 small business will receive ARC loans.

Well, that is, if the private lenders agree to participate.

You see, it seems--again via Fortune; swell job covering this one, guys--that many lenders who were initially skeptical due to the lack of information about the program are now skeptical because of the information about the program. Specifically: there's a question of whether making these loans are really worth it. Well, is it?

Remember, for the borrower the loans are interest-free ("ARC loans are a sweet deal for borrowers," Fortune observes), so any profit for the bank is going to have to come from what the SBA agrees to pay them. And the SBA has agreed to pay them prime +2% interest--which comes to 5.25%, for now. That's low. Now, you'd expect the interest on a 100%-guaranteed loan to be low indeed--you don't need to charge as much interest when it's backed by the full faith and credit of the U.S. government. But the fact remains that when you throw in administrative costs--especially where you need to go to the SBA and get your money on failed loans--and the rest, the margin starts to look pretty thin if you're a profit-seeking lending enterprise. Now add the process by which banks have to recover on defaulted loans from the SBA, which the article calls "onerous," and the prospect of being punished for allegedly lax underwriting standards should too many loans in your portfolio default, and, if you're a private lender, making ARC loans truly begins to look like more trouble than it's worth.

A federal credit plan for small businesses failing because private actors legitimately don't want to participate? We know we've heard that before. We're pretty sure we discussed it yesterday, in fact.

Meanwhile, not all lenders are saying they may not participate in the ARC program. A North Dakota community bank CEO tells Fortune that "the weak financial incentives and uncertainty surrounding the program are outweighed by the needs of the community. 'The interest rate is irrelevant. We're only dealing with $35,000....The more important point is helping businesses survive. Those businesses may have $150,000 loans from us in the future. It's that long-term goal that's making us want to help them survive in the short run.'"

Certainly that makes sense. But in a credit environment as debilitated as the current one, should that weighing process even need to take place? The ARC program should either be more worth private lenders' while, or--and we tend to think this is what makes the most sense--it should not require their participation in the first place. What we mean to say is: would direct SBA loans really be that bad?

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June 10, 2009 9:39 AM