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Small Business Suite Lenders Wary of Plan to Compensate For Small-Business Program Shortfall

The Wall Street Journal (March 19, 2002) -- A roughly $5 billion shortfall in funding for the Small Business Administration's biggest loan program has the Bush administration proposing to shift loan capacity from another, underutilized SBA program.

But lenders involved in the smaller program, known as 504, doubt it could accommodate many borrowers from the SBA's larger loan program. And the lenders note the many difficult logistical issues in moving borrowers between the programs.

"It won't happen," says Kurt Chilcott, president and chief executive officer of CDC Small Business Finance Corp., San Diego, the nation's largest handler of loans under the 504 program.

The flap comes as an apparent economic recovery is expected to prompt many smaller companies to seek financing to expand their businesses. Despite that need -- and the fact that small business is a constituency that both political parties court assiduously -- the Bush administration and Congress are sparring over the SBA's lending programs.

Essentially, the Bush administration's Office of Management and Budget, and the SBA, are taking a more cautious approach than Congress would like in estimating future losses on SBA-guaranteed loans. Loan losses are covered by fees paid by outside lenders or borrowers, or by taxpayer funds, or a combination of the two. And higher loss estimates make the loan programs more expensive and thus, in the case of the SBA's biggest program, known as 7(a), reduce the amount of loan money available.

The 7(a) program would drop by more than half to $4.85 billion in fiscal 2003 from $10.7 billion in the current fiscal year under the Bush budget proposal. The administration proposes to use some leftover funds from fiscal 2002 along with unused capacity in the 504 program to help boost 7(a) lending in fiscal 2003.

But the programs are very different and the loans are made through separate sets of lenders. Certified-development companies originate nearly all of the 504 loans. And the law requires these loans be for economic-development purposes, such as job creation, and that they finance fixed assets such as real estate or equipment.

The 504 program is limited to $4.5 billion for fiscal 2003, estimated to be about $2 billion more than the program actually needs. But shifting those funds to 7(a) isn't easy. The 7(a) program is mostly for working-capital loans, which aren't allowed under 504, and banks make most of the 7(a) loans. "You're talking about different purposes and, more importantly, different delivery systems," says Mr. Chilcott.

The SBA has said that a certain number of the larger 7(a) loans are real-estate loans and could be switched. But Mr. Chilcott and other certified-development company executives say that since 504 is generally a better deal for borrowers, most who could qualify under 504 are already steered toward that program. "I have this conversation with our banks all the time," Mr. Chilcott says. "'Hey, are there any 7(a) real-estate loans out there that could go 504?'" The answer, he says, is not many.

"We see few," agrees David King, president of Bay Colony Development Corp., Waltham, Mass., and another 504 lender. "A 504 is a better deal."

How many 7(a) borrowers would qualify for 504 loans? "We don't quite have that feel yet," says Lloyd A. Blanchard, the SBA's chief operating officer. "We're going to be looking at that."

Sen. John F. Kerry, a Massachusetts Democrat and chairman of the Senate small-business committee, opposes the move to switch borrowers to 504 loans. "It's a bad idea and I don't support it." He wants to see the larger 7(a) program fully funded.

The 504 loan's typical structure: The borrower must put 10% down; the certified-development company arranges 40% of the loan guaranteed by the SBA and funded through the issuance of debentures; and a commercial bank or other conventional lender lends the remaining 50% and gets a senior lien against the real estate or other assets. The 504 loans can't be used for refinancings, though 7(a) loans can.

Tim Fahey, senior vice president at Middlesex Savings Bank, Natick, Mass., which makes 7(a) loans as well as the senior portions of 504 loans, says, "We don't do any 7(a)s that are real estate." And therefore Middlesex wouldn't have 7(a) loan demand that it could shift to the 504 program.

Tim Pierce, director of economic development for the South Plains Association of Governments, Lubbock, Texas, and head of its certified-development company, packages both 504 and 7(a) loans. Last year, his organization handled between 15 and 20 7(a) loans. "One or two of them could have been a 504 loan," he says. But generally, "We do just about everything that could be a 504 as a 504."

Barbara A. Vohryzek, executive director of California Statewide Certified Development Corp., Davis, Calif., a big 504 lender, worries that one SBA program running short of money could discourage borrowers across the board. "What they hear is that SBA is running out of money. That isn't going to help us."

And would the biggest 7(a) lenders, which are for-profit commercial banks, take time to refer borrowers who might qualify for 504 to certified- development companies, which are nonprofits devoted to economic development in their communities? Banks ask, "'What do I get out of this?'" Ms. Vohryzek says. "We see a lot of that."

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