The draconian budget cuts facing the Small Business Administration have some lenders questioning whether the agency should stop guaranteeing real estate loans - arguing such credit does little for the economy.

"Real estate loans do not create a single job," complained a California lender, who asked not to be identified. "Buying real estate actually hurts the working capital of these companies."

Not everyone agrees. While some bankers argue that small companies need working capital to expand, others believe small businesses need long-term financing that banks are reluctant to provide without the SBA guarantee.

"Small companies have a hard time accessing long-term capital, absent the SBA program," said Tony Wilkinson, president and chief executive of the National Association of Government Guaranteed Lenders, the trade group representing SBA lenders. "The major source of long-term credit to small business today is the Small Business Administration."

The idea of curtailing guarantees for real estate loans - which account for an estimated one-third of SBA loans - was raised last month by SBA Administrator Philip Lader. In testimony, he suggested that such loans could be made through the 504 program, which has a lower subsidy rate.

The agency scuttled the idea in favor of capping the size of all 7(a) loans. But industry officials have continued the debate.

The argument brings into focus two sometimes conflicting views of the purpose of the SBA and comes at a time when lenders want to be united in their fight to save the popular loan programs from Republican proposals to scale back or eliminate the agency.

Even before Congress debates the program, the SBA has curtailed its lending. Faced with projected demand well above its $7.8 billion lending authority, the agency has capped loan approvals at $500,000.

But as the budget debate heats up this week in Congress, the subtle disagreements over how to use SBA guarantees expose differences between large banks and small ones.

Regional banks typically make smaller loans and hold them to maturity. Of the 25 most frequent users of the 7(a) program, big banks like First National Bank of Boston and Bank One Texas had average loan amounts between $95,000 and $120,000. For these reasons, the SBA's $500,000 loan cap has not upset many of these lenders.

On the other hand, small banks and nonbank lenders regularly sell the guaranteed portion of their SBA loans into the secondary market. Both tend to make larger loans.

Secondary market poolers say that institutional investors such as pension funds prefer the longer-term of securities backed by real estate- backed loan pools. Part of the reason is that the prepayment risk on these securities is small since most SBA borrowers would have difficulty refinancing a long-term loan.

But there is also demand for shorter-term SBA loans. In particular, banks like these loans because they do not tie up their money for 15 to 25 years.

"It's no more difficult to pool business loans than it is to do real estate loans," said a dealer at one Memphis firm. "A government guarantee is a government guarantee."

And getting that guarantee to as many loans as possible is what the guaranteed lenders association is trying to do. In testimony before the House Small Business Committee recently, Mr. Wilkinson proposed reducing the SBA's guarantee to a flat 75% and imposing fees on all loans guaranteed by the SBA as ways to widen the SBA's reach. Currently, the SBA imposes a 40 basis point fee only on those loans sold into the secondary market.

But that proposal drew sharp criticism from the small-bank lender who said a reduced guarantee would favor safer, real estate loans over working capital and equipment loans.

"If they reduce the guarantee to 75%, banks would not be making any business loans," said a western banker. "You don't lose money on real estate loans. You lose it on business loans."

Worse, the banker complains, is the fact that SBA guarantees for real estate loans tend to soak up bigger chunks of the agency's authority. The problem is even more acute in California, where loan amounts tend to be larger.

Other lenders defend real estate loans as helping small business in other ways.

"I've seen some very successful businesses who have been able to stabilize their overhead costs by buying a building," said Steve Mattern, a senior vice president with Truckee, Calif.-based Truckee River Bank, one of the largest SBA lenders in the nation. "The money saved from not having to pay rent becomes working capital for the company."

Truckee River uses the 7(a) program for both real estate and business loans. Mr. Mattern said the sole reason for the proposal by the guaranteed lenders association is to reduce the subsidy rate is to increase the number of loans backed by the SBA.

The subsidy rate acts like a multiplier. If the rate is 2.73%, that means the SBA can guarantee $36.63 worth of loans for each congressionally appropriated dollar. A decline of five basis points in the subsidy rate means the SBA can guarantee an additional 68-cents for every dollar.

However, the subsidy rate is affected by such things as loan losses, program expenses, fees generated, appropriations and the average guarantee by the program. The combined effects of the success of the LowDoc program - which provides guarantees as high as 90% on loans of less than $100,000 - and the $500,000 loan cap are expected to cause the subsidy rate to rise.

"That will cause upward pressure on the subsidy rate at a time when Congress is telling us to get our subsidy rate down," Mr. Wilkinson said.

One compromise suggested by a big bank lender is to widen the tiers between loan types. The source suggests lowering the guarantee and fees for those SBA loans with real estate collateral.

"I'm sure banks would be willing to take more risk for these loans because they are safer," he said.

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