As the Small Business Administration next week caps the size of its popular 7(a) loans, lenders say the move could drive some banks from the program and reduce credit to businesses.

The cap, effective Jan. 1, will limit the size of a loan guaranteed by the SBA to $500,000 -- down by one-third from the current maximum of $750,000.

By setting the cap, the agency hopes to avoid running out as it did in July 1993. The action should allow it to make more loans to fewer companies at a time when the popularity of its programs has stretched resources.

"The object was to let our finite capacity of loan approval be extended to a larger number of small businesses," said SBA Administrator Philip Lader in an interview.

The cap on loan size is the most dramatic action the agency has taken to avoid exceeding the $7.8 billion limit set by congressional budget writers. The agency had estimated that without some restraining action, demand in fiscal 1995, which ends next Sept. 30, would reach $10 billion.

There has long been a tension between funding and loan demand at the agency. However, in mid-1993 the problem became so acute that it forced major changes.

That year, the SBA changed the guarantee formula for the 7(a) program, added a 40-basis-point fee on loans sold into the secondary market, and imposed a 50% tax on premiums for loan securitizations that sold for more than 110% of par value.

Further aggravating the issue of funding versus demand has been the advent of programs such as Low-Doc, which provides loans of $100,000 or less.

In fiscal 1994 the agency reported approving 5,860 loans worth $315.6 million.

"While this is not something we planned to do, it is consistent with the steps the agency has taken over the past year and a half," said Mike Stamler, an SBA spokesman. "It is focusing on doing more with less and to reach more businesses with smaller loans."

In interviews with some of the biggest SBA lenders, officials say that focus on smaller loans will not help companies looking for long-term capital to finance equipment or real estate.

"The main advantage of SBA programs to the client and the bank is that we can offer long-term financing," said David Bartram, an executive vice president with Bank of Commerce in San Diego, Calif. "Without the SBA vehicle, banks must resort to conventional financings of up to three years"

Mr. Bartram said nearly 70 of the bank's 209 SBA-backed loans in 1994 -- 50% of the $86.1 million lent -- came from deals above the $500,000 limit. The bank ranked first among bank SBA lenders in dollar value of loans for the fiscal year ended Sept. 30.

Much of the reason for the bank's high average is the cost of real estate in Southern California, which Mr. Bartram said has remained higher than most parts of the nation despite the recession. He said his bank has 15 loans above the $500,000 mark in the pipeline.

At Truckee River Bank in Truckee, Calif., officials are considering whether to continue making SBA loans. Steve Mattern, a senior vice president, said the industry is in such confusion that three SBA district offices have called him trying to find out what is happening.

"We're trying to figure out how to stay in the program and have it remain profitable for us," Mr. Mattern said. Truckee River was the seventh-largest SBA lender nationally during fiscal 1994, with 176 loans totaling $69 million. "This is just the tip of the iceberg," he said. "Is the next step to do away with the program altogether?"

At the biggest SBA lender, Money Store, officials said they can get around the cap on many loans because the company can still fund its niche of real estate-backed loans under the agency's 504 program, which is not affected by the new policy.

Larry Wodarski, president of Money Store Investment Corp., the SBA unit of Union, N.J.-based company, said the cap will hurt his company's ability to fund some large equipment projects.

Ironically, the changes come as a result of the popularity of the SBA's innovations. Loan guarantees at the agency jumped 21.4% in fiscal 1994, to nearly $8.2 billion.

Pam Davis, vice president and manager of the guaranteed government lending program at Meridian Bank in Reading, Pa., said "This is just a setback to program that was just coming back from other setbacks."

One observer predicts the move will increase the SBA's loan loss rate. Robert Coleman, a former lender and publisher of The Coleman Report, said eliminating larger loans will raise the agency's subsidy rates.

Right now, the subsidy rate, which is based on losses and expenses less anything the SBA earns from fees, is 2.73% for the 7(a) program. The subsidy rate is 0.58% for the 504 program, which is secured by real estate and is generally used in financing larger projects.

The SBA guarantees a maximum of 40% of a project under the 504 program, and is always secured by real estate.

"They're assuming the 2.73% subsidy rate will remain constant," Mr. Coleman said. "But if you delete that larger amount, the subsidy rate has to change -- because the smaller loans are also the riskier loans."

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