The government's push to encourage lending could create a new breed of security - the small-business-backed loan.

Securitizing small-business loans is intriguing bankers, who would like to increase their lending by getting old small-business loans off the books.

Investment bankers - including some at large commercial banks - also are exploring the issue, anticipating a big market for structuring the deals.

But experts warn that it will be a long time before banks can overcome the accounting rules and credit-diversification problems that currently hinder development of a small-business securities market.

|True Sale' Requirement

One of the biggest hurdles is the regulatory accounting requirement that securitizations represent a "true sale" of assets that cannot be returned to a bank's balance sheet.

Equally difficult is the problem of structuring the loan pools backing the securities. The small-business pools must be diversified enough to win high credit ratings from Moody's and other agencies.

Payment streams also must be predictable, so investors can be assured they will collect their interest at prescheduled intervals.

"Very few banks are focusing on these deals," said Ronald G. Keenan, managing director and co-head of the asset-backed securities group at Chemical Banking Corp. "Right now, it's a no-win situation. You can spend a lot of time on them and not get anywhere."

SEC to Change Rules

But new attention has focused on small-business loan securitizations for two reasons: The Securities and Exchange Commission plans to modify rules that restrict loans backed by receivables - a stalwart of small-business lending - from being securitized.

Also, Merrill Lynch & Co. is said to be on the verge of announcing a $200 million deal for a California finance company.

If the SEC approves its proposed rule, the market should broaden quickly. Small-business loan securities are now sold either privately or in the Euro-markets.

Meanwhile, Merrill is working on a $200 million deal with Fremont Financial Corp., an asset-based lending unit of Fremont General Corp., an insurance holding company based in Santa Monica, Calif.

Deal Would Be Milestone

Fremont Financial lends to companies with revenues of $5 million to $100 million. The loans, which range from $1 million to $5 million, are secured by accounts receivable, inventory, machinery, or equipment.

The Fremont deal, which could be ready by the fall, would be the first public securitization of non-government-backed small-business loans.

Ed Lamb, a senior vice president, said Fremont has tried to securitize loans before without success.

"The deals fell apart because the bankers didn't have the experience or the pull with Standard and Poor's," said Mr. Lamb.

Finance Firms Unencumbered

Officials at Merrill declined to comment on Fremont, but acknowledge they are eagerly exploring small-business loan securities.

Fremont, however, is not a bank company. Bankers say that the biggest source of deals will be commercial finance companies, which are not subject to regulatory accounting rules and often have a vast lending network across the nation.

"Unless the accounting issue is dealt with," the number of bank securitizations will be small, said Martin D. Essenburg, vice president in the securitized products group at continental Bank.

"We're talking to a number of finance companies now, but have had limited conversations with banks."

In addition to Continental, major banks that have structured securitizations include Citicorp, Chemical, and Bankers Trust New York Corp.

Franchise Securitizations

Some have dabbled in securitizing loans to suppliers of fast food or to gas station franchises. They also have securitized dealer floor-plan loans, where a manufacturer finances the inventory carried by its own dealers.

Since May 1990, Chemical has securitized $350 million in loans to suppliers of McDonald's restaurants and Exxon gas stations, according to Mr. Keenan.

Meanwhile, Mr. Essenburg says Continental will bring at least one small-business loan securitization deal to market by the end of this year.

"The market is beginning to open up," he said.

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