WASHINGTON - Senate Small Business Committee Chairman Christopher Bond hears a time bomb ticking in a popular Small Business Administration loan program.

At a hearing last week, the Missouri Republican grilled SBA chief Philip Lader and representatives of the banking industry on the potential for losses in the low-documentation program that streamlines application procedures for SBA guarantees on loans of $100,000 or less.

Sen. Bond believes the program increases the agency's exposure to loan losses and may move to curb such so-called lowdoc loan volume, an aide to the senator said.

"What we are talking about is a potentially larger liability under the guarantee," Sen. Bond said at the hearing.

Designed to encourage lending to start-up businesses and other small companies, the program shifts the entire credit risk of the loan from banks to the SBA, Sen. Bond said.

The loans, which carry a 90% guarantee, enjoy strong secondary market support. Because the lowdoc loans are made at above-market rates, banks are able to sell the guaranteed portion of a loan for 110 percent of its face amount and leave the default risk with the government.

Defaults may rise, Sen. Bond suggested, as banks insulated from losses scrutinize lowdoc loan applications less rigorously.

But Mr. Lader said only .6% of the $2 billion in lowdoc loans funded since the program was rolled out nationally last year are delinquent, compared with a 1.2 percent delinquency rate for other SBA loans.

The delinquency figures failed to impress Sen. Bond, who pointed out that the lowdoc loans have yet to complete the three-year seasoning period during which defaults are most likely to occur.

Bankers testifying before the committee assured Sen. Bond that lowdoc loans undergo the same credit scrutiny applied to other loans. Michael Gallagher, manager of government loan programs at Wells Fargo Bank in San Francisco, noted that SBA audit standards are the same for lowdoc and conventional loans.

Industry spokesmen dispute the notion that banks are less careful in reviewing loans that will be sold in the secondary market.

"If the credit isn't a good credit, you might not be able to get 110 percent for the loan," said Herbert Spira, tax counsel for the Independent Bankers of America.

"I don't care how high the guarantee is - if that loan screws up, it's a problem for the banker," added John Blanchfield, associate director of agricultural and small business banking at the American Bankers Association.

None of these arguments have allayed Sen. Bond's doubts, his aide said. Particularly troubling to the senator is a 90 basis point buffer built into the loan loss reserve estimate provided by the SBA. An added cushion against losses would not be needed unless defaults are expected to rise, the aide explained.

Sen. Bond probably will decide next week whether to propose measures to reduce the risk he sees in the lowdoc program. The aide declined to speculate on what form such measures might take, but possibilities discussed at the hearing included reducing the guarantee percentage for lowdoc loans to 75 percent or setting up a separate, higher SBA loss reserve for the loans.

Mr. Cahill writes for the Medill News Service.

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