Business finance degree

ENTREPRENEURS ARE NOT SURE WHAT TO make of the bill signed by President Bush in December to eliminate the $79 million federal subsidy for the SBA's loan guarantee program--and with good reason. Before the ink was dry, the spin was flying. One side, aligned with the White House, called it a small-business-friendly legislative compromise that would save the SBA's 7(a) program by making it "self-sustaining." The other side saw it as an unnecessary tax on small-business borrowers.

They're both right to some degree. Congress raised the program cap to $16 billion from $12.5 billion, and restored the maximum SBA guarantee on 7(a) loans from $1 million to $1.5 million. But making the program self-sustaining ultimately means higher fees for borrowers and lenders, who will now subsidize the program in place of the federal government, with the SBA in the role of facilitator.

Borrowers will pay twice as much--now 2 percent--in fees to take out a 7(a) loan of $150,000 or less. And fees on larger loans up to $700,000 increased to 3 percent from 2.5 percent. But Mike Stamler of the SBA maintains that this is not actually a fee hike, since rates were only temporarily reduced in December 2001. He adds that the fee difference is nominal.

But others say the reason fees were reduced in 2001 (the reduction took effect in 2002) was that they were too high, and frustrated lenders were threatening to pull out of the program, recalls David Bartram, president of U.S. Bank's San Diego-based SBA division. "That doesn't mean [fees are] not too high now," he says, adding that, had the $79 million subsidy remained, fees could have remained at the lower rate. The 2 percent fee is a potential hardship for the smallest borrowers, he says, and a loan of $2 million--the maximum the program allows--costs a borrower about $50,000 in fees. "That's substantially more than what somebody pays for a conventional loan."

Bartram predicts that some small-business owners will opt for conventional lower-fee loans, albeit with less favorable terms than 7(a) loans. However, given that the program was designed primarily as a lender of last resort for those who don't qualify for conventional loans, those borrowers may have no choice but to choke down the higher fees. "What other viable option do they have?" asks Kristie Darien, director of government affairs with the National Association for the Self-Employed. Beyond dipping into savings or tapping generous relatives, entrepreneurs are left to use credit cards with "ridiculous" interest rates of 12 to 24 percent, she says.

There will likely be more costs ahead for 7(a) loans. Some banks will pass along a portion of their fees to customers in their loan product pricing. "You'll probably see some interest rate increases," says Tom Schneider, president and CEO of Pathfinder Bank, a $300 million community bank in Oswego, New York. Schneider says he hopes to do more SBA loans this year, but smaller lenders may leave the 7(a) field rather than try to make up the difference.

Bigger banks may even have to tighten up their lending criteria to increase profitability, says Bartram. As a result, "there are going to be a certain amount of small businesses that could have gotten financing last year that won't get [any] this year," he says. And looking ahead, there's the risk of higher fees now that the program has no federal subsidy.

But Bartram and other lender representatives still call the new legislation positive, since it's keeping the 7(a) program alive. And because it's being subsidized completely by lender and borrower fees, with the higher program limit of $16.5 billion, entrepreneurs will be spared the temporary program suspensions and emergency caps seen over the past two years. "This stabilizes the program for the first time in a long time," says Tom Burke, national program director for Wells Fargo SBA Lending. "The funding source may have changed, but the program continues to be viable."

That's true at least for the next two years, assuming the 2006 budget doesn't make any changes. But as for 7(a)'s future health--and the current administration's interest in keeping it going--Capitol Hill observers say the jury is still out.

35% of new borrowers will explore nonbank financing options over the next year.

C.J. PRINCE is executive editor of CEO Magazine. She can be reached at cjprince@chiefexecutive.net.