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Sharp drop in small business loans

The Small Business Administration processed 57% fewer loans last quarter than it did a year ago.

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(CNNMoney.com) -- The credit freeze afflicting America's small businesses shows no signs of thawing. In the last three months of 2008, the Small Business Administration's flagship loan-guarantee program backed less than half the number of loans it approved a year earlier - a sign that fewer entrepreneurs are getting financing to start or expand their ventures.

In the first quarter of its 2009 fiscal year, which ended Dec. 31, the SBA's 7(a) program backed 8,996 loans. That's a 57% drop from the 20,859 loans the SBA backed in the first quarter of 2008, and a 62% drop from 2007's first-quarter total. The total dollar value of loans processed by the SBA also plummeted to $1.94 billion, down 40% from last year's $3.24 billion.

The SBA's 7(a) program insures against default a portion of qualifying small business loans, an incentive aimed at motivating risk-adverse banks to extend financing to fledgling companies. For the past year, entrepreneurs have reported a sharp clampdown in bank lending that has left many firms without access to the loans and credit lines they need to operate.

Banks are unquestionably being more stringent in picking their borrowers. In the Federal Reserve's most recent loan officer survey, released in October, 75% of banks polled said they had tightened their lending standards for small business loans within the past three months, and 90% said they were charging more for loans and credit lines.

Grady Hedgespeth, the SBA's director of financial assistance, agrees that tightened lending standards are to blame, but notes another major factor that contributed to the fall-off starting in September: the inability of banks to resell their loans to investors.

"The secondary market for SBA loans came to effectively grinding halt," he says. "This market has historically financed about 40% of the loan volume. So the freeze resulted in less access to a liquidity source for banks."

Small business observers say reduced demand is also contributing to declining loan volumes.

"Owners tell us that their primary concern is terrible sales. Under those circumstances, why would they want to expand? They just aren't doing that right now," said William Dennis, a senior research fellow with the National Federation of Independent Businesses, a Washington trade group.

Banks are also under pressure to protect their own bottom lines. Write-offs on bad home loans and other troubles have led to 25 banks failures so far this year. Additionally, as property values decline, the value of the assets entrepreneurs have to offer as collateral against loans is diminishing.

"We hear complaints in the banking industry that they are trying to be more open, but the regulators who review bank examiners are getting stricter," Dennis said. "On one hand, bankers want to make more loans, but regulators are more cautious. So there are a bunch of things coming together here that makes lending difficult."

Bankers say they're still actively lending to qualifying borrowers. Bob Polito, senior vice president at Webster Bank, in Waterbury, Conn., says his bank is wary of extending loans to businesses at risk of borrowing too heavily.

"I declined a loan recently and the customer said, 'You have to give it to me because you have government funds.' But the reason for turning down the loan was not because we didn't have the money - it was because the customer didn't have collateral, didn't have enough personal investment in the venture, and was clearly unable to repay it," Polito said. "I want to get money out and create jobs, but it's got to be done in a credit-worthy environment. I don't want to get people in a bind. I don't want to go after them." To top of page

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