Loans made under the Small Business Administration's flagship credit program have fallen dramatically in the first six months of fiscal 2008 -- and none of the interested parties can agree on the cause. As of March 31, approvals for 7(a) loans are off nearly 18 percent compared to fiscal 2007, while the total dollar volume of 7(a) loans has fallen by 9.3 percent. If these trends hold for the rest of the year, 2008 will mark the steepest decline in 7(a) lending since 1982. And it would make this the third straight year for falling loan approvals, as measured in dollars. The last time the SBA saw such a streak was in the early 1970s.

The SBA has long been promoted as a counter-cyclical stimulus -- when traditional credit is tightened, the agency loosens its spigot -- but because the SBA guarantees loans made by commercial banks instead of making them directly, its ability to counteract an economic downturn is limited. Moreover, there's no consensus that small businesses are finding it harder to borrow this year. Even so, Sen. John Kerry (D-Mass.), chairman of the Senate Committee on Small Business & Entrepreneurship, accuses the SBA of being asleep at the tap. "The lack of available credit is making it more difficult for small businesses to create new jobs," Kerry said in a statement to Inc.com. "Unfortunately, the Bush Administration and Republicans in Congress have been too busy bailing out big businesses on Wall Street to help small businesses on Main Street." Kerry blames the slowdown in part on high fees levied in the 7(a) program, and has introduced legislation that would cut those fees for the rest of fiscal 2008, which began last October. The assessments, which include a servicing fee paid by the bank and a guaranty fee that's passed on to the borrower, are used to offset losses from loan defaults.

A close look at the loan numbers, however, suggests that these fees have had little effect on the steep drop since 2007. Most of this fall-off occurred with one new type of 7(a) loan known as SBAExpress. In exchange for a smaller guaranty, banks are able to use their own application forms and credit scoring models to make SBAExpress loans and can approve them immediately. In this arrangement, a borrower who doesn't qualify for a conventional loan may receive an SBAExpress loan, often without even realizing he's applied for one. The SBA has guaranteed 24,069 of these loans this year, 30 percent fewer than last year. Dollar volume is off by 23 percent.

There's no clear explanation for this. The agency contends that most of the reduction came from small, often revolving credit loans, made principally by five large lenders. "When they modeled their expected losses based upon credit scoring levels, these banks found that the losses are greater than what they had expected," says Eric Zarnikow, associate administrator for the SBA's Office of Capital Access. "So they've raised their credit standard, which has reduced the volume of loans in that area."

But at least one industry analyst believes that the problems with the SBAExpress program are widespread, because credit scoring has made banks lax. "Lenders who years ago limited the debt-to-income ratio on a consumer to 40 percent, max, have come over the past two or three years to see a 50-55 percent ratio as acceptable," says Joel Pruis, a consultant at Baker Hill who advises banks on small business lending. As a result, "We've seen an increase in charge-offs among our clients -- it went up about 40 percent from the end of 2006 to the end of the 2007. " Indeed, the SBA's own lender statistics show that 18 of the 20 banks that appear to be the most prolific SBAExpress lenders have issued fewer loans in 2008. (Such analysis is limited because some banks make several kinds of 7(a) loans, and the figures aren't broken out by category. Zarnikow, for his part, declines to name the banks.)

On the other hand, executives at two top SBAExpress lenders insist that slackened demand accounts for the drop. At US Bank, where SBAExpress loans have fallen 23 percent, "We've not changed our credit policy," says SBA division national sales manager Eric Daniels. Adds Wells Fargo vice president Tom Burke: "This was a great tool, but what 's happened is that a lot of small businesses -- services and retailers -- that didn't get line of credit loans in the past were getting them now. And they've been impacted by the economy." Burke says that the decrease in Wells Fargo's SBAExpress loans -- even greater than at US Bank -- had nothing to do with the fees, and lowering them would not have affected lending.

Indeed, while it's hard to find a banker who objects to lowering fees, the lenders and industry observers interviewed for this report agree that the impact on lending of the proposals embraced by the Kerry legislation would be, at best, small. "The guaranty fees have been in the program for years," notes one banker. Burke, speaking generally about SBA lending, says that the high fees might serve as a further psychological barrier to keep the borrower from the bank, "but," he adds, "we finance the fees. At the end of the day, it's incremental at most." In any case, "we're seeing more applicants for traditional 7(a) loans."

Instead, the agency is alienating many smaller bankers with a different set of fees, not addressed in Kerry's bill. The SBA, with Congress's permission, has begun charging banks for auditing their 7(a) portfolios. "It's just more of the SBA pushing what I see as their responsibility off on the banks," says Tim Metz, vice president of loan services at Douglas County Bank of Lawrence, Kan., which last year closed 24 7(a) loans. Particularly upsetting is the agency's plan for "on-site" audits. "They'll spend a week, regardless of the size of the institution," says Tony Wilkinson, president and CEO of the lender trade association NAGGL. "They basically have two categories, big reviews and small reviews, and the difference in cost is insignificant." According to Bryan Hooper, director of the SBA's Office of Credit Risk Management, the biannual review will typically cost every bank servicing at least $10 million in loans between $22,000 and $27,000. While the SBA contends that this excludes the vast majority of lenders in the program, in practice only lenders that do little or no actual SBA lending escape the fee.

Small community bankers who make an effort to do SBA lending fear the new fees will squeeze them out of the program. Tim Metz raised eyebrows at a meeting in the SBA's Kansas City regional office when he announced to agency officials visiting from headquarters that "if the fees grow to this, you've just lost the third-biggest participating lender in the Kansas City area." Metz insists he's serious. He describes himself as a loyal SBA user and says that "for all their recent problems, the SBA is one of the most efficiently run government agencies that there is." But, he adds, "These loans have only average profitability. We do SBA loans because we feel a commitment to our community to get that program out to do what it's meant to do."

Others rail against a newfound zealousness at the SBA to deny or reduce guaranties to banks that fail to follow the rules for documenting loans, no matter how small the overlooked detail. "SBA has been very aggressive in holding lenders' feet to the fire," according to Bob Coleman, who publishes a newsletter tracking SBA lending, and banks are not only taking losses on the loans but have to withhold more cash in reserve against their current portfolios, to account for future guaranties that may not materialize. If nothing else, the heavy administrative burden discourages banks from embracing the program, says Pruis. "They worry that if they don't dot all the Is and cross all the Ts -- whether or not it was material to the results of the loan -- the SBA will walk away from the guaranty." Pruis argues that the best way the SBA can stimulate lending is to "restore confidence that the guaranties will truly be honored."

Despite these complaints, there's no evidence that lenders have yet abandoned SBA lending -- indeed, the number of banks that made at least 10 loans in the first half of the year increased slightly. Traditional 7(a) loans, with their burdensome rules and a sheaf of paperwork to match, are now the smallest segment of the 7(a) line but actually grew 26 percent in the first half of 2008 (though the average loan size shrunk). The new Community Express program, designed to reach borrowers in the poorest communities, has grown by 37 percent.

However, even this last gain is now in jeopardy. Community Express is a pilot program and limited by law to not more than 10 percent of the total number of 7(a) loans. With the drop in SBAExpress and other lending, Community Express has exceeded 12 percent of the new loans in 2008, and according to bankers and industry watchers, the SBA has told major Community Express lenders to cut their loan approvals for the rest of the year. "We were doing about 26 units a month, and we were looking at bringing our volume to 50 or even 75 loans a month," says US Bank's Daniels. "But they called us up and told us we had to limit the program to just 15 loans a month for the rest of the year."