One of the first places the Reagan Administration began "trimming the fat" from the federal budget last year was in guaranteed loan programs, which are used extensively by small businesses. For example, budget cutters are already planning to close the Commerce Department's Economic Development Administration (EDA) and the Business and Industrial Loan Guaranty Program of the Agriculture Department's Farmers Home Administration (FmHA). These two programs together have helped guarantee or loan about $15 billion to small and troubled firms.

Such cuts might lead one to think all government loan programs have been, or will be, lopped off. But one is still going strong: the Urban Development Action Grant (UDAG) program, started in the Carter Administration and run by the Department of Housing and Urban Development (HUD). This fiscal year HUD will give $440 million to cities, which in turn will lend the money to qualifying companies.

Most of the money goes to finance acquisition of buildings or real estate for business expansions or new commercial ventures. Both large and small companies have participated in the program, but with the proposed termination of the EDA and FmHA programs, it is expected that more small companies will take advantage of it.

UDAGs are being kept alive because they have demonstrated a good track record in leveraging public investment with private capital. Whereas other federal loan programs often contributed, or guaranteed, as much as 90% of a project's needs, the UDAG program will put up 40% at most; its average contribution is 16%.

Recently, Rep. William J. Coyne (D-Pa.) asked the Congressional Research Service to project the results of continuing the UDAG program at $500 million a year through 1984. The study predicted that UDAGs would generate $11 billion in new private investment, saving or creating 200,000 private-sector jobs over the next three years. "The UDAG program is a winner," Rep. Coyne says.

To receive UDAG funds, a business must be located in, or willing to locate to, an area of urban decay or high unemployment as designated by the U.S. Census, and it must demonstrate that the loan will help create or save a large number of jobs. A company that intends to move away from an urban or impoverished area may be able to obtain UDAG funds to stay and modernize in its present location instead. Typical uses for UDAGs include new factories, industrial parks, and office buildings, as well as hotels or retail space that would serve to attract other development to the area.

Take, for example, the case of Rodless Decorations Inc. of New York City, a manufacturer of bedspreads and draperies with annual sales of $13 million. Two years ago, the building Rodless was leasing in lower Manhattan suddenly became hot commercial property, and the rent was hiked accordingly. The company couldn't afford to stay there.

So Thomas A. Salamone, the manufacturer's production and Plant manager, went to the city's Industrial Development Agency. "We said that a new plant would cost Rodless $2.2 million, and that we didn't have access to that amount of capital," Salamone says. If the agency could help out, he told officials, Rodless could continue growing, raising its number of employees from 180 to 250 within three years.

The agency proposed selling $1.9 million in tax-exempt 10-year industrial revenue bonds for the company. (Up to a quarter of all UDAGs are combined with IRBs.) Prime rates at the time were about 20%; the tax-exempt status of the bonds would bring Rodless's interest on the 10-year notes down to about 11%.

The plan seemed on track. The company located a vacant facility in Queens, and the state's Economic Capital Corp. chipped in an additional $300,000, 15-year loan at 8%. This amount, along with the $1.9 million in IRBs, would have given Rodless the $2.2 million it needed.

But a complication arose. The company intended to buy two separate properties, one for $1.7 million and the other for $500,000. The seller of the smaller one wanted to remain a tenant in part of the building. Federal rules governing industrial revenue bonds, however, prohibit their use in such a case. The Industrial Development Agency had to drop that half-million from the bond issue, reducing the money available to a total of $1.7 million.

It was an ideal case for a UDAG: all the commitments made; 70 new jobs to be created, primarily for low-income people; and a financing "gap" of $500,000, or 23% of the purchase price. HUD came through with the needed half a million at 8% for 15 years. Now Rodless Decorations is prospering in its new neighborhood.

"The reason it's called an 'action' grant is that the need has to be immediate," says Rick Patoski, UDAG specialist in the Boston HUD office. "All the other permanent financing has to be in place. We want to see options on property, architectural plans, etc."

Each quarter, HUD holds what it calls a "competition," approving UDAGs for the projects it rates highest in terms of job creation and other criteria. HUD's UDAG spokesman, John J. Flynn, estimates that about 20% of its UDAG applications are approved each time. Those that don't win may be considered for three more consecutive quarters. In the long run about half of all UDAG applicants receive money, Flynn says.

To apply, a business must go to its mayor or city development commission officer, who sets the terms, prepares the paperwork, and marshals the application through the decision process. If the application is approved, HUD gives the money to the city, which then lends it to the business. When repaid, the city keeps the money and can use it to finance other such projects. Cities may also take "equity kickers" or shares of a project's projects.

The UDAG program has its critics. Some grants have supported middleclass and luxury housing, the rationale being that such developments may help revive a depressed neighborhood. Other grants have gone to commercial or industrial projects of large corporations that perhaps would have undertaken the developments even without the subsidy.

About 10% to 15% of the approximately $2.2 billion in UDAG funds dispensed since 1977 has gone to housing. Such projects generally fall at the low end of HUD's private-to-public investment ratio. The minimum ratio HUD permits is $2.50 of nonfederal capital to $1 of UDAG money. Commercial and industrial projects generally come in with even higher ratios -- often as much as $10 to $1 or more. Flynn says a change in UDAG rules, effective this year, may direct more money into the higher-ratio investments rather than housing.

Though the department doesn't keep track of UDAG recipients by size of company, Patoski points out that many cities tend to arrange UDAG loans for large companies. Bigger corporations often can afford relatively short term borrowing -- which means that the city will soon have its money back to lend to other worthy businesses. The city's subsequent use of the money, according to HUD requirements, must be targeted to similar job-creating or urban revitalization investments. Thus Patoski urges companies seeking financial help to inquire whether their city has received UDAGs already, and if so, when and if the money will be repaid and available for other uses.

Despite the scattered criticism, the UDAG program has won wide political backing. Says Kenneth R. Harney, author of a nationally syndicated real estate column: "Ask mayors, commercial real estate developers, local chambers of commerce, and bankers for the one innovation of the Carter years that should be retained by the Reagan Administration and you'll get the same cryptic response: UDAGs... No federally funded program in the real estate field in the last two decades has attracted such fervent support from diverse interest groups as this experiment in 'public-private partnerships."

Because of this political support, the UDAG program seems safe from the budgetary ax at present. Businesses that run into a financing gap in their capital needs may find a UDAG waiting for them down at city hall.

Published on: Jun 1, 1982