) -- Now that

mortgage bailout dollars

have worked their way through much of the housing market -- delivering tens of billions of dollars in profit to large, mortgage-servicing banks -- the next profit center via government subsidies appears to be commercial lending.

Small businesses and major corporations alike have been voicing increasing frustration at their lack of available credit. The credit crunch began nearly two years ago as panic started around the difficulties of

Bear Stearns

, and slowly spread out from the financial markets to the real economy. The weekend's collapse of

CIT Group

(CIT) - Get CIT Group Inc. Report

-- which has relationships with more than 1 million small and medium-sized businesses -- has only exacerbated the problem, as the firm has sharply cut new and existing credit in an effort to survive.

Tom Drennen was about to receive a loan with CIT back in October 2008 -- roughly a year before the troubled lender

filed for bankruptcy

-- to open a Beef 'O' Brady's restaurant in Newport, Ky. But two weeks away from closing, Drennen says CIT told him it could no longer issue the funds.

"They called and said they had frozen all their loans; they weren't lending anymore, period," says Drennen. "It was back to the drawing board ... I pretty much just hit the pavement. I went to every single bank in the area."

He visited more than a dozen banks over several months, paying rent on a building he had leased, without the credit cushion he had expected. Northern Kentucky University's Small Business Development Center helped him develop a detailed business plan as part of his pitch, but he still had no luck. The Obama administration announced its stimulus package, with promises of small-business support, but the lending spigots were still clogged.

"I thought a lot of this money would be going to the banks, but after stimulus passed, banks still weren't lending to start-up businesses," he says. "Banks are getting this money, but they aren't lending."

As Drennen's cash reserves drained, the Northern Kentucky Area Development District -- a public-private partnership with a revolving credit facility -- finally offered him a $100,000 loan. With that financial support in hand,

Huntington Bank

(HBAN) - Get Huntington Bancshares Incorporated (HBAN) Report

agreed to provide another $90,000 in financing -- an indication of the powerful role that government support plays in the economic recovery.

Complaints from small-business owners in similar situations have reached a fever pitch, and the Obama administration has been forced to take action on several levels.

Earlier this year, the

Federal Reserve

began pouring liquidity into the commercial paper and asset-backed lending markets to aid capital-starved corporations. The stimulus plan approved in February also cut fees on government-backed small business loans and raised the maximum guarantee level to 90%.

The Small Business Administration extended additional support last week, increasing three different types of loan guarantees, in some cases up to $5 million. SBA Director Karen Mills indicated the agency may take further steps.

"There is much more work to be done," Mills said in a statement, noting that the country's 29 million small businesses "have been hard hit in this recession."

Evidence of a credit dearth as the economic recovery has started to emerge is not just anecdotal. According to Fed data released Monday, bank loans and leases have contracted by $530 billion so far this year, a 9% annualized rate of decline. Commercial and industrial loans have dropped an even more dramatic 17%.

While bigger fish can tap the commercial-paper market -- and have been doing so increasingly, for the past three months -- small firms are more reliant on direct bank loans, with few other options. According to surveys by the National Small Business Association, banks still account for more than half of small-business financing, but companies have been using credit cards and cash flow more often as bank loans have dried up.

Third-quarter reports from the biggest small-business lenders add credence to those claims.

Bank of America

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-- the No. 1 U.S. commercial lender by size, according to the SBA -- saw a $15 billion decline in commercial loans and leases last quarter alone, just $528 million of which was a write-off of loans gone bad. The next-largest,

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Wells Fargo

(WFC) - Get Wells Fargo & Company Report

, posted an $11.9 billion decline, $924 million of which was a write-down.

The third-largest,

JPMorgan Chase

(JPM) - Get JPMorgan Chase & Co. (JPM) Report

slashed commercial credit by $5 billion, much less on a relative basis, with a larger portion going toward credit costs. Still, on an annual basis, JPMorgan's commercial lending is down 16%.


(C) - Get Citigroup Inc. Report

, which ranked No. 4 last year, doesn't break out commercial loans, but has put an emphasis on whittling down its risk-sensitive assets in the U.S. as it focuses abroad.

"This is reality check time -- we're walking on onion paper here," says Mark Kollar, CEO of Rosemont, Il.-based Kollar Financial Strategies. "The flow of money is being restricted everywhere I'm looking, and that's going to kill us."

One of his clients recently lost a $250,000 credit line "out of the blue," Kollar adds, though he relied on it to fund day-to-day operations.

The next wave of growth is sure to come from stimulus dollars being funneled throughout the economy. But, says Anthony Crescenzi, a strategist and portfolio manager at PIMCO: "Missing in this equation is a turn in lending."

Small businesses represent a huge market for big banks, especially as small competitors crumble and consolidate under the weight of bad loans. According to the SBA, small businesses generate over half of all private-sector employment and non-farm private GDP. Though they have won $93.3 billion worth of government stimulus-program contracts, they remain in dire need of additional cash from banks.

If big lenders continue slashing commercial credit lines and rejecting new loans, they may be missing out on a huge cache of opportunity. The housing market has begun to recover and gross domestic product expanded by a stunning 3.5% last quarter. Though growth was spurred by government-subsidized consumer spending, it indicates both a willingness to spend, and a chance for businesses to grab low-hanging federal fruit when opportunities arise.

For instance, Tyler Barnett recently visited a Bank of America branch on Wilshire Blvd., across the street from his office in Beverly Hills, Calif. He had bought out a partner, and wanted to discuss a loan to expand his marketing business.

"The woman behind the desk told me they are unable to discuss loans in person," says Barnett. "Unable to discuss loans in person? Isn't that the nature of a lender, meeting you, trusting you, analyzing etc.?"

Barnett says the loan officer offered to help by calling the corporate office with him on speakerphone. An automated system could analyze his credit metrics for instant approval or denial. His response?: "I left."

Barnett, who does all his banking at BofA, is now researching local community banks to bring his business "where there are actually people who want to talk to you."

A report last week by Rick Buczynski, chief economist at the research firm IBISWorld, indicates that lenders are starting to get the hint.

Buczynski sought to identify commercial and industrial lending opportunities for banks, as the economic recovery sets in. He examined the 10 economic recoveries since 1950 and found that manufacturing, trade, transportation, storage, health care and energy appear poised for tremendous growth because of depleted inventory levels, and, as the administration plans for a new health-care system, a better utility grid, and the development of clean-energy technology.

"In my dealings with commercial bank clients in recent months, I've noticed a palpable change in attitude," Buczynski writes. "Now, despite vigilance and risk mitigation reigning supreme, the mantra 'Where do we go from here?' rings loud and clear."

While banks are asking those questions, others are already stepping up to the job.

Lynn Tilton, founder and CEO of the private-equity firm Patriarch Partners, has been voicing her concern about a dearth of small-business credit since the beginning of the crisis. She has placed advertisements in the

New York Times


Washington Post

issuing a "clarion call to rebuild America" through the creation of a federal bank that issues loans directly to capital-starved companies. She has also proposed a public-private partnership that would leverage funds from other rescue programs to do the same.

In the meantime, she's invested billions of dollars in dozens of small businesses.

"When these companies are gone, they're gone forever," says Tilton. "We can't get their business model back; they can't get their workers back; they can't get their production lines back."

Though banks aren't interested in lending to these companies, says Tilton: "We turn dust to diamonds every day."

-- Written by Lauren Tara LaCapra in New York