THE SMALL LOAN MARKET is heating up again. After several years of relative inactivity, banks have regained their appetite for balance-sheet loans and will likely wrest some business away from Fannie Mae this year.
Chase Commercial Term Lending—the new incarnation of Washington Mutual's small loan program that once dominated the market—has grown much more active in recent months, particularly on the West Coast. And other national, regional, and community banks, such as Sovereign Bank, are beginning to step off the sidelines.
Since banks overwhelmingly prefer shorter-term loans, they are particularly competitive on higher-leverage five-year deals. “If a very active bank wants to compete on proceeds and rate in the five-year space, they're probably going to win that deal,” says Rick Wolf, who previously led Fannie Mae's small loan program and is now a senior vice president at New York–based Greystone. “On some of the lower-leverage business, we can be very aggressive on five-year money."
Still, the banking sector is only just beginning to ramp up, and not every borrower in every market will find success with banks. The competition to win deals for the strongest borrowers is becoming fierce in major metros, but middle-market borrowers in secondary and tertiary markets weren't seeing a lot of competition in the fourth quarter of 2010.
“If you're a strong borrower with a solid portfolio and financial wherewithal, you're going to have options,” says John Edwards, a vice president at Uniondale, N.Y.–based Arbor Commercial Mortgage. “But the banks' appetite is not that great; they might pick off a few deals here and there, but it's not like they're in all markets 24/7."
Rates Cut Into Proceeds
The increased competition from banks began in the fourth quarter of 2010, just as all-in rates on small loans began rising dramatically.
The yield on the benchmark 10-year Treasury was at 2.6 percent in early November, when borrowers were still locking in rates in the mid–4 percent range. But a month later, the benchmark reached 3.26 percent, and during that time, investor spreads climbed about 25 basis points (bps).
That's a rise of 91 bps in just one month.
Meanwhile, 10-year small loans from Fannie Mae were quoting 5.6 percent. That 5.6 percent rate is an important milestone. Fannie Mae uses an underwriting floor of 5.5 percent in sizing 10-year loans, and for much of the second half of 2010 it wasn't an issue given the low rates.
Seven-year deals, on the other hand, were around 5.05 percent, and five-year money came in at 4.4 percent in mid-December.
The higher rates are throwing a blanket on transaction velocity, which seemed to gain steam with each passing month last year. And this shift obviously affects the refinancing market, which constituted the majority of business for Fannie Mae lenders in 2010.
“I'm working on several acquisitions for January, and that is having an impact, cutting into proceeds and potentially renegotiating the purchase and sale,” Edwards says. “I certainly expect first-quarter acquisitions to be impacted."
Will Spreads Tighten?
The question of whether Fannie Mae will tighten spreads to help keep the rate lower was on everyone's mind in mid-December. Fannie Mae's guarantee and servicing fees were pretty high in the fourth quarter, presenting some wiggle room.
“Once you start to see maybe 6 percent, there will be talk of some spread tightening,"
Wolf says. “Rates have to go up a little higher before that starts to become a conversation."
The best way for any market to see spread compression is competition. And while Fannie Mae is seeing increased competition from life insurance companies and, of course, Freddie Mac in its conventional business, those lenders don't play in the small loan marketplace.
Fannie Mae is likely waiting to see what happens in the investment community in January.
Investor interest in Fannie Mae MBS declined late in the fourth quarter, as it usually does, since investors were closing out their books for the year. But those books get reset every year.
“If we're going to see any spread tightening, it probably won't be until the [beginning] of the year,” says Rick Warren, managing director of the small loan division at New York–based Centerline Capital. “Everyone's going to see what happens as far as investor appetite, and what their yield requirements are pegged at."
Despite the growing competition, borrowers looking for 10-year deals will still find the best rates and terms with Fannie Mae's small loan program.
Fannie small loan lenders don't expect to see any big changes in underwriting this year. In the spring of 2010, Fannie Mae started loosening up a little bit, and that trend is likely to continue, but no wholesale changes to the underwriting guide are expected.
“We've seen some incremental flexibility around things that six months ago were off - limits,” says Wolf, pointing to waivers granted on underwriting floors in strong markets.
“Where you've got a good story, the ”˜come talk to us' approach has been in place since the spring."
Unfortunately, the borrower scrutiny that has characterized the debt markets won't go away any time soon. There's a renewed interest in the strength of the borrower with respect to liquidity, net worth, REO schedules, and the performance of a borrower's portfolio.
For instance, the minimum FICO score for a Fannie Mae small loan is 680, and Fannie is holding tight to that metric. If a borrower has a 679 credit score, they will get turned away.
And chances are, if you get turned away by Fannie Mae, you probably won't find much success elsewhere—banks often use very similar metrics.
Given the late entrance of banks in 2010, most Fannie small loan providers had a good year last year and expanded their operations.
Consider Greystone, which opened new offices in New York and Chicago. And Centerline opened a Northeast regional market in the third quarter, along with a Chicago office in the fourth quarter, growing its small loan staff from eight to 20 since the program started in September 2009. Centerline is also exploring other products to complement its Fannie Mae small loan line, which focuses on increasing flexibility on some underwriting terms.