Fannie Mae has streamlined its 3MaxExpress small loan program, reducing the debt-service coverage ratio (DSCR), fees, and required documentation in an effort to fight off increased competition.
Many large financial institutions have developed securitization programs in recent years, making the cost of their capital cheaper. “The market is getting more and more competitive as the larger players get more sophisticated,” said Rick Wolf, who manages Fannie Mae’s small balance multifamily loans. “And the community banks are out there, and they know their borrowers and their markets so well, they’re very aggressive in those markets.”
In fiscal 2006, Fannie Mae’s small loan volume slid 25 percent to $3.9 billion from $5.2 billion in the year before. Fannie Mae defines small loans as those up to $3 million for market-rate properties, and up to $5 million in high-cost metro areas like Boston, New York, and Chicago.
Last year, Fannie Mae financed a lower level of pool transactions, or bundles of loans bought all at once, which partly explains the decline in volume. The company also spent much of 2006 revamping 3MaxExpress to ward off increased competition, which further restrained growth.
“Some of it is just the ebb and flow of the pool business. We did somewhat less in pool acquisitions last year. The other part was that we were preparing to grow,” said Wolf. “I think we’re there now, with changes to the underwriting, and putting in procedures and controls to make sure we can manage the growth,” Wolf said.
The government-sponsored enterprise rolled out its new 3Max term sheet at the end of March.
Debt-service coverage ratios
One of the most notable changes to the program is its new minimum 1.20x DSCR, down from the traditional 1.25x.
Delegated Underwriting and Servicing (DUS) lenders applauded the move, as it strengthens their ability to compete with the many large financial institutions and conduit lenders that allow DSCRs as low as 1.15x on small loans. “Up until recently, there was a sizing constraint where we were a little disadvantaged relative to those other guys,” said Kevin Williams, executive vice president and chief operating officer of the Fannie Mae DUS program at Greystone Servicing Corporation, Inc. “But we are catching up.”
Another significant move is a loosening of the standards on economic vacancy rates—or the portion of gross potential rent that landlords lose during a year as a result of vacancies. In the past, properties with 10 or fewer units had to be underwritten using the assumption that their economic vacancy rate would be, at the lowest, 10 percent, but Fannie Mae has now lowered that threshold to 5 percent. “The impact of this change is that borrowers will be able to get incrementally higher loan proceeds for loans between 5 and 10 units,” said Wolf. “This allows the Fannie Mae product to be more competitive in the five- to 10-unit space and offers borrowers the benefits of the additional liquidity.”
ARCS Commercial Mortgage, which recently agreed to be acquired by PNC, had sought many waivers for the DSCR and minimum economic vacancy rate in the past. In fact, the company recently closed a 3Max deal with a 1.05x DSCR for a 10-year fixed rate loan on a small rent-controlled multifamily property in Santa Monica, Calif.
“We had been doing 1.20x and below on a waiver basis, and a lot of those waivers have now become common practice,” said John Barbie, director of ARCS’ small loan division. The debt-service coverage and minimum vacancy changes “were huge enhancements for all Fannie Mae lenders,” he said.
Third-party requirements, documentation
Since small loan borrowers tend to be cost-sensitive, Fannie Mae has streamlined many requirements for third-party reports, like engineering, appraisal, and environmental reports, to make the program more cost- effective.
“We’ve looked at the underwriting requirements and said, ‘Is this the appropriate level of due diligence for a small balance loan’?” said Wolf. “Small loan borrowers are almost more willing to increase the spread that they pay on the loan than they are to write a check to pay for third-party costs.”
The engineering report is more limited in scope than it once was. “The new position on the engineering report is a big change; there’s no longer a requirement for the physical needs assessment for properties that are well-maintained,” said Williams. “Previously, regardless of our assessment of condition, we were required to do a certain report that added to the due diligence costs.”
The pest report is no longer required unless there’s prior evidence of infestation observed by the appraiser, lender, or underwriter during a property inspection. “This is good because it lowers the cost to the borrower,” said Barbie.
Fannie Mae has also streamlined its main appraisal Form 1050 to reduce the required documentation, and has limited the scope of its environmental report. “We tried to identify the appropriate risks to watch and to underwrite to,” said Wolf. “That doesn’t necessarily mean that you have to spend $2,000 having an engineer walk a seven-unit building.”
Previously, borrowers would have to provide a description of their experience by filling out a certified multifamily history statement as part of the 3Max approval process. Now no such description is required for loans on developments with 11 or fewer units.
Reducing the required documentation brings 3Max more in line with small bank practices. “We still have more paperwork than the banks do, but it’s been significantly reduced,” said Barbie.
Wolf says that more improvements to the 3Max program are on the way, including expanding the roster of eligible DUS lenders. “We are invested in this space, and we want to increase our production,” said Wolf. “This year and certainly next year, you’ll see us doing more business and engaging more lenders.”
And borrowers will have more small loan options soon. Freddie Mac has been ramping up its small loan program, leveraging its delegated network to grow its volume of small loans, and is expected to go live with a new program this summer.
“When we think about the delegated work that we’re doing for targeted affordable, we’re approaching that with the understanding that we’re going to leverage that for small loans,” said Mike May, Freddie Mac’s senior vice president of multifamily sourcing, in March. “So we’re building the lender network, building the underwriting process, delegating the underwriting to the lenders, and building the control process to produce more small loans.”