Fannie Mae has rolled out a new small loan program as it continues to siphon off market share from the dormant commercial mortgage-backed securities (CMBS) market.
Many small loan programs that relied on capital markets executions have exited the market, and recent entrants have turned away from CMBS in favor of selling their small loans to Fannie Mae. What’s more, banks, which have historically dominated the sector, are beginning to max out their balance sheets with all the business that has come their way.
“Small loans are following the same pattern as larger loans: The conduits are out,” said Rick Wolf, who runs Fannie Mae’s 3MaxExpress small loan program. “But some of the big banks are still chugging along, and it will be interesting to see how much balance-sheet capacity they really have.”
Boost in small loans
Last year, Fannie Mae invested more than $5.7 billion in multifamily loans of between $1 million and $3 million through pool transactions (purchasing bundles of loans) and through its flow business (individual deals brought to Fannie Mae by its delegated lenders), compared with $2.7 billion the year before.
Buoyed by this success, Fannie Mae rolled out its Micro Loan program in January. The program targets loans of up to $750,000 on properties of five units or more in strong markets—such as Boston, Chicago, Los Angeles, and New York City—a market segment dominated by community banks.
Wolf expects the bulk of Micro Loan deals to be for Class B and Class C buildings housing those earning 100 percent of the area median income and below.
Fannie Mae’s conventional small loan program, 3MaxExpress, was a bad fit for such loans, the company said. “The underwriting that you need to do on a loan of $750,000 and below really can’t, in a cost-effective manner, be the same underwriting that you do on a larger loan,” said Rick Wolf, who heads Fannie Mae’s small loan programs. “The drivers of the credit risk are different.”
For instance, the Micro Loan program looks more at the borrower’s FICO score (700 or better is the requirement) instead of the thirdparty analysis and asset management requirements that are hallmarks of underwriting on larger loans.
The paperwork for Micro Loans is also lighter than for the larger 3MaxExpress program. Borrowers don’t have to submit annual financial statements, for instance. In addition, third-party reports, like engineering and environmental reports, are streamlined to save borrowers money—outside engineers don’t have to be hired to put together those reports.
Micro Loans feature a maximum loan-to-value (LTV) ratio of 75 percent, and 10-, 15-, 20-, and 30-year amortization schedules. To be competitive with community banks, the Micro Loan program offers a debt-service coverage ratio (DSCR) of just 1.10x, compared with the standard 1.20x DSCR on 3MaxExpress loans.
Fannie Mae is still working on fleshing out the program. At press time, Fannie Mae had five lenders delegated to make Micro Loans and more on the way, but declined to name them.
Fannie Mae has also become a popular exit strategy for lenders who had previously relied on the CMBS market to make small loans.
RBC Capital Markets was forced to re-invent its small loan program, called Streamline, which makes commercial loans of between $500,000 and $5 million.
The company unveiled Streamline last summer. But its primary strategy for delivering those loans was tied to the CMBS market, and as the CMBS news went from bad to worse last year, the company pursued another strategy.
RBC struck up a relationship with Fannie Mae, and it uses the government-sponsored enterprise as its primary exit strategy to sell small loans these days. As part of this shift, the Streamline program has shied away from other commercial sectors in favor of multifamily, which is in stronger shape than other commercial markets.
“We’ll still quote a CMBS deal, but nobody wants the pricing right now, and the quotes are only good for a short period of time,” said Dan Smith, managing director of RBC’s Real Estate Mortgage Capital U.S. operations. “We’re really focused on multifamily now, not just because Fannie Mae is our primary exit strategy, but also because it’s now the preferred property type.”
The rates and terms of Streamline are mostly identical to Fannie Mae’s 3MaxExpress program. Streamline loans typically offer a 1.20x DSCR and will go down to 1.15x in strong markets. The maximum LTV is 80 percent.
RBC (which stands for Royal Bank of Canada) has been building its U.S. commercial lending programs for the last two years, and it has opened five offices and hired 20 people focused exclusively on the Streamline program. RBC is targeting $500 million in small loans for 2008. RBC touts its swift closing process as a chief differentiator— the company typically can close a small-balance loan in about 30 days.
The paperless approval process is front-loaded: Borrowers requesting quotes can have their basic information submitted electronically, and RBC’s approval committee approves or denies the deal (subject to due diligence) before the borrower ever fills out a formal application.
While it’s anybody’s guess as to when the CMBS market will return, Wolf believes that once it does, the small loan market will lag behind other conduit executions. And when that market does come back, RBC—for one—will quote loans that offer both CMBS and Fannie Mae pricing.