IT'S GETTING MORE DIFFICULT to find small loans these days.

Many national banks that once dominated the small-loan space are a shrinking presence, while local, regional, and community banks are intermittently active. As a result, more borrowers are instead turning to Fannie Mae's Small Loan Program, even as that program grows more conservative.

“There's definitely a hole in the market; the market for these loans has really dried up,” says Todd Watkins, co-founder of Bethesda, Md.-based J.S. Watkins Partners, which pools small loans from banks and sells them to Fannie Mae through Bethesda, Md.-based Walker & Dunlop. “The banks have capital issues, so they're not devoting the same amount of capital to it, and Fannie is the only liquidity source now.”

But some Fannie Mae lenders that participated in the Small Loan Program are now putting that platform on ice. Cleveland- based KeyBank Real Estate Capital exited the small-loan space earlier this year, shuttering its Commercial Mortgage Access division and laying off the program's 12 employees. Keybank's minimum Fannie Mae or Freddie Mac deal size is now $3.5 million. Likewise, Des Moines, Iowa-based Principal Real Estate Investors, which also holds a license for Fannie Mae's Small Loan Program, has temporarily abandoned the space as well. The firms are cutting back on staff and redirecting resources to focus on larger deals.

The same is true for balance-sheet lenders. The former Wachovia and Washington Mutual, two of the biggest players in the small-loan space, have grown more conservative. The word on the street is that both, in their new incarnations as Wells Fargo and Chase, are lending fewer small loans as the year goes on.

Many other lenders are raising their minimum loan size as they focus on larger loan requests. Pittsburgh-based PNC ARCS, which also participates in Fannie Mae's Small Loan Program, now only does loans above $2 million, up from $1 million last year. And Walker & Dunlop has fixed its minimum deal size at $3 million since last year. “We were very busy, and if it takes as much time and manpower to process a small loan as it does a large loan, we opt to focus on larger deals,” says John Barbie, a vice president at PNC.

One of today's most active small-loan lenders is Arbor Commercial Mortgage. The company continues to grow and gain market share, even during the current capital disruption. In fact, the firm is using the downturn to bolster its origination staff and siphon off clients from their household- name rivals. “We're now looking at deals from customers who only dealt with Wachovia or WaMu, and that just didn't happen two years ago,” says Ken Fazio, national sales manager for the Uniondale, N.Y.-based lender.

Arbor, which is part of Fannie Mae's Small Loan Program, will entertain requests for loans down to $500,000. “Most firms won't do business under $3 million, but we won't walk away based on loan amount, ever,” Fazio says.

Fannie, May I?

Fannie Mae has made some big adjustments to its Small Loan Program this year. In the first quarter of 2009, the company shut down its Micro Loan Program, which made loans of less than $750,000, just a year after introducing the execution. The reason for the shutdown are twofold: There was little investor demand for mortgagebacked securities based on Micro Loans, and the company, like many of its lenders, decided to focus its limited manpower on larger loans. Fannie Mae will still consider loans of $750,000 and less through its Small Loan Program but on a more select basis, a company spokesman says.

Additionally, in the second quarter of '09, Fannie Mae instituted tougher underwriting standards for its conventional small-loan program. Small loans from the agency once featured slightly better underwriting standards than larger loans; that's not true anymore. Small loans are now being underwritten at a minimum 1.25x debt service coverage ratio (DSCR), and offer a maximum 75 percent loan-to-value ratio—just like large loans. As recently as March, small loans could be underwritten at a 1.20x DSCR and 80 percent leverage. Fannie Mae is also taking a closer look at an asset's market; the property's trailing 12 months of net operating income; and the borrower's financial health. For instance, the minimum FICO score for a borrower is now 680, up from 650 (and sometimes as low as 620 with a waiver) in the past.

Still, rates for Fannie Mae small loans are reasonable. A standard 10-year small loan was pricing in the mid-5 percent to 6 percent range in early June, though fiveand seven-year loans run closer to the midto high-6 percent range. What's more, Fannie Mae's small loans can be nonrecourse for deals in a handful of major markets—a competitive advantage today.

Many small-loan borrowers are now increasingly turning to the Federal Housing Administration (FHA). The FHA's 223(f ) program has solid terms, featuring up to an 85 percent LTV and 1.18x DSCR, but borrowers often have to wait four to five months before closing the deal.

The New Chase

Not all major banks have exited the small-loan arena. For the last decade, Washington Mutual dominated this space, especially in large metros such as Los Angeles, New York, and San Francisco. The company's small-loan platform, now called Chase Commercial Term Lending, has retained its operating model and is still open for business, according to Al Brooks, president of the New York City-based division who formerly led WaMu's platform.

Like WaMu, Chase Commercial Term Lending issues balance-sheet loans as low as $400,000, its application fee is far below the industry standard, and it doesn't charge appraisal or legal fees. Unlike many of its competitors, JPMorgan Chase has a healthy balance sheet, and its multifamily delinquency rate is very low, due to WaMu's conservative underwriting approach.

While many conduits underwrote based on projections of future rent growth, “we always looked at rents in place, with no projections whatsoever,” Brooks says. “And that saved our bacon.” The company maxes out at 65 percent loan-to-value, and most of its deals use a DSCR of 1.30x.

Chase still offers adjustable-rate mortgages for repositioning deals on its balancesheet loans, unlike many of its competitors. And while the rates for its balance-sheet loans are often slightly above Fannie Mae's, the firm also offers Fannie's Small Loan Program and will steer borrowers that way from time to time, according to Brooks.

Like all banks, the company's primary concern is serving its existing borrowers, but says it's also winning new customers. “It's incredibly important to support our long-term customers,” Brooks says. “We're being prudent, but we're also in business to do deals.”