The small-loan market heated up in a big way last year, and that momentum has carried over into 2012.

Fannie Mae’s small-loan program continues to dominate the market, offering some of the best rates available for deals of $5 million or less. But more balance-sheet lenders, mainly national, regional, and community banks, are pecking away at Fannie’s market share.

Chase Commercial Term Lending continues to be one of the most active small-loan lenders, especially in major markets on the West Coast and Chicago. And though most life insurance companies favor large loans, there are a few, including Symetra, StanCorp, and Protective Life, that have an appetite for deals below $5 million.

“A lot of multifamily bank lenders got back into the game last year,” says Rick Warren, a managing director who runs the small-loan business line for New York–based Fannie Mae lender Centerline Capital Group. “We saw competition come back very strong in the small-loan space—a lot more competition than I think anybody had anticipated.”

In fact, many Fannie Mae small-loan specialists—a stable that includes just 11 lenders—are reporting volume declines compared with 2010.

If you’re looking for a seven- or 10-year small loan, Fannie Mae is probably your best bet. Banks overwhelmingly prefer to do five-year deals, and the ones that use their balance sheet for loans of seven years or longer are the exception to that rule.

And Fannie’s rates are hard to beat. The government-sponsored enterprise was quoting full-leverage, 10-year small loans in the low– to mid–4 percent range, with five-year loans about 100 basis points below that, in mid-January.

But banks in many major metros can get close to Fannie’s five-year pricing—close enough to entice borrowers with other attributes. Banks can outshine Fannie, most notably by offering more proceeds as well as more prepayment (underwriting) flexibility.

Fannie Mae lenders use an underwriting floor, an artificial constraint for sizing loans, that’s more stringent than what banks use. But Fannie recently made some changes across its multifamily division that had some impact on loans of $3 million to $5 million.

First, the GSE provided a little flexibility by reducing those underwriting floors, allowing many loans to be sized more generously. And the company designated a handful of markets, such as Boston, New York, and Washington, D.C., as “strong markets”—a list that was completely empty for a long time. Fannie views markets on three tiers (strong, nationwide, and pre-review), and deals in “strong markets” can achieve the most proceeds and the lowest debt service coverage ratio.

“They’re becoming a little more flexible; I think it’s a flight to quality,” says Warren. “When you’re competing against banks and life companies that cherry-pick the quality deals, you have to counter that with a product that puts you on a more level playing field.”

In the second quarter last year, Fannie began offering nonrecourse to a greater spectrum of small-loan borrowers, as well as more interest-only periods. These are two places where Fannie can shine—banks aren’t as generous with nonrecourse and interest-only. And DUS lenders are hopeful that a combination of today’s ultra-low rates and Fannie Mae’s willingness to be flexible will fend off the competition.

“Fannie has made some very positive strides to keep the program competitive,” says Rick Wolf, a vice president at New York–based DUS lender Greystone and former head of Fannie’s small-loan program. “To the extent that rates stay low—and it looks like they’re going to—and Fannie continues to give us a very solid product to sell, our trajectory could be a lot better than what it was in 2011.”