Last year, Fannie Mae was the clear front-runner in the smallloan market—the business grew to $2.4 billion from $2.2 billion the year before. But the agency can now hear footsteps rapidly gaining on it, prompting the government-sponsored enterprise (GSE) to pick up the pace and make some borrower-friendly changes to its program, including allowing for more nonrecourse loans and interest-only (IO) terms.

The changes couldn't have come at a better time. For the past few years, Fannie's increased small-loan volume has been driven by continued problems in the banking sector. But now, many national, regional, and community banks have worked through their balancesheet issues. FDIC-insured commercial banks reported an aggregate $29 billion profit in the first quarter of 2011, the highest level since the second quarter of 2007. And as the banking sector returns to profitability, it's sprinting back into the small-loan market.

“We've definitely seen more capital coming into the market in the past four or five months,” says Keith Van Arsdale, president and CEO of Dallas-based small-loan specialist BMC Capital. “A lot of people don't realize that there are a lot of options out there now other than Fannie Mae."

Chase Commercial Term Lending, for one, has grown more active this year, especially in the Chicago and Western markets, including California, Oregon, Washington, and Colorado— regions once dominated by its former incarnation, Washington Mutual. And while many life insurance companies favor large loans, there are quite a few—including Symetra, StanCorp, and Protective Life—with an increasing appetite for deals below $5 million.

The competition is fiercest in major metros such as New York, Chicago, and Los Angeles. “In some of the big markets, the banks are offering some pretty aggressive financing on a five-year basis,” says Rick Wolf, former head of Fannie Mae's small-loan program and now a senior managing director at New York–based Fannie lender Greystone. “And we're defi- nitely seeing the life companies step into the smaller-loan space now, but it's a major-metro phenomenon."

As a result, many banks are now undercutting Fannie on price, and are offering more proceeds, in the five-year loan space. While Fannie has the advantage on longer-term small loans of seven to 10 years, terms that most banks will shy away from, the GSE must work to remain competitive as the lending belt continues to loosen.

Flexing Flexibility

The fact is, some borrowers simply prefer the relative ease and flexibility of dealing with a portfolio lender. For instance, a guiding principle of Fannie Mae underwriting is the 90-for-90 requirement—a deal has to be 90 percent occupied for 90 days to qualify. But not every lender feels that way.

“There are some Fannie Mae underwriting requirements that will kick some deals out or knock down the LTV [loan-to-value] ratio," Van Arsdale says. “A lot of borrowers think they've got to be 90-for-90 to get a small loan, but guess what? You don't. There are banks and life companies that have a little bit more subjectivity to their underwriting."

It's not just banks and life insurance companies showing flexibility. Many CMBS lenders are increasingly going down to $3 million, and some, such as Wells Fargo, are willing to go all the way down to $1 million.

What's more, the conduits are again entering secondary and tertiary markets, some of which would be flagged by Fannie Mae as “pre-review markets.” In a pre-review market, it's extremely difficult to get a loan above 70 percent LTV.

“But conduits don't have pre-review markets,” Van Arsdale says. “They're going to be careful, of course, but if they have a deal in Phoenix, for instance, that's well-located with a good borrower, they're going to do that at 75 percent."

Van Arsdale believes that, by the end of the year, conduits will be much more competitive for smaller multifamily deals. In the meantime, the growing appetite among banks and life companies will keep things competitive this year, at least until the fourth quarter.

“Life companies have a finite capacity, and banks are limited as well in terms of their commercial real estate ratios, so it will be interesting to see what the fourth quarter brings," Wolf says. “Fannie Mae is going to be relevant and consistent for quite a while—we just may not win every deal like we used to."

Fannie Ups the Ante

Given the increased competition, it's no coincidence that Fannie Mae made some borrower-friendly changes to its small-loan program, allowing more nonrecourse loans and interest-only (IO) terms, at the end of April.

In the past, only 14 metropolitan statistical areas (MSAs) across the nation w ere eligible for Fannie-backed nonrecourse small loans at any leverage level. In the rest of Fannie Mae's delegated nationwide network, borrowers could achieve nonrecourse only on lower- leverage deals, those 65 percent LTV and below.

But Fannie Mae is now offering nonrecourse to a broader universe of borrowers. Today, full-leverage deals (up to 80 percent LTV) are eligible for nonrecourse in any of the company's delegated nationwide markets, with a few caveats: The loan has to be $750,000 or more, and the borrower must meet a FICO score requirement of 680. A physical-needs assessment has to be performed, and full funding of replacement reserves is required to achieve nonrecourse.

In addition to nonrecourse modifications, Fannie Mae is now allowing more IO options in its small-loan program. In the past, the GSE's IO terms were very limited: Only low-leverage 10-year loans could achieve up to two years of IO. Now, in those 14 primary MSAs, 10-year loans of 65 percent LTV and below can get up to five years of IO. And loans at the 55 percent LTV level and below are now eligible for full-term IO up to 10 years.

“We can use the IO to position ourselves a little bit more aggressively against banks, which generally don't like to offer it,” Wolf says. “And in markets where you didn't have that nonrecourse option before on higherleverage loans—like Minneapolis or Denver— it's a very nice selling tool."

Fannie has also designated the Philadelphia MSA—which includes certain counties in New Jersey, Delaware, and Maryland—an eligible MSA. Small loans in this area can now be as high as $5 million, where before $3 million was the maximum. The GSE also took the Riverside/San Bernardino, Calif., area off its pre-review list, though it added the Kennewick/Pasco/Richland area of Washington state.

“Fannie Mae has been very focused on finding ways to stay competitive within the market,” says Charles Ostroff, chief underwriter at Uniondale, N.Y.–based Arbor Commercial Mortgage. “There is more competition now—a lot of community and regional banks are focusing again on their core business, which is small loans in their own backyard."

Arbor is perhaps the most prolific Fannie Mae small-loan lender out there today. Last year, the company was ranked No. 6 in terms of volume production on Fannie's “Top 10" lenders list, up from No. 8 in 2009—an impressive feat when you consider that the company specializes in small loans, as opposed to the rest of the Top 10.

And according to Ostroff, Arbor is ahead of last year's pace: “The strength of the program is certainty of execution."