How Competition Is Impacting Small-Balance Lending

Dustin Pevear, Senior Vice President, Arbor Realty Trust (Photo Courtesy of Arbor Realty)

Last year was a good one for multifamily lending, particularly in the small-loan sector. Freddie Mac reported that out of  $78 billion of total production in 2018, more than $8.3 billion were for small deals, up 6 percent for the year. The volatility caused by rising interest rates and the instability of the stock market did not cause any shifts in the segment, which is projected for further growth in 2019.

Freddie Mac recently extended its loan caps to adapt to market changes and meet the needs of a growing pool of borrowers. As most are active in affordable housing, demand for financing is likely to increase. Dustin Pevear, senior vice president at Arbor Realty Trust, recently addressed the most challenging issues facing small-balance lenders and what’s ahead in the niche. Arbor ranked among Freddie Mac’s top small-loan lenders in 2018.

The small-balance market has been on an upward trend in the past years. What are the factors behind this growth?

Pevear: For many years, the financing options for small loans were fragmented and the space had historically been dominated by banks. The evolution of agency products developed particularly for this space has significantly contributed to the growth of the small balance loan market by offering borrowers similar terms and benefits to Fannie Mae and Freddie Mac’s standard-size multifamily loans, but with reduced fees and a more simplified loan process.

Recently, Fannie Mae announced an increase in its national small-loan ceiling to $6 million nationwide, up from $3 million nationwide and $5 million in certain high-cost markets. Freddie Mac’s Small Balance program, which was rolled out in late 2014 also has a $6 million cap nationwide and allows for loans up to $7.5 million in certain markets. As values across the country have increased, the size of the small-loan box has gradually increased, and we also have more options to offer our borrowers.

There is a lot of competition in the debt markets currently, with a notable diversification of available products and services, including in the small loans sector. How does this change underwriting and the lending process in general?

Pevear: The fundamentals of the underwriting and agency credit standards have remained strong despite increased competition in the debt markets.

How did the increase in interest rates impact the small balance loan market so far?

Pevear: The increase in interest rates in 2018 presented challenges for borrowers and lenders across the entire market. At certain points in 2018, the 10-year Treasury note was more than 70 basis points higher than what it was at the beginning of the year, and there was concern in the market regarding how quickly rates would continue to increase. Some borrowers put deals on hold or paused while the market leveled out.

The good news is we’ve seen rates decrease over the last several months and the 10-year Treasury has remained steady, close to 2.70 percent thus far in 2019. From a lender’s standpoint, increasing rates can put additional stress on loan sizing, given many of our deals are constrained by the actual debt-service coverage ratio. To combat some of the rate uncertainty, we have several options that allow borrowers to lock their coupon at application or very early in the underwriting process.   

What are the challenges in the small loans environment and what are your expectations going forward?

Pevear: The small-loan market is getting more competitive from both a product and participation standpoint. Our agency partners have done a good job innovating and adapting in the small-balance space over the years to ensure we offer the most competitive terms and products. Competition from banks continues to be strong. However, we feel there is continued opportunity for agency lenders to increase market share in the small-balance loan space across the country. Market fundamentals in the small-balance space remain strong and we anticipate another busy year in 2019 and beyond. 

What can you tell us about the most active markets when it comes to small-loans closings?

Pevear: For Arbor, the New York City and Los Angeles markets have historically been the most active in the small-balance space. Loans in the small-balance space typically support affordable housing, and we are very committed to providing liquidity in the workforce housing space across the country.