Where the Trouble Will Be in Lending Next Year

There is something for everyone looking for lending pitfalls in the coming months.

Mortgages, subprime auto lending, commercial-and-industrial loans and student lending are ripe for setbacks and, in some cases, crises.

Here is a breakdown of each of those risk factors, the reasons behind them and the possible upsides or alternative strategies.

Mortgages

The refinance market has largely carried the mortgage industry over the past few years because consumers took advantage of historically low rates. Now that the Federal Open Market Committee has raised rates twice in the past year, and the benchmark 10-year Treasury has spiked upward since the presidential election, many expect the refinancing market to nosedive.

"We'll see refinancing all but dry up, and the mortgage business is going to really suffer" in 2017, said Donald Musso, CEO of FinPro Capital Advisors, a bank consulting firm in Gladstone, N.J.

The question becomes whether an improvement in the overall health of the housing market can take up the slack.

"It's going to be sales that drive your mortgage lending now," said Jay Pelham, president of the $3 billion-asset TotalBank in Miami.

That may be easier said than done. The incoming Trump administration and the Republican-led Congress have signaled they may reduce the mortgage interest deduction, a move that the National Association of Realtors and other housing industry groups have warned will wallop the housing market.

Banks' mortgage fortunes could vary among geographic markets, too. The South Florida market, especially downtown Miami, appears to be set for a high level of purchase activity, Pelham said.

"If you look at our downtown market, it's full of restaurants, jobs and apartments that both professionals and young people want," he said. "When I look at prices per square foot here, we are still cheap compared to New York, London and Chicago."

Auto Loans

For months, regulators have forcefully warned about soaring balances of subprime auto loans and the risks associated with them. The data seemed to back them up.

In March, Fitch Ratings reported that more than 5% of securitized subprime auto loans were at least 60 days late, the highest delinquency rate in 20 years.

And the 90-day delinquency rate for subprime auto loans was 2% in the third quarter, versus 1.9% a year earlier and 1.4% in the third quarter of 2012, according to a Federal Reserve Bank of New York report. Over the same period, delinquency rates for borrowers with higher credit scores were relatively flat. Meanwhile, about 3.6% of overall auto loan balances were 90 days behind in payments.

Lenders have downplayed those concerns, saying that they have applied strict underwriting standards.

Yet some banks have begun to take precautions. The $143 billion-asset Fifth Third Bancorp in Cincinnati and the $147 billion-asset Citizens Financial Group in Providence, R.I., this fall announced plans to scale back indirect auto lending.

At the same time, some community banks have shown greater interest in auto lending as consumer demand for car loans continues to soar. The $4 billion-asset Fidelity Southern in Atlanta and the $9 billion-asset First Interstate BancSystem in Billings, Mont., each posted double-digit increases in auto loans in the third quarter.

Lenders have recently made improvements in how they underwrite subprime auto loans, and that may prevent a big meltdown, said Jon Winick, CEO of Clark Street Capital, a bank consulting firm in Chicago.

"There have been real innovations in the subprime auto space that are unique to that asset class," he said. "You can prevent someone from using their own car if they're 30 days delinquent and you don't have that level of control with a real estate deal."

C&I

Tough competition for commercial-and-industrial loans has created one of the riskiest situations as many banks are said to have cut pricing to win business.

Banks have crowded into the C&I space for plenty of reasons. One is that regulators have placed a great deal of emphasis on commercial real estate loan concentrations, and banks have responded by improving risk management and bolstering capital levels. Those steps may help limit CRE losses, but they have encouraged more banks to risk expansion in C&I loans as they hunt for places to deploy their capital.

There is so much competition in the C&I market that many players have caved to borrowers' demands for lower rates and better terms, Winick said.

"Underwriting standards have collapsed the most in C&I," he said.

At the same time, C&I loans present significant challenges when they default as they are typically not collateralized by tangible assets.

"If a C&I project defaults, you don't have an automobile you can repossess or a house you can foreclose on," Winick said.

But there are some potential bright spots for C&I. One is that the presidential election is over, which should remove the anxiety that had led many businesses to hold back on capital spending for months because of political uncertainties, Musso said. Talk of tax cuts and regulatory relief has played well in commercial sectors.

"I actually think we may see a modest uptick there because the business community believes we'll see some relief from the Trump administration," Musso said.

Another is that banks may have already suffered through the worst part in two subcategories of C&I lending, energy and taxi medallion loans. A rebound in oil prices dampened the losses at energy lenders, while some banks like the $72 billion-asset Comerica in Dallas reduced their exposure to the sector. And executives at the $38 billion-asset Signature Bank in New York recently said that they have restructured troubled taxi loans.

"I think the new normal has come out in taxi loans," said Dave Etter, managing director of loan review services at Sheshunoff Consulting. "To try to sell taxi loans now is just impossible. You're just looking to generate some cash flow."

Finally, some banks have attempted to carve out specialties within the C&I category to diversify loan portfolios and improve yields. The $28 billion-asset First Horizon National in Memphis, Tenn., for example, has expanded in franchise finance and health care finance to help dilute its C&I exposure.

Student Loans

The massive pile of student loan debt threatens to send scores of consumers into financial ruin. The Congress and the incoming Trump administration may try to address the situation by getting the U.S. government out of the student loan business. That could create an opportunity for banks to re-enter the private student loan market.

Investors are betting that will happen. Shares of SLM Corp., the Newark, Del., company known as Sallie Mae, rose 54% from Nov. 8 to Dec. 28, to $10.95. Sallie Mae is the largest private student lender.

Only a few banks remain active in student loans, including Citizens Financial. Those banks stand to benefit from the new political environment, KBW analysts wrote in a December report, and other banks may want a piece of the action.

What most analysts agree on is that the amount of student-loan debt that consumers are carrying is unsustainable.

"It's my biggest concern in the consumer space, hands down," Winick said. "We know the losses will be terrible."