Loan Loss Concerns Trigger Volatility in Regional Banks and Markets

Article Summary

• Significant loan loss announcements from regional banks raise investor concerns.
• Decline in regional bank stocks and its impact on the broader financial services sector.
• Concerns about the quality of banks' lending standards and their impact on financial stability.
• Comparison between the current situation and the Silicon Valley Bank crisis in 2023.
• Impact of recent bankruptcies on bank losses and increased scrutiny of lending standards.

Amid ongoing economic uncertainty and trade tensions, investors face increasing challenges. Significant loan losses announced by some regional banks have added further pressure to financial markets.

Zions Bancorp, based in Salt Lake City, disclosed in a regulatory filing that it would include a $60 million loan loss provision in its third-quarter earnings report. The bank indicated that approximately $50 million of this amount may never be recovered. Zions has filed lawsuits against two borrowers, emphasizing that this is an isolated incident.

Investors were perhaps understandably unconvinced. Western Alliance Bancorp, headquartered in Phoenix, disclosed that it had filed a fraud lawsuit against a borrower for failing to provide sufficient collateral for a revolving credit line. Despite this, the bank asserted that existing collateral is sufficient to cover the debt and that the dispute would not affect its operating results.

Stephen Innes, managing partner at SPI Asset Management, pointed out that investors are concerned that these isolated incidents are beginning to look like a pattern. These disclosures led to a sharp decline in regional bank stocks, with the SPDR S&P Regional Banking ETF falling by 6.2%, its worst single-day performance since April 10. Even major financial institutions were not spared, as the S&P 500 Financial Services sector declined by 2.8%.

This caused a broader decline in the S&P 500 index by 0.6%. According to Dow Jones Market Data, this sell-off pushed the Chicago Options Exchange Volatility Index (VIX) to close above 25, its highest level since April 24.

Following recent bankruptcies that impacted banks, investors have become more scrutinizing of bank loan losses. First Brands and Tricolor both declared bankruptcy in September, raising questions about why banks did not detect potential losses earlier.

JPMorgan Chase CEO Jamie Dimon used the term "cockroach theory" to describe this situation. He noted that when one cockroach appears, there are likely more. JPMorgan Chase disclosed a $170 million loss related to a loan to Tricolor. Fifth Third Bancorp also announced similar losses.

Michael Green, portfolio manager and chief strategist at Simplify Asset Management, explained that there is increasing concern about how robust the situation is, and that we are seeing a series of credit events.

Many investors may have vivid memories of the Silicon Valley Bank collapse in 2023, leading to knee-jerk reactions in the market. However, Green clarified that there are significant differences between the current crisis and the Silicon Valley Bank crisis. The Silicon Valley Bank collapse was due to deposit withdrawals, whereas current concerns relate to the quality of lending standards.

While there are reasons for concern, Mark Gibbens, chief investment officer at Gibbens Capital Management, believes there is no reason for complete panic. He noted that banks are in a much better capital position than they were prior to the 2008 financial crisis.

Additionally, Jefferies' coverage of an annual investor day has prompted renewed scrutiny of the bank's exposure to the First Brands bankruptcy. Other signs of stress have begun to emerge in the broader credit market, as spreads between publicly traded bonds and their corresponding Treasury bonds have begun to widen.

Companies active in private credit, including Blue Owl Capital, have struggled for months.