A Month After the Fraud Disclosures, Regional Banks Are Still Explaining Themselves
Zions and Western Alliance sought to recover a combined $160 million from lending arrangements tied to distressed mortgage funds, sending regional bank shares to their worst day since the spring.
The October disclosures were brief, technical and expensive. Zions Bancorporation sued to recover more than $60 million lent to investment funds that used revolving credit facilities to buy distressed commercial mortgage loans. Western Alliance moved to recover roughly $100 million from a related entity managed by the same team.
Shares of the two banks fell 13% and 11% respectively on the day, an index of regional banks dropped 6.3%, and the broader KBW Nasdaq Bank Index fell 3.6% — the worst session for both since the spring.
A month later, the questions have not gone away.
Why the market reacted so violently to modest sums
For institutions of this size, the amounts at stake were manageable. The reaction was not about the losses. It was about what the losses implied.
Two large bankruptcies had landed weeks earlier — an auto-parts supplier and a subprime auto lender — both involving complex financing arrangements and both leaving creditors surprised by what they found. Against that backdrop, the disclosure that two well-regarded regional banks had extended credit against collateral that allegedly was not what it appeared to be raised an obvious question: who else?
The pattern investors are testing for
The concern is not a repeat of 2023, when banks failed because of interest-rate losses on securities portfolios and deposit runs. Deposit funding has been stable, and the institutions involved are well capitalized.
The concern is credit discipline at the end of a long expansion. The specific arrangements at issue — lending against pools of distressed assets held by funds — sit at exactly the intersection where underwriting depends on the accuracy of information supplied by the borrower.
What has happened since
Bank examiners have pressed institutions on their exposure to non-bank financial intermediaries, a category that has grown enormously. Several banks have voluntarily expanded disclosure of lending to funds, business development companies and specialty finance vehicles.
Investors, for their part, have begun treating that line item the way they once treated commercial real estate concentration — as the first thing to check in an earnings release.
