Should investors be concerned?
The first week of Q3 earnings has been dominated by banks, mostly large banks, and the results were pretty strong.
Big banks, like JPMorgan Chase, Citigroup, Bank of America, and Truist, to name a few, have benefitted from their diverse services, including investment banking, institutional trading, asset management, in addition to traditional consumer banking.
Small and regional banks don’t typically have the same depth of offerings, relying more on consumer banking – loans and deposits. That can present challenges for regional and smaller banks, particularly in uncertain or choppy economic times.
We saw some of those challenges this week, particularly with regard to Zions Bancorp (NASDAQ:ZION) and Western Alliance Bancorp (NYSE:WAL) – the 30th and 31st largest U.S. banks, respectively. Both of them filed documents with the SEC indicating that they were impacted by some bad loans.
It sent a bit of a panic through the markets, particularly among smaller banks. Both Zions and Western Alliance stocks dropped some 15% on the news, and other similar-sized banks were also down on concerns of worsening credit quality.
The Nasdaq KBW Regional Bank Index, which tracks regional bank stocks, fell about 8% on Thursday, fueled by the Zions and Western Alliance news.
Zions faces $50 million hit
Both Zions and Western Alliance report their third quarter earnings next week – Zions on October 20, Western Alliance on October 21 – so those releases should provide more details on the larger impact.
But both banks laid out their predicaments in SEC filings. Zions officials said they identified apparent misrepresentations and contractual defaults by two borrowers that defaulted on their loans. They were commercial and industrial loans, which are loans for businesses.
Thus, Zions said that it would take a provision for credit losses for the full $60 million outstanding under the loans and charge off $50 million. The provision and charge-off will be reflected in the bank’s earnings. Zions added that it has commenced a lawsuit against the borrowers for full recovery. It also believes it is an isolated situation.
Western Alliance said it had filed a lawsuit against Cantor Group LLC “alleging fraud by the borrower in failing to provide collateral loans in first position, among other claims.” Western Alliance officials added that the existing collateral is enough to cover the obligation.
Stocks bounce back
On Friday, both Zions and Western Alliance stocks bounced back, with the former up 4% and the latter rising 2%. It may have been investors buying back in after the dip, believing that it was more of a one-off than a larger trend of companies going under and big borrowers defaulting.
Although there have been other recent cases. JPMorgan Chase wrote off a $170 million bad loan to subprime auto lender Tricolor in Q3 after it went bankrupt. Also, auto parts supplier First Brands filed for bankruptcy in September, and it left several lenders on the hook, including Jefferies Group (NYSE:JEF) for about $715 million.
“My antenna goes up when things like that happen. I probably shouldn’t say this, but when you see one cockroach, there are probably more. Everyone should be forewarned,” JPMorgan Chase CEO Jamie Dimon said on the third quarter earnings call.
In commentary released on Friday, Morningstar analyst Michael Driscoll said banks were well-equipped to navigate the situation.
In our view, asset quality metrics across banks have been deteriorating but have held up better than we expected. Losses have been low, so these recent and numerous larger loan issues have raised fears of a broader deterioration. Moreover, in each of these issues, there have been fraud allegations causing investors to worry about the pervasiveness of fraud in bank loan portfolios,” Driscoll wrote.
While adding that macro and geopolitical risks will continue to pressure credit, Driscoll said banks are well positioned to absorb higher loan losses. Case in point, he said Zions should remain profitable despite the $50 million hit and Western Alliance has already said it expects no losses.
