How a string of bad loans has bank investors hunting for hidden risks
Including major banks JPMorgan Chase And Goldman Sachs They had just finished their victory lap after a blockbuster quarter when concerns emerged from a dark corner of Wall Street and sent a collective shudder through global finance.
regional bank zions late on Wednesday announced Nearly $60 million worth of loans were written off after “blatant misrepresentations” from borrowers were found. next day friend Western Alliance in question He said he filed a lawsuit against the same debtor, a commercial real estate company called Cantor Group, alleging fraud.
The result was a sudden and profound selloff among regional banks, prompting comparisons to the turmoil created by the 2023 banking crisis that consumed Silicon Valley Bank and First Republic. This time, investors are focusing on a particular type of loans made by banks to non-depository financial institutions, or NDFIs, as the source of possible contamination.
“When you see one cockroach, there are probably more,” JPMorgan CEO Jamie Dimon said this week. “Everyone should be warned about this in advance.”
Concerns about credit quality had been growing for weeks after the September collapse of two U.S. auto-related companies. JPMorgan, the largest U.S. bank by assets, this week reported a $170 million loss tied to one of them, subprime auto lender Tricolor.
But a third case of alleged fraud related to loans to NDFIs has investors fearing the worst, according to Truist banking analyst Brian Foran.
“You now have three cases of alleged fraud involving NDFIs,” Foran said.
Dimon’s comments “really resonated with people who were like, ‘Oh, man, the waves have subsided a little bit and now we’re seeing whose swimsuit is missing,'” Foran said.
What are NDFIs?
The episode highlighted a rapidly growing category of loans made by regional banks and global investment banks. Rules put in place after the 2008 financial crisis prevented regulated banks from making many types of loans, from mortgages to subprime automotive, leading to a surge of thousands of nonbank lenders.
Moving riskier activities outside the regulated banking environment, where failures were stopped by the Federal Deposit Insurance Corporation, seemed like a good move.
But it turns out that banks are a major source of financing for nonbank lenders: Business loans to NDFIs reached $1.14 trillion as of March. Federal Reserve Bank of St. Louis.
St. Bank loans to nonbank financial firms have been the fastest-growing category, up 26% annually since 2012, according to the St. Louis Fed.
“The increase in NDFI loans was actually due to all these different regulations coming together to say that there are a lot of loans that banks can’t make anymore, but if they lend to someone else who does them, that’s fine,” Foran said.
“We really don’t know much about these NDFI books,” Foran said. “People say, ‘I didn’t know it was so easy for a bank to think it had $50 million in collateral, only to find out it had zero.'”
‘Overreaction’ or premature?
One thing spooking investors is that some of the loan losses posted by regional banks, although relatively small, are close to being completely written off, the KBW bank analyst said. Catherine Mealor.
“NDFI loans typically have a higher loss rate due to collateral, and losses can occur very quickly and out of the blue,” Mealor said. “It’s really hard to wrap your mind around those risks.”
The analyst said Mealor has been inundating him with questions from investors regarding the level of NDFI exposure in his coverage universe. Firms including Western Alliance and Axos Financial are among those with the highest proportion of NDFI loans, according to an August research note from Janney Montgomery.
Still, regional banks are benefiting from an improving interest rate environment and increased merger activity that are supporting valuations, Mealor said, adding that he thinks this week’s stock selloff is an “overreaction.”
“You want to avoid companies that appear above the fold for NDFI loans,” he said. “There are many quality companies” KRX “They’re trading at a huge discount.”
