A new banking crisis or a flash in the pan?
That’s the question traders were asking themselves on Thursday as a pair of regional banks sent stocks plunging after giving updates on their lending businesses.
It proved to be the latter, for now, as stocks erased some losses to rise into positive territory on Friday. The two offending banks, Zions and Western Alliance, saw their shares recover slightly following Thursday’s drop.
Yet, this week’s spasm of bank volatility should serve as a clear reminder to investors that sometimes the risk to the market isn’t where most people are looking — in this case, rather than a sudden unwinding of AI bets, it was a shock in the credit ecosystem that caused the brief panic.
To recap: Zions Bancorp disclosed a $50 million charge-off on a loan underwritten by San Diego-based California Bank & Trust, one of its wholly-owned subsidiaries. Western Alliance, meanwhile, revealed a lawsuit against a borrower it alleged had committed fraud. Zions fell 13% and Western Alliance lost 11%.
By Friday though, both stocks were back in the green, with Zions up 4% and Western Alliance up 2% around 11 a.m. ET. The wider market also looked poised to recover from Thursday’s swoon. The momentum can be attributed to positive earnings reports from Truist Financial, Regions Financial, and Fifth Third Bancorp, which soothed fears of widespread credit issues on Friday morning.
That said, credit risk is still in the air, and some high-profile bankruptcies and Jamie Dimon’s latest comments highlight that.
Where are all the cockroaches?
“When you see one cockroach, there are probably more… Everyone should be forewarned on this,” said JPMorgan CEO Jamie Dimon, warning investors to brace for more credit-market upheaval.
Dimon was referring to the recent bankruptcies of subprime auto lender Tricolor Holdings and auto parts supplier First Brands, both of which have become poster children for the risks lurking in the booming private credit market.
The term private credit refers to the sprawling world of non-bank lenders, a patchwork of private equity firms, hedge funds, and specialty lenders that extend loans to companies that might have a harder time getting in the door at a major bank.
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However, banks are major sources of financing to private lenders, which can help explain why worries about credit broadly have spilled over into the banking sector.
“The top US banks continued to play an outsize role in driving loans to nondepository financial institutions in the second quarter,” S&P Global Market Intelligence said in a report last month. “The country’s nine largest banks posted an $86.09 billion increase in nondepository financial institution (NDFI) loan growth, or 75.1% of the industry’s $114.67 billion aggregate growth in the category.”
Market pros say the concerns around private credit are mainly that it is less transparent. The soaring competition in the space in recent years may have eroded underwriting standards as lenders compete for business.
“This is a reflection on the fog involved with private credit and equities,” Marcus Sturdivant Sr, a managing principal at advisory firm The ABC Squared, told Business Insider. “Main Street is concerned, Wall Street is on watch, and the total economy is feeling the pinch.”
Frank Scarso, CEO of Avanza Capital Holdings, echoed that. “When banks are forced to stretch for yield in uncertain economic cycles, it exposes the cracks in conventional risk models and market participants see it immediately.”
Other experts aren’t as concerned, despite Dimon’s ominous warning.
“Loan losses in that market reduce the rates of return on diversified portfolios of such loans. They don’t trigger an economy-wide credit crunch, which has often occurred when bad loans hit the banking system hard,” economist Ed Yardeni wrote in a note following Thursday’s sell-off.
Meanwhile, Moody’s on Friday said they have yet to see real cracks forming in the space.
“When we dig deeper here and look to see if there’s a turn in the credit cycle, which is effectively what the market seems to be focusing on, we can find no evidence,” Marc Pinto, the ratings agency’s head of private credit, said in an interview on CNBC.
