As a series of bad loans has the bank investors on the hunt for hidden risks


Banks questioned about the risks lurking in their balance sheets while increasing NDFI loans

Large banks included JPMorgan Chase e Goldman Sachs had just done victory laps after a very successful quarter when concerns emerged from a dark corner of Wall Street, sending a collective shudder through global finance.

Regional bank of Zion Wednesday afternoon disclosed an almost total write-off of $60 million in loans after finding “apparent misrepresentations” by borrowers. The next day mate Western Alliance he said who had sued the same borrower, a commercial real estate company called Grupo Cantor, for alleged fraud.

The result was one sudden and deep sell among regional banks, drawing comparisons to the collapse of the 2023 banking crisis that consumed Silicon Valley Bank and First Republic. This time around, investors are focusing on a specific type of loans made by banks to non-depository financial institutions, or NDFIs, as a source of potential contagion.

“When you see one cockroach, there are probably more,” JPMorgan CEO Jamie Dimon he said this week. “Everybody should be put on notice in this case.”

Concerns about credit quality simmered for weeks after the September collapse of two US auto-related companies. JPMorgan, the largest U.S. bank by assets, this week reported a $170 million loss linked to one of them, subprime auto lender Tricolor.

But it wasn’t until a third case of alleged fraud surrounding loans to NDFIs that investors were jolted into fearing the worst, according to Truist banking analyst Brian Foran.

“You’ve now had three situations where there was alleged fraud” involving NDFI, Foran said.

Dimon’s comments “resonated a lot with people saying, ‘Oh man, the tide went out a little bit, and now we’re seeing who was missing their swim trunks,'” Foran said.

Regional banks and credit issues: Here's what you need to know

What are NDFIs?

The episode put the spotlight on a fast-growing category of loans made by both regional banks and global investment banks. Rules put in place after the 2008 financial crisis discouraged regulated banks from making many types of loans, from mortgages to subprime autos, leading to the rise of thousands of non-bank lenders.

Moving riskier activities outside the regulated banking perimeter, where failures are backed by the Federal Deposit Insurance Corporation, seemed like a good move.

But it turns out that banks are an important source of funding for non-bank lenders: commercial loans to NDFIs reached $1.14 trillion in March, according to the Federal Reserve Bank of San Luis.

Bank loans to non-bank financial firms were the single fastest-growing category, rising 26% annually since 2012, according to the St. Louis Fed. Louis.

“The increase in NDFI loans was really because all these different regulations added up to say there’s a bunch of loans that banks can’t make anymore, but if they lend to someone who does, that’s fine,” Foran said.

“We really don’t know much about these NDFI books,” Foran said. “People are saying, ‘I didn’t know it was so easy for a bank to think it had $50 million in collateral and find out it had zero.'”

“Overreaction” or early?

Part of what’s spooking investors is that while some of the loan losses disclosed were relatively small, they were almost completely wiped out, the KBW banking analyst said. Catherine Mealor.

“NDFI loans, because of the collateral involved, tend to have a higher loss rate and losses can come very quickly and out of the blue,” Mealor said. “It’s very difficult to understand these risks.”

Mealor said investors have inundated her with questions about the level of NDFI exposures in her coverage universe, the analyst said. Firms such as Western Alliance and Axos Financial are among those with the highest proportion of NDFI loans, according to an August research note by Janney Montgomery.

Still, regional banks are benefiting from a better interest rate environment and growing merger activity, which are underpinning valuations, Mealor said, adding that he believes this week’s selloff in stocks was “overkill.”

“You want to avoid companies that appear high on the NDFI loan screen,” he said. “There are a lot of high-quality companies the KRX which trade at a massive discount.”

Correction: This article has been updated to remove an incorrect mention of losses at one of the regional banks linked to the alleged loan fraud.



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