Including major banks, JP Morgan Chase and goldman sachs Just as the company was taking a victory lap after a blockbuster quarter, concerns emerged from an obscure corner of Wall Street that sent shivers across global finance.
local bank Zions Late Wednesday, it revealed that a $60 million loan had been almost completely wiped out after discovering “obvious misrepresentations” from the borrower. The next day, Pier western alliance The company announced that it had filed a complaint against a fellow borrower, a commercial real estate company called Cantar Group, for fraud.
The result was a sudden and significant stock decline among local banks, drawing comparisons to the turmoil of the 2023 banking crisis that hit Silicon Valley Bank and First Republic. This time, investors are focusing on a specific type of loan that banks make to non-depository financial institutions (NDFIs) as a potential source of contagion.
“If you see one cockroach, there’s probably more,” JPMorgan CEO Jamie Dimon said this week. “I should warn you all about this in advance.”
Concerns about credit quality have been simmering for weeks since the collapse of two U.S. auto companies in September. JPMorgan, the largest U.S. bank by assets, this week reported a $170 million loss related to one of them, subprime auto lender Tricolor.
But Trust Bank analyst Brian Foran said investors began to fear the worst after a third alleged fraud involving NDFI loans came to light.
Foran said there were “three situations of alleged fraud” related to the NDFI.
Mr. Dimon’s comments “resonated with people who were like, ‘Hey, the tide has gone out a little, now we know who’s not wearing swimming trunks,'” Mr. Foran said.
What is NDFI?
This episode focused on the fast-growing category of lending for local banks and global investment banks alike. Rules introduced after the 2008 financial crisis prevented regulated banks from making many types of loans, from mortgages to subprime autos, and led to the rise of thousands of nonbank lenders.
Moving risky activities outside the regulated bank boundaries, where failures would be prevented by the Federal Deposit Insurance Corporation, seemed like a good choice.
However, it turns out that banks are actually the main source of funds for non-bank financial institutions. Commercial lending to NDFIs reached $1.14 trillion as of March, according to the St. Louis Fed.
Bank lending to nonbank financial companies is the fastest growing category, increasing 26% annually since 2012, according to the St. Louis Fed.
“NDFI lending has exploded because all these different regulations have piled up and there are a lot of loans that banks can’t make anymore. But if banks lend to other people who are doing it, that’s fine,” Foran said.
“We don’t really know much about these NDFI books,” Foran says. “People are saying, ‘I didn’t know it was so easy for the bank to think I had $50 million in collateral and I had zero collateral.'”
“Overreaction” or is it too early?
One factor that has surprised investors is that some of the disclosed loan losses, while relatively small, have almost completely disappeared, said Katherine Mellor, a banking analyst at KBW.
“NDFI loans generally have higher loss rates because they require collateral, and losses can occur suddenly and very quickly,” Mellor said. “It’s really hard to wrap your head around these risks.”
Mellor has been inundated with questions from investors regarding the level of NDFI exposure in her coverage, analysts said. Companies such as Western Alliance and Axos Financial have among the highest percentages of NDFI lending, according to an August research report by Janie Montgomery.
Still, regional banks are benefiting from an improved interest rate environment and increased merger activity, which is supporting valuations, Mellor said, adding that he believes this week’s selloff was an “overreaction.”
“You want to avoid companies that come up high in the screening process for NDFI loans,” she says. “KRX is full of high-quality companies trading at deep discounts.”
Correction: This article has been updated to remove an incorrect statement about losses at one of the local banks related to the alleged loan fraud.
