When a small bank that is typically unheard of outside of Utah suddenly makes the front page, a certain kind of unease descends upon Wall Street. In mid-October, Zions Bancorporation discreetly informed investors that it had taken a $50 million charge-off on two bad loans from its San Diego-based California Bank & Trust subsidiary. Its stock had dropped by over eleven percent by the afternoon. After filing a lawsuit accusing a borrower of fraud, Western Alliance in Phoenix was bleeding nearly as quickly. The S&P 500 ended the day lower despite two local names and two seemingly unremarkable issues.
The distinction between a single loan gone bad and a market-wide recoil has become increasingly hazy. A fifty million dollar write-down at a local bank would have been buried in a quarterly footnote years ago. The Dow is now moved by it. Investors’ perception of the room has changed, and this change seems to be permanent.
The background is important. The American banking system has been gradually loosened, knot by knot, since about 1980. Reagan’s deregulatory attitude persisted for a long time. Under Clinton, it softened; after 2008, it hardened once more; and in 2018, it loosened again when Congress increased the threshold at which banks are subject to the strictest regulation. The way water rises to fill any vessel you give it, a number of regional lenders quickly expanded to meet the new cap. In the spring of 2023, three of the four biggest bank failures in American history occurred. Nobody wants to talk about that too loudly because it is not an accident.
The regional sector makes up a smaller portion of the economy outside the marble lobby of the biggest banks. These lenders fund family-run businesses in the Ohio Valley, auto dealerships in Boise, and Tampa’s strip mall developers. The kind of intricate, off-balance-sheet exposures that have infiltrated their loan books over the past ten years were never intended for them. Nevertheless, the exposure is evident when looking at the most recent disclosures.
Think about First Brands, the manufacturer of wiper blades and spark plugs whose bankruptcy in September subtly triggered the current anxiety. The filing showed assets of maybe a tenth of that amount and liabilities of between ten and fifty billion dollars. In court, creditors claimed that $2.3 billion in collateral had just disappeared. Unpaid invoices were frequently used as collateral. In any conventional sense, that is not lending. That is using a paperwork costume for shadow banking.
Jamie Dimon didn’t bother dressing it up when he brought up the subject during a JPMorgan analyst call. “When you see one cockroach,” he replied, “there are probably more.” It was the kind of statement that a CEO probably regrets as soon as he says it, and he most likely meant it.
The question remains whether the cockroaches proliferate. Harris Simmons, the CEO of Zions, told analysts that private credit, which has skyrocketed with little regulatory oversight, poses a greater risk. He maintained that he does not anticipate significant bank losses as a result of it. He might be correct. The KBW Regional Banking Index’s 4.8 percent decline this year compared to the large-cap index’s nearly sixteen percent gain suggests that investors are not totally persuaded.
As this develops, there is a feeling that the regional banking industry is being evaluated based on the presumption that someone, somewhere, is concealing something rather than on its own merits. A system that functioned flawlessly when nothing went wrong was created after forty years of relaxed regulations. The part that follows is the problem.