THE start of earnings season is exposing a potential crack in the stock market’s frothy foundation: risky lending by some regional banks.
Shares of Zions Bancorp and Western Alliance Bancorp plunged Thursday after the companies said they were victims of fraud on loans to funds that invest in distressed commercial mortgages. The disclosures sent the KBW Bank Index to its worst day since April’s tariff tantrum.
They followed a warning from JPMorgan Chase and Co. CEO Jamie Dimon about ‘cockroaches’ in the credit market during the bank’s earnings conference call on Tuesday. He was referring to the implosions of auto lender Tricolor Holdings and car-parts supplier First Brands Group.
With Wall Street already on edge, the chatter about troubled borrowers hitting banks is tapping into fears that a credit crisis could be the pin that pops the three-year bull market in stocks. ‘The market kind of freaked out,’ said Sadiq Adatia, chief investment officer at BMO Global Asset Management, which has $221 billion in assets under management.
From one angle things look great in the financial industry after the first full week of the third-quarter earnings season featured a string of beats from financial giants like Bank of America Corp., Morgan Stanley and Goldman Sachs Group Inc. But next week will offer a different view, as regional lenders such as Zions, Western Alliance and East West Bancorp Inc. are scheduled to report.
‘People are just a little bit spooked and kind of selling first and asking questions later,’ said Zachary Hill, head of portfolio management at Horizon Investments.
In many ways, the finance world is being divided in two. Big banks and Wall Street giants are racing ahead with strong trading and investment banking operations, and their size insulates them from a few bad loans. Smaller firms, however, don’t have that cushion, so the risks are more acute.
Investors are already seeing the difference. The KBW Regional Banking Index plunged the most since April on Thursday, wiping out its gain for the year, while the KBW Bank Index, which includes major national lenders and Wall Street titans, is up 14 percent in 2025.
‘If we’re going to get some continued uncertainty in the banking sector and questions around credit quality, then the large banks are definitely a safer refuge than the regionals,’ Hill said.
The risk, of course, is that problems at a few regional lenders can spread to big banks and, from there, into the broader economy. Even ‘mild’ credit concerns are ‘not good for an expensive stock market,’ said Matt Maley, chief market strategist at Miller Tabak + Co. The tech sector is worth watching ‘very closely,’ he added.
During the first half of the year, there was a ‘huge move’ in lower quality companies and everything related to artificial intelligence, said Adam Parker, founder of Trivariate Research. But now investors are trying to find some ‘ballast’ in their portfolios with stocks that aren’t exposed to these risks, ‘whether it’s higher quality financials, whether it’s health care, whether it’s metals,’ he said.
Still, sentiment remains strong for the big financial names and the sector as a whole.
‘As long as the vast majority of banks, particularly the systematically important ones, are doing OK, the sector will shrug off problems at certain institutions if they appear to be idiosyncratic rather than systemic,’ said Steve Sosnick, chief strategist at Interactive Brokers.
Friday’s batch of earnings reports helped allay some concerns, as Truist Financial Corp., Regions Financial Corp. and Fifth Third Bancorp all reported lower provisions for credit losses than analysts expected.
In general, Wall Street is bullish on third-quarter bank earnings, as the larger lenders are ‘hitting the ball out of the park,’ said Sam Stovall, chief investment strategist at CFRA Research. Analysts now expect financials to post 13.4 percent earnings growth in the third quarter versus the previous forecast of 8.9 percent, he wrote in a note to clients on October 15.
More broadly, banks have also provided ‘a welcome optimistic look at the macroeconomy,’ Peter Williams, economist at 22V Research, wrote in a note to clients on October 15. At a time when data from the Bureau of Labor Statistics and other US agencies isn’t available due to the government shutdown, Williams noted that the bank earnings show ‘consumer spending trends continued to look solid.’
Wall Street will get a closer view of consumer health later this month when Visa Inc. and Mastercard Inc. report. Given the rising concerns about credit, those will be closely watched and have the ability to ‘spook the rally,’ Trivariate’s Parker said.
That being said, bullish investors are likely to view any drop as temporary and a chance to buy into the growth in financials at a lower price.
‘If we have further pullbacks from here, that’ll create a buying opportunity for us,’ BMO’s Adatia said, adding that he’s encouraged by the big banks’ results.