Shares of two prominent regional US banks experienced significant declines after both institutions disclosed they had fallen victim to fraud related to loans provided to investment funds focused on distressed commercial mortgages. This news has intensified concerns about emerging vulnerabilities within the credit markets, particularly affecting smaller lending institutions.

Zions Bancorp reported a substantial 12% drop in its share price following the announcement of a $50 million charge-off. This charge stemmed from a loan underwritten by its wholly-owned subsidiary, California Bank & Trust, located in San Diego. The bank initiated a lawsuit, alleging that California Bank & Trust is owed this amount by two investment funds connected to Andrew Stupin and Gerald Marcil, among other parties. The subsidiary had extended two revolving credit facilities in 2016 and 2017, totaling over $60 million, to finance the purchase of distressed commercial mortgage loans. These agreements were supposed to grant the bank a “first-priority, perfected security interest” in all collateral, including each mortgage loan acquired by the funds. However, an subsequent investigation revealed that many of the promissory notes and underlying properties had been transferred to other entities, and these properties were either already foreclosed upon or facing imminent foreclosure.

Similarly, Western Alliance Bancorp saw its shares tumble nearly 11% after revealing it had made loans to the same group of borrowers. Western Alliance had previously filed a lawsuit against this investor group in August, which, according to Zions, prompted Zions’ own investigation. Western Alliance’s lawsuit highlighted that the outstanding balance of its loan to these investors was $98.6 million. The bank discovered that while the collateral was purportedly backed by a first-priority lien, this was not the reality. It alleged that the borrowers created fake title policies by deliberately omitting senior liens. Furthermore, the lawsuit claimed that the borrowers drained funds from accounts designated as additional collateral, with one account holding just over $1,000 as of August 18, compared to a required monthly average of $2 million.

Both Zions and Western Alliance were the top decliners in the KBW Bank Index, which recorded its steepest drop in six months. These recent disclosures follow other significant loan issues, such as the bankruptcy of subprime auto lender Tricolor Holdings and auto-parts supplier First Brands Group. While major banks like JPMorgan Chase & Co. and Fifth Third Bancorp absorbed hundreds of millions in combined losses from Tricolor, and Jefferies Financial Group Inc. had exposure to First Brands, analysts note that such problems pose a more significant threat to regional lenders. As one analyst commented, while a loan problem might be “puny” for JPMorgan, it takes a much greater toll on smaller banks. Despite its exposure to First Brands, Western Alliance stated that it does not anticipate this issue to alter its 2025 financial outlook.