Alleged loan fraud is frustrating but isolated

Western Alliance, one of the regional banks at the center of concerns over loans made to non-bank financial players, said Wednesday it believes the loan that sparked last week’s selloff is an isolated case.

The bank reported third-quarter earnings Tuesday afternoon and noted it had set aside $30 million in reserves for possible losses on a $98 million loan made to the Cantor Group. Last week, Western Alliance disclosed that it had sued the borrowers behind the Cantor Group for alleged fraud related to the collateral for the loans.

“While incredibly frustrating, we believe this is a one-off issue in our note finance business and have adjusted our onboarding and ongoing portfolio monitoring practices,” Western Alliance CEO Kenneth Vecchione told analysts on Wednesday.

Shares of Western Alliance rose almost 2% in midday trading.

Regional banks are getting a reprieve this week after Western Alliance and Zions, which also had exposure to the alleged loan fraud, reported results that didn’t include any new loan meltdowns. Each of the banks posted rising hauls from net interest income on lower funding costs, while some of their metrics around credit quality actually improved from previous quarters.

The Cantor Group episode forced Western Alliance to review other loans in its note finance portfolio, Vecchione said Wednesday.

“Today we have reverified titles and liens for all notes greater than $10 million and have found no irregularities,” he said.

Analysts grilled Vecchione during the Wednesday call for more details around the bank’s loan collateral and lending to non-depository financial institutions, or NDFIs.

“What are you doing to validate your collateral and safeguard against future frauds?” Autonomous Research analyst Casey Haire asked. “It just seems like as long as you’re not afraid to go to jail, it seems easy to double pledge collateral.”

Besides the recent review, Western Alliance periodically checks collateral to make sure the bank is still in a position to collect if the loan sours, executives said. Much of the bank’s NDFI book is tied to residential mortgages, which Western Alliance considers low-risk, they added.

Western Alliance is also exposed to another recent blowup, the bankruptcy of the auto parts maker First Brands.

But in this case, a loan facility made to a fund managed by a subsidiary of the investment bank Jefferies “remains current, and we continue to receive principal and interest payments as modeled,” said Vecchione.

While this week’s reassurances have calmed markets for now, the sharp selloff in regionals last week is leaving a lasting mark on the industry. Shares of both Western Alliance and Zions plunged on Thursday after the banks disclosed problems with the Cantor Group.

Investors are ready to hit “sell” on any signs that the losses aren’t isolated, and share gains for the group will be capped for the foreseeable future because of these worries, said Timur Braziler, who covers mid-cap banks for Wells Fargo. He cut his recommendation on Western Alliance to “sell” on September 29.

“You can’t unsee these events,” Braziler said in an interview. “The timer for any kind of sustainable outperformance within the regional group has gotten reset once again.”