Banks' credit 'cockroaches' are spooking the stock market. Here's what investors need to know.

By Joseph Adinolfi

A selloff in regional banks cascaded into the broader financial sector on Thursday, dragging the S&P 500 lower

Banks' credit losses are starting to spook the stock market.

Struggling to find their way amid an ongoing economic-data blackout and renewed trade-war tensions between the U.S. and China, investors already had enough to worry about this week.

Then a regional lender piled on one more thing: Another large credit loss, possibly stemming from fraudulent activity. In a regulatory filing published Wednesday evening, Salt Lake City-based Zions Bancorp (ZION) revealed that it would include a loan-loss provision of $60 million in its third-quarter earnings, which the bank is set to release later this month.

See: Zions takes $50 million loan loss as another credit 'cockroach' appears. Regional-bank stocks are falling.

Some $50 million of that will likely never be recovered, the bank added. The bank said it has commenced legal action against the two borrowers, whom it did not name in the filing. Zions also stressed that this was an isolated incident.

Investors could be forgiven for not taking that to heart. Because on Thursday morning, the market received another warning, this one from Western Alliance Bancorp (WAL). The Phoenix-based lender disclosed that it had filed a fraud lawsuit against a borrower for failing to provide adequate collateral for a revolving credit facility. Although the bank added that it believed existing collateral would cover the obligation, and that it didn't expect the dispute would impact its operating results.

These disclosures might not seem like much in terms of dollars and cents. But at this point, investors are more worried about what is starting to seem like a pattern of allegedly "isolated" credit events, said Stephen Innes, managing partner at SPI Asset Management, in commentary shared with MarketWatch.

The twin disclosures hammered shares of regional banks. The SPDR S&P Regional Banking ETF KRE, which invests in many of these companies' shares, fell 6.2%, tallying its worst day since April 10, Dow Jones Market Data showed. Even larger financial firms weren't immune. The S&P 500 financial services sector fell 2.8% on Thursday, also the biggest drop since April. Every single large-cap financial stock finished in the red on Thursday.

This helped drive a loss of 0.6% for the broader S&P 500 SPX.

The selloff pushed the Cboe Volatility Index VIX above 25 by the closing bell, leaving it at its highest end-of-day level since April 24, according to Dow Jones Market Data.

Banks' loan losses have been drawing growing scrutiny from investors lately, following a pair of high-profile bankruptcies that saddled lenders with losses. Auto-parts supplier First Brands and subprime auto lender Tricolor both went bankrupt in September, and plenty of questions remain about how lenders didn't pick up on the potential for losses earlier.

During an analyst call on Tuesday, JP Morgan Chase & Co. (JPM) CEO Jamie Dimon invoked the age-old "cockroach theory" to describe the situation.

"When you see one cockroach, there are probably more," Dimon said after JPMorgan had reported its third-quarter earnings. The report was another blockbuster, but the country's largest bank by assets also disclosed $170 million in losses tied to its loans to Tricolor. Ohio-based Fifth Third Bancorp (FITB) has also disclosed losses related to Tricolor.

"What this all speaks to is a growing concern and awareness that the quality of underwriting seems not to have been as robust as people believed," said Michael Green, portfolio manager and chief strategist at Simplify Asset Management, during an interview with MarketWatch.

"Now we're seeing credit event, after credit event, after credit event," he added.

For many investors, memories of the 2023 collapse of Silicon Valley Bank are still relatively fresh. That could have contributed to investors' fearful reaction on Thursday as stocks jerked lower, said Steve Sosnick, chief strategist at Interactive Brokers.

But there are several important differences between the latest round of regional-bank credit difficulties and what happened with SVB, Green explained.

SVB succumbed due to a bank run, as investors with uninsured deposits pulled their money after the bank warned that it had committed too much of its capital to long-dated Treasury bonds. These bonds saw their value plummet as the Federal Reserve aggressively raised interest rates in 2022.

What is happening now is rooted in questions about banks' lending standards, and whether they have been appropriately stringent.

While there is certainly reason for concern, investors don't have any cause for outright panic. Banks are generally much better capitalized today than they were before the 2008 financial crisis, said Mark Gibbens, chief investment officer of Gibbens Capital Management.

"I think there could be additional issues with other players in the banking or private-credit space, but I don't view it as a system-wide issue that could threaten the broader financial system," Gibbens said.

Additionally, Jefferies Group (JEF) held its annual investor day on Thursday. Although the event was closed to the press, the bank's exposure to the First Brands collapse came under fresh scrutiny, Innes said.

Others signs of stress have started to emerge in the broader universe of credit, where spreads between publicly traded bonds and their corresponding Treasury notes had recently touched the tightest level in decades. Spreads on BB-rated bonds have recently started to climb, according to Federal Reserve data. Green said there has also been a rise in delinquencies and defaults that could create problems in the securitization market, where consumer debt is packaged into products that are told to investors.

Shares of firms active in the private-credit lending, including industry pioneer Blue Owl Capital (OWL), have been struggling for months.

-Joseph Adinolfi

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10-16-25 1931ET