Loose Conditions, Fragile Loans: When Easy
Money Hides Hard Problems
By the Curmudgeon with Victor
Sperandeo
Are Regional Banks in Trouble?
Recent credit concerns, triggered by loan fraud and bad debt
disclosures from two regional banks, have heightened investor anxiety. Analysts
have expressed heightened concerns around credit quality, loans to non-bank
financial institutions (NBFIs), concentrated exposure to commercial real
estate, and portions of the private credit market that may be less transparent.
A Morningstar DBRS report published on Friday said
that banks are likely to see more delinquencies and loan losses in the coming
quarters as they come under pressure from inflation, geopolitical concerns and
losses from loans to lower income consumers.
Banks have tapped the Federal Reserve's Standing Repo
Facility for over $15 billion since Wednesday, a sign of funding stress,
according to Morningstar’s Michael Driscoll. Still, most regional lenders have
set aside enough reserves to absorb loan losses, he added. "We were
expecting higher losses than what we have seen at this point of the credit
cycle - the market seems to be overreacting," Driscoll said in an interview with Reuters.
Some are comparing the current situation to the 2023 regional
banking crisis, i.e. the failure of Silicon Valley Bank followed by Signature
Bank and a fire sale of First Republic Bank to JP Morgan Chase. That is
reviving fears about potential systemic risks.
Others have noted that the current market reaction is driven
by credit quality issues rather than interest rate risk tied to bond portfolios
which caused the 2023 regional bank crisis. Let’s examine what happened last week.
l Zions Bancorp on Thursday disclosed a $50 million charge-off related to a
pair of loans made to real estate investors looking to buy distressed
commercial mortgages. ZION shares fell 12.3% on Thursday.
l Western Alliance Bank also disclosed on Thursday that it believed it was the
victim of fraud involving commercial real estate loans and that it had sued the
borrowers. WAL stock declined ~11% on Thursday, after it disclosed it had
initiated a lawsuit alleging fraud by Cantor Group V, LLC.
Those disclosures came after the September bankruptcies of
the subprime auto lender Tricolor
and the auto parts supplier First Brands
Group. Several big banks including
JPMorgan Chase, Fifth Third Bancorp and Jefferies disclosing losses from
loans to those companies.
The SPDR S&P Regional Banking ETF (KRE) fell
-6.2% on Thursday but rebounded +1.6% on Friday along with ZION and WAL,
causing many bank investors to breathe a sigh of relief.
Other Opinions:
Michael Gayed wrote in
his October 18th Lead-Lag report: “The boom in non-bank lending—trillions in
corporate loans made outside public markets—has long promised steady, high
returns, but much of it rests on opaque valuations¹⁷. Without daily price
discovery, funds can report smooth returns even as risk builds. This year,
large managers like BlackRock, M&G, and Fidelity trimmed exposure to
lower-rated debt, warning spreads had become “too tight”¹⁸¹⁹.
With corporate bond premiums near historic lows, one manager cautioned that any
shock could cause “substantial” widening of spreads.” Please see next section on Tight Credit
Spreads.
"We have a serious credit bubble right now," said Justin
D'Ercole, founder of Long/Short bank hedge fund ISO-MTS.
“You need a perfect economy, with low volatility, very stable interest rates
and everything else to go right for this stuff not to become an issue,” he
added.
-->That statement suggests that the current level of
credit and debt in the financial system is unsustainable and has inflated asset
prices to dangerous levels. He believes this credit "bubble" is
highly vulnerable and could burst unless the economy remains flawless, which he
views as unlikely. We thought that would happen years ago!
"In the post-SVB (Silicon Valley Bank) world, regulators
have been asking banks about their commercial real estate exposure, the
percentage of their uninsured deposits, deposit strategy, how they are set up
at the discount window, and those conversations have not changed," said Dan
Hartman, a lawyer at Nutter.
-->This increased scrutiny by regulators is a mitigating
factor, but it does not guarantee that another banking crisis will be averted.
Fifth Third CEO Tim Spence said pressure on regional banks'
shares this week is very different from the 2023 confidence crisis. "I
would not equate the two situations. At that time, there were concerns about
liquidity and funding mismatch, with short-term deposits funding long-term
loans. Now, I think investors initially reacted to losses they did not
understand well, but as more information was released over the last 24 hours
you start to see shares recovering."
Curmudgeon: While this
week’s regional bank scare set off alarm bells, it remains to be seen if a full blown banking crisis ensues, especially if financial
conditions remain loose and the Fed continues to cut rates.
….……………………………………………………………………………………………………………………………………
Risk-On for Credit as Tight Spreads Continue:
Tight (or narrow) credit spreads between corporate bonds and
U.S. Treasuries have persisted for many years with few exceptions (e.g. COVID
shutdowns in March 2020). That’s a clear
indication of investor complacency with little or no perception of the inherent
risk of corporate bond defaults.
As of October 16, 2025, the credit spread between
high-quality corporate bonds and U.S, Treasuries was 1.11%. This is calculated
using the Moody's Seasoned Aaa Corporate Bond
Yield of 5.10% and the 10-Year Treasury Constant Maturity Yield of 3.99%.
The spread for lower investment grade bonds is even tighter, with the BBB
corporate index showing a spread of 0.89% on the same day (4.88% yield
minus 3.99% yield).
Financial Conditions Remain Very Loose:
The Chicago Fed’s National Financial Conditions Index
(NFCI) provides a comprehensive weekly update on U.S. financial conditions
in money markets, debt and equity markets, and the traditional and “shadow”
banking systems a reading of 0 is neutral while negative readings indicate
loose financial conditions.
The NFCI decreased to –0.56 in the week ending October
10th which was a 12-month low. Risk indicators contributed
–0.28, credit indicators contributed –0.17, and leverage indicators contributed
–0.10 to the index in the latest week.
An alternative index, the Adjusted NFCI (ANFCI)
isolates a component of financial conditions uncorrelated with economic
conditions to provide an update on financial conditions relative to current
economic conditions.
The ANFCI also decreased in the latest week, to –0.56;
also, a 12-month low. Risk indicators contributed –0.33, credit indicators
contributed –0.16, leverage indicators contributed –0.07, and the adjustments
for prevailing macroeconomic conditions contributed 0.01 to the index in the
latest week.
The table below denotes how many series of the 105 used to
construct the NFCI and ANFCI indicated tighter-than-average or looser-than
average conditions in the most recent week.
As you can see almost all the sub-indicators are looser than average:
….……………………………………………………………………………………………………………………………………..
Victor’s Comments:
The feud between President Trump and Fed Chairman
Jerome Powell appears to be over. The Federal Reserve has signaled it will halt
the decline of its balance sheet (QT) “soon.”
The Fed is expected to lower the Federal Funds rate by 25 basis points
at each of the FOMC meetings on October 29th and December 10th. That despite already loose financial
conditions, as noted in the section above.
The economy is slowing sharply, reflected in U.S. Treasury
yields hitting a new 12-month low (3.99%) on Thursday, before a minor rebound
Friday.
Lumber prices—often a proxy for mortgage rate trends—bottomed at 572.5 on
September 17th (as per the November lumber futures), which was the
date of the last Fed rate cut. It has since rallied to 634, a new interim high
as of Friday, October 17th.
A rally in lumber futures after a bottom implies traders are
anticipating easier monetary policy and more rate cuts. Lower borrowing costs
make mortgages more affordable, which boosts construction and housing demand —
hence higher lumber prices.
The National Association of Home Builders (NAHB)
Confidence Index increased slightly to 37 due to anticipation of a Fed rate
cut at the end of October. Yet the Index sits well below the neutral level of
50, which indicates builders continue to feel pessimistic about the current and
near-term outlook for housing.
-->Victor prefers lumber futures over the NAHB index as a
housing market indicator because it is forward looking and confirms lower
interest rates.
China has clearly gained the
upper hand in the ongoing trade conflict with the U.S. By restricting exports
of rare earth minerals critical to U.S. weapons manufacturing, Beijing has put
Washington on the defensive. Trump’s response—a tariff hike to 130%—would be
the end of meaningful trade between the two nations. With China holding the
stronger hand, a U.S. recession appears increasingly likely unless the Trump
administration makes a major policy pivot, aka TACO (Trump Always Chickens
Out).
Inflation is not currently a
concern. Truflation is at 2.0% year-over-year, compared with 2.9% for
the CPI.
GDP growth remains
overstated due to import distortions caused by tariffs, a discrepancy unlikely
to be resolved until negotiations resume—which remains
uncertain.
Market Positioning:
Victor remains long gold and five-year Treasury note futures,
with a small, long silver position. Equities are anticipating lower rates, but
he plans to short the Nasdaq 100 and S&P 500
following the October 29th FOMC meeting.
Chair Powell has only four FOMC meetings left in his term
which ends May 2026. Long-dated Treasuries present a “pay me now or pay me
later” setup—lower short-term rates are a near certainty.
Victor’s Conclusions:
1. The Fed’s credibility remains in question, given its
persistent misjudgments and lack of perceived objectivity. Meanwhile, the Fed’s independence is being
threatened by Trump appointees like Stephen Miran, who is currently “on leave”
as the chairman of the Council of Economic Advisors.
2. The one thing that is
certain in observing history is that, in general, government is not serving the
people,
3. Interpretation of the U.S.
Constitution has diverged sharply from the original intent and principles
of the Founding Fathers. Congress, the
courts, and especially the Executive branch of government
now either ignore the Constitution or apply its principles in ways that would
have been unrecognizable to its founders. The vast majority
of modern government actions, laws, and judicial rulings no longer align
with the Constitution’s original meaning with limited-government intervention
or control.
End Quote:
“A man's natural rights are his own, against the whole world;
and any infringement of them is equally a crime, whether committed by one man,
or by millions; whether committed by one man, calling himself a robber, (or by
any other name indicating his true character,) or by millions, calling
themselves a government.”
Lysander Spooner was an
American individualist anarchist, abolitionist, and legal theorist who
challenged government monopolies and authority. He wrote extensively on
subjects like the constitutionality of slavery, natural law, and the role of
the jury, arguing that the Constitution did not support slavery and did not
obligate individuals to a tyrannical government.
….………………………………………………………………………………………………………………….
Wishing you good health, success and good luck. Till next
time……
The Curmudgeon
ajwdct@gmail.com
Follow the Curmudgeon on Twitter @ajwdct247
Curmudgeon is a retired investment professional. He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996. He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.
Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever-changing and arcane world of markets, economies, and government policies. Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.
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