By Manya Saini, Arasu Kannagi Basil and Ateev Bhandari (Reuters) -U.S. regional bank stocks fell on Thursday after Zions Bancorporation disclosed it would take a $50 million loss in the third quarter on two commercial and industrial (C&I) loans from its California division. The disclosure added to growing investor unease about hidden credit stress as lenders navigate elevated interest rates and economic uncertainty. "The optics of a large balance C&I loan to a fraudulent borrower from a bank that specializes in small balance C&I loans is not great, and puts into question Zions' underwriting standards and risk management policies," Raymond James analysts said in a note. The bankruptcies of auto parts maker First Brands and subprime lender Tricolor, and recent fraud allegations, have put a spotlight on the risk controls of banks and the opaque credit market, where complex loans and new facilities have made it harder to gauge participants' exposure. "Following the prominent bankruptcies of Tricolor and First Brands, bank investors are rightfully on high alert for any change in asset quality trends," KBW analysts wrote in a note. IDIOSYNCRATIC RISKS Some analysts still see the collapses as idiosyncratic and tied to individual borrowers, rather than systemic. But the cases are fueling unease. "Bankruptcies and fraud are natural in markets, but it doesn't always lead to something systemic," said David Wagner, head of equities at Aptus Capital Advisors. Shares of Zions were down 8.6% in afternoon trading. The bank said it expects to recognize the charges in the third-quarter and has filed a lawsuit in California to recover the loans. "Zions faces the challenge of showing that this is a one‐off event and not indicative of broader supervision or credit control weakness," said Brian Mulberry, senior client portfolio manager at Zacks Investment Management. Western Alliance's stock pared some losses after the bank disclosed it had initiated a lawsuit alleging fraud by Cantor Group V, LLC. The Phoenix, Arizona-based bank said it is providing additional information about one of its credit relationships after a recent peer bank 8-K filing. The lender sought to reassure investors, saying its total criticized assets — credit identified as weak — were lower than on June 30. Its shares were last down 7.8%. "If further disclosures reveal more losses or related exposures, the risk is that the broader regional banking index — or weaker names — gets re-rated aggressively downward," Mulberry added. The broader regional banking index fell nearly 4%. TEST OF TRANSPARENCY Wall Street analysts drew parallels of Zions' disclosure with the collapse of auto parts maker First Brands, which exposed gaps in lenders' oversight and raised questions about credit market transparency. Brokerages pointed to JPMorgan Chase CEO Jamie Dimon's comments this week about anxiety in the credit market following the bankruptcies of First Brands and subprime lender Tricolor. As major global lenders file unsecured claims, the issue has become a key test of transparency and management in the rapidly expanding private credit market. JPMorgan wrote off $170 million in the third quarter related to the Tricolor bankruptcy and said it was reviewing its controls, with Dimon describing the bank's exposure as "not our finest moment". "When you see one cockroach, there are probably more, and so everyone should be forewarned," Dimon said. (Reporting by Manya Saini, Arasu Kannagi Basil and Ateev Bhandari in Bengaluru; Editing by Lananh Nguyen, Tasim Zahid and Arun Koyyur)
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