Boo! Frightening fraud at regional banks
Can't say I am surprised at all.
Mejor solo que mal acompañado Better alone than in bad company. Mexican dicho
Zions Bancorp and Western Alliance Bancorporation have made some fraud allegations. (Gift link)
Traders ‘Spooked’ as Bank Lending Risk Puts Stock Market on Edge
Shares of Zions Bancorp and Western Alliance Bancorp plunged Thursday after the companies said they were victims of fraud on loans to funds that invest in distressed commercial mortgages. The disclosures sent the KBW Bank Index to its worst day since April’s tariff tantrum.
They followed a warning from JPMorgan Chase & Co. CEO Jamie Dimon about “cockroaches” in the credit market during the bank’s earnings conference call on Tuesday. He was referring to the implosions of auto lender Tricolor Holdings and car-parts supplier First Brands Group.
Bloomberg’s Matt Levine says this afternoon what I have been saying to folks in the background for the last few days. But, of course he says it in his roundabout, obtuse, “whatever” way:
The suggestion here is:
1. There is a public record of mortgages, so anyone can search the record and see if there is already a mortgage on a particular property.
2. Therefore it is basically impossible to “double-pledge” a property: If you have already borrowed $800,000 against your $1 million property, and you go to another lender to borrow another $800,000, the second lender will do a title search, see the existing mortgage, and say no.
3. But what if you have a buddy who is a mortgage lender? What if you go to him and ask to borrow another $800,000 and he says yes? Then you have borrowed $1.6 million against your $1 million property.
4. Then your buddy can go to his bank and borrow, say, $500,000, secured by his $800,000 mortgage on your property.
5. His bank might not check the title: The bank might say “hey this is a first-lien mortgage right,” and your buddy will be like “oh sure here’s the title report,” and the bank might not do its own search to check. Why would it? Your buddy has skin in the game; he has incentives to make sure that he has a good lien on the property, so that he can get paid back. Or so the bank thinks.
6. You and your buddy have, between you, extracted $800,000 from the first lender and $500,000 from his bank, for a total of $1.3 million against your $1 million house.
7. You skip town together.
Let me say it in plain language: Due diligence is dead, and maybe, in a lot of cases, there’s some collusion thrown in to grease the wheels.
Few are checking or monitoring anything before extending billions in credit. That creates serious risks when everyone wants to grow their book of business by leaps and bounds. The potential problems are exacerbated by the remote second, third, or fourth degree relationship that private credit and securitization and structured products create for banks and investors related to the actual goods/services they are investing in or lending against.
Why do I say due diligence is dead? There are plenty of examples.
KPMG and Autonomy acquisition by HP
Investors in Theranos who did not ask for audited financial statements
Crypto ventures in general and Shima Capital takes money from Bill Ackman, in particular.
JPM analyst Stephen Tusa on GE:
Here’s JPM analyst Stephen Tusa, talking about GE in February of 2019, saying “the stock could go up based on narrative and sentiment,” and no one is reading the 10-K, starting at the 6:15 mark.
Elon Musk and others and the Twitter deal:
Elon Musk struck a deal with Twitter’s Board to acquire the company and take it private, but he used loans against his stock in Tesla and plans to spend billions more of his own cash along with raising money via a lemonade stand — kidding, it’s a motley crew of investors of various shapes, sizes, and denominations — without ever looking under Twitter’s financial hood.
On May 10 Bloomberg reported that in addition to the commitments from a roster of libertarian-leaning leaders — The New York Times euphemistically says Twitter investor Marc Andreessen is like Musk a “free-speech enthusiast and a backer of crypto technologies” — Apollo Global Management Inc. is now poised to lead a preferred financing for Musk’s proposed Twitter buyout. Citing the usual “people with knowledge of the deal”, Bloomberg says the funding, arranged by Morgan Stanley, will exceed $1 billion and may include Sixth Street Partners, among other firms.
That brings total commitments to about $8.1 billion including $1 billion from Larry Ellison and a flip-flop from Saudi Prince Alwaleed bin Talal, originally anti-Musk, who agreed to roll the dice, I mean roll his $1.9 billion of Twitter stock into the privatized company.
The Bloomberg report called the deal “brash” because it “came together at breakneck speed in part because Musk waived the chance to look at Twitter’s finances beyond what was publicly available,” writing off such behavior as “how the billionaire works.”
That sounds like how the billionaire individual and family office investors in Theranos operated, investing with very little due diligence and no financial audits. We see a repeat in the Twitter investor list of a few like Larry Ellison and Steve Jurvetson. Some with less money to burn sued Theranos successfully and Elizabeth Holmes was recently convicted of criminal charges for defrauding some others.
It’s highly unusual for an individual to make such a huge, socially significant acquisition without doing any due diligence, using only publicly available financial information to support your bid, according to George Mason law professor Jordan Neyland.
Maybe not so unusual for this crew, though.
Bloomberg reported that not only did Musk waive looking at anything but Twitter’s publicly available financial information but he also didn’t get a peek at a valuation analysis prepared by Twitter’s advisers, which included Goldman Sachs Group Inc. and JPMorgan Chase & Co., that was presented to the board last Friday, given the decision to bypass reviewing Twitter’s books and records.
Throw in collusive fraud in and you have PwC and Deloitte missing the fraud at Taylor Bean & Whitaker and Colonial Bank:
Was it possible for PwC to detect this fraud?
The fraud between Taylor Bean & Whitaker and Colonial Bank centered on the Colonial’s Mortgage Warehouse Lending Division, where the bank provided short-term funding to TBW so that it could originate mortgage loans. The MWLD provided funding to TBW through various funding facilities, including one called the COLB Facility.
In late 2003, fraudsters began running the TBW fraud using the COLB accounts by having TBW “sell” Colonial 99% participation interests in mortgages that had already been sold to other investors. That helped conceal TBW’s overdraft by making it appear on Colonial’s financial statements as if Colonial owned an interest in legitimate COLB mortgages. Colonial’s 99% participation interest would have been represented by a “participation certificate” held as collateral for Colonial in its vault until Colonial was paid for its 99% participation interest in the underlying mortgages.
Judge Rothstein wrote in her decision that PwC could have uncovered the fraud simply by inspecting some of the underlying documents for the mortgages at issue, but it didn’t. PwC never inspected nor requested to inspect a single TBW COLB loan document, despite being in the same building as the secured file room. During the TBW trial, Steven Thomas, the attorney for the trustee, quipped, “All you had to do was press ‘B’ in the elevator for basement,” because testimony during the trial based on the trustee’s investigation revealed there were no “participation certificates” for these loans and, therefore, no mortgage collateral.
The judge wrote that, instead of looking at the actual documents, PwC relied on TBW CEO Lee Farkas, to confirm the key information about the collateral underlying the Colonial credit facility for TBW. Using CEO Farkas confirm the existence of TBW’s collateral was “quintessentially the same as asking the fox to report on the condition of the hen house,” Rothstein wrote.
When banks lend on hard collateral like commercial properties or purchase securitizations of debt backed supposedly by hard collateral, there are accounting, auditing, and regulatory rules about how they are supposed to verify, document, monitor and then account for the risk of collateral that does not cover the loans.
Ask Judge Rothstein!
I have previously written a lot about ALL, Allowance for Loan and Lease Losses, and how KPMG, in particular as the dominant auditor for listed large banks in the US, has had trouble auditing banks’ allowance for loan losses. The firm has struggled with this since before the great financial crisis of 2008-2010, continues to struggle with it, and resisted fixing it so much that its partners chose to intentionally subvert the regulatory process by stealing data regarding upcoming inspections in order to get past the criticisms from regulator the PCAOB.
The terminology was revised from ALLL to ACL in 2016. From the Office of the Comptroller of the Currency, Allowances for Credit Losses Version 1.0, April 2021:
An ACL for loans replaces the former allowance for loan and lease losses (ALLL).
The ALLL, originally referred to as the “reserve for bad debts,” was a valuation reserve each bank established and maintained by credits or debits against the bank’s operating income. The objective of a valuation reserve is to estimate uncollectible amounts used to reduce the book value of loans and leases to the amount expected to be collected. An ACL similarly represents an estimate of uncollectible amounts maintained through charges to a valuation reserve adjusted through a bank’s operating income. The measurement framework and conceptual basis supporting an ACL differ from that of the ALLL.
After the 2008 global economic crisis, banks and financial statement users expressed concern that U.S. generally accepted accounting principles (GAAP) restricted the ability to record credit losses that were expected but did not yet meet the probable threshold. Various stakeholders requested that accounting standard-setters, the Financial Accounting Standards Board (FASB) and International Accounting Standards Board, work to enhance standards on loan-loss provisioning to incorporate more forward-looking information.
Standard-setters concluded that the approach for determining the impairment of financial assets, based on a probable threshold and an incurred notion, delayed the recognition of credit losses on loans and resulted in loan-loss allowances that were “too little, too late.” As a result, the FASB issued a new accounting standard, Accounting Standards Update (ASU) 2016-13, ASC Topic 326, “Financial Instruments – Credit Losses,” on June 16, 2016. ASC Topic 326 introduces the CECL methodology for estimating ACLs.
You may be interested to know that this is the first edition of the Comptrollers Handbook for safety and soundness focused on asset quality that removes “reputation risk” as an examination criteria.
What was the reason? Via The Block:
OCC ends reputation risk examinations amid backlash from the crypto industry over debanking
By Sarah Wynn March 20, 2025, 7:31PM EDT
The U.S. Office of the Comptroller of the Currency said it has ended examining national banks and other financial institutions for reputation risk following condemnation from the crypto industry over being cut out from the financial sector.
In a statement released on Thursday, the OCC Acting Comptroller of the Currency Rodney E. Hood said the agency’s examination process has been focused on “appropriate risk management processes,” not on drawing judgment on certain activities.
“The OCC has never used reputation risk as a catch-all justification for supervisory action,” Hood said. “Focusing future examination activities on more transparent risk areas improves public confidence in the OCC’s supervisory process and makes clear that the OCC has not and does not make business decisions for banks.”
Did Zions and Western Alliance have sufficient ACL for losses they reported this most recent quarter? Did they have adequate internal controls to prevent, detect, and mitigate the kinds of frauds they now allege? Via Bloomberg:
Zions, Western Alliance Banks Disclose Bad Loans Tied to Alleged Fraud, October 16, 2025
Zions Bancorp sank 13% after it disclosed a $50 million charge-off for a loan underwritten by its wholly-owned subsidiary, California Bank & Trust, in San Diego. And Western Alliance Bancorp tumbled almost 11% after it said it made loans to the same borrowers.
Zions said in a lawsuit that California Bank & Trust is owed the money from two investment funds tied to Andrew Stupin and Gerald Marcil, among other parties.
California Bank & Trust provided two revolving credit facilities to the borrowers in 2016 and 2017 totaling more than $60 million, to finance their purchase of distressed commercial mortgage loans, according to the lawsuit. The terms gave the bank “first-priority, perfected security interest” in all collateral, including each mortgage loan purchased by the investment funds.
But after an investigation, the lender found that many of the notes and underlying properties were transferred to other entities, and that those properties have already been foreclosed on or were about to be, according to the lawsuit.
“My clients vehemently deny all the allegations of wrongdoing,” Stupin and Marcil’s attorney, Brandon Tran, wrote in an emailed statement. “These claims are unfounded and misrepresent the facts. We are confident that once all the evidence is presented, our clients will be fully vindicated.”
Spokespeople for Western Alliance and Zions declined to comment.
Zions said its investigation was prompted by a Western Alliance lawsuit against the same group filed in August.
Western Alliance also lent money to the same investor group, for them to originate or buy mortgage loans, according to the bank’s lawsuit in August. The outstanding balance of that loan is $98.6 million.
Western Alliance found that the collateral was supposed to be backed by a first-priority lien, but that wasn’t the case. It alleged that the borrower created fake title policies by omitting the senior liens.
At the same time, the borrower drained funds from accounts that acted as additional collateral, according to the lawsuit. As of Aug. 18, the borrower held a little over $1,000 in their bank account at Western Alliance, while the required monthly average was $2 million, according to the lawsuit.
Western Alliance, which also has exposure to First Brands, said it doesn’t expect the issue to change its 2025 outlook.
Zions Bancorporation has been audited by Ernst & Young (EY) since 2000, 25 years! Before that KPMG was the auditor.
EY and Zions management have not identified any material weaknesses in internal controls over financial reporting since the annual report for the year ending December 31, 2009. (Via Audit Analytics sourced from SEC filings.)
EY has identified “Allowance for Credit Losses” as a critical audit matter or CAM, in its opinion every year since 2019, the first year that the disclosure was possible, based on records obtained via Audit Analytics sourced from SEC filings.
CAMS are not well understood by the general investing public or journalists.
I wrote back in 2023 about CAMS and the failure of three KPMG-audited banks in the Spring of 2023.
In his post for The Dig on April 19, Jim Peterson also discussed the futility of pointing to missing Critical Audit Matters or CAMs.
As for CAMs —and their analogs elsewhere in the world where “key” is substituted, thus KAMs — their availability and use have been gradually creeping into practice since introduced via the International Auditing Standards in 2016 and imposed by PCAOB requirements with application starting in 2019.
Wider use, however, has not made C[K]AMs more illuminating, reliable or demonstrably useful to information users. The limited available scholarship on their ability to signal future issues is no better than mixed, since there’s no good research proving up the questionable hypothesis that investors actually pay attention to CAMs or make real-world decisions based on their inclusion in corporate disclosures. And there is at least anecdotal evidence that, in fact, they do not. That includes instances where fresh inclusion of a CAM or KAM was met with the typical indifference of investors and negligible effect on the reporting company’s share price.
An academic who has done considerable work looking at CAMS weighed in with me on the question of whether anyone was studying or listening to CAMs.
Professor Miguel Minutti-Meza, chairman of the accounting department at the University of Miami and an esteemed researcher on this and related topics, told me, “There is plenty of research about CAMs/KAMs showing that these disclosures provide investors little incremental information to make decisions. Although some research shows that there could be effects, the bulk of the evidence confirms scant attention and, therefore, little incremental information for investors or the market.”
A WSJ report from April 10 says KPMG was not alone in not highlighting a lot that led to these bank failures and the ongoing concerns about similar banks. KPMG did not mention the risks as CAMs, and raised none of them to the level of material weaknesses in internal controls over financial reporting, even though they were cited as serious concerns in the Fed and CA DFPI reports and KPMG, and other auditors, have a legal obligation to ask for and gain access to regulatory reports.
Auditors’ apparent blind spot on the interplay of interest-rate and liquidity risks isn’t confined to Silicon Valley Bank.
Auditors for nine other U.S. banks most exposed to bond losses also didn’t flag this as an issue when they signed off on the financial statements for 2022, according to an analysis by The Wall Street Journal.
The Journal reviewed the audit opinions for the 10 small to midsize U.S. banks that last year reported the highest losses on held-to-maturity securities as a proportion of their shareholder equity, based on data from research-firm Calcbench. Silicon Valley Bank ranked second on the list.
None of the auditors included a critical audit matter related to the bank’s treatment of the bonds. Instead, nine of the 10 reported a critical audit matter for estimated losses from loans or other bad debts. That is the risk that brought down banks in the 2008 financial crisis. Auditors didn’t report any critical audit matter for one of the banks, the analysis found.
Eventually at least one journalist, at my urging, dropped the discussion of going concern opinions and CAMS and focused on the consequences for KPMG of having three bank audit clients fail in quick succession.
In Zions’ 2024 annual report, EY begins its CAM on its audit of the bank’s ALLL this way:
Description of the Matter
The Bank’s loan and lease portfolio and the associated allowance for loan and lease losses (ALLL), were $59.4 billion and $696 million as of December 31, 2024, respectively. The provision for loan and lease losses was $72 million for the year ended December 31, 2024.
As of the end of the 2nd quarter of 2025, period ending June 30, 2025, this is what the ACL — the ALLL and the reserve for unfunded lending commitments — looks like. See page 13 of the 10-Q:
Note that in the 2nd quarter of 2025, just a few months ago, Zions said that any adverse economic conditions driving higher reserves were offset by “lower reserves associated with certain portfolio-specific risks, such as commercial real estate.”
The net impact on its P&L from ACL activity in the 2nd Quarter was actually positive, a positive $1 million (!) because of the release of reserves for unfunded lending commitments and a tiny provision for ALLL.
What a difference a few months and some unpleasant revelations have brought! Now, one quarter later, Zions finds out that all is not so shiny in the commercial real estate environment. From the 8-K:
Zions Bancorporation, N.A. (the “Bank”), recently became aware of legal actions initiated by several banks and other lenders against parties that appeared to be affiliated with two borrowers (the “Borrowers”) under two related commercial and industrial loans extended by the Bank’s California Bank & Trust division (the “Loans”). The Bank’s Loans are guaranteed by several individuals (the “Obligors”).
Upon discovery of this information, the Bank commenced an internal review of the Borrowers, the Obligors, the Loans, and the supporting collateral. During this review, the Bank identified what it believes to be apparent misrepresentations and contractual defaults by the Borrowers and Obligors and other irregularities with respect to the Loans and collateral. The Bank’s subsequent demands and notices of default and acceleration to the Borrowers and Obligors have gone unanswered.
Based on currently available information, on October 15, 2025, the Bank determined to take a provision for the full approximately $60 million outstanding under the Loans and charge off $50 million of said amount. The provision and charge-off will be reflected in the Bank’s earnings and financial statements for the third quarter of 2025.
Zions says that, the “provision and charge-off will be reflected in the Bank’s earnings and financial statements for the third quarter of 2025,” which have not yet been released. That’s despite admitting it only made the determination to take an additional reserve and write-off, with a net negative $15 million P&L impact, on October 15, 2025, 15 days after the end of the third quarter on September 30.
Will this be identified as a “subsequent event”, something that affected the results that became knowable, supposedly, only after the end of the quarter? It fits the general definition and so Zions says they will book it in the 3rd quarter.
According to PwC guidance:
As discussed in ASC 855-10-20, there are two types of subsequent events:
Excerpt of definition from ASC 855-10-20
a. The first type consists of events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements (that is, recognized subsequent events).
b. The second type consists of events that provide evidence about conditions that did not exist at the date of the balance sheet but arose subsequent to that date (that is, nonrecognized subsequent events).
Recognized subsequent events (see FSP 28.5) are pushed backed and recorded in the financial statements to be issued. Examples include the realization of a loss on the sale of inventory or property held for sale when the subsequent act of sale confirms a previously existing unrecognized loss. See FSP 28.5 for other examples.
But here’s what Deloitte’s guidance says.
However, PwC guidance says:
Nonrecognized subsequent events (see FSP 28.6) are considered for disclosure based on their nature to keep the financial statements from being misleading. An example is a natural disaster that destroys a facility after the balance sheet date. See FSP 28.6.3 and 855-10-55-2 for other examples.
Fortunately, it was not a sleight of hand announcement that came between a positive earnings announcement and a revised 10-Q that few read.
And what about Western Alliance Bancorp? What is its history with material weaknesses in internal controls, CAMs, and its ACL/ALLL?
RSM US LLP has been auditor for Western Alliance since 1994, 31 years!
Western Alliance responded on October 16 with its own disclosure to the bombshell Zions Bank dropped on it and the. market:
In response to investor inquiries about a recent peer bank 8-K filing, Western Alliance Bancorporation (“Company”) is providing additional information about one of Western Alliance Bank’s (“Bank”) credit relationships.
The Bank has a note finance revolving credit facility to Cantor Group V, LLC secured by pledged commercial real estate loans and their cash proceeds. In August, the Bank initiated a lawsuit alleging fraud by the borrower in failing to provide collateral loans in first position, among other claims. We have evaluated the existing collateral and believe it covers the obligation, based on “as-is” appraisals. Additionally, the Bank has a limited guaranty and full guaranty from two ultra-high net worth individuals under certain circumstances, such as fraud.
As projected, the Company’s total criticized assets are lower than they were on June 30, 2025. At this time, the Company affirms its guidance and 2025 outlook included in the Company’s Second Quarter 2025 Financial Results press release dated July 17, 2025.
So, Western Alliance says that in its case, it’s covered!
Auditor RSM has not identified any material weaknesses in internal control over financial reporting at Western Alliance Bancorp ever, at least as far back as 2006, the date that records obtained via Audit Analytics sourced from SEC filings go.
RSM has identified “Allowance for Credit Losses” as a critical audit matter or CAM, in its opinion for Western Alliance every year since 2019, the first year that the disclosure was possible. It has also noted the company’s accounting and disclosures regarding Other investments, Valuation of Mortgage Servicing Rights as a CAM in 2021-2024 and Business Combinations and Goodwill in 2021 and 2023, respectively.
So, no worries!
In its 2Q 10-Q the Western Alliance said, “Management considers the level of ACL to be a reasonable and supportable estimate of expected credit losses inherent within the Company’s HFI loan portfolio as of June 30, 2025.”
Western Alliance believes it can weather the fraud and there have been no prior signals from its auditor that its controls are anything but robust.
But what about the rest of the regional banks, and the big banks? Are there cockroaches still to come as Jamie Dimon warned? FT columnist Robert Armstrong thinks not (Gift link):
And on Thursday another mid-sized bank, Western Alliance, disclosed that back in August it had initiated a fraud lawsuit against one of its commercial real estate borrowers. The bank said that it believed the collateral covered the loan, but the market wasn’t waiting around to see a realtor’s report. Both Zion and Western alliance sold off hard yesterday.
The wider market responded, too. Not only did bank stocks sell off, dragging the wider market with them, but the two-year Treasury yield fell sharply and the dollar index weakened. All of this suggests that the market is pricing in some possibility that the cockroaches signal a wider problem, either in the financial system or the economy — a problem the Federal Reserve might have to respond to by cutting rates faster than expected (The jitters may not all be down to credit bugs, we should note. On Thursday a bank, or banks, tapped the Fed’s standing repo facility for the second day in a row, a rare-ish occurrence suggesting illiquidity in the money markets, which could have added to the nervy atmosphere).
A financial pundit who predicts that a systemic crisis is not imminent is a special sort of masochist. If you get it wrong, it’s the kind of mistake people remember, whereas dire prognostications are forgotten the instant they are falsified. But we try to follow the evidence at Unhedged and, so far, the evidence suggests that the recent crack-ups are more or less idiosyncratic casualties of a hot credit market, rather than symptoms of a deeper systemic or economic issue. To extend the entomological metaphor: there will be more cockroach sightings, but termites don’t appear to have chewed through the foundation.
And Bloomberg again on October 18, says approximately the same:
By Friday morning, however, investors took comfort from the fact that no major new concerns were raised in the third-quarter earnings reports released by several regional banks, including Fifth Third, which posted a provision that was smaller than analysts expected.
Shares of Fifth Third gained 2.6% in early New York trading. Zions advanced 0.7% and Western Alliance was up 1.5%.
And there were other signs that industry executives believe the problem might be contained: the level of money the biggest banks set aside in the third quarter to cover what they think their future bad-loan totals might look like.
While JPMorgan boosted its provision to $3.4 billion, its five closest rivals were collectively setting aside the least in two years. One of them, Morgan Stanley, added nothing at all.
Do I agree? Nope.
For one thing I have learned not to second-guess the omniscience and teflon qualities of Jamie Dimon. I also think that the behavior of the big banks is odd.
Via Pranav Ghai, CEO of Calcbench on LinkedIn:
My comment:
Ghai provided more info on JPM’s results to, perhaps, explain its behavior:
So, what’s going on?
JP Morgan can afford to save for a potentially rainy day. The increase in reserves did not damage its results. JPM knew it had plenty of room to build a cushion. On the other hand, WFC may not, and instead used its reserves to boost results. JPM is playing offense, trying to make others afraid when it may instead have incredible visibility on the whole landscape.
© Francine McKenna, The Digging Company LLC, 2025