Bank stocks rebounded on Friday. Zions up over 6%; Jefferies up over 5%; Western Alliance up over 3%; BAC up 1%.

Investors grew uneasy about risk in the sector, which has been shaken by exposure to two auto bankruptcies.

Zions sank 13% on Thursday after disclosing it would take a $50 million loss in the third quarter on two commercial and industrial loans from its California division. Western Alliance's stock slumped almost 11% after the bank separately disclosed it had initiated a lawsuit alleging fraud by Cantor Group V, LLC.

Investment bank Jefferies Financial Group Inc., which held an investor day on Thursday, plunged 11%. The firm has disclosed exposure to bankrupt auto parts maker First Brands, and its stock has fallen by more than one-fifth since First Brands' bankruptcy announcement.

"It shows you can't take credit quality for granted, and poor performing credit quality at one bank can drag down the group quite fast," said Stephen Biggar, a banking analyst at Argus Research.

JEFFERIES LEFT 'QUESTIONS UNANSWERED'

Jefferies' investor day was closed to the press. Morgan Stanley analyst Ryan Kenny said in a note that Jefferies' investor day was positive on the core business, "but left some questions unanswered on what exactly went wrong with First Brands and whether or not JEF could have mitigated risk in advance."

Jefferies did not respond to a Reuters request for comment. Zions did not respond to a request for comment.

"It appears that investors are electing to sell first and ask questions later regarding Jefferies, a selloff that soon threatens to be overdone," said Sean Dunlop, bank analyst at Morningstar Research, in a note

The situations shook the broader market, with the KBW Regional Banking Index dropping 5.8% and the S&P 500 losing nearly 1%.

Wall Street analysts drew parallels from 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.

"When you see one cockroach, there are probably more, and so everyone should be forewarned," Dimon said.

The banks' selloff comes more than two years after Silicon Valley Bank's 2023 failure, when high interest rates drove paper losses on its bonds, sparking a fatal deposit run that felled Signature Bank days later.

FIRST BRANDS, TRICOLOR PUT SPOTLIGHT ON RISK CONTROLS

The bankruptcies of First Brands and Tricolor 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.

Zions said it expects to recognize the charges in the third quarter and has filed a lawsuit in California to recover the loans.

Western's disclosure said it had alleged the defendants breached a business loan and security agreement by forging title policies related to the lien - a legal claim - on properties underlying several loans.

The August court filing showed Cantor was a company that did business in California's Los Angeles County.

Western will provide context about its diversified business model and "strong credit structures" when it announces quarterly results on October 21, the bank said in an email.

Attorneys for Cantor denied the allegations made by Western Alliance.

"These claims are unfounded and misrepresent the facts. We are confident that once all the evidence is presented, our clients will be fully vindicated," Brandon Tran, senior counsel at Dhillon Law Group, said in an email.

Western has sought to reassure investors, saying its total criticized assets — credit identified as weak — were lower than on June 30.

Some analysts still see the collapses as idiosyncratic and tied to individual borrowers, rather than systemic. But the cases are fueling unease.

"In times of loose credit, you are going to have more instances of fraud," said Mike Mayo, banking analyst at Wells Fargo. "Right now, credit in general is fine, but there's a heightened need to watch the recent issues."