MW There has been some bad news in credit. Investors can learn to live with the 'cockroaches.'

By Hardika Singh and Max Motz

The Federal Reserve's Financial Stability report is expected to be released Friday, which could shed light on some of that credit opacity and put Wall Street at ease

Investors are spotting credit "cockroaches" in the financial system, sparking worries about a broader infestation.

But you don't burn the house down just because you spot a few cockroaches - even at those as big as BlackRock-owned HPS Investment Partners. You avoid leaving crumbs, clean up more frequently, and at worst, call the pest control, so you can go on about your life.

In that same way, investors need to remind themselves that the recent bad news from the credit industry is an idiosyncratic issue rather than an early sign of a catastrophe that could throw an already flailing economy into a downturn. When opaque corners of the market make headlines, they invoke painful memories of the exotic financial instruments that contributed to the 2007-09 recession.

The Federal Reserve's Financial Stability report, expected to be released Friday, could shed light on some of that opacity and put Wall Street at ease. But for now, plenty of market signals suggest that it's OK for investors to live in a home where there are cockroaches in the walls - as icky as it feels.

For instance, third-quarter earnings from the S&P 500's financial sector knocked it out of the park. It has the highest percentage of companies expanding margins out of the 11 segments from a year ago.

What's even better is that the financial sector has the third-largest number of companies posting positive guidance for the third quarter. That could bode good news for the sector's future share-price performance, which has been in the doldrums since auto dealer Tricolor's bankruptcy on Sept. 10 first made investors wary this year.

The sector has inched down 1.3% over that period, lagging behind the S&P 500's SPX 4.3% gain. The declines were made worse by news of alleged loan fraud at smaller banks from Zions Bancorp $(ZION)$ to Western Alliance Bancorp $(WAL)$ in October, further hitting sentiment. Both of them are trying to recover millions of dollars from the same entity.

Of course, that's not enough proof that their troubles are unique to them. That's why investors should look at median net charge-offs as a percentage of average total loans. The measure refers to loans that are unlikely to be paid back, and their proportion with respect to the broader loans made.

In the third quarter, that measure was at 0.04% for the 50 banks in the KBW Regional Banking index. At the height of the financial crisis, it hit 0.31%, so only a very small percentage of loans are currently going bad.

Looking at more discretionary measures of loan health, banks also forecast what they expect in terms of loan losses and set aside an amount in advance of loans not being paid back. While there's no guarantee that the numbers they estimate end up being right, it can still be helpful to understand how banks are perceiving the health of current borrowers.

The median provision for loan losses has moved up in recent years as credit conditions have tightened. But data for the second quarter shows that it remains 62% off its pandemic-driven 2020 recent high and 80% away from its financial crisis-caused 2009 peak, meaning that banks don't expect they've made too many bad loans.

It's a similar picture when you look at smaller banks, too, with provisions for loan losses growing in the past few years, but far from hitting concerning levels. Smaller banks don't have as much capital and as many revenue streams as the bigger players, so they tend to get hit first during crunch times.

So the recent woes of the sector are just a knee-jerk reaction to seeing a handful of cockroaches lurking around in the home.

But at least on the bright side, that urge to crush the critters has made the S&P 500's financial sector look attractive from a valuations standpoint. Stocks in it are trading at 15.9 times forward earnings, the second cheapest out of the index's 11 sectors. The broader index is trading at a 22.9 multiple.

Risks are everywhere, like Fed governor Lisa Cook said Monday, but if investors lift the hood, they'll realize the outlook for the financial sector and the broader economy remains sound.

"[Risks are] under every rock and the rocks we haven't gotten to yet," Cook said at a Brookings Institution event. "The history of financial stability concerns is that the last episode is not going to predict the next episode, so you have to be attentive to everything."

Hardika Singh is an economic strategist at Fundstrat Global Advisors, an investment research firm. You can read her disclosures here. Max Motz is a macro research associate at Fundstrat. You can read his disclosures here.

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November 06, 2025 11:57 ET (16:57 GMT)

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