Goldman Sachs‘s trading desk issued a warning to clients this morning, placing regional banks on NDFI credit watch. What caught my attention about this development is how it exposes a growing vulnerability in the banking system that many investors haven’t fully appreciated.
NDFI stands for non-depository financial institutions, and this term is about to become part of everyday financial vocabulary. The pattern emerging here is significant: TriColor, First Brands, and now the situations involving Zions and Western Alliance all share this common thread.
The Scale of NDFI Exposure
Looking at the numbers reveals just how substantial this market has become. NDFI loans currently total approximately $1.2 trillion out of $13 trillion in total loans among all FDIC institutions nationwide, according to data from Janney and the FDIC. That’s nearly 10% of the entire regulated banking system’s loan portfolio tied to non-depository financial institutions.
What makes this particularly noteworthy is the regulatory timeline. About a year ago, banking regulators required institutions to separate these loans in their reporting from other credit categories. That regulatory change wasn’t arbitrary—it drew attention to the rapid growth and interconnectivity developing in this space.
Understanding the Private Credit Connection
The rise in NDFI lending stems from nonregulated private lenders gaining significant ground in the credit markets. Private credit firms and business development companies (BDCs) have been securing credit lines from FDIC-regulated banks, creating a web of interconnections between the regulated banking system and the largely unregulated private credit markets.
This is more nuanced than it first appears. When private credit firms borrow from traditional banks, they’re essentially using regulated institution capital to fund their own lending operations. The regulated banks get diversification and yield, but they also inherit exposure to whatever risks those private lenders are taking.
The Interconnectivity Problem
What stands out in the current situation is how separate incidents are revealing systemic connections. The TriColor and First Brands bankruptcies operated independently from the Zions borrower situation. Yet the timing raises critical questions about how deeply interconnected the regional banking system has become with private markets.
The way I interpret these developments: we’re seeing stress tests in real-time. When multiple NDFI-related situations surface simultaneously, it suggests potential broader vulnerability rather than isolated incidents.
The Fraud Factor Complicates Everything
Beyond interconnectivity concerns, fraud allegations are emerging across multiple cases. Zions has filed suit alleging its borrower engaged in fraudulent activity. Lenders made similar fraud allegations at TriColor. Yesterday, Jefferies CEO Rich Handler told investors that First Brands defrauded them as well.
This pattern of fraud claims adds another layer of concern. The data suggests these aren’t just business failures or credit misjudgments—potential intentional misconduct may be involved. For regional banks with NDFI exposure, this raises uncomfortable questions about due diligence and oversight when extending credit lines to private lenders.
What This Means for Regional Banks
Regional banks face particularly acute pressure here. They’ve been competing aggressively for yield in a challenging rate environment, and NDFI lending offered attractive returns. But that yield came with risk that’s now materializing.
Goldman Sachs putting regional banks on NDFI credit watch signals growing concern among major financial institutions about contagion potential. When one of Wall Street’s most sophisticated trading desks issues warnings about credit exposure, markets typically pay attention.
The critical factor to understand: regional banks operate with different capital buffers and risk management capabilities than money center banks. NDFI exposure as a percentage of total capital could be materially higher for some regional institutions, creating outsized vulnerability.
The Regulatory Microscope Intensifies
What becomes clear from the regulatory requirement to separate NDFI reporting is that supervisors saw this risk building. By forcing disclosure, regulators created transparency around an exposure category that was previously buried in broader loan classifications.
Now that transparency is revealing concentrations that make both regulators and investors uncomfortable. The interconnectivity between regulated banks and unregulated private credit markets creates potential channels for stress to spread quickly across the financial system.
What to Watch Next
The key question going forward centers on how extensive NDFI problems might become. Are these isolated situations involving specific problematic borrowers, or early indicators of broader stress in the private credit market that will ripple through regional banking?
Investors should monitor quarterly earnings calls closely. Regional banks with significant NDFI exposure will face pointed questions about their credit quality, underwriting standards, and fraud detection capabilities. How management teams respond will signal whether they view current situations as contained or systemic.
The Goldman Sachs credit watch also matters as a market sentiment indicator. If more major financial institutions begin flagging regional bank NDFI exposure as concerning, we could see funding costs rise for affected banks and potential pressure on their stock valuations.
The banking system’s connection to private credit markets has grown rapidly while flying somewhat under the radar. That dynamic is changing fast, and the spotlight on NDFI lending will likely intensify before any resolution emerges.