Banking Stress Shifts Focus to the ‘NDFI’ Lending Market. Here’s What You Need to Know

The recent troubles at two regional banks that triggered Thursday’s market sell-off may turn out to be isolated incidents but Wall Street isn’t taking any chances. Investors are now keeping a close watch for signs of broader credit risk that could ripple through the financial system.

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Stocks declined sharply on Thursday, with the Dow Jones Industrial Average dropping more than 300 points amid renewed anxiety about the health of regional banks. The SPDR S&P Regional Banking ETF (KRE) fell over 6%, while Zions Bancorporation of Utah and Western Alliance Bancorp of Arizona the two institutions at the center of the turmoil saw their shares tumble roughly 13% and 10%, respectively.

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Analysts were quick to suggest that these developments might be bank-specific rather than signs of a wider systemic issue. According to several on Wall Street, the difficulties at Zions and Western Alliance stem from a few troubled borrowers rather than the broader private credit risks flagged by recent corporate bankruptcies such as First Brands and Tricolor Holdings.

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Adding to that sentiment, Baird upgraded Zions’ stock from “neutral” to “outperform” on Friday, arguing that the sell-off was overdone. Even so, most analysts remain cautious, maintaining a consensus “hold” rating.

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But despite the reassurances, the sudden appearance of bad loans and the sharp reaction in bank stocks highlights a growing sense of unease among investors. As JPMorgan CEO Jamie Dimon colorfully put it, when you see one problem, there may be “a few more cockroaches” lurking beneath the surface.

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“I asked Jamie Dimon about these issues, and he basically said, ‘when you see one cockroach, there are probably a few more,’” noted Mike Mayo, a veteran banking analyst. “That’s what’s happening right now investors are looking around for those cockroaches.”

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The deeper concern centers on the rising exposure of traditional banks to nondepository financial institutions (NDFIs) a sector that includes mortgage lenders, insurers, and private asset managers. These entities extend credit outside the traditional banking system, often providing alternative sources of financing for borrowers.

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The issue is that NDFIs operate with far less transparency and regulatory oversight than banks, meaning their leverage levels and credit exposures are harder to gauge. That opacity raises the risk that problems within private credit markets could unexpectedly spill over into the broader financial system.

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According to Federal Reserve data, loans from U.S. commercial banks to NDFIs have surged by more than 50% year over year in 2025 the largest jump in records going back to 2016.

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“The troubling part of this story is that with NDFIs’ looser lending standards, we have to assume there’s more exposure out there than meets the eye,” wrote Peter Corey, chief market strategist at Pave Finance. “Because private credit is so opaque, a wave of concern could hit the market even before we know whether a real problem exists.”

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Corey added that dismissing Tricolor and First Brands as isolated events is becoming increasingly difficult in light of the new developments at Zions and Western Alliance. “If we continue to see more of these stories, sentiment could deteriorate further,” he warned.

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Another risk is that private credit has never been fully tested in a downturn. If economic growth slows or unemployment rises, the resilience of this fast-growing asset class could be called into question. For that reason, upcoming jobs data currently delayed due to the government shutdown—will be crucial for assessing the health of the economy and credit markets.

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Still, not everyone is sounding the alarm. Some investors see the current backdrop as fundamentally supportive for banks. Macrae Sykes, portfolio manager of the Gabelli Financial Services Opportunities ETF (GABF), pointed out that the combination of lower interest rates, improving sentiment, and a still-solid economy makes the sector appealing.

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“We think it’s a constructive environment for owning bank stocks,” Sykes said. “Of course, you have to do your homework understand management quality, underwriting discipline, and the strength of their balance sheets.”

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Sykes remains upbeat on large money-center banks such as JPMorgan and Wells Fargo, as well as select regionals like First Citizens Bank and M&T Bank, where fundamentals appear sound.

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Even with some optimism, investors can’t ignore how quickly sentiment has shifted. The recent flare-ups are a reminder that, in a market sensitive to credit quality, there’s little room for error when surprises emerge.

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“This just shows how thin the margin for error is when unexpected issues surface,” said Mike Mayo.

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In short, while the problems at Zions and Western Alliance may not point to an immediate crisis, they have reignited concerns about credit quality, private lending transparency, and systemic risk all key themes likely to dominate the market narrative as investors navigate the final months of the year.

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