A massive reclassification of bank loans mandated by federal regulators in 2024 has revealed a $1.5 trillion exposure that may represent one of the financial system’s most significant hidden risks, according to a veteran distressed debt investor who tracks regulatory developments.
Bill Bymel, founder and CEO of First Lien Capital, says the Federal Reserve’s requirement that banks reclassify certain loans from Commercial and Industrial (C&I) to non-depository financial institution (NDFI) categories has exposed a troubling two-tier lending system that few market participants fully understand.
Federal regulators in 2024 required banks to reclassify a large set of loans previously labeled as Commercial and Industrial (C&I). According to Bymel, these loans were in fact made to private lending institutions rather than end borrowers, representing roughly $1.5 trillion in exposure.
The Structure of the Hidden Risk
According to Bymel, these NDFI loans represent a fundamental shift in how risk flows through the financial system. Rather than banks lending directly to end borrowers, they’re increasingly lending to other financial institutions that then make loans to consumers and businesses.
Bymel says banks have been extending credit to other lenders they view as secure, even though these institutions often apply looser underwriting standards and then lend into markets traditional banks avoid. This creates what he sees as a major disconnect between how banks classify the risk and the actual quality of the underlying loans. He warns that much of this debt ends up with borrowers who fall below the standards banks would normally accept.
The types of institutions receiving these loans include “non bank lenders, folks that lend that act as lenders in other markets, merchant bank lenders, auto lenders, prime or subprime real estate private lenders,” according to Bymel.
The Opacity Problem
One of Bymel’s primary concerns about NDFI loans is their lack of transparency. Unlike traditional bank lending where regulators can examine the underlying borrowers and collateral, these loans create multiple layers of intermediation that obscure the true risk.
Bymel warns that NDFI loans remain largely opaque, yet banks still label them as “good credit” and keep them on their books as performing assets — even though the end borrowers are often far riskier than typical bank clients.
While regulators required banks to reclassify these loans in 2024, signaling concern about their opacity, Bymel argues the change does little to fix the underlying problem. Banks continue to treat this debt as high-quality, he says, even though it ultimately flows to lenders operating with standards far below what banks would normally accept.
Real Estate Market Implications
Bymel’s concerns about NDFI loans are particularly acute in the real estate sector, where private lending has grown significantly in recent years. Many real estate developers and investors who cannot qualify for traditional bank financing have turned to private lenders, who in turn may be funded by bank NDFI loans.
“We’re seeing a lot of concern around that right now, and especially when it comes to coming back to the world of where I am, which is in real estate,” Bymel says. This creates a situation where banks have indirect exposure to real estate risks that they might not accept as direct lenders.
The structure also means that when real estate markets experience stress, the impact may flow back to banks through their NDFI loan portfolios in ways that are difficult to predict or measure. “We’re seeing more and more of this stuff surface daily and weekly,” Bymel observes, referring to problems in private credit markets.
Market Structure and Secondary Trading
According to Bymel, the NDFI loan market operates largely outside traditional banking channels, with significant secondary market trading that lacks transparency. “Finding somebody that has connections in the secondary market, directly to banks or private equity, is a key component, because the best deals kind of get traded off market. Nobody ever hears about them,” he explains.
This off-market trading means that pricing and risk assessment for NDFI loans may not reflect the same market discipline that applies to publicly traded securities or traditional bank loans. The lack of price discovery could mean that risks are building without being properly recognized by regulators or market participants.
Regulatory Response and Future Outlook
The 2024 reclassification requirement represents an acknowledgment by federal regulators that the previous categorization of these loans was inadequate. However, Bymel suggests that more fundamental changes may be needed to address the systemic risks.
His firm, First Lien Capital, positions itself to benefit from potential disruptions in this market by maintaining relationships with banks and private equity firms that may need to sell distressed NDFI loans. “The best deals kind of get traded off market,” he notes, suggesting that opportunities will emerge for investors who understand the market structure.
Whether the $1.5 trillion in reclassified loans represents a manageable risk or a systemic threat may depend on how the underlying private lending markets perform in the coming years, particularly as interest rates and economic conditions continue to evolve.
