The canary in the private credit coal mine just dropped dead

Houston Cofield/Bloomberg

The recent Tricolor and First Brands bankruptcies highlight growing cracks in the credit market. Both cases reveal the dangers of complex financing arrangements, from weak due diligence and questionable collateral to opaque borrowing structures. First Brands, in particular, relied heavily on off-balance sheet financing and collateralized loan obligations, or CLOs, sourced from a fragmented group of lenders. The lack of transparency is striking.

While the full extent of institutional and fund exposure is still emerging, the bigger implication is the risk this poses to the banking system. Although banks improved their risk management in the years since the 2008 financial crisis — especially in consumer and commercial lending — their growing involvement with nonbank financial intermediaries has led them into unfamiliar terrain.

The scale of bank exposure to nondepository financial institutions, or NDFIs, is no longer marginal. In 2025, U.S. bank lending to NDFIs reached an all-time high of approximately $1.7 trillion, representing about 13% of overall bank loans and accounting for all the lending growth this year, according to Federal Reserve data.

The borrowers tend to have strong credit profiles and direct access to capital markets while the loans are often collateralized and do not directly expose banks to heightened capital requirements. This makes them seemingly low risk and provides an attractive path to gain indirect exposure to private credit without triggering the same capital requirements or regulatory scrutiny.

But this perception masks deeper vulnerabilities. As more credit formation migrates to unregulated corners of finance, the traditional safeguards of the banking system are losing their effectiveness. The risks may not lie in individual loans, but in the system-wide opacity that comes with shadow lending.

Three structural issues deserve immediate attention. First is the lack of transparency. While many of these loans generate returns outside of the banking system, banks still face residual risk. The valuation of these underlying assets is difficult to ascertain as they feature complex structures and nonstandard documentation, with some not valued mark-to-market except on a quarterly basis.

Second is significant wrong-way risk. Funds that borrow from banks often hold a range of risky assets. In a downturn, the value of those assets declines as borrowers begin drawing on credit lines. From a bank's perspective, the value of the collateral is declining just as the exposure to the borrower is increasing — at exactly the wrong moment. The lack of transparency creates the risk of double exposure and makes it difficult to assess the direct or indirect exposure or concentrations to a segment or a borrower, masking the true level of risk.

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Third is the regulatory blind spot that exists as shadow lenders operate in gray zones, often outside banking regulators' oversight. Although regulation has built a protective moat around the banking industry, it has also pushed more lending activity beyond it. The illusion of containment may lull banks into complacency, just as risk builds outside their view.

It is worth noting that much of the lending to NDFIs has taken place amid economic tailwinds, which could have broader implications in a downturn. JPMorganChase's CEO Jamie Dimon recently observed, "We've had a credit bull market now for the better part of what, since 2010 or 2012? … If we ever have a downturn, you are going to see quite a bit more credit issues."

The parallels to the run-up to the global financial crisis are hard to ignore. Back then, AAA-rated tranches of mortgage-backed securities masked the toxic loans beneath. Today, structured loans to shadow entities could play a similar role. When risk is mispriced and obscured by complexity, the fallout can be fast and far-reaching.

The system has so far largely absorbed the immediate impact of the First Brands and Tricolor failures. But that should not breed false comfort. Banks cannot afford to wait for the regulators to intervene — especially when some, like European Central Bank President Christine Lagarde, have called for leveling the playing field by imposing regulations on credit funds and other "darker corners" of finance.

Banks must take independent steps to protect themselves, starting with stronger credit risk protocols. That means demanding greater transparency and disclosure from nonbanking financial institutions, requiring independent and more frequent asset valuations, enforcing tighter loan covenants and liquidity protections, and applying more conservative loan-to-value ratios.

Primary and secondary monitoring of credit risk and sector drivers that impact NDFI lending and CLOs is critical. Risk teams should develop specific metrics for tracking leveraged loans, CLO exposures and large sector concentrations. They also need to establish stronger governance mechanisms, including enhanced second-line oversight and aligning incentives with loan performance rather than origination. Banks should treat indirect lending to shadow banks as a high-risk activity that demands active oversight, enabling them to manage these risks more effectively.

The real threat is not investor losses — it is both systemic and idiosyncratic exposure. If banks ignore these signals, today's canary could become tomorrow's crisis, with banks at the center of it.