Overview
Recent reporting has spotlighted growing stress in private credit markets. While this may seem to affect primarily money center banks, any bank that has extended warehouse lines of credit to non-bank lenders could be affected by deterioration in these markets. Banks may have more exposure than anticipated — and now is the right time to review that exposure and manage credit risk.
What Is Private Credit and Why Is It Struggling?
Private credit refers to loans made by investment funds, rather than traditional banks, directly to businesses, often smaller or mid-sized companies that can't access public bond markets or the traditional leverage loan market. The private credit industry grew rapidly in the last decade primarily because post-2008 banking regulations made it harder for traditional banks to serve these borrowers, and a decade of low interest rates pushed investors to seek higher yields. Private credit funds filled both needs. Many banks supported this growth by providing warehouse lines of credit to private credit funds—essentially short-term funding these lenders use to make loans before selling them in secondary markets.
As interest rates rise, many borrowers of these funds are struggling to make payments. Some funds are quietly extending payment due dates or deferring interest rather than recognizing losses — meaning the credit lines backing these funds may not be as solid as they appear, and that risk can flow back to the bank.
Why Warehouse Lines of Credit Are in the Crosshairs
Banks that have extended warehouse lines should be aware of the following risks:
- Collateral value may decline: A warehouse line is secured by loans that the non-bank lender is making. If those loans are deteriorating, the collateral protecting the bank's advance may be worth less than it appears.
- The borrower may not be able to repay: If the non-bank lender hits a funding wall — meaning it can't sell or refinance the loans it has made — it may not be able to pay down the warehouse line, leaving the bank with a drawn, illiquid credit.
- Loan agreements may have gaps: Many warehouse agreements were written during a more optimistic economic environment. The covenants and safeguards in those contracts may not be strong enough to protect the bank in a changed economic scenario.
Recommended Actions for Banks
Banks should prioritize the following steps:
- Conduct a full inventory of warehouse line exposure: Identify all existing warehouse and credit facilities extended to non-bank lenders, fintech originators, or private credit-adjacent entities. Quantify outstanding balances, advance rates, and collateral types.
- Stress-test underlying collateral pools: Request updated borrowing base certificates and conduct independent collateral reviews. Do not rely solely on sponsor-provided marks for private credit collateral.
- Review loan documents and covenant structures: It is a good practice to periodically revisit the underlying legal agreements governing warehouse lines — including covenant packages, borrowing base provisions and reporting requirements — to confirm that they remain current and provide adequate protection. If it has been a while since these documents were reviewed, now is a reasonable time to do so.
- Engage proactively with regulators: Anticipate examiner scrutiny of non-bank and private credit exposures. Banks should prepare clear documentation of their risk management framework, credit approval rationale, and ongoing monitoring protocols.
This is not necessarily a crisis, but it is a moment to engage in meaningful risk management. Banks are encouraged to place this item on the agenda at the next ALCO or Board Risk Committee meeting.
We have extensive experience advising banks on credit risk, loan documentation, and regulatory compliance. Our attorneys have deep familiarity with the structure of warehouse lending arrangements and the legal frameworks that govern them, giving us the ability to quickly identify gaps in existing agreements and recommend practical steps to strengthen a bank's position. If you have questions about your institution's warehouse line exposure or would like assistance reviewing your loan agreements and covenant structures, our team is available to help.
