Private credit's diligence problem

Two corporate collapses, eighteen days apart, did more for private credit due diligence than a decade of conference panels. Tricolor Holdings filed a Chapter 7 petition in the Northern District of Texas on September 10, 2025 — a straight liquidation, with a trustee now prosecuting adversary proceedings to claw value back. First Brands Group followed with a Chapter 11 filing in the Southern District of Texas on September 28. In both post-mortems, the questions that matter are not about credit selection at the margin. They are about verification: what the lenders actually confirmed before the money moved. For allocators evaluating private credit managers in 2026, that is the diligence problem in one sentence.

The pressure was named before the failures

None of this should read as hindsight. In April 2024, with the asset class having passed roughly $2 trillion globally, the IMF’s Global Financial Stability Report described the mechanism in plain terms: as assets under management grow and deployment pressure intensifies, supply-demand dynamics shift — “lowering underwriting standards,” compressing risk premiums, and weakening covenants. The same chapter catalogued the structural vulnerabilities underneath: borrowers smaller and more leveraged than the syndicated market carries, multiple layers of leverage, a growing share of semi-liquid vehicles, and “stale and potentially subjective valuations.”

The data since have run in the direction the IMF feared. A Federal Reserve research note published in May 2025 put committed credit lines from the largest U.S. banks to private credit vehicles at roughly $95 billion as of the fourth quarter of 2024 — up 145 percent over five years, against 14 percent growth in those banks’ credit lines to nonfinancial companies — with about 60 percent of that exposure concentrated at five U.S. G-SIBs. Leverage at publicly traded BDCs rose from roughly 40 percent to 53 percent between 2017 and 2024, outpacing other nonbanks. Capital poured in, leverage stacked on leverage, and the official sector identified the predictable casualty in advance: underwriting standards.

What September’s collapses actually tested

Neither bankruptcy is resolved, and the central factual disputes remain contested. But the failure modes visible in the court records are precisely the ones a deployment race produces.

At First Brands, the court appointed an examiner to investigate the company’s prepetition factoring and off-balance-sheet inventory financing. Trade press coverage describes roughly $6.1 billion of on-balance-sheet debt alongside approximately $2.3 billion in off-balance-sheet factoring obligations that creditors say they cannot locate, a further $800 million in supply-chain finance, and creditor allegations that the same receivables and inventory were financed more than once. The examiner’s first interim report was filed under seal on April 17; a redacted version reached the public docket on April 27. Interim, because the report itself records the investigation as paused, with significant work remaining, once the court-approved budget was exhausted. Its findings are not characterized here — but the questions the examiner was commissioned to answer are themselves the lesson. Whether a receivable was sold once or twice, and whether a “true sale” holds up, are questions of U.S. state-law doctrine now being litigated, not settled facts.

Tricolor’s Chapter 7 — a liquidation from the outset, with recovery running through trustee litigation — is the other face of the same problem. By the time verification fails, what remains is not a workout; it is an adversary proceeding.

Strip the names away and four diligence failure modes remain: collateral never independently confirmed to exist; off-balance-sheet financing no single lender could see in full; underwriting built on borrower-furnished data; and speed prioritized over verification while committed capital waited to be deployed.

The regulatory backstop is thinner than assumed

Allocators sometimes treat regulation as a floor under manager discipline. For U.S. private funds, much of that floor was removed in June 2024, when the Fifth Circuit vacated the SEC’s Private Fund Advisers Rules in their entirety. The mandated quarterly statements on fees, expenses, and performance; the audit requirement; the fairness or valuation opinion for adviser-led secondaries — none of these is an entitlement any longer. For an SEC-registered private credit manager, each is now a bilateral negotiation. Offshore vehicles are a separate matter: Cayman-registered funds carry their own local audit obligations that the U.S. ruling does not touch.

Nor can allocators assume supervisors see what they cannot. The Federal Reserve note cited above is candid that regulatory data make it difficult even to identify banks’ private credit exposures. The SEC’s examination priorities for fiscal 2026, published in November 2025, keep private credit on the examination map for a second consecutive year — but the standalone private funds section of prior years is gone, its territory folded into broader fiduciary themes. The document names alternative investments such as private credit and private funds with extended lock-ups; advisers running private funds alongside separately managed accounts, examined for favoritism in allocations; advisers new to private funds, examined for liquidity, valuation, fees, disclosures, and differential treatment of investors, including side letters; and, throughout, retail exposure to illiquid products. That list is worth borrowing. But an examination program is a sampling exercise, and its newest emphasis is the retail investor arriving at private markets, not the institutional allocator already in them. The diligence load rests where it always did.

What to pressure-test in a private credit manager

The court records and the examination priorities together yield a concrete agenda.

Collateral verification, in practice. Not the policy — the practice. Who confirms that pledged receivables and inventory exist? Are lien searches and borrowing-base audits performed independently, or accepted from the borrower? How would this manager detect the same collateral financed twice?

The off-balance-sheet map. Ask the manager to demonstrate how it sizes a borrower’s full obligations — factoring, supply-chain finance, and other financing that never reaches the balance sheet — before underwriting against the visible ones.

Deployment discipline. Pace of deployment against team capacity; covenant terms in recent vintages versus older ones; deals declined. A manager who cannot produce evidence of transactions walked away from during the fundraising cycle has answered the volume-pressure question already.

Leverage at every layer. Fund-level facilities, vehicle borrowing, and the borrower’s own debt compound one another. The BDC trend — roughly 40 to 53 percent in seven years — is the benchmark for that conversation.

Reporting as contract. Because quarterly fee and performance statements, audits, and secondaries fairness opinions are no longer mandated for U.S. advisers, they belong in the documents: negotiated, defined, enforceable. Valuation policy and the handling of stressed marks deserve the same contractual treatment — and so do side letters and any differential treatment among investors, both named in the fiscal 2026 examination themes.

Underwriting the underwriter

The IMF named the mechanism in 2024. The Federal Reserve measured the buildup in 2025. The bankruptcy courts in Texas are now producing the case studies. The consistent thread: in private credit, the allocator is underwriting the manager’s verification habits — and under volume pressure, verification is the first discipline to erode quietly and the last to be disclosed voluntarily. The managers worth backing can demonstrate that theirs withstood the race.

SetOne Labs pressure-tests private credit managers’ underwriting and verification practices the way the court records suggest they should be tested. To discuss a manager review in confidence, begin a conversation.

SetOne Labs provides advisory services and general information. Nothing here is legal, tax, or investment advice.