From Diligence to Recovery: Managing Risk in Private Credit

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The continued expansion of private credit has become one of the fastest-growing segments in global finance, delivering impressive yields. But recent events have exposed its fragility. Two high-profile lending cases have forced many to confront a difficult truth: even sophisticated lenders can be blindsided when collateral integrity fails.

In one case, loans to telecom firms were allegedly backed by fabricated receivables that were later revealed to have been double-pledged to multiple lenders. The estimated exposure exceeded half a billion dollars and sparked a wave of lawsuits questioning how collateral was verified. In another, a major auto-parts borrower reportedly included overstated inventory and receivables, leading to sudden covenant breaches and steep write-downs among direct lenders and fund investors.

Both cases share a common thread: borrowers seemingly misrepresented the assets securing their loans and lenders lacked the independent visibility needed to detect it early. It’s easy to say in hindsight that stronger verification, clearer data and independent oversight might have mitigated the risks. The real challenge for today’s lenders is to build those safeguards into their process before the next default makes headlines.

Effective Risk Management in Private Credit

In private credit, the most impactful risk management begins long before capital is deployed. Lenders typically define risk across two dimensions: market risk, which reflects changes in interest rates, valuations or liquidity conditions, and credit risk, which relates to the borrower’s ability and willingness to meet obligations. It is within this latter category that many of the recent failures have occurred.

The market’s rapid growth and competitive dynamics have, in some cases, encouraged lenders to prioritize speed over scrutiny. Yet, as recent cases show, when verification and independent oversight are insufficient, even well-structured transactions can unravel quickly.

To better manage credit exposure and strengthen resilience, lenders should increase their focus on two areas that define the integrity of any credit process: counterparty due diligence and collateral confirmation and protection.

Counterparty Due Diligence

Knowing the borrower, not just their balance sheet but their governance, integrity and internal controls, is essential. A thoughtful review should begin with a clear picture of ownership, reputation and regulatory standing:

• Governance and ownership reviews: Map corporate hierarchies, identify beneficial owners and uncover undisclosed related-party entities or offshore structures.
• Background and integrity checks: Analyze management and sponsor history including litigation, bankruptcies, liens, regulatory actions and adverse media.
• Regulatory and sanctions screening: Search international watchlists, politically exposed person (PEP) databases and cross-border compliance sources.
• Financial statement and cash-flow integrity testing: Reconcile reported performance with independent third-party data or direct counterparty confirmations.
• Identity and contact verification: Validate company domains, email addresses and digital presence to detect impersonation or synthetic entities.
• Comprehensive know your customer (KYC) procedures: Verify legal existence, registrations and compliance documentation in line with global anti-money-laundering (AML) standards.

A second layer of diligence should then focus on the borrower’s and sponsor’s internal governance and control environment, where operational weaknesses often emerge.

• Cash management and controls, including segregation of duties, authorization processes and reconciliation practices.
• Cybersecurity and technology controls, assessing how systems are protected, accessed and monitored.
• Expense and income allocations, testing the reasonableness and transparency of policies to identify potential manipulation or misstatement.
• Valuation governance, reviewing how fair value is determined, challenged and documented, particularly for illiquid or hard-to-value assets.

Together, these elements form the basis of a comprehensive understanding of counterparty risk. They allow lenders to evaluate not only a borrower’s ability to repay, but also the strength of the systems and controls that underpin that capability.

Protecting and Verifying Collateral

Where possible, collateral verification and confirmation should always be performed to ensure lenders have an independent view of the assets securing their exposure.

Publicly registered assets can be verified through:

• Searches in the Uniform Commercial Code (UCC), the U.S. system for registering lenders’ security interests in a borrower’s assets, or the Personal Property Security Act (PPSA), the system in Canada and Australasia for registering security interests in personal property, to confirm perfected security interests and identify competing liens.
• Lien-release and filing reviews to confirm the lender’s first-priority or first-lien position.
• Verification of legal representations and warranties to ensure the borrower’s valid ownership and authority to pledge the asset.

Privately held or unregistered assets can be verified through:

• Inventory and site inspections to validate existence, quantity and condition.
• Counterparty and obligor confirmations to verify the authenticity of receivables and contracts.
• Enterprise Resource Planning (ERP) or accounting system integrations to provide the visibility into pledged assets lenders need.
• Payment-flow mapping and control accounts to secure cash proceeds linked to collateral.
• Analytical and forensic testing to identify duplicate or synthetic assets through data-pattern analysis.

Beyond Verification: Contractual Protections

Lenders can and should further strengthen their position beyond diligence and collateral verification by incorporating contractual and structural controls designed to mitigate credit risk. These protections commonly include:

• Representations and warranties that provide recourse if borrower statements about collateral or operations are false.
• First-priority security interests (first-lien positions) ensuring senior recovery rights in a default or insolvency.
• Covenants and early-warning triggers requiring regular reporting so lenders can act promptly when collateral quality or liquidity deteriorates.
• Prohibitions on double pledging clarifying that pledged collateral cannot secure multiple facilities and reducing competing-claim risk.
• Insurance and preservation of assets provisions which require the borrower to insure and maintain collateral to preserve value.
• Information rights guaranteeing timely access to financial statements, operational updates and inspection rights.
• Cross-default clauses ensuring that a default under one financing arrangement triggers review or default under others, limiting exposure escalation.
• Negative pledges preventing the borrower from granting security interests to other creditors without lender consent.

Together, these layers, rigorous counterparty diligence, asset verification and enforceable protections, create a durable credit framework. They enable lenders to deploy capital confidently while guarding against the type of breakdowns recently seen in the private credit market.

Ongoing Review and Monitoring

Collateral verification and due diligence should never be treated as a “one-and-done” exercise. Borrowers evolve, markets shift and collateral values fluctuate. Periodic reviews, including regular assessments for compliance with covenants and validation of the continued existence and quality of collateral, allow lenders to spot emerging issues before they escalate.

When Things Go Wrong: The Role of Forensic Expertise

Even the most robust controls can miss a well-concealed fraud until it unravels. When that happens, decisive and independent forensic work often determines whether a situation leads to recovery or write-off.

The warning signs are often subtle: missed routine payments (especially on small obligations like utilities or insurance), sudden resignations from finance teams, unexplained auditor changes, recurring data anomalies or even behavioral shifts in borrowers. Any of these may warrant a confidential discussion with a forensic specialist — not necessarily to investigate immediately, but to assess whether further inquiry is justified.

At PKF O’Connor Davies, our forensic and valuation professionals help clients at every stage of that process. We conduct detailed accounting investigations, trace collateral and cash flows across borders, perform independent valuations for impaired portfolios and provide litigation support and expert testimony. The goal is to quantify exposure quickly and pursue recovery with the independence and rigor stakeholders expect.

The Bigger Picture

The recent high-profile incidents are not isolated: they are warning signs. As private credit continues to expand, the market must move beyond reliance on borrower-reported data and untested assumptions. Sustainable performance depends on moving beyond borrower-supplied data and developing frameworks and relationships that encourage transparency, verification and accountability.

Lenders who integrate rigorous diligence, ongoing monitoring and credible forensic support will be better equipped to navigate evolving risks and preserve investor confidence.

At PKF O’Connor Davies, we support that mission through a deep bench of experienced teams. Our operational risk and counterparty due diligence professionals, who work alongside clients both at the time of underwriting and throughout loan performance, are complemented by our dedicated forensic and valuation specialists, who assist when challenges emerge, helping quantify exposure, assess recoveries and provide objective insight. Together, these teams deliver tailored solutions that strengthen diligence, enhance monitoring and help reinforce credit discipline across the investment lifecycle.

Contact Us

If you have any questions, please contact your PKF O’Connor Davies client service team or:

Helen Rexwinkel
Director
hrexwinkel@pkfod.com | 203.705.4143

Patrick Moran, CPA
Partner
Pmoran@pkfod.com | 914.279.0276

Darryl Wegner, JD
Managing Director
dwegner@pkfod.com | 212.286.2600

Rachel DiDio, CPA
Partner
rdidio@pkfod.com | 954.947.3941