Distress, defaults, and ESG in private credit

When portfolio companies begin to struggle, financial metrics rarely tell the whole story. Operational challenges, workforce issues, environmental liabilities, and governance concerns can all affect how successfully a business navigates a period of distress. As private credit managers become increasingly involved in helping companies stabilize and recover, these factors are playing a larger role in investment and restructuring decisions.

Private credit market conditions

The North American private credit market has spent recent months under a microscope as default fears rise and liquidity concerns ripple across major funds. From peak unease in Spring 2026, expert sentiments have continued to swing between doomsday scenarios and less punishing outlooks. Such choppiness has even prompted a rise in distressed and opportunistic strategies, which may carry well into 2027.

At the height of this turbulence, we saw headlines featuring high-profile borrower failures in late 2025, most notably the bankruptcies of First Brands Group and Tricolor [1, 2], the news of which perhaps played a role in private credit default projections reaching as high as 15% in early 2026 [3]. Macro uncertainties subsequently prompted major private credit managers to enforce withdrawal caps or temporary liquidity freezes as investors sought to pull out capital [4, 5, 6]. Recent fund downgrades, such as those of Future Standard and KKR, further exacerbated fears of instability in the asset class. Notably, in March 2026, Blackstone’s BCRED reported its first monthly loss in over three years [7].

Though none of these developments constitute crisis conditions on their own, together they reflect growing pressure on fund liquidity, valuation stability, asset management, and underwriting assumptions across the ecosystem. While there is debate on the stability of the asset class heading into 2027, there is relative consensus that private credit’s “renaissance” of recent years is unlikely to return in the short term. 

As such, managers are closely considering their strategic position within this “new normal.”

A deeper look - What is driving today’s distress environment?

• High-profile bankruptcies raising asset class-level questions: The failures of First Brands Group and Tricolor – attributed to opaque financing structures, severe allegations of fraud, and double-pledging collateral – pointed to deeper issues in how governance, reporting, and financial controls are managed at scale. These cases highlighted how weaknesses in management systems can remain undetected, especially when credit markets were flush, and capital was cheap. This has prompted managers to revisit underwriting approaches and re-instill fundamentals that were arguably less rigorous in recent years.
  
• Macro-economic pressures stoking investor concerns: Many of the loans made in the 2020-2022 vintages – a time characterized by loans with “excessive leverage, bad covenants, and rock bottom rates” – have continued to stoke concerns among investors [8]. As these exposures season, investors are increasingly attuned to the likelihood that underwriting optimism from that period may unwind more sharply than previously expected.
  
• Software’s outsized presence in private credit: Per the S&P, software and technology borrowers account for ~25% of the private credit market; concerns will continue to mount about both short– and long-term valuations of such investments as AI continues to reshape the software industry [9, 10]. This concentration risk is prompting many GPs to reconsider their software portfolios with fresh eyes, while navigating closer scrutiny from LPs seeking visibility into indirect AI‑related exposure.

What could this mean for private credit managers?

Pre-close underwriting prudence

As lenders carve a path forward in this environment, their expectations may begin to shift. For example, it is possible that underwriting once again becomes more conservative or fundamentals-driven – rather than relationship-driven – with a reinvigorated focus in investment committee conversations on downside protection and risk management.

Loan-to-own

Among existing loans, these macro challenges may prompt an uptick in covenant breaches within credit agreements, in some cases pushing lenders into equity positions with increased influence and control (i.e., board seats) over their investments. While lenders with experience in distressed environments may be well-poised for this shift, other lenders may find themselves in a unique position, contending with operational complexities outside their typical remit. This creates a bifurcation, where, for some, distress can be a welcome opportunity, and for others it is a sunk cost to sell at pennies on the dollar.

The ESG dimension

Though mismanagement of environmental, social, and sustainability governance factors are rarely the primary reason for a company’s financial distress, the turnaround and restructuring processes that follow will inevitably require key ESG decisions that will play an important role in a recovery. In a turnaround, where a business is in its most vulnerable state, any material missteps in these ESG decisions can derail a management team’s efforts to induce a positive inflection point. For example, where cost cuts become necessary, it is important to consider the ESG implications thereof; failures to address these implications can lead to steep legal, reputational, and/or social costs that could require significant time and resources to correct and manage, thereby distracting management teams from other organizational priorities.

It is for this reason in loan-to-own dynamics that a lender-turned-owner would be well-served to consider key ESG risks and opportunities that bear weight on a portfolio company’s future.

Many examples of commercially material ESG decisions will organically emerge within the “triage” process of a turnaround, both across cost-cutting measures and in driving topline growth:

As previously noted, ESG issues are rarely the primary driver of a company’s financial distress; however, it would be prudent to consider cases in which ineffective ESG management pushes a business towards bankruptcy. In the case of First Brands Group, for example, its collapse was rooted in allegations of rampant financial fraud, governance failures, and billions in misrepresented debt. Beyond cases of fraud or criminal activity, any company’s inability to manage its “E”, “S”, or “G” postures across any of the below topics can suffer commercial repercussions that can lead it to a position of distress:

• Bribery and corruption
• Ethics and compliance
• Data privacy and security
• Environmental management
• Social and labor conditions
• Worker health and safety
• Product safety
• Sustainable branding
• Supply chain management
• And more…

It is therefore in lenders' interest to closely consider these risks, ideally in a pre-close diligence capacity, to identify and analyze the areas where such repercussions are most likely to occur.

How SLR supports private credit managers in today’s environment

SLR’s role in supporting distressed credit opportunities is grounded in pragmatism. ESG is rarely the first consideration when a lender is stepping in to stabilize a business. What matters is mission-critical intervention, applied selectively and with an operator’s mindset, rather than as a standalone compliance exercise. In this context, ESG becomes a practical risk-management and value-restoration tool that supports broader restructuring objectives. This is accomplished by blending the expertise of SLR’s dedicated private credit, private equity, and portfolio operations practices.

SLR’s support typically includes the following:

1. Thoughtful Pre-Close ESG Diligence
   As lenders apply more rigorous underwriting standards, SLR conducts targeted ESG diligence across governance, data security, operations, workforce, supply chain risk, and more. This work is designed to identify material ESG risk exposures that could accelerate distress, impair recoveries, or meaningfully complicate a restructuring, allowing lenders to price risk appropriately and plan for post‑close intervention where necessary.
2. Post-Close, Operator-Style Engagement
   In distressed situations, SLR can be engaged post–close to support transition planning and provide practical, execution–oriented analysis tailored to the realities of operating under financial stress. Drawing on extensive experience working directly with private equity sponsors and portfolio company management teams, SLR helps lenders prioritize ESG actions that stabilize operations, mitigate near–term legal or operational risk, and support the long–term viability of the business. Our work is designed to add value in those early months, even when time, resources, and management attention are constrained.
3. Supporting LP Reporting and Transparency
   As market volatility persists, LPs are placing greater emphasis on transparency and risk oversight. Common questions include:
   • How are industries within a GP’s portfolio facing elevated distress risk?
   • How actively are lenders engaging with borrowers during periods of stress?
   • What steps are being taken to manage ESG risks that could impact recoveries?

Stronger ESG underwriting and ongoing monitoring enable GPs to respond to these inquiries clearly and proactively, helping reinforce confidence at a time when visibility and discipline are at a premium. 

Illustrative example: Supply chain ESG assessment

A middle–market durable goods manufacturer that received senior secured financing from a private credit fund is experiencing acute liquidity pressure following a demand downturn and rising input costs, placing the business at risk of covenant breach and prompting management to pursue rapid cost reductions by replacing incumbent suppliers with lower–cost alternatives. In this scenario, SLR can be engaged post–close to support a time–sensitive assessment of alternative suppliers, working alongside management to map critical supply dependencies and evaluate prospective counterparties against material ESG–related topics, including regulatory compliance, labor practices, geographic concentration, and operational resilience. Through this process, SLR can support the sustainability elements of the company’s supplier transition plan to help navigate any associated compliance, quality, or reputational risks — thereby supporting operational stability, protecting enterprise value, and strengthening the lender’s downside protection during a period of heightened financial stress.

A new understanding within the private credit market

The private credit market is undergoing a period of recalibration. Defaults are up versus prior years, lender behaviors are shifting, and deeper operational involvement is becoming more necessary. Within this landscape, ESG is both a diagnostic tool and a stabilizer, helping lenders to understand the drivers of distress and supporting management teams as they work to restore financial health.

For private credit managers who must now act not only as financiers but also as operators, access to the right playbooks and resources is critical. SLR provides the ESG expertise that supports those efforts, helping lenders navigate complexity with clarity and discipline, so that distressed situations become opportunities for structured recovery rather than uncontrolled decline.