Private credit lenders tighten PIK terms as concerns mount over hidden defaults

Private credit lenders are tightening payment-in-kind (PIK) terms amid mounting concerns about hidden defaults, according to a Wall Street Journal report. PIK provisions permit borrowers to postpone interest payments by incorporating the owed amount into the loan's principal balance. The practice gained popularity as private credit managers competed fiercely for deals, granting borrowers more flexibility in servicing their debt.

However, lenders are now exercising greater negotiating power as credit conditions tighten and investors scrutinize portfolio performance more closely. The usage of PIK in new private credit loans dropped to 13.5% in the second quarter of 2025, down from 25% at the end of 2025, as per Lincoln International. Lenders are also becoming more cautious about extending leverage to businesses vulnerable to AI disruption, particularly software companies, and tightening provisions that enable borrowers to raise financing against assets.

Despite this, PIK remains prevalent in existing portfolios, with approximately 11% of outstanding private credit loans having some or all of their interest payments structured as PIK during the second quarter, compared to 7% at the end of 2021. Post-origination modifications, often labeled as "bad PIKs," are particularly concerning as they may indicate that borrowers are already in financial distress.

Lenders fear that PIK can conceal deteriorating credit quality, as deferred interest is often recognized as income, while the borrower's debt balance continues to rise. Some investors and credit analysts deem post-origination PIK arrangements as potential "shadow defaults," situations where companies receive concessions from lenders without being formally classified as in default.

The restructuring of Medallia, a software company, exemplifies the risks associated with PIK. Its creditors, led by Blackstone and including KKR and Apollo, seized control of the business recently after Thoma Bravo's efforts to extend a period of deferred interest failed. Medallia's mounting debt burden, including debt from acquisitions, contributed to the decline in its equity value.

A similar scenario unfolded at Pluralsight, a technology training company acquired by Vista Equity Partners in 2021. Following financial troubles, lenders, including Blue Owl, Ares Management, BlackRock, and Goldman Sachs, agreed to restructuring measures that included interest deferrals, leading Vista to write off its equity investment and transfer ownership of the company to its lenders.

As private credit investors face mounting pressure to showcase portfolio resilience, wealthy individual investors are reevaluating their exposure due to growing concerns about loan performance. Raymond James research has discovered a link between interest deferrals and the likelihood of eventual default. Additionally, materially modified loans held by publicly traded business development companies remain near their highest levels in over a decade.

Private equity-backed businesses across various sectors, including healthcare, consumer finance, and property services, have also utilized PIK arrangements as lenders and sponsors attempt to manage companies under financial strain. Private credit executives anticipate that borrowers will encounter a more challenging environment for securing payment deferrals or extending existing arrangements, with lenders increasingly demanding significant concessions from private equity sponsors before approving additional breathing room.