Focus on private credit – when PIK becomes a warning sign

Private credit has grown rapidly over the past decade, but as the market moves through a tougher part of the financing cycle, attention is shifting to what happens when loans written in easier conditions come under pressure.

Many floating-rate loans originated in 2021 and 2022 have already been absorbing much higher cash interest costs for several years. As those loans approach refinancing, borrowers must also confront today’s more demanding financing terms, which can expose private capital structures designed for a much cheaper-money environment. One response has been greater use of payment-in-kind, or PIK, interest, which allows borrowers to defer some cash interest by adding it to the outstanding debt. 86% of those Ocorian surveyed¹⁸ expect its use to increase.

PIK is not inherently a sign of stress

There is a useful comparison with a zero-coupon or deeply discounted bond. An investor buys the bond below its face value and receives the higher amount at maturity, with the difference reflecting the return baked in when it was issued. The absence of regular interest is not a sign of distress because it was part of the deal from the outset.

PIK can work in much the same way. Where it is built into a loan at origination, the lender knows some or all of the return will accrue rather than arrive as cash, and can price, document and model it accordingly.

When the economics change

The position is different when a cash-pay borrower later switches to PIK because it can no longer comfortably cover its interest bill. Interest is added to the loan balance, easing pressure on cash flow and potentially avoiding restructuring or default. The loan may continue to perform contractually, but the borrower is no longer servicing it as originally envisioned.

In its May report¹⁹, S&P Global Ratings noted that among companies experiencing a selective default, 63% used PIK. That concern is reflected in Ocorian’s survey, where 90% believe growing PIK usage risks masking underlying borrower stress.

This also changes how reported returns should be viewed. A fund may still report a strong headline yield while receiving more of that income as accrual rather than cash. If a loan converts to PIK shortly after a valuation date, the deterioration may also take time to feed through to NAV and performance reporting.

Can reporting keep up?

Only 17% of professionals we surveyed say they have robust automated systems that fully account for PIK within waterfall modelling. 39% require significant manual adjustment and 32% in total rely on external providers. Accrued interest affects not only the loan balance but preferred returns, waterfall calculations and the split between realised and unrealised performance.

For LPs, this makes the detail increasingly important. How much income has actually been received in cash? Which loans contained PIK from the outset and which converted later? What prompted the change? And how quickly was that reflected in valuations and reporting?

PIK is a legitimate financing tool and we do not seem to be staring over the abyss: the Federal Reserve noted this year that default rates among private-credit borrowers remain low, even as PIK is being used to defer interest payments on many loans. But the distinction between PIK built into the original investment case and PIK introduced because a borrower needs relief is increasingly important. As its use grows, investors will want much clearer visibility of that difference.

¹⁸ Ocorian’s 2026 asset manager survey of 300 senior executives at private equity fund managers
¹⁹ S&P Global Ratings, “Private Credit Fundamentals Remain Resilient”, published 21 May 2026

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