The Rise of PIK in Private Credit: A Deep Dive

Payment-in-kind interest (PIK) has become an increasingly common feature of private credit, offering borrowers flexibility to preserve cash while giving lenders the potential for higher returns. But as PIK usage rises, so does scrutiny over how and why it is being used. Here, we examine the different forms of PIK, the distinction between “good” and “bad” PIK, and why its growing prevalence is raising concerns about credit quality.

What Is Payment-in-Kind Interest in Private Credit? 

PIK interest allows borrowers to defer cash interest payments by capitalizing them onto the principal balance. Once largely associated with junior, distressed, and highly structured financings, PIK has become increasingly common across a broader range of transactions, including senior secured loans in the private credit market.

PIK creates three important dynamics for borrowers and lenders:

• Larger loan balances and higher debt. Capitalized interest increases the principal balance, meaning borrowers ultimately have more debt to repay and pay interest on. Because subsequent interest accrues on the higher balance, the debt can compound significantly the longer PIK remains in use.

• Potentially higher yields and returns. Given the additional risk and complexity of PIK, lenders typically demand a premium over comparable cash-pay loans. That premium can translate into higher yields and potentially stronger returns, while also giving borrowers an incentive to use PIK selectively.

• Risks that can compound over time. PIK is generally recognized as income even though no cash payment is received, and its use does not, in itself, constitute a default or covenant breach. But widespread or prolonged PIK usage can materially increase borrower leverage and portfolio risk, making it important for lenders to monitor both PIK exposure and the underlying health of the borrowers using it.

What Are the Different Forms of Payment-in-Kind Interest?

Lenders can structure PIK in several ways, giving borrowers varying degrees of flexibility over when and how they pay interest.

• Pure PIK: The full interest payment is capitalized and added to the outstanding loan balance rather than paid in cash.
  
• PIK toggles: Borrowers can elect to pay interest in cash or in-kind, typically subject to predefined conditions. In some structures, the ability to activate or deactivate the toggle depends on financial performance, leverage or other agreed-upon thresholds.
  
• Partial PIK: Borrowers pay a portion of their interest in cash while capitalizing the remainder onto the principal. This provides greater liquidity flexibility while still generating some cash income for lenders.
  
• Synthetic PIK: A newer structure in which borrowers draw on a delayed-draw term loan alongside the primary facility to fund cash interest payments, effectively providing the borrower with additional liquidity without capitalizing the interest directly onto the original loan balance.

To limit excessive principal growth and preserve incentives for borrowers to improve performance, PIK provisions typically come with a defined election period, often ranging from six months to two years. These limits are negotiated between lenders and borrowers and may be tied to specific business milestones, financial targets or value-creation events.

For example, a healthcare borrower may be permitted to use PIK after a drug reaches a key clinical milestone, a private equity-backed company may have access to it in the months following an acquisition, or a software company may use PIK while investing heavily in the R&D required to launch a new product.

What Is the Difference Between Good PIK and Bad PIK?

One of the biggest topics in the private credit ecosystem in recent years has been the concept of “good” and “bad” PIK. As noted, PIK can be an effective tool for supporting performing borrowers while potentially enhancing lender returns. At the same time, it can significantly increase a borrower’s debt and leverage. When used to mask deteriorating performance or weakening cash flows, however, it can carry significant risks. To distinguish between these different applications, the industry has generally come to define “good” and “bad” PIK along the following lines:

• “Good PIK” typically refers to PIK that was incorporated into the credit agreement at origination. It is generally provided to high-growth borrowers as a pre-planned mechanism to support M&A or organic growth initiatives, such as investments in product development, geographic expansion or drug development.
• “Bad PIK” typically refers to situations where a PIK provision was not included in the original loan documentation but was added later through an amendment, often as the borrower’s performance or liquidity position deteriorates.

What Are the Nuances of Good PIK and Bad PIK?

While this distinction has become broadly accepted across the industry, the reality is more nuanced. The risk PIK presents to a borrower — and, by extension, to a lender — ultimately depends on the circumstances of the individual credit and the borrower’s ability to execute against its underlying business plan.

Simply having a PIK toggle embedded in the original underwriting does not, on its own, make a loan low risk. The growth thesis underpinning that flexibility still has to materialize. The unraveling of Medallia, for example, illustrates how a PIK toggle can be built into a deal at origination only for the borrower to ultimately fall short of the performance expectations that the flexibility was intended to support.

The inverse is also true. PIK granted through an amendment does not necessarily signal a deteriorating credit. A borrower may face temporary cash flow pressure, encounter an unexpected macroeconomic shock or be underperforming while pursuing a credible turnaround plan.

In those cases, allowing the borrower to defer cash interest can give management a critical runway, conserve liquidity and potentially help avoid a default. The COVID-19 pandemic offers a clear example of how lenders used PIK provisions to help otherwise viable businesses navigate an unprecedented disruption while preserving cash for core operations.

All is to say — the distinction between “good” and “bad” PIK cannot be reduced to whether the provision was included at origination or added later through an amendment. Ultimately, the risk comes down to what is happening beneath the surface of the loan and whether the borrower can execute on its value creation plans. 

How Prevalent is PIK Income in Private Credit? 

Part of the reason PIK has come under greater scrutiny in recent years is its growing role across private credit, particularly in the period following the pandemic-era dealmaking boom and amid persistently higher interest rates. According to an analysis by Golub Capital, PIK accounted for an average of roughly 4.2% of direct lending income between 2005 and 2020. Since the pandemic, PIK as a share of income has remained well above its pre-COVID average.

While estimates vary depending on the loans and borrowers included in each analysis, PIK has generally accounted for roughly 7% to 11% of direct lending income in recent years. Lincoln International’s proprietary database, for example, shows that roughly 11% of loans used PIK in Q2 2026, a level that has remained broadly consistent since 2025. LCD’s analysis of the 15 largest exchange-traded BDCs points to a somewhat lower figure, with PIK accounting for 8.4% as of Q1 2026, a level it has similarly hovered around over the past two years. 

What Is the Breakdown of Good and Bad PIK in Private Credit?

More concerning, however, is not simply that PIK usage has increased since the pandemic, but that a growing share of that PIK appears to be “bad PIK.” Lincoln International’s analysis shows that bad PIK rose from 37% of PIK loans in 2021 to roughly 55% by Q2 2026, a level that has persisted since 2025. The concern is that bad PIK can function as a form of “shadow default,” allowing borrowers to defer cash interest and effectively kick the can down the road even as underlying performance deteriorates. 

When PIK accumulates alongside weakening performance, the risk profile of the loan can deteriorate quickly. Leverage rises, loan-to-value ratios expand, and the equity cushion protecting lenders shrinks. For example, among the companies in Lincoln International’s analysis with bad PIK, LTV increased by an average of 37%, from a relatively healthy 39% at inception to 76% today.

For lenders, that can create a materially different risk profile from the one originally underwritten. If growth stalls and valuations decline while PIK continues to compound the debt balance, lenders can find themselves facing increasingly equity-like exposure and greater uncertainty around repayment.

Why Is PIK Gaining Extra Scrutiny Amid AI Concerns in Software Borrowers? 

Part of the reason PIK has come under particular scrutiny is that many software loans originated during the pandemic-era dealmaking boom included PIK toggles. Direct lenders had accumulated significant amounts of capital, intensifying competition for deals and giving sponsors greater leverage to negotiate borrower-friendly terms. For lenders, meanwhile, the case for PIK provisions were compelling.

Software companies were viewed as high-growth businesses, valuations and exit multiples were at record levels, and recurring, seat-based revenue models appeared to offer a durable path to continued growth. By allowing borrowers to defer cash interest, lenders could support growth while preserving the potential to enhance returns. This dynamic has pushed PIK interest as a share of income on software loans to 12.8%, a notable increase relative to the broader private credit market.

Of course, the problem is that the assumptions these PIK toggles were underwritten against have since come under pressure. The rise of AI has challenged the durability of many software business models and is increasingly separating winners from losers. This raises scrutiny on if the growth or performance narrative for a large cohort of AI-exposed companies with these provisions can materialize. 

How Can Private Credit Firms Track PIK Usage Across Their Portfolios? 

With loan accounting data, borrower KPIs, credit metrics, and qualitative context centralized in Chronograph, firms can monitor PIK usage alongside the fundamentals driving borrower performance:

• Distinguish “Good” from “Bad” PIK. Track whether PIK was underwritten at origination or introduced through an amendment, when a PIK toggle is activated or turned off, and how much of the available PIK capacity has been used. At the portfolio level, this enables firms to identify the breakdown of good vs. bad PIK. 

• Track Cash vs. PIK interest. Analyze the mix of cash and PIK interest at both the borrower and portfolio level to understand how much interest is being paid in cash versus PIK.

• Capture the Context Behind PIK Usage. Centralize the rationale for PIK elections, such as preserving cash for an acquisition, funding growth initiatives, or navigating a temporary cash flow disruption.

• Monitor PIK Alongside Borrower Performance. View PIK usage alongside KPIs, EBITDA, and other credit metrics to assess whether the underlying thesis is playing out. Is growth materializing? Is cash flow recovering as expected? Or is PIK masking a more persistent deterioration in credit quality?

Chronograph is the leading portfolio monitoring platform for private credit firms. Request a demo to see how Chronograph centralizes comprehensive borrower and loan information, automates covenant compliance, and develops the trusted portfolio data foundation for AI workflows.