Private Credit Firms Reduce PIK Provisions Amid Shadow Default Fears

Private-credit firms are reducing the use of payment-in-kind (PIK) provisions, which allow borrowers to defer interest payments by adding them to a loan's principal balance. This shift follows a period of intense competition where PIK served as a sweetener to win deals. However, lenders now fear shadow defaults, particularly when deferrals are requested after a loan has already been originated.

Data from Lincoln International indicates that PIK provisions in new second-quarter loans fell to 13.5%, a significant drop from 25% at the end of last year. This tightening of standards comes as loan performance worsens and investor scrutiny increases, especially for software companies vulnerable to disruption from artificial intelligence.

The risks of PIK deferrals are evident in recent creditor takeovers. Blackstone led the takeover of software firm Medallia after its owner, Thoma Bravo, failed to secure further interest deferrals or commit more equity. Medallia had delayed interest payments for four years on 2.8 billion dollars in debt. Similarly, ownership of Pluralsight transferred to lenders including Blue Owl and BlackRock after Vista Equity Partners wrote off its investment.