Offense and Defense: Why Borrowers and Lenders Use PIK in Private Credit
September 2026
Payment-in-kind (PIK) interest — where interest accrues and is added to a loan’s principal balance rather than being paid in cash — has long been a feature of private credit, particularly in subordinated and holding company (holdco) structures. Its use has grown markedly since 2021, and the reasons borrowers and lenders turn to it are not uniform.
In some cases, PIK is a proactive, competitively priced feature that a lender offers to win a mandate, or that a sponsor uses to fund growth or an acquisition. In others, it is a reactive accommodation extended when a borrower can no longer meet its cash interest obligations. This article uses the terms offensive PIK and defensive PIK to describe that distinction, without treating either use as inherently favorable or unfavorable.
PIK is Becoming More Prevalent in Private Credit
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Source: Lincoln International
Payment-in-kind (PIK) interest — where interest accrues and is added to a loan’s principal balance rather than being paid in cash — has long been a feature of private credit, particularly in subordinated and holding company (holdco) structures. Its use has grown markedly since 2021, and the reasons borrowers and lenders turn to it are not uniform.
PIK is Becoming More Prevalent in Private Credit
Click to find out more
Source: Lincoln International
In some cases, PIK is a proactive, competitively priced feature that a lender offers to win a mandate, or that a sponsor uses to fund growth or an acquisition. In others, it is a reactive accommodation extended when a borrower can no longer meet its cash interest obligations. This article uses the terms offensive PIK and defensive PIK to describe that distinction, without treating either use as inherently favorable or unfavorable.
This distinction matters because formal default statistics in private credit are measured by reference to contractual breach, not cash flow. A loan amended to permit interest capitalization continues to be classified as performing even where the underlying cause was an inability to meet cash interest obligations. Several data providers have begun publishing measures intended to capture this gap, generally referred to as a “shadow default rate.”
This article looks at why PIK is used — both offensively and defensively — what the shadow default rate is intended to capture, and how the resulting picture moves through the private credit distribution chain to funds, rated vehicles, and their ultimate investors.
This distinction matters because formal default statistics in private credit are measured by reference to contractual breach, not cash flow. A loan amended to permit interest capitalization continues to be classified as performing even where the underlying cause was an inability to meet cash interest obligations. Several data providers have begun publishing measures intended to capture this gap, generally referred to as a “shadow default rate.”
This article looks at why PIK is used — both offensively and defensively — what the shadow default rate is intended to capture, and how the resulting picture moves through the private credit distribution chain to funds, rated vehicles, and their ultimate investors.
Offensive PIK vs. Defensive PIK
PIK is not a single, uniform feature, and the circumstances in which it arises affect what it signals about a loan, without on its own indicating whether that signal is positive or negative.
Offensive PIK is built into a facility as a deliberate, competitively priced feature, generally at origination. Private credit lenders increasingly offer PIK options, often through a toggle, to win mandates against the broadly syndicated loan market, which is typically unable to match that flexibility because collateralized loan obligations (CLOs) are restricted from holding instruments that do not pay cash interest. Sponsors, in turn, use offensive PIK to fund growth or acquisitions where near-term cash generation is limited but future cash flows are expected to service the obligation at maturity. They may also use it to smooth out the cash-flow impact of transaction costs in a mergers and acquisitions (M&A) or buy-and-build strategy.
A related example is a holdco PIK facility arranged shortly after an acquisition to fund a dividend where the operating company’s financing does not permit a direct distribution. Repayment in such cases typically depends on one of three contingencies maturing over time: dividend baskets at the operating company growing sufficiently to permit cash servicing, refinancing of the holdco PIK at maturity, or a sale of the company before the obligation falls due. None of these outcomes is assured when the facility is put in place, and offensive PIK defers credit risk rather than eliminating it.
Defensive PIK arises differently: typically where a borrower can no longer meet its cash interest obligations under the original terms and the parties agree to convert a present cash obligation into a deferred one rather than triggering a formal default. The economic instrument is often identical to offensive PIK, but the circumstances of its introduction differ.
PIK toggle provisions, which allow a borrower to elect interest capitalization at its own discretion, can be used either way. A borrower may toggle to PIK to reinvest cash in a high-return growth opportunity — an offensive use — or because of liquidity constraints or deteriorating fundamentals — a defensive use. Because the same contractual feature can support either use, its presence in a capital structure is, on its own, a weaker signal of where, or whether, stress is concentrated within a portfolio than the rationale behind its activation.
Why PIK Usage Is Rising
Several data points illustrate the scale of the shift, though estimates vary by provider and are updated frequently. Lincoln International’s most recent data shows that 11.3% of the private credit investments it valued carried some form of PIK as of Q4 2025 (10.6% as of Q1 2026), up from approximately 7% in Q4 2021. Of that PIK exposure, approximately 56.5% (55.7% in Q1 2026) reflected PIK that was not present or utilized at the time the loan closed, up from roughly 35.5% in Q4 2021. Not all of that growth reflects defensive use: private credit providers increasingly offer PIK, including to their strongest borrowers, as a competitive, offensive feature that can enhance both borrower flexibility and lender returns12.
A significant driver of defensive PIK has been floating-rate exposure during a period of sustained higher base rates. Following a prolonged period of historically low rates, the increase from 2022 onward left many highly leveraged borrowers facing materially higher cash interest obligations than their capital structures had been designed to absorb, prompting lenders and borrowers to revisit cash-pay terms through amendment.
Why PIK Usage Is Rising
Several data points illustrate the scale of the shift, though estimates vary by provider and are updated frequently. Lincoln International’s most recent data shows that 11.3% of the private credit investments it valued carried some form of PIK as of Q4 2025 (10.6% as of Q1 2026), up from approximately 7% in Q4 2021. Of that PIK exposure, approximately 56.5% (55.7% in Q1 2026) reflected PIK that was not present or utilized at the time the loan closed, up from roughly 35.5% in Q4 2021. Not all of that growth reflects defensive use: private credit providers increasingly offer PIK, including to their strongest borrowers, as a competitive, offensive feature that can enhance both borrower flexibility and lender returns12.
A significant driver of defensive PIK has been floating-rate exposure during a period of sustained higher base rates. Following a prolonged period of historically low rates, the increase from 2022 onward left many highly leveraged borrowers facing materially higher cash interest obligations than their capital structures had been designed to absorb, prompting lenders and borrowers to revisit cash-pay terms through amendment.
PIK Toggles Are a Standard Feature
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Source: S&P Global Ratings, Private Credit And Middle-Market CLO Quarterly: Unknown Unknowns (Q2 2025)
Rate sensitivity alone, however, does not fully account for the trend. The IMF has reported that nearly half of direct lending borrowers recorded negative free operating cash flows at the end of 2024, compared with approximately 25% in 2021 — pointing to underlying cash-flow generation as a defensive driver independent of the rate environment3.
On the offensive side, PIK toggles have become a near-standard feature at the upper end of the market: a 2024 review of more than 300 private credit agreements found that 41% of large-market deals (loan sizes above $750 million) included a PIK toggle at origination, compared with just 7% of middle-market deals.
This reflects the use of PIK as a competitive tool to win mandates that might otherwise go to the syndicated market4. PIK has also migrated to some degree from its traditional home in subordinated mezzanine and holdco facilities into senior and unitranche positions, layers of the capital structure not historically associated with deferred interest arrangements.
Rate sensitivity alone, however, does not fully account for the trend. The IMF has reported that nearly half of direct lending borrowers recorded negative free operating cash flows at the end of 2024, compared with approximately 25% in 2021 — pointing to underlying cash-flow generation as a defensive driver independent of the rate environment3.
On the offensive side, PIK toggles have become a near-standard feature at the upper end of the market: a 2024 review of more than 300 private credit agreements found that 41% of large-market deals (loan sizes above $750 million) included a PIK toggle at origination, compared with just 7% of middle-market deals.
PIK Toggles Are a Standard Feature
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Source: S&P Global Ratings, Private Credit And Middle-Market CLO Quarterly: Unknown Unknowns (Q2 2025)
This reflects the use of PIK as a competitive tool to win mandates that might otherwise go to the syndicated market4. PIK has also migrated to some degree from its traditional home in subordinated mezzanine and holdco facilities into senior and unitranche positions, layers of the capital structure not historically associated with deferred interest arrangements.
The Shadow Default Rate
Private credit’s formal default statistics are calculated by reference to contractual breach: a payment default is recorded when a borrower fails to make a payment required under the loan terms. Where a loan has instead been amended to permit interest capitalization, the borrower satisfies its payment obligations in full without making any cash payment, and no breach occurs. The loan is therefore recorded as performing in the same manner as a loan paying cash interest on schedule.
Several market participants have sought to quantify the resulting gap. KBRA’s Middle Market Default Monitor, which consolidates borrowers in payment default or assessed as likely to default absent ongoing lender concessions, stood at approximately 2.1% by value of assessed notional debt outstanding as of Q3 20255.
Lincoln International has published a “shadow default rate,” calculated as the share of loans carrying PIK that was not present or utilized at close, multiplied by overall PIK incidence. This measure stood at approximately 6.4% as of Q4 2025 and 5.9% as of Q1 20266. The two figures are not directly comparable — they are produced by different providers using different methodologies and coverage — but the gap between them illustrates the broader point that formal default statistics and defensive PIK activity are capturing different things.
Collateral-level data adds further texture. Lincoln reports that the average loan-to-value (LTV) ratio on loans carrying defensive PIK rose from approximately 42.7% as of Q1 2025 to 76.0% as of Q1 20267. Separately, research by Rintamäki and Steffen finds that activation of a PIK toggle provision is associated with a 2–3 percentage point increase in the probability of non-accrual in the following quarter — a meaningful increase relative to an unconditional non-accrual rate of around 3% — with the effect persisting for at least two years.
Average LTV of Loans Carrying Defensive PIK
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The research also finds that these adverse outcomes are concentrated in PIK exercised after origination rather than PIK structured into the loan from the outset8. The same research finds that valuation dispersion across lenders holding the same loan increases materially following toggle activation, and that private equity sponsorship partially mitigates the deterioration, consistent with sponsors’ ability to inject capital or renegotiate terms alongside a PIK accommodation.
It is worth noting the limits of this data: there is no standardized, loan-level reporting obligation in private credit, and the figures published by valuation firms and rating agencies necessarily reflect partial and differing market coverage. The shadow default rate is best understood as an analytical lens rather than a precise or universally agreed metric.
The Shadow Default Rate
Private credit’s formal default statistics are calculated by reference to contractual breach: a payment default is recorded when a borrower fails to make a payment required under the loan terms. Where a loan has instead been amended to permit interest capitalization, the borrower satisfies its payment obligations in full without making any cash payment, and no breach occurs. The loan is therefore recorded as performing in the same manner as a loan paying cash interest on schedule.
Several market participants have sought to quantify the resulting gap. KBRA’s Middle Market Default Monitor, which consolidates borrowers in payment default or assessed as likely to default absent ongoing lender concessions, stood at approximately 2.1% by value of assessed notional debt outstanding as of Q3 20255.
Lincoln International has published a “shadow default rate,” calculated as the share of loans carrying PIK that was not present or utilized at close, multiplied by overall PIK incidence. This measure stood at approximately 6.4% as of Q4 2025 and 5.9% as of Q1 20266. The two figures are not directly comparable — they are produced by different providers using different methodologies and coverage — but the gap between them illustrates the broader point that formal default statistics and defensive PIK activity are capturing different things.
Collateral-level data adds further texture. Lincoln reports that the average loan-to-value (LTV) ratio on loans carrying defensive PIK rose from approximately 42.7% as of Q1 2025 to 76.0% as of Q1 20267. Separately, research by Rintamäki and Steffen finds that activation of a PIK toggle provision is associated with a 2–3 percentage point increase in the probability of non-accrual in the following quarter — a meaningful increase relative to an unconditional non-accrual rate of around 3% — with the effect persisting for at least two years.
Average LTV of Loans Carrying Defensive PIK
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The research also finds that these adverse outcomes are concentrated in PIK exercised after origination rather than PIK structured into the loan from the outset8. The same research finds that valuation dispersion across lenders holding the same loan increases materially following toggle activation, and that private equity sponsorship partially mitigates the deterioration, consistent with sponsors’ ability to inject capital or renegotiate terms alongside a PIK accommodation.
It is worth noting the limits of this data: there is no standardized, loan-level reporting obligation in private credit, and the figures published by valuation firms and rating agencies necessarily reflect partial and differing market coverage. The shadow default rate is best understood as an analytical lens rather than a precise or universally agreed metric.
Considerations for Market Participants
The growth of PIK and the development of shadow default rate metrics around defensive PIK specifically raise practical considerations for different participants in the private credit market.
For lenders and credit committees:
Distinguishing offensive PIK from defensive PIK at the time it is elected — including the borrower’s cash interest coverage immediately beforehand and any change in LTV — is a useful diligence point, both when PIK is introduced and on an ongoing basis, given the data suggesting a correlation between defensive toggle activation and subsequent credit deterioration.
For business development company (BDC) boards and valuation committees:
The data on valuation dispersion following PIK toggle activation suggests that loans carrying defensive PIK, particularly where LTV has deteriorated materially, may warrant closer attention in the fair value process under Accounting Standards Codification (ASC) 820, including engagement with third-party valuation firms regarding the basis for marks at or near par.
For investors in rated vehicles and insurers acquiring private credit notes:
Given that rating methodologies are generally applied at the portfolio or manager level, investors may wish to seek transparency from issuers and managers on the split between offensive and defensive PIK in the underlying loans and the LTV profile of the defensive subset, particularly given the favorable capital treatment available for qualifying instruments.
More broadly, the divergence between formal default rates and shadow default measures is likely to persist for so long as private credit’s disclosure framework treats the absence of a contractual breach as the relevant indicator of performance, irrespective of whether a borrower is meeting its obligations in cash. As PIK toggle provisions become a standard feature of new originations, distinguishing offensive PIK from defensive PIK — rather than treating the overall PIK percentage as a single metric — is likely to determine how early that divergence is identified within any given portfolio.
This article was co-authored by Cleary summer associate Catrin Thomas
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