PIK Now and Pay Later - How Deferred Interest Reshapes Private Credit

Abstract

We study the role of Payment-in-Kind (PIK) provisions in private credit markets as a substitute for bank-provided liquidity. Using novel loan-level data from U.S. Business Development Companies (BDCs), we show that borrowers without access to bank lending often rely on PIK features to manage liquidity shortfalls. These features allow borrowers to defer interest payments, effectively providing contingent financing during periods of distress, but may also postpone distress while amplifying debtholder- equity-holder conflicts. We find that exercising PIK options strongly predicts future credit deterioration, delinquency, and bankruptcy, but less so for borrowers with private equity sponsors or with equity-holding lenders. Consistent with efficient contracting, we find that loan features that can reduce agency conflicts are actively included in PIK loans. At the lender level, we show that increased PIK usage constrains BDCs’ portfolio growth and is associated with tighter bank credit. Our findings reveal how nonbank lenders adapt liquidity provision and manage related pitfalls.

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