Private Companies Are Deferring Loan Payments at a Higher Rate

(Bloomberg) -- The share of private equity-backed companies that deferred cash interest payments ticked higher for a third consecutive quarter, pointing to growing signs of stress, according to Lincoln International.

Data from the valuation firm show that 11% of fourth-quarter borrowers paid interest in-kind, which is when creditors are given more debt in lieu of cash. More than 58% of those loans featured so-called “bad PIK,” meaning that borrowers opted to delay interest payments during the life of the loan versus when the debt was originated.

While private lenders typically avoid offering flexible covenants like PIK, allowing for it in an initial agreement can help them win deals in a highly competitive credit market.

An unforeseen decision to start paying in-kind can often signal mounting strain, such as a cash crunch. But sometimes, borrowers will see a sudden opportunity to spend capital and bad PIK can be used as a strategic measure.

Bad PIK was in 6.4% of private loans last quarter, up from 6.1% in the three months prior and substantially higher than the 2.5% ratio recorded in the last three months of 2021, when Lincoln began tracking the data. The firm is among the largest providers of third-party loan valuations in the private credit industry, and analyzed more than 7,000 companies during the fourth quarter.

“There’s been a lot of debate about our PIK analysis, but it all comes down to loan-to-value,” said Ron Kahn, global co-head of valuations and opinions at Lincoln. “Companies we flagged as having bad PIK went from roughly 40/60 debt-to-equity, which is reasonable, to about 76% debt today — that’s a sign of stress.”

Issuing bad PIK adds to a company’s debt pile without increasing its value. When a loan-to-value ratio rises, a lender’s downside protection erodes. The average loan-to-value ratio for deals with bad PIK has been above 75% since the fourth quarter of 2024, according to Lincoln, compared to 47% in the same period in 2021.

Amid a broader market selloff in the software industry, even the largest business development companies have been laser-focused on rising exposure to PIK in their portfolios.

Kort Schnabel, CEO of Ares Capital Corp., told analysts last week that there was a “slightly higher percentage of PIK” on the firm’s software book last quarter, but that the vast majority of it was planned.

“The PIK in that software book is, I want to say, 99%, maybe even 100%, structured at the upfront, at the outset of the investment,” Schnabel said.

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