Private Companies Are Deferring Loan Payments at a Higher Rate
(Bloomberg) — The share of private equity-backed companies deferring cash interest payments rose for the third quarter in a row, pointing to signs of growing stress, according to Lincoln International.
Data from the valuation firm shows that 11 percent of borrowers paid interest in kind in the fourth quarter, meaning more loans were made to creditors rather than cash. More than 58 percent of these loans had what is called “bad PIK”; This meant that borrowers chose to defer interest payments over the life of the loan rather than when the debt was incurred.
Although private lenders generally avoid offering flexible agreements such as PIK, allowing this in the initial deal can help them win a deal in a highly competitive credit market.
An unforeseen decision to begin paying in kind can often signal mounting troubles, such as a cash crunch. But sometimes borrowers see a sudden opportunity to spend capital, and bad PIK can be used as a strategic hedge.
Bad PIK was in 6.4% of private loans last quarter; That was up from 6.1% in the previous three months, significantly higher than the 2.5% rate recorded in the final three months of 2021 when Lincoln began tracking the data. The firm is among the largest third-party credit valuation providers in the private credit industry and analyzed more than 7,000 companies in the fourth quarter.
“There’s been a lot of discussion about our PIK analysis, but it all comes down to loan-to-value ratio,” said Ron Kahn, Lincoln’s global co-head of valuation and insights. “Companies we have flagged as having poor PIK have gone from having a debt-to-equity ratio of around 40/60, which is a reasonable ratio, to around 76% debt today – a sign of stress.”
Issuing bad PIK increases the debt pile without increasing the value of the company. When the loan-to-value ratio rises, the lender’s downside protection erodes. According to Lincoln, the average loan-to-value ratio for deals with bad PIK has been above 75% since the fourth quarter of 2024, compared to 47% in the same period in 2021.
Amid a broader market sell-off in the software industry, even the largest business development companies have focused on increasing interest in PIK in their portfolios.
Ares Capital Corp. CEO Kort Schnabel told analysts last week that there was a “slightly higher percentage of PIK” in the firm’s software book last quarter, but the vast majority of it was planned.
“I want to say that the PIK in this software book is 99%, maybe even 100% structured at the beginning of the investment,” Schnabel said.
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