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 credit lines 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 or high interest rates. We find that PIK usage strongly predicts future credit deterioration, delinquency, and bankruptcy-especially for borrowers lacking private equity sponsors or where lenders do not hold equity claims. A simple model highlights the agency conflicts inherent in deferred interest and identifies contractual mechanisms that mitigate these risks. At the lender level, we show that increased PIK usage constrains BDCs’ portfolio and dividend growth and is associated with tighter bank-imposed covenants. Our findings reveal how nonbank lenders adapt liquidity provision and the associated risks to the financial system.
Paul Rintamäki, Frankfurt School of Finance and Management
Sascha Steffen, Frankfurt School of Finance and Management