In this lesson
- Terms: PIK, Default and recovery, NAV
- To work through: a worked example, a 40-second film, 3 check questions
Underlined terms show their definition when you rest on them or tap them.
Under payment-in-kind interest, the borrower does not pay cash; it adds the unpaid interest to the loan’s principal, as the Boston Fed describes it. The loan grows, and interest is then charged on the larger amount. The lender records the income, but receives it only when the loan is repaid.
PIK can be agreed at the start, for a company that is investing for growth and wants to keep cash. It can also be agreed later, when a borrower cannot pay cash interest. That second use is why investors watch it. The Boston Fed found the share of BDC loans with PIK rose from about 6% in early 2022 to about 10% by early 2026, across nearly every industry.
Other signs sit beside it. Interest coverage, a company’s earnings divided by its interest bill, was already thinner for private credit borrowers than in the syndicated market (about 2.0 times against 2.7 in 2023, per the Fed note). Loans coming due can be extended on changed terms instead of repaid. And the IMF has warned of uncertainty about the valuations of private loans, and that managers may have reasons to delay recognising losses.
A $40 million loan pays 12% a year, all as PIK, for three years.
| After year 1: $40m × 1.12 | $44.8 million |
|---|---|
| After year 2: × 1.12 | about $50.2 million |
| After year 3: × 1.12 | about $56.2 million |
| Cash interest received | none |
The fund reports $16.2 million of income over three years. Whether it is ever collected depends on the company being worth more than $56 million when the loan is due. Simple example.
Key takeaway: why it matters to investors
PIK income looks like any other income in a fund’s results, but it has not been paid. When PIK grows and interest coverage thins, more of a credit fund’s return depends on borrowers recovering, which is why investors look behind the headline yield.
Watch · 40 seconds
The loan that pays its interest with more loanA payment-in-kind loan lets a borrower pay interest with more debt instead of cash. The interest is added to what is owed and compounds, and the rate is typically much higher than on senior loans.
Also: A loan coming due can simply get more time, One ratio shows whether a borrower can keep up
Check yourself
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Sources
The facts in this lesson were checked against these public pages on November 11, 2026. Examples use round invented numbers. Simple examples; terms vary by fund.
- Early Warning Signals in Private Credit? What BDC Portfolios Reveal about Emerging Risks (Current Policy Perspectives 26-6, August 5, 2026), Federal Reserve Bank of Boston. US private credit over $1 trillion; PIK means adding unpaid interest to principal; share of BDC loans with PIK rose from about 6% in early 2022 to about 10% by early 2026; median BDC spreads 4 to 5 percentage points over SOFR, narrowing about 1 point over two years; some BDCs are publicly offered but not listed and often have repurchase programmes.
- Private Credit: Characteristics and Risks (FEDS Notes, February 23, 2024; Fang Cai and Sharjil Haque), Board of Governors of the Federal Reserve System. Definition (debt-like, non-public instruments from non-bank lenders, mostly through funds and BDCs); nearly $1.7 trillion as of June 2023, direct lending about $800 billion or half; borrowers typically middle-market firms with $10 million to $1 billion of revenue; direct loans typically senior secured; about 15% hybrid loans, more junior; almost all floating rate; average maturity around five years, about 16% due in 2024; spreads above syndicated term loans; mean interest coverage about 2.0x vs 2.7x for leveraged loans (2023); default rates low vs syndicated loans through October 2023, not yet tested by a prolonged recession; post-default value around 33% vs 52% syndicated loans and 39% high-yield bonds (KBRA DLD); recent deals often without financial maintenance covenants (industry commentary); Form PF Q4 2021: pensions about 31% of private credit fund assets, other private funds 14%, insurers and individuals about 9% each; BDCs created by the Small Business Investment Incentive Act of 1980.
- Global Financial Stability Report, April 2024, Chapter 2: The Rise and Risks of Private Credit (executive summary), International Monetary Fund. Private credit has grown rapidly to provide long-term financing to middle-market firms, typically floating rate, to relatively small, highly leveraged borrowers; customised terms; banks less willing to lend to the middle market; semi-liquid funds could create first-mover and run risks; uncertainty about valuations and incentives to delay recognising losses.
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