Are the Private Credit Markets Under Stress? PIK Usage & Covenant Erosion May Tell the Tale
Private credit may be entering its first significant stress test of the modern cycle. Our latest research suggests structural pressures have been building beneath the surface.
Data from Q4 2025 shows that 11% of borrowers paid interest in-kind, marking the third consecutive quarterly increase. More notably, 6.4% of all loans now carry “bad PIK,” nearly triple 2021 levels. These are situations where borrowers began deferring interest mid-loan due to liquidity constraints rather than at origination, often a signal of underlying strain.
At the same time, covenant protections have materially weakened. Approximately 70% of private credit issuance is covenant-lite, while more than 90% of the broadly syndicated leveraged loan market lacks traditional maintenance tests. The historical premium once paid for weaker protections has largely disappeared, leaving lenders with reduced safeguards and no additional compensation.
The interaction between rising PIK usage and covenant erosion is significant. PIK elections can temporarily relieve cash pressure, but they also increase leverage over time. Companies classified as bad PIK have seen loan-to-value ratios increase from approximately 39% at origination to 76% today. This deterioration has occurred alongside slowing EBITDA growth, limiting borrowers’ ability to deleverage organically.
Official private credit default rates have risen to 5.7%, up from near-zero levels in 2022. When combined with rising bad PIK activity, the data suggests that stress may be more widespread than headline figures imply. In prior cycles, maintenance covenants often served as early warning systems. In the current environment, those tripwires are less common.
Private credit expanded during a period of abundant liquidity, low rates, and limited defaults. The operating backdrop has shifted. Slower growth, sustained financing costs, and refinancing pressure over the next two years may test structures that have not previously been through a full credit cycle.
This report examines the convergence of PIK usage, covenant erosion, leverage trends, and recovery dynamics to assess whether current conditions represent a temporary dislocation or an early structural warning signal.
For allocators, the question is not whether private credit remains viable. It is whether underwriting discipline, structure, and manager selection will matter more in the next phase of the cycle than they did in the last.View Full Report