Private Credit: Evaluating PIK Optionality in CLOs

Elevated interest rates over the past several years have increased debt service pressure on leveraged corporate borrowers. Borrowers facing liquidity challenges have started deferring and capitalizing all or a portion of their interest payments, known as payment-in-kind (PIK) interest. Other borrowers with stronger credit fundamentals have proactively negotiated PIK optionality with lenders to enhance financial flexibility.

Direct lending financing structures—including collateralized loan obligations (CLO), credit facilities, rated feeder notes, and other corporate securitizations—face varying degrees of cash flow risk depending on the prevalence, magnitude, timing, and duration of interest deferrals within their collateral pools. KBRA has been monitoring these trends, particularly in private credit (PC) and middle market loan (MML) transactions, where we have observed an evolution in documentation, definitions, and concentration limits related to PIK loans.

This KBRA report discusses…