Private credit lenders are increasingly negotiating deferred-payment terms and covenant changes with individual borrowers to forestall defaults and limit visible losses on their loan books. The tactic, centered on payment-in-kind, or PIK, provisions, has gained traction as the market that funds smaller enterprises through business development companies (BDCs) confronts rising stress.
PIK mechanics allow a borrower to delay cash interest payments and instead capitalize those amounts by adding them to the loan principal. Lenders and analysts say the practice is being used more often right now as BDCs and many of the software companies that make up a substantial share of their loan portfolios struggle under several simultaneous pressures.
Some of the sector's largest BDCs, including Ares Strategic Income Fund, Apollo Debt Solutions and BlackRock’s HPS Corporate Lending Fund, have faced sharp redemption requests from investors. That investor pullback has coincided with concerns around opacity and credit quality in private credit strategies, contributing to decisions by some funds to limit withdrawals by gating redemptions.
The borrowers most affected are often software companies that raised significant private debt during the low-rate period of 2020-2021. These companies are now contending with strained profitability, falling equity values, looming loan maturities and competitive disruption from emerging technologies. In response, BDCs appear to be creating more flexibility in loan terms to avoid recording non-performing loans, or non-accruals, which would force markdowns and disclosures to investors.
Analysts at Houlihan Lokey estimate that by the end of 2025 more than a third of private credit agreements to software borrowers included an option to switch to a PIK structure, a roughly three-fold increase over three years. Despite the rising presence of the PIK option in loan docs, Houlihan Lokey's analysis shows that only a relatively small share of borrowers who have that option have actually elected to use it - just over 5% at the end of 2025.
Oxford Economics has estimated that PIK arrangements now account for more than 20% of BDCs’ net investment income, with roughly half of those PIK-related contributions concentrated in the technology sector. That dynamic, the analysis warns, could lead to additional leverage in the sector as BDCs borrow to meet obligations tied to debt and dividend distributions.
Market participants quoted in industry analysis describe a clear incentive for lenders to postpone strict remedies. Robert Cohen, director of global developed credit at DoubleLine Capital, said lenders are motivated to give borrowers flexibility rather than trigger covenant defaults that would likely require disclosures, loan markdowns and potentially forcing remedial action.
Varkki Chacko, managing principal at Credit Capital Investments, noted that investors agreeing to PIK arrangements may be anticipating a future surge in cash flows - a so-called hockey-stick recovery - that would eventually allow borrowers to resume traditional debt servicing.
Data provider SOLVE Fixed Income looked at 167 BDCs and found that roughly one-fifth of BDC loans were tied to software companies as of the third quarter of 2025. According to BDC regulatory filings cited by market observers, that exposure appears to have increased slightly in the fourth quarter of 2025.
On the covenant front, lenders have also moved to amend loan terms to reduce the risk of technical defaults. Saumil Annegiri, co-founder of CredCore, a platform that scrapes loan agreements for covenant language on behalf of lenders and borrowers, said software services companies have been failing to meet loan obligations. To reduce default risk, lenders have sought to avoid converting covenants from revenue-based to earnings-based metrics.
Despite the growing presence of PIK options in loan agreements, industry advisers caution that the actual conversion rate remains modest so far. Chris Cessna, an adviser in Houlihan Lokey’s financial and valuation advisory business, said if a broad group of borrowers faced simultaneous liquidity constraints, the share of loans switching to PIK could rise sharply as multiple borrowers choose to exercise the option.
In investor communications and marketing material referenced by market participants, questions have surfaced about whether particular funds remain attractive. One example cited in filings and investor outreach is ARES, which has been highlighted in third-party product analyses that assess stocks using multiple financial metrics and artificial intelligence-driven strategies. Such promotions underscore the ongoing focus from both investors and fund managers on assessing risk-reward across BDC portfolios while navigating heightened redemption pressure.
For now, the signs point to a sector that is delaying some of the immediate pain associated with stressed credits by expanding contractual flexibility. Whether that approach simply puts off recognition of losses or helps stabilise borrowers until cash flow improves will depend on developments in the software sector and the choices of borrowers and lenders in the months ahead.
Summary: Private credit lenders, particularly BDCs, are increasingly using payment-in-kind provisions and covenant amendments to let distressed software borrowers defer cash payments and avoid technical defaults. That strategy aims to limit non-accruals and portfolio markdowns amid heavy investor redemptions, even as only a small share of eligible loans have converted to PIK so far. Analysts warn the approach could lead to more leverage and greater risk concentration if pressures persist.