Global Direct Lending Stress Monitor FY’25: PIKing the Can: How ‘Buying Time’ Is Stalling More Comprehensive Restructurings

Relevant Items:
BDC News & Analysis
BDC Stressed Watchlist
PCDO Dashboard

Concerns around stress in private credit have been on the rise on both sides of the Atlantic in 2025. JPMorgan’s Jamie Dimon and the regulators at the Bank of England have been some of the most outspoken among the concerned, generating headlines about “cockroaches” and the need for stress tests.

But looking closely at the data and speaking to people involved in the industry reveals a slightly different picture. Default rates have remained low and discussions between sponsors and lenders around underperformance have on the whole remained constructive.

However, the increase in the utilization of PIK-toggle across European private credit portfolios was evident in Lincoln’s third-quarter data and in the U.S., Octus data for third quarter shows that business development companies, or BDCs, reported an increase in nonaccrual debt. Whether this is an early warning sign for a coming wave of defaults or the flexibility of private credit deals working as intended depends on who you ask, but as Ares co-head of European private credit Mike Dennis said, “In instances where a manager needs to support challenged companies, it has become apparent how important it is to have strong and deep portfolio management capabilities.”

America’s Middle Market Plays Waiting Game

While megadeals are getting signed and closed in the fourth quarter this year, the middle market segment continues to suffer from a sluggish M&A cycle and limited exits. Subsequently, direct lenders this year were seen searching for creative solutions for troubled credits and dated funds nearing the end of their investment period.

Octus reported this month that BDCs reported a 12% rise in nonaccrual debt from the second quarter to the third quarter of 2025, totaling $6.72 billion at cost. The information technology sector led the pack in nonaccruals based on total loans. However, companies in the consumer discretionary sector had both the highest share of loan principal in nonaccrual status and also saw the largest sequential increase in the third quarter.

Nonaccruals proved to be a good early indicator of distressed activity in private credit as 17% and 15% of debt that was in nonaccrual status in the first and second quarters, respectively, restructured in the subsequent quarter. As a percent of total debt held by BDCs, nonaccruals represented about 1.5%, just shy of the 1.84% default rate in the third quarter calculated by Proskauer.

“Fundamentally, many middle-market companies that were acquired by private equity in 2021 or 2022 have not met expectations from a financial performance perspective. At the same time, valuation multiples have compressed in many sectors,” said Joseph Weissglass, managing director at Configure Partners. “As a result, sponsors are not ready to exit these businesses.”

In lieu of exits and in light of stressed credits, sources report an uptick in restructuring and debt-for-equity transactions. However, others point out that restructurings are often consensual and feature both contributions from sponsors and concessions from lenders.

More than half of the loans that either restructured, sold at distressed levels or liquidated in the third quarter, restructured out of court, taking the form of debt-for-equity exchanges or maturity extensions.

That represented an increase from the second quarter.

“The recent increase in debt-for-equity swaps is oftentimes consensual and constructive and handled efficiently, often out of court,” said Jennifer Daly, Chair of Private Credit and Special Situations at Paul Hastings, adding the consensual nature speaks to the resiliency of the asset class and its partnership with private equity firms. “I expect that trend to continue as we remain in a volatile environment.”

One advisor said he has seen a record-high volume of debt-for-equity transactions this year.

A number of recent restructurings first started with failed auctions as sponsors and lenders test value for assets in the market. A typical restructuring process begins with lenders and sponsors finding aimable, one-to-one contribution solutions to improve access to cash, per sources experienced in these proceedings. In the event the sponsor is unwilling to provide financing, the next step is an attempted asset sale or using PIK facilities. Only once those options are exhausted do lenders consider a debt-for-equity swap, sources added.

Some sources said this phenomenon could be explained in PIK loans and amend-and-extend solutions that “kick the can down the road.” Such solutions could “cover up cracks,” said one source, noting lenders are staffing up their restructuring teams and workout capabilities, as reported.

Lenders took control of active lifestyle brand Implus Corp. in the second quarter via a debt-for-equity exchange resulting in a 68% reduction in principal and a reported recovery for lenders via debt and equity of 65% on original principal. In November 2024, Octus reported that former sponsor Berkshire Partners was shopping Implus via a sales process through William Blair.

Similarly, Webster-backed BayMark Health turned to restructuring advisors after the operator of substance abuse treatment centers engaged with Jefferies to launch an auction process.

A common question is whether lenders are equipped to own and manage a distressed investment through a cycle. Many recent restructurings were in companies previously restructured.

HomeRenew, a direct-to-home remodeling company, liquidated in November, shortly after lenders took control of the company in the second quarter via a debt-for-equity exchange.

Kellermeyer Bergensons Services, a facility management services company, needed rescue financing one year after undergoing a debt-for-equity restructuring. In the third quarter, Ares Capital Corp. lowered the fair value on its first lien loan to 28% of par as of Sept. 30, down from 55% as of June 30.

The Jordan Company’s Production Resource Group restructured once in 2020 and again this year in a debt-for-equity transaction that gave ownership to its creditors, Ares and FS KKR Capital Corp.

This year, private lenders extended debt runways for the largest Amazon third-party aggregators Thrasio, Razor Group and SellerX – the latter of which scored a restructuring deal with lenders-turned-owners BlackRock and Victory Park Capital after its auction process was canceled last minute. Thrasio emerged from chapter 11 in June last year handing control of the company to lenders. However, loans were again put on nonaccrual status indicating potential stress. Many of these companies were formed via rollups of existing brands selling on Amazon or other ecommerce sites and ran into trouble as these businesses have matured leading to further consolidation as operators look to cut costs. Razor Group merged with other aggregator Infinite Commerce in the third quarter, which included a distressed exchange into debt and equity of the combined company.

Other recent popular rollup strategies could face uncertainty as operators face unexpectedly higher costs or have experienced customer flight post combinations. Two strategies in particular, rollup of veterinary practices and dental service organizations, have seen the fair value of debt of certain companies held by BDCs written down in recent quarters. Ares Capital Corp. lowered the fair value of its holdings in widely held PetVet Care Centers to 88% of par as of Sept. 30 in the face of lower industry vet visits.

Additionally, a number of dental practices have seen fair values of their debt written down including Smile Brands, Dental Care Alliance, 123Dentist, Vardiman Black and Absolute Dental Group, according to Octus’ BDC Database.

Interestingly, Proskauer’s Private Credit Default Index reports that both the middle and lower-middle markets saw slight decreases in default rates in the third quarter of 2025, down by 0.3% and 0.2%, respectively, with the largest improvement seen in the mid-tier sector of private credit, as measured by EBITDA.

For similar reasons, consolidation among smaller-sized BDCs is expected if they struggle to reposition their portfolios or sell undesirable credits at a price attractive for shareholders.

To raise liquidity, New Mountain Finance Corp. made headlines when it announced a block sale to reduce PIK exposure, valued at $500 million. NMFC is working with Evercore to sell 17 middle-market credits with PIK, Octus reported.

“Smaller BDCs could struggle relative to larger peers because they may not have the same levers to pull that larger BDCs do in terms of broad access to capital markets and managing their portfolios,” said legal counsel Peter Williams, co-head of Cahill’s private credit practice. “BDCs need cash income to service their debt and maintain their dividends. Performance hiccups and increasing non-accruals, if combined with higher financing costs, could bring choppy waters.”

To that end, on Aug. 7, Monroe Capital Corp. and Horizon Technology Finance Corp. entered into a merger agreement highlighting key benefits to include greater access to capital and lower per share operating costs. Additionally, the greater liquidity of the combined company’s stock could provide access to a broader investor base.

Similarly, on Nov. 5, Blue Owl Capital Corp. announced a proposed merger with Blue Owl Capital Corp. II stating that the combined company was expected to be rated investment-grade by four separate ratings agencies and that the rationale for the transaction is to expand the investment book, as larger BDCs have enhanced trading liquidity, which will allow for a broader investor base. However, public scrutiny over the equity exchange ratios built into the merger agreement led the companies to terminate the merger.

Meanwhile, private credit continuation vehicles, or CVs, are on the rise to extend life to direct lending funds with older vintages. Financial advisor PJT Partners, for example, is working with Ares Senior Direct Lending I (2018 vintage) and Ares Private Credit Solutions I (2017 vintage) to market billion-dollar-plus CVs. AEA Middle Market Debt Fund III, a 2016 vintage, closed a roughly $550 million CV in October.

“We’ll see CVs rise, but it’s hard because older credit vintages that you’re trying to continue could have underperforming assets that are difficult to underwrite,” Williams said. “But CV investors that are willing to do the diligence could find opportunities others have passed on.”

Europe at Inflection Point?

Despite a string of high-profile debt-for-equity swaps involving direct lenders in Europe this year, the overall default rate has remained low. “The default rate has remained below 2% in private credit,” said Alvarez & Marsal’s Richard Olson. “There was an initial spike when rates went up but we’re back below 2% and although we do seem to be at an inflection point now where things are starting to tick up, it’s still in a relatively benign state.”

Talk of an inflection point has been triggered by several concerning data points. Lincoln International reported that 17% of private credit-backed companies in its index now have some form of PIK interest across their senior debt facilities in the most recent quarter, this was up from 15.5% in the preceding period.

Additionally, the Lincoln data shows that private credit-backed companies with less than 10% covenant headroom are increasing (10% in 2024, 15% in 2025). Lincoln said that many of the companies in this cohort are from the sub €10 million EBITDA category. Part of the reason for this could be that leverage covenants tend to be set tighter in this part of the market and would typically step down through the life of the loan, whereas for larger deals cov-lite or deals with flat leverage covenants are more common.

Nonetheless, direct lenders are paying more attention to their portfolios and many have now hired professionals with a restructuring background to support their investment teams.

Bain Capital’s Tom Maughan explained how his team takes a proactive approach to managing the credit portfolio by taking board seats, for example, to exert more influence and occasionally enlisting support from their private equity colleagues. “We are board observers of a German cybersecurity company where they were looking to invest in their sales force with a view to growing revenue in a new geography. They took on the cost of the sales force but revenue didn’t come in as fast or as much as they wanted in that timeframe,” said Maughan.

“As board observers, we voiced our concerns that we thought that their liquidity would be tight and they should look at liquidity management ideas, such as cost cutting. This was a German management team and they were offended that we suggested they didn’t know how to do cost cutting or weren’t thinking about it, but nonetheless, we got a cost cutting professional from our Bain Capital private equity ops team who we’d worked with before internally, put them in touch with the management team. They came up with a 25 line item plan to cut costs and ended up finding tremendous value. Almost half of the EBITDA was found in extra cost cuts and now the management team like that idea.”

Where situations do deteriorate though, direct lenders have on the whole shown willingness to offer maturity extensions and PIK-toggle, often in exchange for an equity injection from the sponsor and as a last resort to take equity in exchange for debt reduction.

However, one debt advisor speaking to Octus said that private credit fund vintage is increasingly becoming a factor in refinancing or amend-and-extend discussions. “Some direct lenders cannot extend beyond the life of their funds. This is complicating situations where there are 3-4 funds and 1-2 cannot comply due to their rules,” he said.

“Another complication is that often the loan is nominally with one direct lender – but it is spread across their funds, which all have different lives, and some may be strategic management accounts with LPs, which may breach the terms of their investment,” he added.

A continuation vehicle potentially offers a neat solution to this, where transferring to the latest fund could be difficult, especially if there’s been some underperformance or complications. “We also see more continuation vehicles on the debt side as more capital has been raised around this strategy. The LP attraction is that they’re not getting liquidity from the PE strategy and want a steady stream of dependable near term cash distributions,” said A&M’s Olson, adding that “private credit continuation vehicles provide another intermediate liquidity measure, both for the exiting LPs but also steady cash distributions for investors in those strategies.”

To access the remainder of this story, please reach out to [email protected]

Disclosure: Funds associated with Permira hold a majority interest in the parent company of Octus.