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FRM Part II · FRM Exam Part II · The Rise and Risks of Private Credit

A private credit manager amends a struggling borrower's loan to let it pay interest in kind (PIK) rather than cash, and keeps the loan marked at par. From a risk perspective, what is the main concern?

The main concern is masked credit deterioration. PIK lets a stressed borrower avoid a cash payment default while debt balances grow, and marking the loan at par delays loss recognition. Reported income and returns are overstated and the fund receives no extra cash, so liquidity does not improve.

  1. APIK amendments can mask deteriorating credit quality, delaying recognition of losses and overstating performanceCorrect
  2. BPIK interest eliminates the borrower's default risk
  3. CPIK increases the fund's cash liquidity immediately
  4. DPIK converts the loan into senior secured status

Explanation

PIK accrues interest to principal instead of paying cash, so a borrower under stress can avoid a payment default while its debt grows. Holding the loan at par can delay loss recognition and inflate reported returns. It does not add cash or improve seniority.

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