Rates, PIK and the Rise of Asset-Backed Finance - European Debt Markets

Key Takeaways

Three forces are shaping European financing conditions as we move into the final quarter of the year: policy rates and government borrowing costs turning higher after a period of expected easing; the quiet migration of PIK from a growth tool to a stress absorber; and the rapid scaling of asset-backed finance as private credit’s next chapter. In this update, Baird's European Debt Advisory team looks at what's driving these shifts and what borrowers and sponsors should watch as the year draws to a close.

1. Rates Turn Again – Lock Terms While They Last

With the near-zero rate environment of the pre-pandemic era now long in the past and the inflation-driven peak of 2024 also a distant memory, we had grown used to a world of more stable rates and an expectation of further easing to come. That is no longer where we are. On 10 September, the European Central Bank (ECB) raised all three key rates by 25bps, taking the deposit facility to 2.50% – its second hike of the year – and on 16 September, the Fed raised rates by 25bps, its first increase in three years. And while the Bank of England held rates at 3.75% in September, it has already signaled an increase at its next meeting.

More striking than the policy rates is what is happening to government borrowing costs, which the market determines. Long-dated U.K. gilts hit a 28-year high at the start of September and the 10-year reached 5.38% – its highest since July 2007. This is not peculiar to the U.K.: 30-year German yields are at their highest since 2009. To address this, alongside its decision to hold rates, the Bank of England announced plans to overhaul quantitative tightening by scrapping sales of long-dated gilts, and the long end rallied immediately.

After several years of a supply/demand imbalance pushing credit spreads ever tighter, the benefit to borrowers is starting to be undone by the rise in risk-free rates. And as higher rates reflect a higher-risk global backdrop, credit spreads may well start to widen again. Today, however, the market terms we are seeing remain tight, and borrowers are seeking to lock them in before they change.

2. Is PIK a Growth Tool or Stress Absorber?

European unitranche began life as a fully cash-pay product while payment-in-kind (PIK) meant a different instrument altogether. As the rate cycle changed, partial PIK toggles crept into unitranche structures, some even being invoked from day one when rates were at their highest. Today that is the norm, providing flexibility to help fund growth. The question now being asked is whether a tool designed to aid growth has begun to do a different job – absorbing stress before it becomes visible.

An increase in PIK usage across a lender's portfolio often signals that borrowers are struggling. The U.S. market can measure this because its semi-liquid vehicles report quarterly: One recent analysis of 168 business development companies (BDCs) found the share of loans using PIK interest rose from roughly 6% in 2022 to about 10% by early 2026 (Source: Federal Reserve Bank of Boston). The closed-end nature of most European funds means equivalent data is not available.

So, while headline default rates look positive, in a market of single-lender, bilaterally amendable credits, defaults are arguably discretionary. But how should we view that? A sole lender who knows the sponsor and expects to maintain the relationship has every incentive to propose the toggle itself, converting a liquidity problem into a maturity problem and working it through. That is likely a far better outcome for the borrower than the reflex reaction of the old bank market – deferring cash interest to protect an asset through a trough is what a patient lender is for.

The litmus test will be the ultimate recovery rates funds achieve. Funds need to find the right balance between managed flexibility and taking a hard line, and the state of the portfolio will be a key determinant. So, for borrowers, alongside day-one flexibility on terms, some knowledge of the lender’s portfolio matters more than ever.

3. Asset-Backed Finance: Private Credit's Next Chapter

Direct lending's first 15 years were built largely around cash flow structures, sized against EBITDA and repaid out of a refinancing or exit. But in a move that seeks to scale AUM for the credit funds, diversify existing LP exposure and draw new investors into private credit, asset-backed finance (ABF) strategies have grown significantly. Specialty finance strategies – of which generalist ABF is the largest single subset – raised a record $47.4bn across 28 funds in 2025, 72% more than was raised across 2023 and 2024 combined (Source: With Intelligence).

Private credit now accounts for 18-20% of LP private markets portfolios, but as the asset class expands, investors are not simply looking for more of the same. LPs are looking for increasing diversification and ABF helps provide it, offering a different set of return drivers and a different risk profile. Repayment can come from self-amortising pools of contractual assets rather than an individual borrower's ability to refinance, and that offers a different recovery profile from a cash  flow loan. Furthermore, asset-backed structures also allow managers to raise funds from insurers, for whom private credit has not to date been a good fit with their regulatory requirements.

For borrowers, the motivation is flexibility and cost, but the changing mindset of lenders also broadens the types of businesses private equity investors can target. In the past, more capital-intensive businesses simply presented a financing challenge for cash-flow lenders. A fresh approach to the asset base creates new opportunities across a broader range of distribution, equipment hire, logistics and manufacturing businesses. That is in addition to the more specialist asset classes the ABF market has already focused on, such as entertainment royalties, legal assets and healthcare receivables.

Where a borrowing base or a receivables book has traditionally been funded by a bank line or a private securitisation, there is now a growing and freshly motivated pool of private credit lenders willing to explore these structures. They will not compete directly on the low cost of those traditional routes, but the greater flexibility and, ultimately, leverage may well do the same for asset-based structures as the cashflow unitranche market has already done for mid-market LBOs.

Baird's European Debt Advisory team continues to advise borrowers and sponsors navigating this shifting landscape across rate, structure and asset class. Contact our team to discuss further and help navigate what comes next.