The relentless rise in PIK indicates trouble to come for the private markets

(Bloomberg) — A three-letter acronym is increasingly appearing in corporate filings and fueling concern among ratings companies and fund managers.

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Mentions of PIK in company filings, presentations and transcripts have doubled since the start of the pandemic, according to data compiled by Bloomberg. Short for “payment in kind,” the term refers to debt that allows companies the option to defer interest payments.

PIK bonds are often a hidden leverage effect for companies because the late interest is included in the principal owed. Debt has proven particularly attractive to private equity firms, which have been hit by lower valuations and higher borrowing costs after failing to hedge against the risk of rising interest rates.

While deferring interest payments for a few quarters can help avoid a short-term cash crunch, extended payment delays make it more difficult to refinance piles of debt. This, in turn, worries regulators, who worry about the ways in which private credit funds, which can be providers of PIK debt, could impact the financial system.

“Lenders have a number of ways they can mask liquidity challenges with their underlying borrowers,” said Ted McNulty, chief investment officer at MidCap Financial Investment Corp., a middle-market lender managed by an affiliate of Apollo Global Management Inc. ., call with analysts earlier this month. “Whether at origination or as part of restructuring, PIK income is an indicator for borrowers who are currently unable to service their debt.”

PIK accounts for 6.7% of private credit funds’ revenues today, up from 5.4% a year ago, according to Ana Arsov, global head of private credit at Moody’s Ratings, who added that it is not a sustainable strategy, because it creates a heavy permanent. debt structure.

PIK is “a way to buy time for distressed loans while they wait for rate cuts,” she said, adding that it “masks the performance of the funds for investors.”

Others say it’s important to look deeper and see what the loan plan is.

“You have to differentiate between the PIK that was intended at the outset and maybe the PIK that’s being used to reduce the default,” Michael Arougheti, chief executive at Ares Management Corp., said in a recent earnings call. “If you’re thinking about structuring your leverage prudently” and don’t want to constrain a company’s “growth plan,” then PIK is the way you’ll get your excess yield and support your borrowers.

The story continues

The number of documents mentioning PIK debt has increased by about 240% in the last five years among the filings, presentations and transcripts of business development companies. Prospect Capital Corp. stands out among them for using the term more than 400 times in documents, almost four times more than the second-placed one. One-third of the net investment income generated by the Prospect fund in 2023 was paid in kind, double the industry average, according to Fitch Ratings.

Prospect Capital did not return a request for comment Friday. But in a statement posted on its website last week, the firm said PIK “can be an effective financing mechanism” when “companies make incremental investments in their businesses at valuations substantially above the Prospect’s cost base.”

The week in review

• Equity and bond markets are sending mixed signals about the likelihood of a U.S. recession, leading some leading investors to say there is too much credit complacency.

• Bets on more interest rate cuts by major central banks are boosting the appeal of ultra-short commercial debt for some of the world’s biggest companies.

• China’s effort to stem a rise in government bonds is starting to have an impact on corporate debt markets.

• Mars Inc. lined up the largest debt financing for an M&A in nearly a year to help finance its $36 billion acquisition of Kellanova.

• KKR & Co. is in the early stages of financing plans to buy public relations firm FGS Global with about $500 million in debt from private lenders.

• Many investors were hurt by a slide in China’s equity-linked bonds, a market now gripped by default fears.

• Investors who bet billions on mortgage-backed bonds yielding more than investment-grade corporate debt have been waiting all year to get paid. Last week’s volatility crisis briefly vindicated their positions, and some see a complete victory not far off.

• Asian high-yield dollar bonds have room to recover even after earning more than double their global peers this year, money managers say.

• Moody’s downgraded China Vanke Co.’s debt rating. and further into junk territory, underscoring mounting pressure on the state-backed developer as it faces a cash crunch and falling sales.

• Billionaire Charles Koch’s close-knit company is taking advantage of individuals’ appetite for one of the riskiest corners of the loan market — CLO stocks.

• AT1s have seen an almost uninterrupted recovery from one of the most dramatic busts the credit market has ever seen. That left a yearning for more drama.

• Brightspeed from Apollo Global Management Inc. reached a deal with a group of creditors to reduce the telco’s debt by $1.1 billion and receive $3.7 billion in new capital.

• JetBlue Airways Corp. priced $2.77 billion in bonds and loans after the recently downgraded carrier restructured the deal in notes.

• Kroger Co. plans to seek investors for a possible multipart bond sale and has begun an exchange offer for debt issued by takeover target Albertsons Cos. as antitrust scrutiny looms over the potential tie-up.

In motion

• Dwight Scott, who helped transform Blackstone Inc.’s lending operation. in a $330 billion behemoth, is retiring from the firm.

• DWS, the asset management unit of Deutsche Bank AG, has hired Jay DeWaltoff, Daniel Sang, Catherine Millane and Khrystyna Bazylyak from JPMorgan’s asset management arm to help expand its US mortgage business and platform of private credit.

• KKR & Co. has appointed three executives to top management roles in its Global Atlantic insurance business. Billy Butcher, partner at KKR, has been tapped to be CFO of the insurance unit, while partners Brian Dillard and John Reed will serve as co-CIOs.

• Noel Heavey, National Bank of Canada’s co-head of fixed income sales and trading, has left the firm.

• Bank of America Corp. has appointed Lyndsay Langford as head of its Global Payments Solutions business in Canada.

• Securities Division of Mitsubishi UFJ Financial Group Inc. of Asia has hired Evren Cakirahmetoglu as head of Asia ex-Japan credit flow trading.

• Banco Bradesco SA, Brazil’s third-largest bank by market value, has hired Gabriel Trebilcock, one of the founding partners of hedge fund Ace Capital, to lead its local credit sales and trading office as the lender aims to double the business in two years.

• Alvarez & Marsal Inc. plans to expand its Australian workforce by more than half amid expectations that rising interest rates and subdued economic growth will push more companies into financial trouble.

• Bank of Nova Scotia has recruited a team of seven from JPMorgan Chase & Co. of Texas to launch a new mortgage capital markets venture in Houston. Thanh Roettele, who has worked at JPMorgan for over 28 years, will join as one of three managing directors on the new team. The other two are Brice Simpson and Francis Lim.

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