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A three letter acronym is increasingly cropping up in corporate filings and it\u2019s fueling concern among ratings companies and fund managers.<\/p>\n
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 \u2018payment in kind<\/a>,\u2019 the term refers to debt that allows companies the option of deferring interest payments.\u00a0<\/p>\n PIK obligations often amount to hidden leverage for companies, as delayed interest gets tacked on to principal due. The debt has proven particularly attractive to private equity firms, who have been hit by lower valuations and higher borrowing costs after largely failing to hedge against the risk of rising interest rates.\u00a0<\/p>\n While deferring interest payments for a couple of quarters can help sidestep short-term cash squeezes, extended delays of payments makes it harder to refinance debt piles. That, in turn, is\u00a0worrying regulators<\/a>, who\u00a0fret<\/a>\u00a0about the ways in which private credit funds, which can be providers of PIK debt, could impact the financial system.<\/p>\n \u201cLenders have a number of ways they can mask liquidity challenges with their underlying borrowers,\u201d said Ted McNulty, chief investment officer at MidCap Financial Investment Corp., a middle-market lender managed by an affiliate of Apollo Global Management<\/a> Inc., on a call with analysts earlier this month. \u201cWhether at origination or as part of the restructuring, PIK income is a proxy for borrowers who cannot currently service their debt.\u201d<\/p>\n PIK makes up 6.7% of income among private credit funds at present, up from 5.4% a year ago, according to Ana Arsov, global head of private credit at Moody\u2019s Ratings, who added that it\u2019s not a sustainable strategy because it creates a permanently heavy debt structure.<\/p>\n PIK is a \u201ca way of buying time for distressed credits as they await rate cuts,\u201d she said, adding it \u201cmasquerades fund performance for investors.\u201d<\/p>\n Others say that it\u2019s important to look deeper and see what the plan is for the borrowings.<\/p>\n \u201cYou have to differentiate between PIK that is intentional at the outset versus maybe PIK that is used to reduce default,\u201d Michael Arougheti, chief executive at Ares Management<\/a> Corp., said in a recent earnings call. \u201cIf you are thinking about prudently structuring your leverage\u201d and don\u2019t want to constrain a company\u2019s \u201cgrowth plan, then PIK is the way that you are going to capture excess return and support your borrowers.\u201d<\/p>\n The number of documents mentioning PIK debt rose about 240% over the last five years among business development companies\u2019 filings, presentations and transcripts. Prospect Capital Corp. stands out among them for using the term over 400 times in documents, almost four times as much as the second-ranked. One-third of the net investment income the Prospect fund generated in 2023 was paid in kind, double the industry average, according to Fitch Ratings.<\/p>\n Prospect Capital didn\u2019t return a request for comment on Friday. But in a statement posted on its website\u00a0last week<\/a>, the firm said PIK \u201ccan be an efficient funding mechanism\u201d when \u201ccompanies are making accretive investments in their business with valuations substantially above Prospect\u2019s cost basis.\u201d\u00a0<\/p>\n What to Watch<\/strong><\/p>\n Week in Review<\/strong><\/p>\n On the Move<\/strong><\/p>\n\n
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