The unstoppable rise of the PIK points to impending problems for private markets

A three-letter acronym is appearing more and more frequently in corporate documents, causing concern among rating agencies and fund managers.

Mentions of PIK in corporate filings, presentations and transcripts have doubled since the start of the pandemic, according to data compiled by Bloomberg. The term stands for “payment in kind” and refers to debt that gives companies the ability to defer interest payments.

PIK debt often provides hidden leverage for companies by adding deferred interest to the principal due. The debt has proved particularly attractive to private equity firms, which have been hit by lower valuations and higher borrowing costs after largely failing to hedge against the risk of rising interest rates.

While deferring interest payments for a few quarters can help overcome short-term liquidity shortages, a longer delay in payments makes it harder to refinance the debt piles, which in turn worries regulators, who worry about how private lending funds that can provide PIK debt could affect the financial system.

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

According to Ana Arsov, head of private credit at Moody's Ratings, PIK currently accounts for 6.7 percent of private credit fund revenues, up from 5.4 percent a year ago. She added that this is not a sustainable strategy because it creates a permanently high debt structure.

PIK is “a way to buy time for non-performing loans while they wait for interest rate cuts,” she said, adding that it “camouflages fund performance from investors.”

Others believe that it is important to take a closer look and check what is planned with the loans.

“You have to distinguish between PIK that is intended from the start and PIK that is perhaps used to reduce delinquencies,” said Michael Arougheti, CEO of Ares Management Corp., on a recent conference call. “If you are thinking about structuring your debt prudently” and don't want to constrain a company's “growth plan,” then PIK is the way to generate additional returns and support your borrowers.”

The number of documents mentioning PIK debt has increased by about 240% in the filings, presentations and transcripts of business development firms over the past five years. Prospect Capital Corp. stands out among them, using the term over 400 times in documents, nearly four times as often as the runner-up. One-third of the net investment income the Prospect fund generated in 2023 was paid out in kind, double the industry average, according to Fitch Ratings.

Prospect Capital did not respond to a request for comment on Friday, but in a statement posted on the company's website last week, it said PIK “can be an efficient financing mechanism” when “companies make value-enhancing investments in their business at valuations significantly above Prospect's cost base.”

This article was generated from an automated news agency feed without any modifications.