What about PIK?
PIK is a private credit market feature that has also attracted a fair degree of scrutiny. PIK refers to a provision in some private credit agreements that allows the borrower to defer cash interest payments, adding the interest to the outstanding principal. “We wanted to investigate this dynamic more closely,” says Rintamäki. “Is PIK an efficient liquidity management device or a method for postponing default?”
Rintamäki and Steffen’s BDC dataset includes quarterly loan balance data and detailed information on PIK usage. PIK, which appears in roughly 10% of the sample’s quarterly loan observations, takes one of two forms. PIK notes (or planned PIK) incorporate PIK interest from the outset, while a PIK toggle treats PIK as an option that a company can activate if need be.
Switching to PIK indicates that something is not going according to plan. Lenders must sit down with management to understand what went wrong and how to correct it.
Richard Miller, TCW
These two structures are associated with different outcomes. PIK notes were generally used by companies seeking liquidity to support their growth initiatives; PIK toggles (6% of the total sample or about 60% of PIK observations) were more linked to distress. The switch from cash interest to PIK, Rintamäki notes, “was associated with last-ditch efforts to obtain liquidity by any means available”, and strongly correlated with loans entering non-accrual status.
The authors find that activating a PIK toggle predicts a 26 to 29 percentage point increase in the likelihood of receiving maturity extensions compared with non-PIK loans. They also find a seven to 10 percentage point increase in debt-to-equity swaps, evidence consistent with delayed default recognition and forbearance.
PE protection
PE ownership, though, changes this dynamic. “In general, we find that using the PIK toggle doesn’t help the company recover and the likelihood of non-accrual keeps going up,” says Rintamäki. “But when the company has a PE sponsor, the performance deterioration after using the PIK toggle is much milder.”
This is consistent with PE sponsors’ willingness to intervene by injecting additional equity or restructuring the company, the paper says. “Switching to PIK indicates that something is not going according to plan,” says Miller. “Lenders must sit down with management to understand what went wrong and how to correct it.” Most frequently, he notes, the lender asks the owner to inject equity.
However, lender-borrower coordination is vital for resolving the situation that forced the use of PIK. “Just switching to PIK isn’t going to help the company,” says Miller. “You often need to change a company’s direction and should limit the time that PIK is allowed in order to assess the new strategy and determine if the remedy has been successful.”
