PIK, the quick fix that stirs controversy

Seen by some as a useful liquidity tool and by others as a disguiser of stress, payment-in-kind has become one of today’s big talking points.

Expert analysis by Andy Thomson

“Financial duct tape” is how Siddharth Chakravarty of insurer Coaction Specialty imaginatively described payment-in-kind during a Private Debt Investor Network webinar this week. “It doesn’t solve the leak. It doesn’t solve the plumbing,” said Chakravarty. “It just fixes things for the time being.”

As described by our colleagues on Private Equity International in their Friday Letter [registration required] last week, PIK enables portfolio companies to add their interest to the principal, rather than being serviced quarterly. The idea is to provide breathing room for businesses with short-term cashflow problems. The tool has proved controversial, with some believing it signals health problems in the asset and is, in essence, kicking the can down the road.

There are concerns that private equity sponsors – frequently lauded for their proactive stance when market conditions become more challenging – are starting to lose patience, exhibiting “fatigue over supporting these companies for the last four years, concern about investing good money after bad… or the unavailability of capital due to the fund’s life cycle”, according to Lincoln International’s Q2 Lincoln Private Market Index.

Some may see the use of PIK as a kind of last resort measure, keeping the wolves from the door but lacking genuine creativity in seeking to address underlying issues.

In the webinar, Chakravarty said that – for the time being – PIK usage is mostly found in the broadly syndicated loan market, where covenants tend to be looser than in private debt. However, he added that PIK has become more common in the business development company market – a kind of public market proxy within private debt – and wondered whether the trend would also seep into mainstream private debt.

On the same webinar, Clark Hoover, who oversees private credit for the Los Angeles City Employees’ Retirement System, said some documentation is explicit about the potential use of PIK as a liquidity management tool – enabling continuing growth of a business when trading conditions become more challenging. This is so-called ‘good’ PIK.

And then there’s the other kind: the ‘bad’ PIK that’s not mentioned in the documents but is reached for as a panic measure when a business is in trouble and can’t cover its interest payments. This is not yet a widespread feature of private debt. Investors presumably hope it never will be.

Write to the author at andy.t@pei.group

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