Payment-in-kind income increasingly higher for funds
Some direct lending funds are seeing an increasing portion of their income come from payment-in-kind (PIK) payments, experts say.
Ratings agency Fitch recently issued a report that showed that eight per cent of direct lending business development company income in the US was derived from PIK income.
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Principal Asset Management, in a subsequent study, found that an even higher percentage this year is from PIK income, “demonstrating this trend has only further increased this year,” Matthew Darrah, head of underwriting for direct lending at Principal Asset Management, told Alternative Credit Investor.
He pointed out that the increase in interest is due to two factors: legacy portfolio company issues that were levered to perfection prior to interest rate rises, and the increasing number of new platforms with PIK toggle transactions seen in the upper middle market, where lenders are offering higher leverage to compete against the reopened broadly syndicated market.
Read more: Brookfield Oaktree says payment-in-kind trend is “worth monitoring” for risks ahead
“This higher leverage can’t be supported if borrowers had to pay in cash, and so instead, those lenders have allowed for PIK,” he added.
In a high interest rate environment and with valuations facing downward pressure, he said the firm prefers to focus on the lower and core middle market, where PIK toggles are far less common and coupons are paid in cash.
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According to one investment banker, PIK elements have been narrowing but they are still more prevalent than before rate rises started. However, the banker noted that they are seeing lower spreads offered in the PIK realm.
The banker also reported instances of restructuring debt to PIK or introducing them during negotiations around covenants.
PIKs are also being introduced into the holding company’s balance sheet rather than that of the operating company.
