How Do You PIK?

We are sometimes asked whether financial professionals should be worried about the amount of payment-in-kind (“PIK”) debt being used in private credit portfolios. Our answer is “it depends,” and there is a second clarifier that is important to explain: “Which kind of PIK?”

What is PIK?

Instead of paying interest payments in cash, as is typical, the borrower may pay a portion of the interest payment in the form of more debt, typically at a higher interest rate, and in a senior priority position to the equity. As a result, the total amount of debt grows.

We generally view PIK in two buckets:

1. “PIK at Origination” is offered at the beginning of the loan term as an option and typically to fast-growing companies that are viewed as higher-quality borrowers. This option can allow the borrower to reinvest more cash back into future growth, particularly during periods of expansion. These arrangements can also occur during the life of the loan to support investment into new growth initiatives.
2. “PIK after Origination” or “Amendment PIK” is often offered as the result of a company struggling to make its agreed-upon payments. PIK debt may then be offered by the lender, often in conjunction with additional equity contributions by the sponsor, as a way to extend some runway or grace, with the view that the borrower can improve its financial position in time and make good on its backlog of interest owed.

In our view, PIK is misunderstood and is a tool that direct lenders can use to garner outsized returns by providing it selectively to higher-quality borrowers. When inquiring about various managers’ approach to PIK, it’s important to distinguish whether the PIK income is provided at origination to support growth or if the PIK is providing flexibility to an underperforming credit.

Disclosures:

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AccessAres is the thought-leadership and educational division of Ares Wealth Management Solutions. The materials distributed by AccessAres are for informational purposes only and do not constitute investment advice or a recommendation to buy, sell or hold any security, investment strategy or market sector. Ares Wealth Management Solutions is a global brand of Ares Management Corporation.

This information is for informational purposes only and is neither an offer to sell nor a solicitation to purchase any related securities. Investing in private markets investments involves a high degree of risk including, but not limited to, risk of substantial loss of principal. Direct investments in private companies and investments involve a high degree of business and financial risk that can result in substantial losses.

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