PE-Backed Firms Leaning On PIK Toggles
A number of PE-backed companies have triggered PIK options to meet interest payments, according to Moody's Investors Service.
November 11, 2008
Several corporations, many of them private equity-backed, have triggered payment-in-kind (PIK) options in the last 60 days to meet their interest payments, according to a new report from Moody’s Investors Service.
At least 11 high-yield issuers have elected to meet interest payments in the last two months by exercising the PIK option, which essentially allows a company to meet its obligations with debt instead of cash, according to Moody's.
Six portfolio holdings of Apollo Management opted to use the PIK option: Berry Plastics Group, Claire’s Stores, Harrah’s Operating Co., Metals USA Holdings, Momentive Performance and Realogy Corp. Other buyout firm portfolio companies include Avista Capital Partners’ WideOpen West Finance, Crestview Partners’ Symbion and Welsh Carson Anderson & Stowe’s US Oncology Holdings, according to Moody’s.
Moody's report noted that debt with PIK options symbolizes the exuberant nature of the debt markets before the credit crisis took hold.
The PIK issuances—readily embraced by investors from 2005 to 2007—are thought to provide issuers with more flexibility since interest payments can be made by increasing the size of the principal on the notes, or a combination of cash and PIK interest for a specified term. “Some investors would argue that the PIK feature would give them additional flexibility, it might delay the point at which companies would default,” said Steve Oman, an analyst and senior vice president at Moody’s.
Of course, the PIK also allows the investor to make a normal cash payment on interest due. A company that opts for a PIK toggle note issuance, though, generally pays a higher interest rate. From 2005 to 2007, these issuers generally paid 75 basis points more on the debt they issued, Moody’s found.
In researching PIK toggle note issuers, the credit rating agency discovered that these companies had lower corporate ratings than non-PIK issuers.
It also noted that the lower ratings could be attributed to leveraged buyouts or dividend recapitalizations carried out by the businesses’ private equity investors. Additionally, negative rating actions, which means either a downgrade or change in corporate outlook to negative followed or pre-dated the PIK election for seven issuers in the last six months.
Moody’s states that it’s not surprising some companies have sought to use the PIK function in light of the credit crunch, and those that do so would be expected to have weak liquidity as well as exhibit credit stress. Moreover, the number of companies that use their PIK option is expected to increase over the next year as the economic downturn causes cash flow to decline and tougher credit conditions make it difficult to refinance long-term debt or amend existing credit lines.
For more information on related topics, visit the following:
