A rising variety of debtors are turning to payment-in-kind (PIK) loans for curiosity fee flexibility as charges stay excessive, in accordance with Brookfield Oaktree.
The asset supervisor’s newest quarterly Alts Market Dashboard highlighted the phenomenon among the many prime themes of the primary quarter of 2024.
PIK allows a borrower to make curiosity funds in a type aside from money, reminiscent of further debt or fairness, through the time period of the mortgage.
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“It’s important to know not simply whether or not a borrower has turned to PIK however why they’ve finished so, and whether or not the underlying enterprise continues to be sound,” the report mentioned.
“For instance, some debtors use PIK from the purpose of mortgage origination when they’re first pursuing financing for his or her operations and the underlying enterprise mannequin is nonetheless wholesome. Others flip to it as an modification to the settlement through the lifetime of the mortgage in instances of stress or once they can’t afford curiosity funds anymore.”
Whereas some PIK shouldn’t be a serious concern, it’s a development that Brookfield Oaktree recommends monitoring.
“When it takes the type of fairness, it may dilute shareholder fairness,” the report mentioned. “The chance for lenders is that the accrued curiosity is rarely obtained. Then again, the upside for lenders is that PIK will increase the yield on a mortgage, probably boosting returns.
“Whereas some PIK is mostly not thought-about to be a serious concern, it may add to the potential riskiness of the mortgage by growing the debt load. As such, it stays a development price monitoring as a result of it may be one indicator of potential portfolio points forward.”
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The report cited current analysis from S&P World Ranking that predicts that using PIK will improve into subsequent yr as firms wrestle to maintain up with their debt obligations amid excessive charges. There’s additionally a considerable amount of debt that can should be refinanced within the subsequent few years
The Alts Market Dashboard highlighted that debtors might wrestle to seek out financing by way of syndicated financial institution loans as a result of financial institution loans are largely offered into collateralised mortgage obligations (CLO). As CLO issuance declines, a rising variety of debtors are anticipated to look to personal credit score options.
“For traders, the growing incidence of PIK is maybe greater than something a reminder of the significance of working with a non-public credit score supervisor with a confirmed monitor file of navigating financial cycles and being prudent about how and when to make use of a characteristic reminiscent of PIK in a portfolio,” the report mentioned.
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