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A rising variety of debtors are turning to payment-in-kind (PIK) loans for curiosity cost 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 permits a borrower to make curiosity funds in a type aside from money, similar to further debt or fairness, through the time period of the mortgage.
Learn extra: Alternative for personal credit score as LBO deal circulate picks up
“It’s important to grasp not simply whether or not a borrower has turned to PIK however why they’ve executed so, and whether or not the underlying enterprise remains 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 occasions of stress or once they can’t afford curiosity funds anymore.”
Whereas some PIK will not be a significant concern, it’s a development that Brookfield Oaktree recommends monitoring.
“When it takes the type of fairness, it may possibly dilute shareholder fairness,” the report mentioned. “The chance for lenders is that the accrued curiosity is rarely acquired. However, the upside for lenders is that PIK will increase the yield on a mortgage, doubtlessly boosting returns.
“Whereas some PIK is mostly not thought of to be a significant concern, it may possibly 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.”
Learn extra: Competitors intensifies between non-public credit score and syndicated loans
The report cited current analysis from S&P International Ranking that predicts that using PIK will enhance into subsequent yr as firms wrestle to maintain up with their debt obligations amid excessive charges. There may be additionally a considerable amount of debt that may must be refinanced within the subsequent few years
The Alts Market Dashboard highlighted that debtors could wrestle to search out financing by way of syndicated financial institution loans as a result of financial institution loans are largely bought into collateralised mortgage obligations (CLO). As CLO issuance declines, a rising variety of debtors are anticipated to look to personal credit score options.
“For buyers, the growing incidence of PIK is maybe greater than something a reminder of the significance of working with a personal credit score supervisor with a confirmed observe report of navigating financial cycles and being prudent about how and when to make use of a characteristic similar to PIK in a portfolio,” the report mentioned.
Learn extra: S&P: Rising defaults will check asset high quality of personal credit score funds
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