Utilization of Payment-in-Kind Provisions in Private Credit

Highlights

• Recent media reports have highlighted the risks of increased utilization of PIK loans by private credit funds.

• According to Fitch Ratings, utilization of PIK surged in 2020 as companies sought to preserve liquidity in the midst of the COVID-19 pandemic and growing competition from the broadly syndicated loan market has played a part in the rise of PIK terms in loan agreements.

• On average across all non-traded BDCs currently covered on the Altidar platform, reported PIK income as a percentage of total investment income has increased from 5.9% in 2023 to 6.2% for the first half of 2024.

Private credit funds often hold investments in which all or a portion of the interest or dividend payment is in the form of the issuance of additional securities, known as payment-in-kind (“PIK”) interest or dividend. PIK provisions may be included in loan documents at origination, known as PIK at origination, or when a distressed borrower needs relief, known as PIK by amendment. Deferring cash interest payments for a period of time can help to temporarily alleviate borrower liquidity challenges; however, it reduces cash flow to the lender and the increased loan balance can make it more difficult for the borrower to refinance or repay the debt when it matures.

On August 6, 2024, Bloomberg reported that Prospect Capital Corporation (“PSEC”), a listed business development company (“BDC”) that is conducting a continuous offering of non-listed preferred stock, has attracted significant criticism recently from various analysts, and in particular, for potential risks posed by the fund’s utilization of PIK loans, which represented approximately one-third of its net investment income for 2023. The percentage of PSEC’s investments with the potential of PIK income was 31.3% as of June 30, 2024, up from 27.3% one year earlier. In a statement posted on its website, PSEC defended its use of such arrangements, stating “Prospect’s payment-in-kind interest can be an efficient funding mechanism for certain portfolio companies where such companies are making accretive investments in their business with valuations substantially above Prospect’s cost basis.”

PSEC is not alone in its increased utilization of PIK terms. Fitch Ratings notes that growing competition from the broadly syndicated loan market has played a part in the rise of PIK terms in loan agreements, which are increasingly being used as private lenders compete for transactions. Utilization of PIK surged in 2020 as companies sought to preserve liquidity in the midst of the COVID-19 pandemic, a trend that has continued in subsequent years. According to Bloomberg, PIK fell out of favor during the years following the global financial crisis due to the lower costs and wide availability of debt; however, the higher rate environment has played a role in driving this trend, as the elevated interest rates have left a growing number of companies struggling to accumulate interest paid-in-kind in lieu of cash payments. The graph below presents PIK income: (i) as a percentage of total interest and dividend income, based on a survey of BDCs rated by Fitch; and (ii) as a percentage of total investment income for all non-traded BDCs currently covered on the Altidar platform:

NOTE: In certain instances, we have included figures reported in a fund’s statement of cash flows when PIK income is not reported in the statement of operations or the accompanying notes. Amounts reported in the statement of cash flow may not be consistent with amounts that would have been included in the statement of operations if required.

According to a survey conducted by Bloomberg, references to PIK in company filings and presentations have doubled since the onset of the COVID-19 pandemic; among BDCs over the past half-decade, the number of mentions rose about 240%. The average percentage of portfolio investments that have the potential for PIK income was 11.8% as of June 30, 2024 for all non-traded BDCs covered on Altidar, an increase from 11.3% one year prior. Additionally, the average percentage for potential PIK income was 14.8% on a weighted basis as of June 30, 2024, an increase of 130 basis points from one year earlier. The graph below illustrates the percentage of the portfolio (by fair value) that has the potential of PIK income as of June 30, 2024 and June 30, 2023 for all non-traded BDCs covered on Altidar:

The graph below illustrates reported PIK income as a percentage of total investment income for the six months ended June 30, 2024 and the year ended December 31, 2023; the average percentage has increased from 5.9% in 2023 to 6.2% for the first half of 2024:

(1) We have included figures reported in the fund’s statement of cash flows when PIK income is not reported in the statement of operations or the accompanying notes. Amounts reported in the statement of cash flow may not be consistent with amounts that would have been included in the statement of operations if required.

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Sources

• SEC Company Filings for:

  • Apollo Debt Solutions BDC

  • BlackRock Private Credit Fund

  • Blue Owl Capital Corporation II

  • Blue Owl Credit Income Corp.

  • Blue Owl Technology Finance Corp.

  • Blue Owl Technology Income Corp.

  • FS Specialty Lending Fund

  • Hancock Park Corporate Income, Inc.

  • HPS Corporate Lending Fund

  • Kennedy Lewis Capital Company

  • MSC Income Fund, Inc.

  • NexPoint Capital, Inc.

  • Nuveen Churchill Private Capital Income Fund

  • Oaktree Strategic Credit Fund

  • Prospect Capital Corporation

  • Steele Creek Capital Corporation

  • T. Rowe Price OHA Select Private Credit Fund

• Bloomberg.com, The Relentless Rise of PIK Hints at Trouble to Come for Private Markets

• Bloomberg.com, Why ‘Payment-In-Kind’ Debt Is So Appealing — and Risky

• Bloomberg.com, Private Credit Fund Burned by Risky Bets Is Bleeding Cash

• Bloomberg.com, Prospect Capital Defends Record, Says It Has Access to Funding

• FitchRatings.com, BDC Cash Income Dividend Coverage Pressured by Payment-in-Kind Income

• FitchRatings.com, Rising Payment-in-Kind Trends in Private Credit Will Have a Mixed Impact

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