What is Synthetic PIK???
Can someone pls explain how this works? Isn’t creating more debt that is interest basically PIK in the first place? How does rhe lender get comfy here?
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I guess it's just legalese to say your interest coverage ratio is better than it is?
Perhaps a company could use this “synthetic PIK” to improve the interest coverage ratio (as you are saying), for the purposes of fooling lenders into supplying said company with even more debt.
This isn’t fooling lenders. It an option in the credit agreements. Lender have to approve it
This type of PIK is where instead of paying the interest each quarter in cash it just accrues (each payment frequency) to the total principal amount due at maturity. It can be used in direct lending when a company can’t or doesn’t want to pay interest for a certain period of time.
How is this different to normal PIK?
I was about to say bro literally said the definition of PIK
Maybe it doesn’t compound? Like accrued simple interest?
You just described PIK
I could be mistaken but believe synthetic PIK is not recorded on the BS and there is a separate loan to cover the interest payments.
How would you have a separate loan but no BS impact...
Fugazi
I could be wrong, but I think they're just trying to highlight the debut of hybrid facilities that look like a combination of a traditional term loan (for companies with FCF/cash balance to service debt) and a PIK facility (which would be more common for venture or earlier stage companies with limited cash flow).
These hybrid term loans allow you to (i) split interest payments between cash and PIK pay (usually at a few pts of incremental interest, e.g., +2.5%), and (ii) change your elections as the facility matures (e.g., start out with PIK pay for first few quarters, then flip over to cash pay once FCF increases).
I'll agree perhaps there's nuances to the covenants (interest coverage, leverage ratio, etc.) and how the accrued interest is treated, but those would all be negotiating points.
If this is a correct description it’s not really new, we did a deal with this structure from Carlyle in 2020. Doesn’t really feel like it deserves a Bloomberg article…
Hey, its intern season, you have to let them do something
Ty
I’m not familiar with the term but my read is that it looks and feels the same as a normal PIK Loan but the interest is recorded on the BS as a separate liability rather than additional debt principal to avoid penalizing your leverage ratio with the accrued PIK.
Xx
This makes a lot more sense. Looks like cash pay to the TL vehicles too so probably better for IRR for the PC firms to market vs. a compounding PIK? A bit pyramid schemey but neat solution for everyone.
Yes this it. Not sure I understand how this boosts the IRR though. Yes it probably boosts the one on your main TL but aren't taking a hit on the DDTL?
Right, potentially dumb question but would the DDTL be cash interest? Would it just be smaller notional amount so the interest burden is less? I guess I’m thinking of it almost like a revolver strictly used to pay interest on one piece of debt in the stack, which I’m assuming would all be laid out in credit doc?
My impression of how the PC firms I've seen operate is they have multiple different funds in each. So for example the TL may be funded by Fund III but the DDTL is backed by Fund IV. So Fund III gets cash pay (improving its IRR vs. PIKing that interest) and Fund IV gets deployed w/ the expectation of receiving cash pay later. Theoretically you can keep rolling this into different funds which is how it can start to look like a pyramid scheme if the music stops & Fund X is left holding the bag while the rest of your funds have had great performance.
If I understand correctly, your TL / DDTL / Revolver funds may all have different investor bases too so your TL investors are looking for "steady" repayments while your DDTL investors want shorter term opportunistic deployments.
Additional potential benefit to lenders is earning fees on both the original $100m, plus any additional capital deployed through the DDTL.
Typically don't get to charge fees on accrued PIK interest.
I would have to imagine once you factor in undrawn fees and closing fees/OID on the DDTL this nets out poorly for the borrow or am I missing smthg here
Probably to help the loans still get marked at par by valuation firms. I’m interested to see how to this plays out.
THIS. And the comment above regarding DDTL draws to pay the cash interest is the correct definition of "synthetic PIK" in PC context.
PC is getting desperate to keep their loans marked at/near Par - one significant write-off can totally tank a funds returns in PC land (whereas not necessarily the case in PE land as they have equity upside on other PortCo's).
Let me be clear, THERE ARE PLENTY OF PC LOANS OUT THERE marked > 85 that should probably be marked at 20-30.
I don't think anyone realizes how much trouble some PE and PC funds will be in by EOY with 5.4% SOFR. Equity is going to get wiped one way or another - via significant dilution as a result of PIK (increasing debt), outright downturn in performance, further depression in multiples due to EBITDA declines etc. Anyone who doesn't see a recession coming is blind as fuck, by the way.
See: Vista Equity writing down the entire equity value of PluralSight. The PC lenders will probably see very significant losses as there as well - in part because lenders are dumb as hell and don't close loopholes.
Lending on ARR vs. EBITDA is brilliant. The Vista's / Clearlake's / Thoma Bravos are going to get slammed. The Gig is up, ZIRP is OVER.
Also, wouldn't be surprised to see some type of enforcement action on Valuation firms marking these loans when shit hits the fan and pension funds lose money. They are willfully blind.
Want to know the reality? The val firm proposes marking down the loan; PC firm goes nuts / pressures the val firm to switch gears and they do so. Criminal
I thought private credit held pen on the credit agreement so I'm shocked that someone like Ares didn't insist on putting language regarding transfers of IP to non-loan parties, but apparently private credit just managed to recreate the same issues syndicated loans have. I wonder if lender's counsel in private credit works for the sponsor like in public credit.
EDIT: Changed borrowers to lenders counsel.
The market clearly is aware. Many BDCs trade below there ‘alleged’ net asset value.
One thing that will destroy these PC firms is most of the businesses are very asset light (otherwise they could just get cheaper bank financing). This means when the companies go belly up there are no assets to grab and the company is effectively dead with no residual value meaning PC gets paid back some current/saleable assets but that's about it...PC is the biggest house of cards out there in that when things do blow up it'll ripple through PE so hard in a virtuous liquidity cycle where lenders will be out of market (sound familiar with banks in 2010?) it'll blow up so many PE firms that only exist in 2024 due to PC (their companies aren't bankable and putting 100% equity would lead to R2000 or worse returns).
What are a few examples of the types of loopholes that PC lenders are failing to close? Genuinely curious to understand what's happening in this asset class since so many people have been touting it as the future and it's seen massive capital inflows.
Synthetic PIK is the combination of the following: 1) a debt instrument the company would like to finance 2) a revolver with the sole purpose of paying off the previously mentioned debt instrument
Is it cheaper? Combination of the HY debt and higher rate on the revolver leads me to think that the future payments would be around the same or less but with a higher principal.
Why then? 1) Synthetic PIK is a better public face than traditional PIK and could be rated better by credit agencies. 2) If you find independent sponsors for debt 1 and 2, you could pay a cheaper price in total
I wonder how many dumbass allocators realize they're about to take a hit on their PE and PC holdings? 2025 is going to be brutal.
Very few. I assure you.
I think this also has to do with the fact that for a lot of private credit funds that employ back leverage, they only allow a certain % of loans to be PIK loans, so gaming it this way your original loan is still technically cash pay even if the interest is juts funded by a ddtl synthetic pik
The BBG article legit explains it in detail. Both the mechanics as well as the rationale. A lot of PC funds have limitations on the amount of PIK exposure they have, as they use backleverage (which banks are less eager to provide the more non-cash paying instruments the fund has invested in)
Why would a risk committee at a bank view a hybrid structure any differently? I get the cash interest expense is lower, but the leverage is the same, no?
It's purely around the cash interest. It reduces the debt/interest serviceability on a blended level across the portfolio (which the credit risk committee at a bank looks at)
Long story short, PC funds are in trouble and the industry is showing its cracks, matter of time until we see PC fall.
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