Questions on PIK Notes

PE

4y

Not sure if you have something specific in mind when you refer to "PIK Notes" but generally:

Yes - notes / loans can have both cash and PIK components
Yes - although you usually don't see a 50/50, it'll be something more like L+800 in cash + 1% PIK for more second lien / mezz paper.
Depends on how detailed you're going with your model but you would do it either BoP quarterly or average of BoP and EoP. The former is slightly closer to correct but it doesn't make a huge difference.

Authored by: Certified Private Equity Professional - 1st Year AssociateCertified Private Equity Pro

TheGrillMan

IB

4y

Thanks a lot for this. I was not referring anything specific, just PIK debt which is senior to a shareholder loan but junior to second lien debt.

Follow-up questions:

Is the aforementioned type of PIK debt not usually priced as just a percentage rather than a spread over LIBOR (e.g. Cash: 8.00%, PIK 10.00% rather than Cash: L+800, PIK: L+1000)?
If you were modelling PIK notes in a LBO, would you model them with a cash sweep (i.e. principal being paid down each year)?
If it is an annual model as opposed to quarterly, is using the BoP to calculate interest expense still the most correct methodology to use?
Assuming you have $500m of the aforementioned type of PIK debt which is priced at Cash: 8.00% and PIK: 10.00%, would you calculate interest using A or B (assuming we are calculating on BoP balance for simplicity)?

A) Cash Interest = 8.00% * $500m = $40m PIK Interest = 10.00% * $500m = $50m Total Interest = $40m + $50m = $90m (this seems too high...)

B) (Assuming the term sheet said something like "half of the interest is to be paid by cash, half by PIK") Cash Interest = 8.00% * $500m/2 = $20m PIK Interest = 10.00% * $500m/2 = $25m Total Interest = $20m + $25m = $45m

Metholodgy A) is almost double counting the interest expense no? How can you be paying the full 8.00% and full 10.00% on the same $500m quantum (acknowledging that the former is cash and latter is PIK)?

Thanks!

Authored by: Certified Investment Banking Professional - 2nd Year AnalystCertified Investment Banking Pro

marcopolar

PE

4y

Most Helpful

No problem.

The way I've usually seen the PIK coupon quoted is in terms of a static amount in addition to the cash interest rate (whether the cash rate is fixed or floating). I've never seen a floating PIK spread. If you were looking to price the total security at L+1800 (in your example), it would be L+800 cash and 10% PIK. If you say "L+800 cash and L+1000 PIK" you're double counting LIBOR. Both the cash and PIK portions are generated from the same security, so you don't need to add LIBOR in for both.
That's a negotiated point, depends on the situation. If there's more senior debt, that would always receive the cash sweep first, then potentially the PIK notes. Once all the more senior debt is paid off, then the PIK notes may start receiving the sweep.
In an annual model, I would use BoP to calculate the PIK interest, add that to get the EoP period and use the average of BoP and EoP to calculate the cash portion. The PIK is most likely getting accrued quarterly, so you'd be understating the cash interest amount if you just used BoP for both.
In your example, A is correct. 18% is a pretty high rate depending on the situation, so you're right in that it's a lot. If you wanted to have an 18% yielding security with half cash, half PIK, it would be 9% cash / 9% PIK. Whatever your stated rate is for cash and PIK is what you'd be charging on the full amount of the loan ($500M in your example). Make sense?

Authored by: Certified Private Equity Professional - 1st Year AssociateCertified Private Equity Pro

TheGrillMan

IB

4y

Thank you very much for the help - that totally makes sense now. If you have a $500m instrument quoted at a Cash/PIK of 8.00%/10.00%, the 8.00% and 10.00% would both be applied to the $500m. I guess depending on your structure that would have a big negative impact on net income, but ultimately you add back the non-cash PIK component of that in the levered FCF calculation section of the LBO.

Thanks again!

Authored by: Certified Investment Banking Professional - 2nd Year AnalystCertified Investment Banking Pro

TheGrillMan

IB

3y

Just to confirm - if you see something quoted in the following format: "$100m of PIK notes at 7.00%/7.50%", year 1 interest would be calculated as:

Cash: 7.0% x $100m PIK: 7.50% x $100m

or

Cash: 7.0% x $100m PIK: 0.5% x $100m

Thanks a lot!

Authored by: Certified Investment Banking Professional - 2nd Year AnalystCertified Investment Banking Pro

PE

Analyst 1 in PE - LBOs

Anonymous

4y

did something recently where loan amoun was offered unsub with x% plus 3% pik. basically that means x% was just the regular loan but 3% accrued until end of 5 year holding period (estimated) where we would pay off the entire loan PIK balance at exit. that’s just what we did doesn’t mean it’s always like that but that’s how we modeled it

Authored by: Certified Investment Banking Professional - 2nd Year AnalystCertified Investment Banking Pro

PE

Analyst 1 in PE - LBOs

Anonymous

4y

but regardless both are recorded as interest on IS etc PIK added back on OS of CFS etc etc

Authored by: Certified Investment Banking Professional - 2nd Year AnalystCertified Investment Banking Pro

IB

Analyst 1 in IB - Cov

Anonymous

4y

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