What does PIKing mean?
QUestion is the above. What does it mean when someone says PIKing when referring to PIK notes? Confused on this
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payment-in-kind - instead of paying cash interest semi-annually, the note will accrue semi-annually. if you have a $100 million mezzanine note that is 10% cash / 2% PIK, the issuer will pay $10 million cash interest to the lender and the $100 million note will accrue $2 million PIK and become a $102 million note. it’s a way to juice yields for investors but not to take all of the free cash flow from the borrower.
Hi, that is a helpful explanation for what a PIK note is, but Im confused about what PIKing means specifically.
I have a debt schedule that looks like the below:
PIK Notes PIKing?
oh that means in the model you’re working with there’s an option to trigger the PIK interest. I.e. sometimes in some highly structured mezzanine or second lien notes, there will be a trigger for PIK interest. EBITDA below a certain amount or FCF below X, which will change cash interest into PIK interest. so there should be a Y or N in the model you have.
Got it thank you! Yes, it is recorded as 0s and 1s. As a followup, do buyout firms tend to prefer to fund LBOs with term loans or PIK interest if they have a choice? Im thinking that with PIK interest you dont need to pay out cash interest each period until you payback so it helps juice returns?
I mean yes, for the Borrower, time value of money would say that PIK interest is preferred if the same rate as cash. but thats rarely if ever the case. Lenders would rather have cash upfront instead. so you would never see deals funded solely by PIK notes.
PIK interest is really used for two cases:
increase yield of the debt, without cutting free cash flow to the bone for the Borrower. If debt investors need a 12% return, but the in the Borrowers base case model, they can only handle 10% cash interest, then you need to plug in 2% PIK assuming the lenders are comfortable with that level of PIK interest
used in distressed scenarios where the lenders believe the Borrower is viable in the medium-long term, but the borrower doesn’t have the EBITDA to fully pay the contractual cash interest. so instead of being obligated to pay 10% cash interest and the Borrower going into payment default, the lender may restructure or have built in the ability for the borrower to pay an elevated PIK interest at 15%
The PIK interest accrues to the balance of the debt. As an example, say you issue $100m of debt that pays 10% PIK interest. On your debt schedule for Year 1:
Beginning Balance: $100m Plus PIK Interest: $10m Ending Balance: $110m
It has the effect increasing the debt balance, so subsequent interest payments will increase.
Thanks for this as well
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