Last week the FT reported that “corporate debts mount as credit funds let borrowers defer payments”. The article was referring to the use of “payment-in-kind” (known as “PIK”) structures, whereby a borrower can opt to not pay an interest payment in cash but instead add it to the principal balance outstanding. The FT piece focuses on these structures in the US private credit space (that is, lending by an entity which isn’t a bank), tying a seeming increase in its use to persistently high interest rates and the difficulties which highly levered borrowers might otherwise face in making cash interest payments. 

The FT gave less attention to the many upsides – for both borrowers and lenders – which PIK structures can bring. Where included in the loan from day one (rather than added subsequently), PIK structures offer new and growing businesses the opportunity to accelerate growth by enabling cash to be diverted to expansion or investment rather than interest payments. Whilst paying interest on capitalised interest is more expensive over the life of the loan, this may be offset by the returns generated by a bigger or more profitable group. PIK structures are also a useful tool for cyclical or seasonal businesses, bridging the gap between the lender’s requirement for regular interest payments and the borrower’s lumpy cash flows. Where used judiciously, a PIK feature can also help a business span a temporary cash flow issue (leaving other triggers in the loan agreement to trip on any longer term or more serious deterioration in financial condition). 

As the FT flagged, lenders reiterate that “if built into a loan at the start, PIK did not indicate stress”. For lenders, offering flexibility – particularly in the early days of a business’s growth – invites a deeper and more enduring relationship with the borrower in the long term, maximising the chances of a better return on the broader investment it has made in that business. And of course, where the PIK structure is utilised the lender benefits from an increased overall return on that loan. 

Reflecting their utility, we are seeing more PIK “toggle” structures, where the borrower can opt to capitalise part of an interest payment only, sometimes also with a cap on the total amount which can be capitalised through the life of the loan. That’s just one of the tools which we are seeing utilised to afford a borrower more flexibility or to better reflect its anticipated growth trajectory.

Crafting the right PIK structure can therefore be of benefit to both the borrower and the lender.