As we see loans with PIK flexibility become more and more prevalent, managers are grappling with optimizing leverage on those assets. There are a plethora of questions and issues associated with financing PIK assets, including –

  • Should “PIKable” assets be classified as PIK, or should loans be treated as PIK only if the obligor has actually elected to PIK?
  • Should PIKable assets be treated differently based on whether the PIK feature was originally included in the underlying documents or added later by amendment?
  •  Should there be different flexibility for full PIK vs. partial PIK?
  • Should PIK assets receive more favorable treatment if they satisfy a minimum cash pay requirement?  If so, over what period should the minimum cash requirement be measured?  Should minimum cash be measured including the benchmark, or just the spread?
  • Should the value of a PIK asset take into account interest actually paid in kind?
  • Should there be a difference in the treatment for these assets under different types of leverage facilities? Compare, for example, some key features in the current treatment of PIK assets under two common types of asset-based financings for asset managers: fund-level corporate revolvers and SPV-level ABL facilities.
    • At fund-level corporate facilities:
      • Performing PIK high yield investments and PIK mezzanine investments typically receive a partial advance rate haircut that falls between performing cash pay and non-performing assets of the same type
      • PIK bank loans may immediately be treated as non-performing bank loans, which are subject to a steeper advance rate haircut
      • PIK assets may also be subject to additional concentration limits (including, for example, junior, non-core and non-performing caps)
    • At SPV-level ABL facilities:
      • In a facility with a VAE-based valuation construct, an obligor election to PIK or an amendment to the underlying documents to add a PIK feature is often a VAE
      • There is often a difference in treatment in the eligibility criteria and concentration limits for different categories of PIK assets, including PIKing vs. PIKable assets, full PIK vs. partial PIK, and assets with minimum cash pay requirements
      • Even in a facility with a box-based approval mechanic for certain assets, PIKable assets may still be subject asset-by-asset approval

The answers to these questions are heavily fact-specific, and vary due to a number of factors, including lender, manager, and type of portfolio.  The Dechert Global Finance Team has extensive experience helping our clients navigate these issues. Please reach out to anyone on the team to help guide you on the latest trends!