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PIK loan
From Wikipedia, the free encyclopedia
A PIK Loan is a type of loan which typically does not provide for any cash flows from borrower to lender between the drawdown date and the maturity or refinancing date, not even interest or parts thereof (see mezzanine loan), thus making it an expensive, high-risk financing instrument. PIK (payment in kind) is to be interpreted as interest accruing until maturity or refinancing. PIK loans are typically unsecured (i.e. not backed by a pledging of assets) or with a deeply subordinated security structure (e.g., third lien). Maturities usually exceed five years and in a standard offer, the loan carries a detachable warrant (the right to purchase a certain number of shares of stock or bonds at a given price for a certain period of time) or a similar mechanism to allow the lender to share in the future success of the business, making it a hybrid security.
Contents
1 Return and Interest 2 PIK toggles 3 Leveraged buy-outs 4 PIK bonds 5 Examples 6 See also 7 References 8 External links
PIK toggles
With a PIK toggle note, the borrower in each interest period has the option to pay interest in cash or to
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PIK the interest payment. Sometimes, the borrower may also be able to PIK some portion of the interest (usually half) while paying the rest in cash; at times, only some of the interest may be paid in kind and the rest is cash-only. This feature allows the issuers to reduce cash interest payments for a period if necessary. The documentation often provides that if the PIK feature is activated, the interest rate is increased by 25, 50 or 75 basis points. In some cases, cash payment or PIK is at the discretion of the borrower; in other cases, it is determined by a cash flow trigger. These are sometimes derisively referred to as PIYW (Pay If You Want) and PIYC (Pay If You Can).
Leveraged buy-outs
In leveraged buy-outs, a PIK loan is used if the purchase price of the target exceeds leverage levels up to which lenders are willing to provide a senior loan, a second lien loan, or a mezzanine loan, or if there is no cash flow available to service a loan (i. e. due to dividend or merger restrictions). It is typically provided to the acquisition vehicle, either another company or a special purpose entity (SPE), and not to the target itself. PIK loans in leveraged buy-outs typically carry a substantially higher interest and fee burden than do senior loans, second lien loans, or mezzanine loans of the same transaction. With yield exceeding 20% per annum, the acquirer has to be very diligent in assessing whether the cost of taking out a PIK loan does not outbalance his internal rate of return of equity investment. Before the credit crunch of Summer 2008, several LBOs have seen some secured second-lien term bank loans coming with PIK or, more frequently, PIK toggle features, in order to support the firm's ability to cover cash interest during the initial period after the LBO. If the acquired company performs well, the PIK toggle feature allows the equity sponsor to avoid giving extraordinary returns to the PIK debt, which might happen if the debt were strictly PIK. Since the credit crunch, the PIK toggle has largely disappeared.
PIK bonds
In modern finance, when a bond pays in kind (PIK), it means that the interest on the bond is paid other than in cash. The most common form of this is for the principal owed to the bondholder to be increased by the amount of current interest. Other forms of PIK arrangements are also found, such as paying (transferring to) the bondholder an amount of stock (in the company issuing the bond or in another, typically related, company) with value equal to the current interest due. Often such arrangements are referred to by the acronym PIK. Most bonds pay cash, not in kind, coupons. PIK can be used as a verb (e.g. the bond "PIKed") or an adjective (e.g. that bond is "PIKable"). Where a previously PIKed amount is revoked (as is permissible in some agreements), this is known as "unPIKing".
Examples
Main article: Malcolm Glazer ownership of Manchester United One high profile use of PIKs involved the controversial takeover of Manchester United Football Club in
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England by Malcolm Glazer in 2005. Glazer used PIK loans, which were sold to hedge funds, to fund the takeover, much to the displeasure of many of the clubs supporters,[1] because the burden of the debt was placed on the club itself, not the Glazers.
See also
Negative amortization, a similar arrangement in mortgage loans Payment in kind Zero-coupon bond
References
1. ^ Credit crisis one year on: Risky debt notes could be a losing game
External links
Travelport Holdings Limited Plans to Issue $1.1 Billion in Term Loans Under a Senior PIK Facility Company Enters Into $854 Million Senior Secured Credit Facilities and $300 Million Holdings Senior PIK Loans
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http://en.wikipedia.org/wiki/PIK_loan
11/8/2010