‘PIK toggle’ bonds allow issuers to defer payments until the bond matures © FT illustration

Private equity firms are testing investors’ appetite for returns with new sales of payment-in-kind bonds that offer juicy interest rates but are among the riskiest deals since the Covid crisis began.

The re-emergence of PIKs underscores how fixed-income investors are increasingly being asked to accept higher degrees of risk and more onerous terms from corporate bond issuers as soaring prices of higher-quality assets in recent months has deeply depressed yields.

A duo of highly-indebted borrowers are seeking to raise a combined $1bn through so-called PIK toggle deals, in which issuers are allowed to defer interest payments. The structure allows companies to pay interest using more debt, leading the amount that ultimately needs to be paid at the bond’s maturity to balloon.

Apollo and Platinum Equity, the private equity parents of the two issuers, will receive bumper payouts from the proceeds of the bond sales if they go through as planned.

The deals follow a flurry of so-called dividend recapitalisations through the loan market, where private equity owners have used borrowings to fund payouts from their portfolio companies.

Anatomy of a PIK deal

  • PIK notes allow a company to defer interest payments until the bond matures.

  • The interest is paid “in kind” by being added to the principal of the bond, with the debt’s interest effectively being paid with more debt.

  • The notes are associated with deeply distressed issuers who need extra cash to survive, but would struggle to immediately begin paying investors interest on the debt.

  • The debt typically sits low down in a companies capital structure, putting it at greater risk of being wiped out should the company slip into bankruptcy.

  • “PIK toggle” deals allow issuers to switch between paying coupons and paying in kind.

Ken Monaghan, co-director of high yield at Amundi Pioneer, said the re-emergence of PIK deals was an indication of a “frothy” market. “It tells you investors are willing to take on a greater level of risk,” he said. 

Apollo-owned Aspen Insurance borrowed $500m through its Bermuda-based parent company Highland Holdings on Friday, with roughly 50 per cent set aside for a dividend, according to people familiar with the issuance. The five-year deal priced with an interest rate of about 7.63 per cent, which would rise above 8 per cent if the payment is deferred. 

Platinum Equity-backed label maker Multi-Color Corporation is also looking to raise $500m with a five-year note. The proceeds will be used solely to fund a payout to the companies’ owners, after fees, according to people familiar with the deal. Early discussions hinted at a double-digit interest rate on the bond.

However, the deal has received some pushback from investors. The borrowing was initially expected to be finalised on Thursday but plans have since been delayed to next week, according to people familiar with the fundraising.

Apollo declined to comment. Platinum did not respond to a request for comment.

Interest rates on safer debt either issued by governments or more highly rated companies have fallen to historic lows since the coronavirus crisis began, kicking off a hunt by bond investors for deals in which they can garner higher returns.

This shift has reduced the borrowing costs lenders can demand even from companies with speculative-grade credit ratings.

Rise of the PIK

Neiman Marcus

When Warburg Pincus and TPG bought the US department store chain in 2005, they sought to protect against an unexpected downturn in the business by structuring the first PIK toggle note

Manchester United

Later in 2005, the Glazer family used PIK notes to fund its takeover of the English Premier League football club

The average yield across high-yield US corporate debt has fallen to 5.3 per cent this month, having traded as high as 11.4 per cent during the depths of the coronavirus induced market tumult in March, according to Ice Data Services.

Federal Reserve officials have repeatedly warned of the potential for rising leverage, with some calling for tougher rules to prevent the central bank’s policy of keeping US interest rates low from leading to excessive risk-taking.

This is not the first time Platinum has turned to PIKs to raise funds through the companies it owns. In 2013 the car chassis maker Chassix completed a $150m PIK to fund a payout to Platinum. The company slipped into bankruptcy two years later. 

Earlier this year Platinum-backed packaging company Husky sold $460m of PIK notes to fund a dividend to its owner. The price of the debt slipped below 70 cents on the dollar — a sign of worries among traders about the company’s ability to pay back the debt — during March’s turmoil. It has since recovered close to par, or 100 cents on the dollar.

Additional reporting by Eric Platt in New York

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