Return of risky PIKs doesn't mean high defaults: Moody's
NEW YORK, Sept 25 (IFR) - The comeback of risky payment-in-kind (PIK) notes, a type of high-yield bond popular before the financial crisis, is unlikely to lead to the same high default rates as before, Moody's said Wednesday.
So-called PIK toggle bonds, which allow the issuer of debt the option of making interest payments on the bonds with still more debt, all but disappeared in the wake of the crisis.
But they are making a serious return in the debt market - and while that has some drawing comparisons to the credit bubble, the ratings agency believes the new PIKs are a different breed.
"PIKs have been associated with high risk ever since [the crisis] but the new crop of PIKs differs in a number of respects from the bubble-era vintage," a team of Moody's analysts led by Lenny Ajzenman wrote in a new report.
"Most of the new PIK issuers, such as the holding company parents of MultiPlan Inc. and Michaels Stores Inc., funded dividend payouts to private equity owners, while others used PIK for share repurchases."
In contrast, many PIK deals in the bubble era went to finance large, top-of-the-market leveraged buyouts (LBOs) that performed poorly after the subsequent downturn.
BACK IN EARNEST
Rated US non-financial companies have already issued 13 PIK bonds totaling US$5.1bn this year through August 31, compared with 14 for US$5.8bn in all of 2012, according to Moody's.
But while the older PIKs usually allowed the issuer a window of time during which to decide whether to pay with debt or cash, the new crop of the bonds typically require companies to pay cash interest to the extent they have capacity to do so under covenants that regulate restricted payments.
"This limits their flexibility to use PIK to hoard cash, make investments or pay other debts at the expense of the PIK note holders," the Moody's analysts wrote.
The agency said one thing has not changed, though: Today's PIK issuers are just as leveraged as their bubble-era predecessors - so the deals still present significant risk to investors.
"Restrictions on PIK elections, shorter tenors, and issuers with a history of deleveraging may present less credit risk for investors, but these benefits are balanced against highly aggressive capital structures," the analysts said.
"Consequently, all of the 2013 PIK issuances have very low ratings from Moody's."
Even so, if the US economy continues its slow but steady recovery, Moody's does not expect the new crop of PIK issuers to repeat the previous high default rate.
About 32% of bubble-era PIK issuers defaulted between 2008 and mid-2013, mostly through distressed exchanges in 2009, and some are at risk of defaulting again.
If there is another economic downturn, however, the aggressive leverage in these deals would leave these companies vulnerable, Moody's said.
Private equity firms, which sponsor many of the PIK issuers, would likely continue to use distressed exchanges to preserve equity value.
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