is a type of bonds for which, on each coupon payment date, the accrued coupon is capitalized and fully or partially paid in the form of additional bonds
or added to the principal amount.
PIK bonds refer to deferred coupon bonds. Interest rates for such bonds are usually higher than for regular bonds due to the higher risk of default. The majority of the buyers of these bonds are institutional investors.
The main features of PIK bonds are as follows:
- Usually these bonds are not secured by any assets as collateral;
- The maturity period of most PIK bonds exceeds 5 years;
• The Hybrid nature of the security
- Often these bonds are issued together with a separate warrant, which entitles the holder to purchase a certain number of shares or bonds at a certain price for a certain period of time;
• Refinancing ban
- PIK refinancing is generally prohibited in the first years after the placement, or allowed at a high premium.
Benefits and risks for issuers:
PIK bonds are often issued by issuers with liquidity problems but able to pay the coupon in non-cash form. It can be attractive for the companies looking to avoid cash outflows at the moment in connection with bond coupon payments, for example, during a funded buyback or during a phase of strong business growth. In this way, companies try to protect their liquid assets. The PIK grade of bonds is usually below other cash-settled debt obligations in the finance structure. In this regard, the PIK interest is significantly higher than the cash coupon.
Benefits and risks for borrowers:
On the other hand, borrowers benefit from a higher payment-in-kind interest. It’s done in order to compensate borrowers for refusing to receive cash payments during the life of the bonds. However, borrowers bear additional credit risk due to the increasing in the principal amount, which they must receive as a result of accumulating interest payments.
The main types of PIK are as follows:
• Regular PIK
- The requirement to pay a coupon (or a specific part of a coupon) in the form of additional bonds is mandatory and is specified in advance in the terms of the bond issue.
• Pay if you can
- The Issuer is required to pay the bond coupon in cash if certain conditions are met. If these conditions are not met (for example, financial covenants are below a certain level), then the coupon is paid in the form of additional bonds, usually at a higher rate than in cash.
• Pay if you want (PIK toggle)
- the Issuer can pay, at his option, for a certain coupon period the coupon in cash, in the form of additional bonds, or use both forms of payment in a certain combination. This type of PIK bonds was popular with highly leveraged organizations before the financial crisis.