Article 6.5 Pre-crisis debt products make comeback

By Vivianne Rodrigues and Tracy Alloway

Financial Times October 22, 2013

Risky lending practices that were a hallmark of the boom years before the financial crisis are staging a comeback in the US as companies take advantage of investor hunger for higher returns.

The issuance of payment-in-kind toggle notes, which give a company the option to pay lenders with more debt rather than cash in times of squeezed finances has surged in recent months.

The esoteric debt structures last gained prominence during the leveraged buyout boom that defined the 2006-2007 credit bubble, and their return has raised concerns that markets could once again be overheating.

PIK note issuance has taken off in the past month, with deals from luxury retailer Neiman Marcus, drive-through burger joint Checkers & Rally's, and Ancestry.com, pushing the amount sold so far this year to $9.2bn, according to S&P LCD [Leveraged Commentary and Data]. That is the highest volume since 2008, when $13.4bn worth of PIK notes were sold.

A wave of junk-rated borrowers, including Michaels Stores, the chain of arts and crafts shops, and CommScope, a maker of communications cable equipment, have also included PIK structures as part of new bond deals earlier this year.

PIK-toggles were widely criticised for fuelling the bubble in cheap credit before the crisis. About 32% of the companies that issued PIK bonds during the bubble era defaulted at some point from 2008 to mid-2013, according to Moody's, although the rating agency says the outlook for today's issuers is less bleak.

‘PIK structures are back,' said Lenny Ajzenman, senior vice-president at Moody's. ‘It has become easier for companies to issue such notes given lower borrowing costs and use the proceeds to fund dividend payments to shareholders. And with the low yields in debt markets, investors are snapping up all these notes.'

Bankers say the intense demand for higher-yielding bonds and loans has made selling such assets much easier in recent years.

FT

Source: Rodrigues, V. and Alloway, T. (2013) Pre-crisis debt products make comeback, Financial Times, 22 October.

PIKs relieve the company of making cash payments, but regularly add to the amount of debt, which can then become excessive and cause problems, as it did for the fashion company New Look - see Article 6.6.