- Buyside credit analysts need clear definitions
regarding coupon conversion and calculation of the net income
basket in European PIK toggle deal
- The warning comes as year-to-date European PIK
issuances reach a record high, exceeding full-year 2012
volume by eight times;
- The toggle feature is major distinction between
this PIK market and the previous cycle that peaked in
- Lawyers say the deal structures are more
conservative than before, however, with more stringent rules
on when coupons are paid in cash or in-kind.
Credit analysts need clearer definitions in
payment-in-kind (PIK) bond documentation to accurately assess
The number of caveats in recent deals, combined
with this year’s new-style toggle feature, has
forced investors to seek confirmation from issuers on the
formula that determines when the coupon will switch from
cash-pay to PIK-pay.
European PIK issuance has reached an all-time-high,
with Fitch revealing that year-to-date volumes are
eight-times that of 2012 levels. But comments by the
investor community at this week’s Association for Financial
Markets in Europe High Yield Conference suggest it is a
market still needing to mature.
"While we are certainly open-minded to cash-pay
PIKs, I don’t think we have got the proper
transparency yet to really understand what we are investing
in," said panellist Nancy Utterback, senior credit analyst with
Polkomtel PIK: a sign
of things to come?
No renaissance for PIKs
protections in high-yield notes being
The biggest problem, she
said, was lack of clarity surrounding definitions regarding the
toggle feature in the deal documentation. The excessive number
of caveats in definitions has forced investors to ask
management to clarify the specifics on how to calculate the net
This, however, can be met with an obscure response.
"Sometimes management report what the basket itself is, but we
need the calculation [to assist going forward]," said
Panellist Fred Kooij, head of European high yield research
at BlueBay Asset Management, noted that the prevalence of the
toggle feature is a key difference between the 2013 market
compared to the peak of the previous cycle, six or seven years
Given toggles give the issuer the ability to pay coupons in
additional bonds or cash, with PIK interest being accrued at a
higher rate than cash interest, the feature has a significant
impact on deal pricing.
As such, another investor panellist noted that calculating
the likelihood of the toggle mechanism being activated is
credit analysts’ most difficult task.
But while they are considered riskier than pure PIK notes,
many of this years toggle deals have included more stringent
and noteholder-friendly rules on the coupon payment.
"I think it is important to note that while there have been
a lot more PIK bond issuances this year, they have been more
conservatively structured and have generally come from solid
credits," said panellist Jaenette Cruz, partner at Allen &
For example, German car company Schaeffler’s €800 million ($1.28
million) PIK toggle in July –
Europe’s biggest this year – requires the
issuer to pay cash coupons during certain interest periods.
CRA and investor scepticism
PIK toggles have received a lukewarm reception from credit
"From our perspective, we don’t really like PIK
toggles, but it does fundamentally depend on where it takes the
total leverage in the deal," said panellist Paul Watters, head
of corporate research at Standard & Poor’s
While a company that has delevered and then subsequently
issued a PIK to pay a dividend is one thing, opportunistically
taking advantage of liquidity in the market and taking leverage
up a turn is, Watters said, another thing entirely.
"We are always looking at it from the perspective of the
glass being half empty," he said. "If you have the option of
paying cash we presume you will always pay cash, and so we
reflect that in the metric, and that will have an impact on a
Despite this year’s record volumes, some
investors are wary of the full family of PIKs, which are
usually deeply subordinated and fare poorly in a distressed
"One of the major issues we have is just the asymmetry of
risk," said one, speaking at yesterday’s event.
"The returns are generally not appropriate given the risks they
take in terms of what they can control if things do go
Upon the onset of the financial crisis, PIK noteholders
learned they were left in a largely powerless position if the
"I can’t think of a particular solution when a
PIK has done well in a restructure," said the panellist.
"Generally, we don’t think much has changed
[compared to the 2005-2007 vintage] and so we are very
sceptical to invest in PIKs."
Polkomtel PIK: a sign of things to
No renaissance for PIKs yet
Are investor protections in high-yield
notes being eroded?