(Bloomberg) -- Private equity giants are turning to a new take on an old solution to higher debt costs for M&A deals: borrow all of the money they can and defer paying it back.

KKR & Co. is asking private credit funds for a so-called payment-in-kind feature that would allow it to push off all cash interest payments if and when it purchases a 50% stake in health care analytics company Cotiviti Inc. The company is looking for $5 billion to $6 billion of debt for the deal.

While direct lenders have yet to agree to KKR’s ask, their willingness to keep talking with the firm underscores how much more willing lenders have become this year to consider PIK debt. One of the draws is that the loans now have better claims on collateral, a recent innovation that’s made it far more palatable for debt providers.

Any deal could serve as a model for other buyout firms with portfolio companies that are struggling with interest rate costs after the Federal Reserve and other central banks began hiking rates last year. 

Those layering PIK debt onto buyouts see it as a temporary solution to deal with any liquidity issues until interest rates moderate, easing the burden. For lenders, the risk is that companies won’t be generating enough earnings to make interest payments when they finally need to. 

The loans vary in length, but some of the big buyout ones have been for two years, according to market participants.   

“It’s quite a nice lever for borrowers,” said Colin Harley, partner at White & Case. “Private equity firms love the extra optionality” from PIK toggles, which allow companies to pay either cash on the borrowings or add more debt, but “ultimately having PIK and accruing more debt will dilute equity returns.”

 

Use of the debt feature has become more popular since Carlyle Group Inc., in pursuit of the same stake in Cotiviti that KKR is now chasing, shocked credit market participants by lining up a $5.5 billion unitranche loan, a blend of first-lien and subordinated debt, a portion of which could be subject to PIK provisions. 

Carlyle eventually abandoned the buyout attempt, and the loan ultimately never happened. In KKR’s case, any similar deal may never come to fruition as Wall Street banks are in a better position for now to win the financing mandate.

Read more: Private Equity Pays LBO Loans with More Debt to Save Cash

Still, the new trend’s spreading to Europe too. Buyout firms are asking private credit lenders for unitranche financing that would allow them to delay all their interest expense, according to people with knowledge of the matter who aren’t authorized to speak publicly. 

In a recent twist, Wall Street banks including JPMorgan Chase & Co. are now trying to pave the way for PIK to become common in leveraged loans. While selling new debt with that feature is still a bridge too far for that market, bankers are hoping that loan investors will accept PIK payments for existing loans where the borrower wants to defer payments, known as amend and extend deals. 

“Using PIK in A&E would help borrowers whose debt costs have gone through the roof, and where rising rates would put huge pressure on the company’s cash position,” said Luke McDougall, partner at law firm Paul Hastings.

Week in Review

  • Goldman Sachs Group Inc.’s asset management arm is seeking to double the size of its $110 billion private credit unit in the medium term, according to its global head of asset and wealth management.
  • Citigroup Inc. will shutter its municipal business after the bank decided it was “no longer viable given our commitment to increase the firm’s overall returns,” according to a memo to staff seen by Bloomberg News.
  • Developer Country Garden Holdings Co. repaid in full an 800 million yuan ($113 million) bond with a put option that expired Wednesday. It also disposed of a stake in a mall operator, with the proceeds to be used for restructuring offshore debt.
  • Dalian Wanda Group Co. reached a revised agreement with investors that will see founder Wang Jianlin give up control of a mall operator after the unit failed to list this year. PAG and other pre-IPO investors in Zhuhai Wanda Commercial Management Group Co. will have a 60% stake in the company following the deal. Under the original agreement, Wanda had agreed to repay investors 30 billion yuan ($4.2 billion) plus interest if Zhuhai Wanda failed to go public by the end of this year.
  • Apollo Global Management Inc. is setting up a lending platform that will give investors exposure to asset-backed loans generated by its credit operations for an initial investment of as little as $2,500.
  • Morgan Stanley is selling a dozen corporate loans mostly linked to European companies as it seeks to cut risk across its leveraged finance lending.
  • Credit markets face a dramatic repricing in 2024 as higher capital costs slam lower-rated borrowers, JPMorgan Asset Management’s Oksana Aronov said in an interview.

On the Move

  • Nick Pappas, a veteran credit specialist who has held senior roles at Michael Hintze’s CQS and Goldman Sachs Group Inc., is starting his own debt fund focused on European investments.
  • BFAM Partners (Hong Kong) Ltd. re-hired Eugene Fung to run its credit business. Fung was previously co-head of global financing & products group in wealth at Credit Suisse Group AG.
  • Credit-card giant Discover Financial Services chose Toronto-Dominion Bank’s Michael Rhodes as its new chief executive office
  • Troubled Swedish landlord SBB appointed industry veteran Lennart Sten as a senior adviser to its board as the company tries to bridge a funding gap

 

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