PIK'ing Credits Carefully

Destra Capital

A Perspective on the use of PIK and LME in Special Situations Credit Investing

Jake Schultz, CFA, Director, Investment Strategy at Destra Capital, recently sat down for a discussion with Dillon Neale, Institutional Portfolio Manager at BlueBay Special Situations (RBC Global Asset Management), to discuss an area of growing interest around the use of PIK (Payment-in-Kind) instruments in Private Credit and Direct Lending, as well as the recent rise of LME (Liability Management Exercises). While PIK structures have long been scrutinized for their potential risks, they also offer strategic advantages in distressed investing. Similarly, LMEs, often misunderstood, serve as critical tools in optimizing capital structures and ensuring financial sustainability.

Jake Schultz: “Dillon, thanks for speaking with us today. Given recent market trends, we wanted to simplify a few acronyms, share some insights about the increase in PIK or “payment-in-kind” activities, and help differentiate its use across investment strategies.”

Dillon Neale: “Yeah, happy to do it, Jake. It is absolutely something that the market is seeing more of on both sides of the Atlantic.”

Jake Schultz: “As popularity around Private Credit and Direct Lending continues to expand, PIK instruments seem to carry a more negative connotation, particularly for lenders underwriting loans at par. However, in the Distressed/Restructuring space, it appears to have clear benefits. How does the Special Situations team view PIK as a tool?”

Dillon Neale: “We see PIK as a valuable tool in Distressed investing, particularly when a company is navigating a restructuring. PIK interest helps preserve cash—an essential factor in stabilizing operations and positioning for growth. By deferring immediate interest payments, businesses can reinvest in their core operations, ultimately supporting a stronger recovery for creditors.”

Jake Schultz: “How can we better separate PIK from being seen as a ‘bad word’ in the direct lending world versus a strategic mechanism for special sits and distressed investors?”

Dillon Neale: “The key is recognizing that PIK isn’t inherently ‘good’ or ‘bad’—its effectiveness depends on the context. Within our Special Sits portfolios, PIK investments are primarily concentrated in the Distressed substrategy, where they are used strategically to support turnaround efforts. That said, we maintain strict underwriting discipline, ensuring any PIK instrument is backed by a clear path to value creation and ultimate repayment.”

Jake Schultz: “Let’s shift to another growing area of discussion—Liability Management Exercises (LMEs). They have become an increasingly utilized tool in special situations investing, but there’s often a stigma attached. How does BlueBay approach LMEs?”

Dillon Neale: “LMEs can take various forms and shouldn’t be automatically negatively thought of. Crucially, the goal of these exercises is typically to optimize the company's capital structure, reduce financing costs, improve financial flexibility, and potentially to ward off any financial distress. As investors, it is important to be prudent when entering into investments, especially those which are likely to require a restructuring. BlueBay aims to have a seat at the table when it comes to negotiations with other lenders and the company. Typically, we target smaller capital structures where we can hold a significant amount of the debt, allowing us to influence terms beneficially for both our investors and the long-term sustainability of the company.”

Jake Schultz: “One concern we often hear about LMEs is the potential for creditor-on-creditor violence. How do you navigate this challenge?”

Dillon Neale: “It is important to highlight that where LMEs are negatively associated is in the case of creditor-on-creditor violence, which is typically more prevalent in the US due to differences in restructuring laws. Sponsor-backed liability management transactions can be more aggressive, sometimes leading to disputes among creditor groups. In Europe, restructuring frameworks often provide more safeguards for minority creditors, ensuring broader participation. For example in some European jurisdictions, lenders of the same class who sit outside of the Ad Hoc Group are still given an option to participate in a restructuring deal, reducing the possibility of creditor-on-creditor violence.”

Jake Schultz: “Lastly, can you talk about how LMEs compare in different markets? Are there regional differences in their application?”

Dillon Neale: “Absolutely. The regulatory and legal landscape plays a huge role in shaping how LMEs are conducted. In the US, sponsor-backed liability management transactions can be more aggressive, sometimes leading to disputes among creditor groups. In Europe, restructuring frameworks often provide more safeguards for minority creditors, ensuring broader participation. This difference means investors must tailor their approach to LMEs depending on the jurisdiction, factoring in the legal protections available to all stakeholders.”

Jake Schultz: “Dillon, this has been an incredibly insightful discussion. Thank you for sharing your expertise and shedding light on the nuances of PIK and LME strategies. We appreciate your time and look forward to future conversations.”