What are Payment in Kind (PIK) Bonds?
A payment in kind (PIK) bond is a bond that pays interest in additional bonds instead of cash.
How Do Payment in Kind (PIK) Bonds Work?
Instead of the returns on a bond being paid in cash, the dividend is returned to the bond buyer in the form of additional principal (more bonds). Usually, the issuer has the option to deliver more bonds during an initial period, instead of a coupon payment.
Why Do Payment in Kind (PIK) Bonds Matter?
PIK bonds are used by the issuer to give themselves some breathing room in case the company runs into liquidity problems. By triggering the provision to issue the buyer more bonds (more debt), the company lessens the need to make cash payments on the bond coupon to the bond buyer. However, it does result in more debt (because of the dividend that will need to be paid to the buyer of more bonds). At some point, the debt needs to be repaid. However, with the company overleveraged, it can sometimes run into problems.
PIK bonds have been used in very competitive bond markets where lots of equity is chasing very few deals.
