Ask Archer: PIK payments are growing in private credit. Should I be worried?

To all my readers: Ask Archer was launched in May 2023 to provide what I would like to think is idiosyncratic and sometimes amusing commentary on trends in investing and the financial markets. A subscription was encouraged but not required. This is still the case. However, in the world of Wall Street, value is generally determined by what someone is willing to pay. Therefore, I would ask that if you find this interesting (and valuable), please consider subscribing, and asking your friends (and their friends) to subscribe, too. To encourage this Archer has asked that I reduced the price of a one-year subscription to $48 (at the link). In addition, all proceeds from the first 50 new subscriptions will be donated to Archer’s favorite charity, First Generation Investors.

Special Offer

A reader asks: Bloomberg recently wrote about the growth of PIK payments in private credit. Should I be worried?

Archer replies:  With a PIK, or “payment in kind” bond, interest is typically paid by issuing more bonds to the investors rather than doling out cash. Sometimes this is a good idea; often it’s not. J. Wellington Wimpy, the bumptious freeloader in the old Popeye cartoons, was there first. “I will gladly pay you Tuesday for a hamburger today,” he liked to say.

PIK bonds ask for a similar generosity of spirit.

As the nation’s debt continues to spiral upwards, perhaps the U.S. Treasury will steal a page from Wimpy’s book. This column strives to remain well above the political fray, so let’s just say that in the current presidential contest neither party has advanced the candidate of fiscal probity. For one reason or another, both of the last two administrations found reasons to heap trillions of new dollars of debt onto the public fisc.

And then … inflation jumped and interest rates rose. The yield curve – the difference in the cost of short-term versus long-term borrowing – steepened. The cost to the US to float its bonds went up; the CBO projects interest payments of about $870 billion this year, up 36% from the year before. It is heading in the direction of $1 trillion.

There are few circumstances in which this is a good thing. But being a scold on the public debt has been a famously profitless exercise since at least the Reagan Administration, and it may be still. It’s the kind of thing that doesn’t matter until it does.

He who steals my purse steals trash, said Iago. T’was mine t’is his, was slave to thousands. And so it was. But he who steals my credit rating, that fellow is dastardly indeed.

Is a household analogy useful, i.e. payments on credit card debt rising to crowd out the electric bill? Maybe, but as a practical matter this argument runs headlong into the currently-in-vogue printing press theory of economics which holds, if you recall, that as long as you pay debts in your own currency – and you can print that currency – you can never go broke.

While that notion would seem to defy historical experience, there has been little to contradict it lately, at least in the US. Still, it is yet further evidence that we have possibly lost sight of the function of money. The products of financial engineering – synthetic debt, swaps, bitcoin and other digital prestidigitations – remove us further from the reality of currency as a mechanism for determining productive value – the distillation of labor, in the memorable phrase of James Grant. “Money” is now a second or third derivative of some fintech bro’s or Marxist economist’s imagination.

As to PIKs, payment-in-kind made up “6.7% of income among private credit funds … up from 5.4% a year ago,” wrote Bloomberg in mid-August, quoting Ana Arsov, global head of private credit at Moody’s Ratings. Still a relatively small slice of the market, though trending in the wrong way. As Arsov said, “it’s not a sustainable strategy because it creates a permanently heavy debt structure. It masquerades (as) fund performance for investors.”

Did Wimpy ever settle his chits? Apparently not. Maybe he was operating on a six-day week. But for most individuals – and most countries – you can only kick the can so far down the road. Eventually Tuesday comes calling.

Woof!