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Welcome to Taking the Credit, 9fin’s weekly observations on the issues affecting the European private credit market. Find out more about what we do for private credit.

Time flies when you’re having… fun? I could have sworn just last week I was sat in my garden, Aperol spritz in hand, soaking in the summer sun — and now the focus is shifting to Q1 25 processes? Round the merry-go-round we go!

That’s not to say Q4 hasn’t kicked off with a bang (in some geographies, at least). Source conversations and 9fin coverage highlight that Germany, the Netherlands, and France have been enjoying the most mid-market activity as of late, although France is perhaps skewed more towards refinancings than M&A.

But with 2024 shaping up to be a nearly-but-not-quite-back year for M&A, private equity’s use of NAV financing and PIK features to tackle strained cash flow has been on the rise, according to fresh insights from a Moody’s report.

The latest Moody’s data shows that the rate at which cash-strapped sponsors are opting to load PIK debt onto their portfolio companies is increasing. For the publicly traded US private credit funds that it tracks, Q2 saw the highest PIK income returns since the rating agency began collecting the data in 2020.

PIK income accounted for 7.4% of total investment income reported by tracked funds in the latest quarter, up from 7.0% in Q1 and 5.8% at the start of 2023.

And sentiment feels much the same in Europe.

"We're seeing more sponsors ask for PIK debt given the liquidity-strained nature of the market," a source who works on such financings said. "There's been a gradual uptick since the start of the year, and they seem to be getting larger as well.”

Recent mega deals like DSV’s buyout of DB Schenker and ITP Aero’s refinancing both featured sizeable PIK facilities well into the hundreds of millions, two sources said.

In the UK, advisors were recently appointed to work on a “jumbo PIK” of slightly over a half-billion sterling, other sources said.

While a lack of cash may be the main impetus behind companies ladening up their interest burden, PIK facilities are being used to serve a variety of purposes.

As well as providing liquidity relief to existing debt structures, sources said PIK loans are increasingly being used to get new money deals over the line with an extra one or two turns of leverage. Take Apollo’s provision of a PIK tranche on top of senior bank debt for Cinven’s buyout of Idealista, for example.

Such deals are providing senior direct lenders with welcome opportunities to deploy capital, as a buoyant syndicated market snatches back market share.

“A lot of the PIK deals you see today are being done by traditional senior lenders who are looking for ways to access strong assets that are going to BSL markets,” a lender said.

“They aren’t being done by specialist junior lenders anymore, and the senior lenders think of it as a vanilla credit, so they have cov-lite formats, no cross default clauses, and no proper rights,” they continued. “If you really look at the docs they look more like preferred equity than debt, the only difference being they have a maturity.”

But other PIK use cases could pose greater potential risk to companies with poor underlying financial health, like using the debt to fund dividend recaps or aggressive expansion plans. Moody’s report highlighted that this also on the rise.

“Using PIK [debt] for dividend recaps is driven by a need to return money to LPs,” a source said. “The problem is it’s expensive debt and eats into your equity, so you have to be very sure of what you are doing if you want to maintain the company’s health in the long-term.”

That said, using PIK debt shouldn’t automatically set off alarm bells. It can help performing businesses to fund expansion plans, and dividend recaps can make sense for firms in strong financial shape.

“It’s often hard to see from the outside if a PIK loan is being used for the right reasons, or just to provide some short-term relief and push maturities back,” the source added.

In May, UK nursery operator Busy Bees tapped direct lenders for a £300m PIK loan to finance a dividend recap, as 9fin reported.

More recently, Hg Capital is looking to raise £200m of PIK debt to fund a series of acquisitions through its compliance software business Ideagen, as covered.

Another busy week across Europe as financings closed, sales processes kicked off, and direct lenders eyed a potential opportunity in a less-than-conventional sector, defence.

In the Netherlands, Arcmont provided €80m-€100m of debt alongside a German bank in a FOLO deal for Parcom’s buyout of Robin Radar Systems.

Meanwhile in France, KPMG Associés carve-out of its Paris-based accountancy unit, Expertise Comptable, has kicked off with a lender education.

And in Germany, private credit funds are showing interest in a potential sale of military clothing provider Mehler Systems as the company’s projected EBITDA soars on the back of increased military spending in Europe.

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