Lenders need to adopt some risk mitigation techniques as the market operates in frothy conditions -
Against a backdrop of optimistic asset valuations driving increased leverage multiples across the large cap and mid-market leveraged finance spaces and fuelled by a seemingly endless supply of debt capital, it is perhaps not surprising that there has been a recent increase in popularity of holding company (holdco) financings. Whether in the form of loans or bonds, these have been deployed both in dividend recapitalisations and forming part of the sources of funding in traditional acquisition financings.
The inclusion of a holdco payment in kind (PIK) instrument in the debt capital structure will add leverage without necessarily imposing an additional cash interest cost on the operating group, and, from a structural perspective, will generally not interfere with the main operating group’s senior financing solution. From a covenant compliance perspective, the borrowing group will need to have substantial consistency of terms between the holdco debt and the senior debt, so the question then arises as to how the PIK holders, in an unsecured, structurally subordinated position, can tailor their documentation to provide adequate downside protection.
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