Cash is tight these days and many people may be considering a trade in services in lieu of monetary transactions. This kind of thinking is similar to a payment-in-kind or PIK loan, however, the major difference is that the payer will get the identical goods and services in return. The philosophy behind a PIK loan is the use of goods or services instead of a cash payment. PIK loans do not typically provide any cash flow from borrower to lender, thus making it a costly and risky financial tool to use.
Specialty fund managers tend to work with PIK loans to increase the possible profitability of their investment. The loans are typically unsecured, meaning they have no financial collateral backing. The maturity time for PIK loans is generally about five years and during that time there is no cash flow relationship between the borrower and lender.
PIK loans are used heavily in leverage buy-outs or when an investor acquires a managing interest in a company's equity. A PIK loan will be used if the sales price of the investment is far greater then the loan lenders are willing to provide.
PIK loan schemes seemed to have some impact on the current financial crisis. Borrowers in the mortgage industry had the option to either pay the interest on the loan in cash or through a PIK interest payment (the strategy is called a PIK toggle). Many borrowers opted for PIK interest payments that ultimately increased the outstanding principal balance of the loan. On paper, it would show up as an outstanding loan balance. These negative balances contributed to the current credit crunch and are not really utilized anymore.
