PIK-Toggle/Dividends - rich pickings - FT.com Why bother with a single scoop when you can have a hot fudge sundae? Private equity sponsors like to issue debt (vanilla ice cream, if you will) to pay themselves dividends, and when the credit markets are jumping, yield-hungry investors are happy to help. The fudge comes from the possibility that the US tax rate on dividends could jump next year, making taking a dividend in 2012 even more delicious. Now the cherry on top: issuing bonds with a "PIK-toggle" feature allows the issuer to switch from paying the interest to "paying in kind," that is, with more debt. Four PE-owned issuers - Jo-Ann Stores, Petco, Emergency Medical Services and Pharmaceutical Product Development - have rushed to the market in less than one month with PIK-toggle dividend deals, according to S&P Capital IQ LCD. Consider the Jo-Ann deal. Investors will be paid a yield of 10 per cent (if the bonds trade at par). The deal will push the company's ratio of debt to cash flow from an already high 6 to 6.8 times, according to Moody's, which rates the deal Caa1. If the company starts to struggle, investors could find themselves with increasing exposure to its debt thanks to the PIK feature. This may sound a little too rich. But managers of junk bond funds have heaps of cash - inflows are running at a record $34bn year to date, Lipper says. And they won't beat their benchmarks sticking with plain vanilla. So investors end up stretched thin while issuers risk diabetes. The PIK option is pitched as a way for issuers to preserve cash in tough times. Yet a study from Moody's found that companies that issued PIK-toggle debt had significantly higher default rates (when default is defined to include debt exchanges with bondholders) in 2009 than similarly-rated peers. Sugar highs can often be followed by a crash.