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In some debt deals (larger ones typically), you'll have what's known as an OID. Think of it as a fee that needs to get paid by the Company / sponsor to get the debt in place.
Example in practical terms: company gets 100 of debt, and it comes with an OID of 1%. Meaning, you will pay a 1% "fee" on the uses side of sources and uses, and you'll be able to put the 100 on the sources side.
In reality it means that those that buy the debt will buy it for 99 cents on the dollar and then get 1 dollar back when the debt gets paid back. That delta is what the company is paying for. Usually this is done to entice investors to buy the debt being issued.
From the lender's perspective, the OID is treated as part of the effective interest rate and recognised to P&L over the life of the loan.
For example, if you loan $100 with 3% cash pay interest pa plus a 1% OID for 2 years, then you book the interest at an effective interest rate of 3.5% (ie 3% + 1%/2 years = 3.5% pa). You'd don't get to book the OID as an upfront fee.
So if I have this right, the OID is amortized over the life of the loan? Not paid back with the principal at the end (similar to zero coupon in my mind)?
in cash terms, it is paid at the time of loan to the lender (in reality, just withheld from the loan amount). only the p&l is amortised, with the OID treated as interest.
Amount of loan x (1-OID).
$100MM in Debt
1.0% OID
Borrower will owe $100MM at day of funding.
Borrower will receive $100MM x (1-.01) = $99MM
Definition of 'Original Issue Discount - OID'
The discount from par value at the time that a bond or other debt instrument is issued. It is the difference between the stated redemption price at maturity and the issue price.
http://www.investopedia.com/terms/o/oid.asp
To expand on what everyone has said more simply, its a fee that investors collect to hold the loan, which is recognized evenly each year through maturity.
For instance, for a less desirable loan, the spread (plus the LIBOR floor, if its bank debt) may not be sufficient compensation to entice lenders. So the underwriter (bank arranging the loan on behalf of the issuer) may need to increase the OID (say to 96, 90, 85, etc.) to enhance the overall yield.
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