Treatment of OID
Hi all
Trying to understand how to model an OID on a certain debt tranche. Can anyone help? Do not have a Credit background and struggling to understand how it flows through the LBO model (i.e. do we reflect it in the Sources and Uses table? What is the value of debt that goes onto the Balance Sheet?)
Thanks!
OID is just another form of financing fees (albeit to the lender and not the advisors). So for S&U, you include full debt quantum in sources and for uses you should include OID in financing fees. For B/S, include full debt quantum and capitalize the financing fees.
For the lender, the modelling is a bit different though, as you effectively only fund the debt net of OID, but amortizations/interest/PIK are calculated on the full quantum
Thanks this is rlly helpful! However, still a bit confused around the mechanics - particularly around how to show the impact of OID on the B/S.
I used the example at the bottom to show how I thought about it from a Borrower's perspective (using the contra liability concept to make the B/S balance). However, not sure if it's correct - with the main question-marks being the follow:
1) Is it really correct to show the TLA as $98m on the B/S in y0? Would we use $100m (TLA value on the "Sources" section) or $98m (TLA value on the B/S) when calculating opening leverage?
1.1) The methodology below gets particularly difficult to follow when introducing the concept of a PIK (it doesn't seem to balance anymore)
2) From a Lender's perspective, would the following be correct when calculating their returns?
- Initial Deployment (y0): $(100)m
- OID (y0): $2m
- Net CFs in y0 = $(98)m
-----------------------------------------------------
Assumptions
• TLA amount: $100m
• TLA tenure: 4yrs
• OID on TLA: 2% ($2m in ABS terms; $0.5m to be amortised each yr)
• Amount funded by Lender A: $98m
-----------------------------------------------------
Impact on S&U
"Sources" = Show TLA gross of OID ($100m)
"Uses" = Add OID of $2
Impact on 3 Statements (y0)
I/S -> Add Line item for OID amortisation over time (i.e. $(0.5)m p.a. over yrs1-4)
CF -> Add OID amortisation back to Net Income given it's a non-cash expense (i.e. $0.5m p.a. over yrs1-4)
B/S ->
"Assets" = No impact
"Equity" = No impact in y0.
→ It will adjust itself as a result of changes to I/S throughout yrs1-4.
"Liabilities" = Show the TLA amount as $98m in y0 (i.e. the $100m net of a newly formed $2m OID contra liability, which is a negative line item in the "Liabilities" section)
→ As we recognise the OID amort over yrs1-4 ($0.5m p.a. over yrs1-4) in the I/S, the OID contra liability will decrease accordingly (i.e. to $1.5m, $1.0m, $0.5m and $0.0m in y1, y2, y3 and y4, respectively).
→ The TLA amount on the B/S amount should reflect the net figure
y1: $98.5m net TLA = $100m gross TLA (-) $1.5m contra liability
y2: $99.0m net TLA = $100m gross TLA (-) $1.0m contra liability
y3: $99.5m net TLA = $100m gross TLA (-) $0.5m contra liability
y4: $100.0m net TLA = $100m gross TLA (-) $0.0m contra liability
Q1: You show $100m on the B/S, not $98m. The $2m OID is similar to financing fees, so they go in non-current assets as Capitalized Financing Fees.
I don't immediately understand what you are doing in the bottom part. You should show $100m TLA on the balance sheet and you don't touch it unless you amortizing the debt. (Note: amortizing the OID or financing fees does not impact the debt balance, it's completely separate
Q2: It's correct that your net CFs in Y0 are $(98)m. However, as a lender, you calculate the returns on that $98m and not the $100m, as your initial deployment is really only that $98m
Thanks a lot this is clear.
Re your question - I was trying to approach the treatment of the OID capitalised fees on the B/S using the contra liability concept (which, from other threads, I understood was the correct way to approach this). However, this method seemed flawed (for eg, the point I raised regarding the debt quantums on the B/S not matching the S&U or the Cap Structure) - which is why I decided to create this thread in the first place (and clarify it once and for all).
Thanks again!
Loan amount: 100
OID: 2%
amount funded by lender: 98
Interest accrues on 100 even though you only give them 98.
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