OID in leveraged loans

Chaps as per the title - Has anyone seen OIDs in leveraged loans? What does this feature accomplish and why is it used?

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Comments (16)

Jul 11, 2020 - 4:20pm

You're just purchasing the security at a discount to Par. Just another lever to get to the target return. Some funds favor OID vs. rate so at times that plays into negotiation.

Jul 11, 2020 - 5:25pm

Instead of issuing at par (100), you issue at OID (say 98) to lenders. They can turn around and flip it for 100 in the secondary market if they so wish on the first day of trading. Easy 2% return.

Issuers do this to sweeten the deal for investors, creating more competition to lend to the issuer. This can drive down pricing (interest percentage), making it worthwhile in the long run.

Array

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Jul 11, 2020 - 6:43pm

There are a few things at play here beyond what has already been said...

Note: This relates to large liquid, institutional loans (TLBs)

OID is a sweetener to potential investors which increases the chances of a successful fundraise for the client. Successful fundraise leads to oversubscription to the transaction which results in cut-backs in investor allocations and thereby leaves investors wanting to buy more in the secondary market.

Lead bank not only successfully syndicates the deal but can also manage secondary trading/liquidity of the deal post-allocation as investors bid for more paper and short-term holders take their profits. Lead bank makes $ on the bid/ask spread...

Everyone looks good:

-client has successful, oversubscribed fundraising

-capital mkts bankers executed successful, oversubscribed fundraising

-sales & trading make incremental $ on secondary trading and maintaining secondary liquidity

All of this adds to the overall attractiveness of the companies story here from an equity, debt, PR perspective and adds fuel to future transactions or mkt awareness generally..

Jul 12, 2020 - 4:51pm

Agree with most everything said above. However, a loan pricing at a 98 OID is generally not going to be able to be flipped at par in the first day of trading- 2 pt OID implies a tougher deal. OIDs are, as was stated, another form of getting to a target return. In a healthy market they range from .25 (think too many CLOs demanding paper, not enough new loans) to 1-1.5pts. Anything beyond that is generally a tougher deal to get done or the borrower has some reason to want to keep spread lower and is willing to give on OID to accomplish that.

Then, there's the concept of the Caps. Depending on if the financing is best efforts (then somewhat ignore this) or committed- meaning the underwriting banks are taking the risk. Usually committed deals have 150-200bps of flex (this varies of course) of which 100bps can be OID. After that, if the banks cannot build a book, they will either choose to hold back some of the loan on their balance sheets (not fully syndicate) or they will choose to use a deeper OID that comes out of their P&L in order to find a clearing level. I've seen OIDs on hung bridges, deals struck as market is turning etc. of as much as 15-18 pts (loans trade in low 80s).

As the OID grows, it is increasingly important to remember that in a bankruptcy, your claim is generally adjusted down for the size of the OID. This becomes material in the case of a big OID.

You can see them in bonds sometimes but I'd say they are much more common in loans where committed financing is more common.

Most Helpful
Jul 14, 2020 - 12:30am

good post @lineanusmaximus. piggybacking
OID - Original issue discount - think of as "Upfront fee

RC/TLA - upfront fee used (10 bps / 20 bps old / new money)
TLB deals - OID used.

**All-in Yield (AIY) Calc: L+400 / 1.00% floor / 99.0 OID **
OID is based on 4 year average life so u divide by 4. it's just some accounting law. all u need to know on that. just go w/ it.

1L TLB
L+400
1.00% LIBOR Floor
99.0 OID

=
400
100
25 (100 / 4 for 99.0 OID)
= 525 bps
AIY = 5.25%

2L TLB
L+800
1.00% floor
98.5 OID

= 800
100
37.5 (150/4)

= 937.5 bps
AIY = 9.375%

does that help?

Underwriting Fee & Flex
Revolver / First-Lien & Second-Lien Term Loan B
To add to the comment on flex w/ OID (honestly this is going to confuse ppl on the calc but here we go

Underwriting Fee:
RC / 1L TLB: ~2.00-2.25%
2L TLB: ~2.50-3.00%(+ ~0.50%)

Market Flex:
1L TLB: ~125-150 bps (~50-62.5 OID)
2L TLB: ~150-175 bps (~50-75 OID)
*Add-on TLs: less flex vs. new deal

1L/2L - Fees and Flex

Flex and Breakeven Analysis
Pricing L+425 / 99.0 OID
Flex: 125 bps (62.5 to OID)

= Flexed L+487.5 / 96.5 OID
L+425 + 62.5 = L+487.5 /
OID: 99.0 - 2.5 (0.625 x 4 = 2.5) = 96.5 OID

Footnotes

(a) First Lien Term Loan B - 125 bps flex (of which no more than 62.5 bps can be used as OID, to 96.5).
(c) OID converted to yield based on a 4-year average life.
For example, an OID flex of 0.50% or 50 bps (200 / 4) would be as follows: 99.5 - 2.0 = 97.5 OID.
(d) 3-month LIBOR of 2.11% on 9/4/2019 (A&R2 date), 1.75% on 1/31/2020. Rounded to 2.00% for ease of calculation and simplicity for illustrative purposes.
€ Underwriting fees converted to yield based on a 4-yr average life. 1L TLB UW fee: 200 bps / 4 = 50 bps

Pricing vs. Market (Pre-Flex, Flex, Flex + Fees)

  • Principal in PE - LBOs
Jul 14, 2020 - 2:28am

OID can be an attractive way to raise high yield capital with a lower coupon (perhaps par interest coverage is too low). The big downside from the investor's perspective, and why OID's generally not preferable, is tax. Issuing at a discount means each year the bond will (in theory) appreciate towards 100 at maturity. Unfortunately, this produces "phantom income" taxed on a straight-line appreciation schedule. Without a nice stream of coupon payments, investors need another source of capital to cover this obligation.

Jul 14, 2020 - 2:58am

@Principal in PE - LBOs,

1) Your comment refers to Bonds & OID, not Loans, correct?
2) And OID in Bonds is less common, would you agree?
3) Whereas in Loans / Term Loan B - it is the norm / standard, in a new-issue deal?

I am not a bond guy / tax guy, and haven't heard this for Loans / Term Loan B's, so just double-checking.

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