OID in leveraged loans

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.

a "sweetener" to commit in the primary market vs. waiting for secondary trading opportunity

Can also be viewed as upfront cost for the issuer as you essentially pay out a certain amount out of the loan you are getting

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..

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.

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.