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Comments (6)

  • Intern in HF - EquityHedge
Sep 16, 2020 - 10:40am

Think about it... some companies may not be able to pay a higher cash interest payment, or may not want to, as Interest Coverage is a key credit metric. Additionally, some investors may want extra protection from downside, so being issued at a discount means less cash out their door. So there are pros for each side which make OID a thing.

Sep 16, 2020 - 10:49am

One may wish to issue zero coupons,  to avoid cash flow.  

Also, based on things like NIC and TIC one may be able to find a better overall rate of financing for the series.  

One may also issue at a specific rate to fit a specific debt service level.  

Of all the issuances I have seen there have been very few that trade at a discount.  Most (80%) have had some sort of premium.  

Sep 16, 2020 - 10:53am

From a yield perspective both could be equivalent, mathematically. The difference is primarily:

1) accounting/tax - how do you recognize financing fee (e.g. OID), whether it's capitalized and amortizing through the debt term vs. ongoing interest/coupon expense

2) cash flow to the issuer - how much proceeds you get on day 1 vs. ongoing debt servicing

3) syndication and market technicals in terms of what can get a deal done

  • Principal in PE - LBOs
Sep 16, 2020 - 11:37am

Typically tax reasons; interest is ordinary income while a discount note appreciating is capital gain

Most Helpful
Sep 16, 2020 - 12:42pm

Surprised no one has mentioned this. It's a way to make a loan more attractive to a lender like a CLO. Loans are typically prepayable with no penalty (call) after 6 months so if a borrower's credit profile improves dramatically or the credit markets become much more borrower friendly the borrower can refinance to a lower interest rate and the juicy yield the lender thought he was going to get disappears, standard risk to the lender on a loan. So in order to make the loan more attractive to lenders (and get them to sign up for your deal) you issue at a discount since then if you prepay the loan you pay back the face value so it effectively locks in a minimum yield for the lender upfront.

Sep 16, 2020 - 12:43pm

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