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Instead of “Original Issue Discount,” OID could just as well stand for “Oh, It Depends,” at least when it comes to how private credit investors book loans that they originate below par. There is no hard-and-fast guidance on how private debt funds should account for OIDs—not from regulators or auditing standard setters—leaving investors to sort through their options.

Absent clear guidance, practice across the dozens of BDCs and other credit funds VRC works with varies, leaving many market participants to wonder how their peers handle the issue. Through an informal survey of more than 40 clients and auditors who work in the private debt arena, we identified a discernible preference for treating the OID as incremental yield consideration and amortizing it over the life of the loan, though that approach is by no means uniform.

Among BDCs, we found that on about 69% of deals with an OID, the discount is treated as yield consideration and amortized, while 15% are booked entirely to immediate income; the balance is treated partly as income and partly as yield. With other types of credit funds, on nearly the same percentage of OID deals, 67%, the OID is treated as incremental yield and amortized, while the balance is treated as fee income; none go with the part yield, part fee split seen among BDCs.

Of the 32 respondents that allocate at least some of the OID to yield and amortize, 22 (69%) said they amortize out to loan maturity, while the others indicated they use a period of anywhere from six months to four years. However, some larger middle market lenders did indicate that when new issuance markets are active and less volatile, they may look to use a shorter amortization period. The support logic is in line with the broadly syndicated markets that typically have an OID at underwriting, then when cleared for trading, sometimes within a month of underwriting, the loan trades close to PAR, thus arguing for more fee-based treatment and shorter amortization periods.

VRC’s Approach

We defer to the sponsor and their auditor for the right approach to valuing any given OID at issuance. If they wish to amortize, we will add the discount to the yield – essentially modeling the OID into our DCF model at investment, treating it as additional yield consideration over the amortization period (usually the contractual maturity of the loan).

If, on the other hand, the fund manager and their auditor consider the discount a fee, we will mark the security at 100/par and set the initial yield equal to the coupon.

In our practice, we find that the decision on whether and how much to amortize or book to income at deal close is usually informed by the particulars of the deal and whether/how much of the OID was built in as a yield enhancer to get the deal over the finish line for lenders, in which case it is typically amortized, or as a proxy for structuring/origination fees, in which case it’s immediately booked as income. One common litmus test for how the OID is treated is to ask, “Would a secondary market purchaser of the loan require the extra yield from amortization of the discount to be enticed to buy it, or would they view the discount as an origination fee that they are not necessarily entitled?”

More on the Split Decision and BDCs

We asked the BDCs that said they sometimes split the OID treatment what considerations go into deciding whether to split and how they determine the respective allocation. One said it is simply a matter of the size of the discount, with anything bigger than four points getting amortized; another indicated the allocation depends on whether they are the only lender—in which case they treat three-quarters of the OID as fee income and the balance yield—or in a club deal, where the split is 50/50; yet another BDC indicated they discount the loan value and amortize the incremental yield when the fees on a transaction are above “standard,” while another earmarked part of the OID as fees based on specific roles such as serving as the arranger or performing deal documentation.

The size of discounts taken by BDCs varied. Four out of five gave a 2-3% range, with the remainder indicating 1% at the low end and 7% at the high end (the latter was inclusive of all fees as well as warrants, mostly with the VC lender community). One large BDC indicated senior/unitranche loans trending toward 1-2%.

Summary

Practices around OIDs vary, but for the most part, there is a method to the madness. Market participants typically look to sort out what they earned as fees—for deal structuring, arranging documenting—and what is extra yield. And they proceed accordingly.