Loans offered at a discount in syndication are popping up more and more as lenders try to appeal to an institutional marketplace looking to make back some of the money it has lost. Original issue discounts (OID) help portfolio managers--particularly collateralized loan obligation managers--push up the average value of their portfolios. With institutional investors claiming the lion's share of new issues, OIDs are expected to gain steam, bankers said. "The trend is likely to continue," said Richard Carey, managing director at Credit Suisse First Boston. "The fastest growing segment of the institutional loan market is the CLO portion, and original discounts cater to their appetite."
American Greetings, Edison Mission Energy and Centennial Communications have all hit the market with recent OID deals. Marking to market among institutional accounts is fueling the urgency of the discounts. "The institutional market is growing and accounts have par-value tests, whereby loans in a portfolio are marked-to-market value and the vehicle has to average at par," one banker said. She explained that many of these portfolios have loans trading at 50/60, especially ones heavy with telecom baskets.
Another banker put a finer point on it. "If a deal is at a discount, then there is also a chance to show NAV improvement," he said. "A loan bought at 96 can trade upwards towards par, and the CLO can show the gain on the book. A loan yielding LIBOR plus 5% bought at par will only show the yield."
For borrowers, in some cases offering at a discount is the best way to ensure it gets the deal done. David Poplar, investor relations manager for Cleveland-based American Greetings, which completed a difficult $1.1 billion refinancing last week, said, "This is a marketplace trend presented to us by the banks. It made sense to us in line with what we were trying to do." But someone has to make up the difference. In most cases, the lead lenders have covered the discount out of their own pockets. Poplar declined to comment on whether there was an added cost to the company for the discount, or whether arrangers Goldman Sachs, National City Bank and Key Bank picked up the tab.
Discounts do not always work. A credit for Williams Communications led by Lehman Brothers and Salomon Smith Barney in March was offered at 96 3/4, but syndication still failed. The discount would have been netted out in the amount of the proceeds the company received rather than the banks eating the difference. An ANC Rentals deal was offered at 98, but difficult market conditions and other rental industry credits trading in the 90s made the discounted credit still unattractive. Calls to officials at Williams and ANC were not returned by press time.