OID question

[yojoakak]

Since this discussion http://www.lendacademy.com/forum/index.php?topic=530.0" class="bbc_link" target="_blank">http://www.lendacademy.com/forum/index.php?topic=530.0 I've been trying to wrap my head around this OID issue and I can't really figure out how it applies to LendingClub notes.

Here's how the IRS defines it:

"Original issue discount (OID).   OID is a form of interest. It is the excess of a debt instrument's stated redemption price at maturity over its issue price (acquisition price for a stripped bond or coupon). Zero coupon bonds and debt instruments that pay no stated interest until maturity are examples of debt instruments that have OID. "

http://www.irs.gov/publications/p1212/ar02.html#en_US_2011_publink1000206276" class="bbc_link" target="_blank">http://www.irs.gov/publications/p1212/ar02.html#en_US_2011_publink1000206276


OK, so what is the "redemption price at maturity" of a LendingClub note. $0.00 right?

What is the "issue price"? Whatever the face value is. There is no discount.

And interest is paid monthly. When a borrower makes reduced payments the interest still gets paid first. (Except for when a loan is in default, but then it either gets charged off or returns to Late status if a payment gets made, right?) So accrued interest doesn't really "build up" as long as payments are being made.

So how exactly does OID apply to a LendingClub loan?

[Zach]

https://forum.lendacademy.com/index.php?topic=646.msg2903#msg88888888Quote"> from: yojoakak on January 16, 2013, 08:24:06 PM

[TravelingPennies]

https://forum.lendacademy.com/index.php?topic=646.msg2905#msg88888888Quote"> from: zpbsfg on January 16, 2013, 09:18:34 PM

[TravelingPennies]

https://forum.lendacademy.com/index.php?topic=646.msg2908#msg88888888Quote"> from: yojoakak on January 16, 2013, 09:54:25 PM

[TravelingPennies]

https://forum.lendacademy.com/index.php?topic=646.msg2909#msg88888888Quote"> from: zpbsfg on January 16, 2013, 10:00:02 PM

[TravelingPennies]

https://forum.lendacademy.com/index.php?topic=646.msg2914#msg88888888Quote"> from: yojoakak on January 16, 2013, 10:43:23 PM

[TravelingPennies]

In the discussion linked to above everyone pretty much agreed that LendingClub limits payments on  notes to 5 years because of rules pertaining to Applicable High-Yield Debt Obligation (AHYDO).

But AHYDO must have "significant OID".

And I don't see how LendingClub notes have any OID at all.

Just trying to understand what exactly it is we're all investing in here.

[rawraw]

https://forum.lendacademy.com/index.php?topic=646.msg2916#msg88888888Quote"> from: yojoakak on January 16, 2013, 11:43:00 PM

[TravelingPennies]

https://forum.lendacademy.com/index.php?topic=646.msg2917#msg88888888Quote"> from: rawraw on January 17, 2013, 05:53:42 AM

[AmCap]

Hey Guys - You are missing a piece of law here, which is making this confusing. Original Issue Discount (OID) is the excess of the Stated Redemption Price at Maturity (SRPM) over the Issue Price (IP) of a debt instrument. The IP is, generally, the value the debt instrument holder (i.e., lending club investor) exchanges for the promise to pay principal and interest payments. The SRPM is the sum of all principal and interest payments, including stated interest, to be made under the terms of the debt instrument.

[this is the part you are missing] SRPM does not include Qualified Stated Interest (QSI), however. QSI is 1) stated interest that is 2) unconditionally payable in cash or property 3)at least annually 4)at a single fixed rate. Member payment-dependent notes do not have QSI because the interest on the notes are not unconditionally payable. Recall that the notes, by form, are issued by Lending Club and held by the investors. By the terms of the notes, Lending Club is only obligated to pay interest on the notes to the extent the interest is paid by the borrower. This arrangement probably does not meet the requirement of a debt instrument having "unconditionally payable [interest] in cash or property." Since the interest is not unconditionally payable, Lending Club notes probably have no QSI.

Since the notes have no QSI, the SPRM is simply the sum of all of the interest due on the note over the term of the note plus principal. Consequently, the notes carry OID that is equal to the stated interest of the note. The OID, for tax purposes, is accrued according to the constant yield method, and is includible in gross income as it accrues regardless of the taxpayers form of accounting. This means that, even if you are a cash-basis taxpayer (e.g., you include income only when you receive it as cash), you will include the accrued interest and pay tax on it.

OID which is included in gross income increases your adjusted basis in the note; so if the note becomes worthless, you would recover the OID as a bad debt deduction. Generally, a debt instrument has significant OID if, during any accrual period after five years from the issue date, the amount of OID that accrues during that period exceeds the amount of interest to be paid during that period plus the YTM x IP.

[edits for formatting]

[TravelingPennies]

https://forum.lendacademy.com/index.php?topic=646.msg2917#msg88888888Quote"> from: rawraw on January 17, 2013, 05:53:42 AM

[TravelingPennies]

The prospectus goes into detail on this (especially on page 68) https://www.lendingclub.com/fileDownload.action?file=Clean_As_Filed_20121128.pdf&type=docs" class="bbc_link" target="_blank">https://www.lendingclub.com/fileDownload.action?file=Clean_As_Filed_20121128.pdf&type=docs

"The U.S. federal income tax consequences of an investment in the Notes are uncertain.

There are no statutory provisions, regulations, published rulings, or judicial decisions that directly address the characterization of the Notes or instruments similar to the Notes for U.S. federal income tax purposes. However, although the matter is not free from doubt, we intend to treat the Notes as our indebtedness for U.S. federal income tax purposes. As a result of such treatment, the Notes will have original issue discount, or OID, for U.S. federal income tax purposes because payments on the Notes are dependent on payments on the corresponding member loan..."

[TravelingPennies]

The portion you quote yojoakak is what we term a "debt for tax" provision.  Basically what it says is that the notes should be treated as debt and not equity (e.g., preferred stock) for tax purposes.  Generally, tax looks to the economic substance rather than the form of a financial instrument to determine whether it is debt or some form of equity instrument; what they are saying is that for their purposes they consider it to be debt for tax purposes (but they aren't all that sure).  The issue is rarely litigated, so it's hard to make a very definitive statement about it in an offering document.

It's my personal opinion that member payment-dependent notes retain more equity-like features and should be treated as equity, but unfortunately my personal opinion doesn't sway the "wise, equitable, and fair administration of the revenue system."  haha

[TravelingPennies]

At the bottom of page 68 it says this:

"The OID on a Note will equal the excess of the Note’s “stated redemption price at maturity” over its “issue price.” The stated redemption price at maturity of a Note includes all payments of principal and stated interest on the Note (net of the 1.00% service charge) under the payment schedule of the Note. The issue price of the Notes will equal the principal amount of the Notes."


So I guess someplace LendingCLub is actually issuing us a non-interest bearing bond with a stated value at maturity, and that's where the OID comes from.

When borrowers make all their payments on time, everything works out fine. When borrowers don't make all their payments on time, LendingClub somehow fixes up these bonds to make the numbers work out.

(Where exactly these bonds with "stated redemption price at maturity" exist I don't know. They're not in any of the SEC filings, not that I can find anyways.)

[TravelingPennies]

The top of page 69 really gets into the juicy details:

"The amount of OID includible in a U.S. Holder’s income for a taxable year is the sum of the “daily portions” of OID with respect to the Note for each day during the taxable year in which the holder held the Note. The daily portion of OID is determined by allocating to each day of any accrual period within a taxable year a pro rata portion of an amount equal to the product of such Note’s adjusted issue price at the beginning of the accrual period and its yield to maturity (properly adjusted for the length of the period). The adjusted issue price of a Note at the beginning of any accrual period should be its issue price, increased by the aggregate amount of OID previously accrued with respect to the Note, and decreased by any payments of principal and interest previously made on the Note (net of the 1.00% service charge). A Note’s yield to maturity should be the discount rate that, when used to compute the present value of all payments of principal and interest to be made on the Note (net of the 1.00% service charge) under the payment schedule of the Note, produces an amount equal to the issue price of such note.

Cash payments of interest and principal (net of the 1.00% service charge) under the payment schedule on the Notes will not be separately included in income, but rather will be treated first as payments of previously accrued but unpaid OID and then as payments of principal."

FASCINATING!

No wonder it's so hard to figure out how exactly LendingClub calculates 30 days of Interest on a note http://www.lendacademy.com/forum/index.php?topic=595.0" class="bbc_link" target="_blank">http://www.lendacademy.com/forum/index.php?topic=595.0

They're not calculating Interest, they're calculating “daily portions” of OID!