2. Applying issue price rules to example. Borrower issued the original debt instruments (Original DI) in January for cash. Therefore, the issue price of Original DI is the first price at which a substantial amount of the issue was sold. However, because it is not clear when the underwriting rule should apply, it is not clear which sale determines Original DI’s issue price
Lender bought Original DI with the intention of immediately placing the instruments with investors, and quickly did so. Therefore, it can be argued that Lender acted in the capacity of an underwriter in a firm commitment underwriting and Borrower’s sale to Lender should therefore be disregarded under the underwriting rule of reg. section 1.1273-2(e). Instead, applying the underwriting rule, the issue price of Original DI should be determined with reference to the price at which Lender sold the instrument to investors, or $1.02 billion. Original DI would therefore have OID equal to the difference between its SRPM of $1.05 billion and its issue price of $1.02 billion, or $30 million.
However, the transaction could also be viewed as a private lending transaction to which the underwriting rule does not apply. The first price at which a substantial amount of Original DI was sold would be $1.05 billion the price for which Borrower issued Original DI to Lender at closing. If Original DI is treated as issued in a private lending transaction, then the cash payments Borrower made to Lender incident to that transaction must be accounted for according to reg. section 1.1273-2(g)(2). Under that rule, such payments generally reduce the issue price of Original DI, unless they are payments for property or services provided by the lender.
In our example, Borrower paid Lender $23 million as a commitment fee, reimbursed Lender for $1 million in loan processing costs, and paid $26 million in other fees. Commitment fees and loan processing costs are payments for property or services provided by Lender, so they do not reduce the issue price. Therefore, the issue price of Original DI equals $1.05 billion less the remaining $26 million in other fees, or $1.024 billion. Original DI has OID equal to the difference between its SRPM of $1.05 billion and its issue price of $1.024 billion, or $26 million.
Whether or not the underwriting rule is applied leads to a difference in issue price of $4 million in our example. However, if Lender had resold Original DI for a lower price, the difference would be much greater. Therefore, it would be useful for Treasury to clarify the scope of the underwriting rule. For purposes of this example, we assume that the underwriting rule does apply when Lender acted as an underwriter in a firm commitment underwriting.
In December, Borrower and Investors agreed to amend Original DI to (among other changes) increase the stated interest rate by 1 percent per year and force a $100 million prepayment. Together, the amendments amounted to a significant modification within the meaning of reg. section 1.1001-3.50 Original DI is therefore treated as if it were exchanged for newly issued debt instruments (Amended DI) together with any additional compensation exchanged in the transaction. Amended DI is deemed to be issued for property, namely Original DI. Because the debt instruments appeared on a quotation medium at the time of the amendment, Amended DI was publicly traded. Therefore, the issue price of Amended DI is its fair market value as of the issue date.
The average price quote for the debt instruments as of the issue date was 80 percent of outstanding principal. Borrower repaid $100 million in principal in connection with the Amendment, and so the outstanding principal amount of Amended DI was $950 million ($1.05 billion -$100 million), and its FMV was $760 million (80 percent of $950 million). Therefore, the issue price of Amended DI is $760 million. Amended DI has OID equal to the difference between its SRPM of $950 million and its issue price of $760 million, or $190 million.