Setup Menus in Admin Panel

Sharing the Knowledge!™

Finance Knowledge and Information

What is loan underpricing?

Suggestion/Report Error


Underpricing is the setting of a loan's offer price to lenders/investors in primary syndication lower than the loan’s break price in the secondary market – analogous to bond original issue discount (OID).  Underpricing rewards participant lenders and reflects their potential profit on the loan when selling it into the secondary market.

Underpricing = Break Price – (Par – Original Issue Discount)

Arrangers often adjust the offer price and/or the underwriting spread of the facilities they syndicate relative to the loan’s anticipated break price.  A loan’s break price is the first available secondary market price after syndication closing and the deal is completed, reported in percentage points of par.

The total cost of the syndication to borrowers is the sum of the underpricing and the underwriting spread.  The greater the underpricing, the lower the amount of funding borrowers receive from the sale of their facilities, where any increase in underpricing increases the cost of financing facilities.

The underwriters then tried to sweeten the deal by raising the spread and offering a steeper discount of 5%.  When even these terms did not attract investors, the banks bumped up the discount to 10%.  After these efforts failed, the financing was subsequently pulled.

Underpricing may also depend on whether arrangers are commercial banks or nonbank lenders (e.g., investment banks, finance companies) and the syndicate structure.  The participation of commercial banks in syndicates is significantly higher if the loan is a line of credit and the borrower is rated.  They also have a competitive edge over nonbank lenders in providing liquidity insurance.

[Observations] demonstrate that syndicated loan pricing differs depending on whether a commercial bank or an investment bank is the lead arranger.

top
© 2015-2022 Pecunica LLC.  All rights reserved.
;