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Excellent post...credit definitely doesn't seem to get the face time or have the glamour of equity but it is without a doubt very important. Credit related skills are great skills to have.
I have to disagree. It's only places like here where equities are more glamorous and focused on. The vast majority here are kids in school and, just like the author smpoints out, equity info is much more readily available.
When I was on the options desk, we had credit guys come do a teach in on credit and CDS (to possibly trade it vs. puts). As a few senior, very talented equity derivatives traders once said: "the credit guys are fuking smart.... They make us look like cash traders!" To anyone that is involved in any sort of finance, equities is not really glamorous at all.
Getting in to stereotype wars I see.
Yeah, I think he was speaking of equity in the sense of returns and public perception. Equity is IMO considered more "sexy", because it is available to the retail investor and therefore gets more air time (Mad Money, etc); also the upside for equity is immense compared with debt.
Yes, exactly - you get so much more exposure to equities, yet there are probably 0 corporate bond quotes on any business channel on any given day.
I think its interesting that you mention equity derivatives guys think credit guys are smart...as a credit guy, I always thought the equity derivatives guys were brilliant...I point out in one of my previous posts (//www.wallstreetoasis.com/blog/picking-the-right-trading-jungle) that I always thought the equity deriv guys were super smart and probably the brightest pure traders on the sell-side. In my training program (now over half a decade ago), the only other math majors in my trading analyst class were in equity derivatives, and my best friends in my analyst class (excluding friends from my alma mater) were equity deriv guys who were on a different level than me in terms of mental math skills. Yet they somehow tend to think credit guys are even more intellectual because we read big documents and build nerdy models and corporate org charts.
I think the reason for this is that unfamiliarity breathes mutual respect. Equity derivs and credit are such different environment with such different underlying skill sets that the concepts in each of them are relatively foreign to one another. And we give each other the benefit of the doubt and assume they all know what they are talking about. Also, both equity derivs and credit guys like picking on vanilla equity guys.
Sorry I should have clarified, I am more refrencing perception.
are you talented with credit skills? if so where can i learn?
This is a great post. Nicely done.
awesome post.
Excellent post for everyone IMO, even if not focused on credit funds. Downside risk is always important.
Great post!
Really enjoyable - thanks.
Nice, will look through the links in my spare time. Thanks for this! Need to remember to +SB later!
exactly what i needed, good timing +1
Great post! Looking forward to more.
agreed great post thanks
Dumb question, but whats the answer to that? I'm having trouble comparing the EBITDA multiples to their leverage multiples.
Is my reasoning correct that its the tech company since 10/6 is greater than 5/4?
No, its the other way around. Basically, my point was to imply the implied equity cushion (enterprise value less debt) was higher for the tech company. So 6x leverage/10x EV for the tech company implies a 40% equity value cushion, and a 4x leverage/5x EV for the auto company implies a 20% equity cushion. Because the cushion for the tech company in this example is higher, it would theoretically be more appealing. This implied equity cushion concept applies when you forecast a downside scenario where you take a potential distressed sale into account - in which case you impair EBITDA as well - or looking at a company with the potential to raise equity which can help reduce outstanding debt.
That makes sense, thanks for clearing it up
This is to test your knowledge of Debt/Cap ratio. In this instance auto company has 80% D/C while tech has 60% D/C therefore auto company is more levered than tech
These are the sort of posts that make WSO awesome! Well done sir!
Great post, thank you.
However, I do not totally agree with this statement "We don’t care about whether or not your company's new product is going to take off in five years if our loan comes due in 4.75 years – we want your cash flow now." I may have a different debt background but I always look at these cases very closely. The company may be significantly short in cash right before a new product takes off so I have a risk of not getting my balloon payment. I always try to avoid these scenarios by shortening the term so that we will get paid at least a year before the new product takes off, or I will take some more risks by extending the term so that I will get paid after the new product yields some profitability (of course I will charge a higher interest rates in this case).
I do agree with what you are saying here - unfortunately, the role I'm in lacks the ability to negotiate maturities more often (focused primarily in liquid stressed/distressed, including the broader HY/leveraged loan primary market).
My example was more focused on companies trying to hit the credit market when an equity raise would be more appropriate for the structure. I think what we are seeing, particularly in the middle market space, is corporates trying to raise capital via the leveraged loan/private bond market as opposed to getting equity financing in structures where raising equity capital would be more appropriate - bespoke retail, pharma, software are some examples of sectors I view as trending towards inappropriate capital structures in recent years. I tend to not like asset-light binary outcome opportunities where the upside/downside is TOO skewed...8% on the upside, 100% on the downside for the bond...50%-100% upside, 100% downside on the stock. Alas, such is the market we operate in.
Are you focused on middle market origination?
I had an internship with a small private equity before and they negotiated financing with some hedge funds and those hedge funds always tried to avoid situations as I said. I now work in private real estate debt (with a focus on construction, bridge, B piece, etc.) and we always try to avoid situations such as lease rollover. In my role, I can easily negotiate terms so I guess I am more flexible than you in term of underwriting.
Thank you. I have an interview in for a credit risk internship in a week and this is valuable. Although it's a bit late to really get these concepts down, if I can just remember the basics it'll be very helpful.
Awesome post. Would SB, but I ran out...
Dude, you're like @BlackHat 's evil fixed income twin!
Wow - I just looked up his profile, he posted this in 1Q12:
"Quick background: Penn undergrad - 2 years at AM firm - 2 years at large HF - currently in 1st year at 2-3b long/short HF with heavy emphasis on value."
Awesome - I probably know as much about deep value Equity Analysis as most 1st year bankers know about long/short credit funds, will be reading through his posts.
Awesome article, will check out the financial statement website you provided.
OP, do you have any suggestions on books to read to help me learn how to perform fundamental analysis on credit, particularly corporate or municipal bonds? I'm not sure if I want to invest as a career, but I definitely want to learn how to analyze debt for my own purposes. I want to be a successful investor to manage my own funds when they come, and I feel credit is a better fit for my personality because it deals with downside risk (as you alluded to) and fixed cash flows. My brain hates uncertainty (I hate doing DCFs because it's quite nebulous as to what the cash flows really will be) and I'm more concerned with what could go wrong than what could go right, which is why I want to learn how to analyze bonds.
Any suggestions?
Hm - "Fundamentals of Corporate Credit Analysis" by S&P and "Distressed Debt Analysis" by Stephen Moyer are my two favorite intro texts. Look for LSTA primers as well - its the official trade group for the loans market.
If you want to get more deep into covenants there are multiple 'legalese' texts that could be useful. I don't believe in DCFs but understanding the ins and outs of the lbo model on this site is pretty relevant to understanding how to view debt from the operator's perspective: http://www.macabacus.com/valuation/lbo/overview
Its a pretty popular site but actually building the LBO model step by step is a useful exercise.
Great post, thanks!
If you wouldn't mind answering these it would be much appreciated (relatively simple answers would be great). I have been doing my own research but.. credit risk interview in a couple of days haha.
How do you determine risk profile of a company?
How would you calculate the credit risk exposure?
What would you look at a bank´s balance sheet regarding credit risk?
What ratios would you use to evaluate credit risk of a company?
"How do I determine the risk profile of a company?" Thats a really broad question - free cash flow, leverage, revenue/margin stability, competitive pressure? You should be able to answer this one already.
I also don't work with banks so I don't know how to look at a bank's balance sheet - more debt the worse? I don't know anything about the credit risk department besides they always used to hassle my team when I was in bond trading.
Ratios that are useful? Leverage, interest coverage, free cash flow/debt, all the basics are useful metrics.
This. And adjust for operating leases, pension liabilities, other contingent liabilities (i.e., asbestos claims, etc.) Also, as big unit said prior, leverage is relative to peers/industry...
I suppose the 5 C's is a key answer.
Given all this, I'm surprised credit focused HFs and PE firms don't recruit from commercial banks.
Given all this, I'm surprised credit focused HFs and PE firms don't recruit from commercial banks.
Whoever gets a job as a credit analyst as a result of this post owes you a night out on the town, @"big unit".
Forreal, you're the man @"big unit". If I eventually land a credit job, I owe you one.
Glad this was helpful, if you look at my profile you'll see "Member for 6 years 9 weeks"
So I used this site as a pretty important resource when I was going through summer and full-time recruiting over six years ago (in fact, based on when I signed up, I actually joined this site right before summer analyst recruiting the spring of my junior year).
So always happy to try to help/pay it forward.
Great post
Good post, thank you
Hey, quick question regarding cap structure leverage. I saw one of your recent posts about yield per turn of leverage which I really enjoyed; so assuming first lien bonds of $300mm with a 2016 maturity, and then two second lien issuances of $200mm and $150mm with maturities of 2018 and 2019, respectively; how would you calculate the yield per turn of leverage for the $200mm issuance with 2018 maturity? Would you aggregate both second liens in a sort of pari passu manner? Or does it receive some kind of seniority due to shorter maturity date?
Thanks!
I would lump the '18 and '19 together for the yield per turn basis (which is meant to be a high level way of segmenting things out), then look at the '18 and '19 yields to see if the additional yield on the 19s more than outweighs the 1 year extended maturity. The less stressed the name the less of a yield premium I'd expect for a later-dated maturity. But in general thats how I would look at it. Keep in mind that for a lot of names, yield per turn is less relevant if you have a 1st lien collateral claim that you think you can actually have a perfected claim on (perfected = mortgaged).
Bookmarked
bump
For some reason I am not seeing the actual post. Is it me or the post has been removed?
Same.. Would be good to recover it, looks like an interesting post.
would love to read it as well!
Found an old version of the post using the wayback machine
https://web.archive.org/web/20170309123850/http://www.wallstreetoasis.c…
Same
This looks like an interesting post but for some reason I am not able to see it, is there any way I can read it? Really appreciated the help!
Was able to find an older version of the post using the wayback machine
https://web.archive.org/web/20170309123850/http://www.wallstreetoasis.c…
Not available any more.. Any chance that you have printed it out? Thanks!
I really want to read this but for some reason, I cant see the OPs post. Does anybody know why that is?
Dunno, but a few posts up has it from the Wayback Machine, and it's still good: https://web.archive.org/web/20170309123850/http://www.wallstreetoasis.c…
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