PRIVATE CREDIT DEBT FINANCE ANALYST CASE STUDY HELP
Got a 45 minute debt finance case study coming up for debt finance role (entry level). I will be given a piece of paper (single or double sided) and a calculator to compute some answers to questions. What should I expect?
Something like this?
- Would you lend to this business?
- What are the main credit risks?
- Is the amount of debt appropriate?
- How would you mitigate the risks? (e.g., covenants, security)
- What term/structure would you suggest? (amortizing? bullet?)
- Would you price this deal at 6% or 9%?
Based on the most helpful WSO content, here's what you should expect and how to prepare for your 45-minute debt finance case study:
Key Questions to Expect:
Preparation Tips:
Case Study Approach:
Common Mistakes to Avoid:
By following these steps and practicing beforehand, you'll be well-prepared to tackle the case study effectively. Good luck!
bump
bump
It might help if you share how you'd answer those questions. I realize you don't have financials in front of you - I'm saying, walk through your thought process on each. The point of these exercises is (usually) not to get to the right answer but to assess your ability to think and analyze information or synthesize information they ARENT sharing with you. (Understand the difference between analyze and synthesize).
To be sure, you have to know something about credit to know what those questions are asking but its not enough to say "well leverage is under 4x so the amount of debt is appropriate." OK... explain why 4x is or has become the industry standard. Or why it might be different for one industry over another. Ex: would you take a beer distributorship up to 8x leverage? Why or why not?
How would you answer the last question? Would you take it to 8x? Why?
Answering with the benefit of a decade of experience... Generally; no, I wouldn't. Could provide a long-winded answer as to why, but the short version is: certain industries are relatively insulated from macro and competitive pressures and wholesale beer distributors are one of those. But they aren't free from competition entirely (either from major brand substitutes or from changing consumer preferences for craft beer) and they are still subject to operational factors which could compress margin. At such high levels of leverage, any change in margin (which could come from a host of factors you can't underwrite) makes cash flow extremely sensitive. And once the business (any business!) starts being managed to service debt; it ceases to be responsive to the market and is setting itself up for failure. Not a situation I want to lend into.
But there are always exceptions! Certain situations could warrant loading it up with debt but that would be a case-by-case (pun intended) analysis and I may not have a qualm about such high leverage to that industry if it made sense for some strategic reason.
I could also get behind it if the debt was relatively small. There's a big difference between $10MM in debt levered 8x and $100MM in debt levered 8x. If the owner is consistently sucking out excess cash flow to invest in assets (not sports teams or yachts or other consumption) and provides some level of guaranty; that $10MM number isn't particularly daunting. But even for extremely successful entrepreneurs with decades of profits withdrawn into their personal balance sheet; $100MM is a ton of money. And even if they had it, they aren't as likely to just write a check as they would be if it were $10MM. So even a transaction with all the same metrics (leverage, DSC, liquidity ratios, etc) is just different with such big numbers.
Would you mind answering the question regarding pricing 6% vs. 9% as well please?
My own initial thinking is as follows (appreciate any input/guidance you provide):
Pricing should reflect the risk of underwriting the loan and should compensate the lender for the inherent risk of lending to the business. Pricing is one lever that can be used to compensate the lender for such risk, in addition to the covenants of the credit agreement, as well as the security asset coverage/recoveries available to the lender. As an example, if the debt we're proposing is of the most senior tranche in the capital structure, has strong gating covenants, and relatively high security coverage, a 6% interest rate may be suitable, however, if we are deeper in the capital structure, and expected recovery given default is lower, a higher cost of borrowing may be warranted. Additionally, competitive factors also play a role in pricing, if there are a lot of lenders chasing the deal, pricing may need to go down in order for a particular lender be able to "win" the deal. This all assumes the company is already vetted for being able to service the debt.
Am I missing anything important here?
(as a commercial banker) Lol risk-based pricing.
Yeah, I mean of course pricing should reflect the relative risk of the loan. But that's not how it works if you want to move size and meet production targets. If you only did deals where you get pricing commensurate with the risk level; not only would your production volume be weak, but you'd also have a disproportionately higher level of risk in your portfolio. A good loan is one that is sought after in the marketplace by competitors and the market price is a reflection of this and independent of your risk-based pricing model. .
The better strategy is to hone in on your risk appetite. Commit to this as an institution so that when you find one that fits in the box; you book the asset and charge what the market will bear. In banking anyway (can't speak to the ALM and pricing of a PC fund), you can make up some level of margin through deposits, treasury, and ancillary revenues. But even if you can't (ex: a CRE deal), it's better (in my opinion) to have earning assets you know are good even if they are cheap.
Expedita ab voluptatem dolor corrupti commodi sint animi. Consequuntur eveniet aut recusandae distinctio tenetur enim qui. Labore ea sed corrupti sint error.
Non explicabo quia animi omnis est. Est numquam ad aperiam quasi distinctio aut magnam accusantium.
Qui sunt nulla minima sed excepturi. Sint dolores occaecati aut enim qui.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...