Leveraged Finance – 2017 Update

There are a number of threads detailing what the job of a leveraged finance analyst and associate entails. A number of these are a bit dated but still pertinent. Therefore, the purpose of this thread is rather to focus on a few lesser spoken about topics, which people may find interesting:

1) Leveraged Finance market update
2) Clarifying exit opportunities
3) Leveraged Finance team structures - who does the model and does it matter?

Leveraged Finance Market Update:

2017 has been a very good year for the leveraged finance market, with record issuance levels, driven primarily by two factors:

a) Lack of macroeconomic impediments - Across Europe and the US, economic conditions have remained stable, with a steadily improving oil price environment and fewer fears around slowing Chinese economic growth; both of which were not the case in early 2016 and led to a large degree of nervousness within the market

b) Supportive technical environment - There is simply a significant surplus of capital to be invested, held by both CLOs and managed accounts, vs. the amount of new primary issuances, making this very much an issuer's market. This has spurred issuance at the tightest levels post-crisis, often with loose documentation. The secondary market has been propped up by this excess liquidity too

Whilst the theme of the past few years of large corporate refinancings driving issuance has continued, there are finally signs that the increasing M&A and LBO activity that people have been predicting for a couple of years is now seeping through, with a few mega-LBOs closing this year and the promise of more to come in the next year. Like CLO funds and managed accounts, sponsors too are sitting on a huge amount of dry powder, and many expect this pressure to deploy to result in an increasing number of take privates in 2018, as well as more secondary and tertiary buyouts.

Another notable trend this year has been the growing shift away from high yield bonds, with leveraged loans becoming the preferred instrument of choice for many issuers. This shift has been aided by the common acceptance of covenant-lite (i.e. incurrence covenants only) packages for leveraged loans

Exit Opportunities

I want to speak about this for two reasons. Firstly, I feel that first there is a slight misunderstanding regarding the exit opps on offer for a leveraged finance analyst. Secondly, the spectrum of exit opps has evolved in the last few years so an update on this front may be useful for people considering starting their career in leveraged finance

To my first point, I'd disagree with the view that leveraged finance is one of the best teams to be in if you want to exit into PE:

  • Your primary focus in leveraged finance is on the credit worthiness on the business, so you have little experience in assessing the equity story behind a prospective investment, which is clearly of paramount importance (although of course your credit experience is useful in PE too)
  • Whilst the due diligence in a LBO process is almost always intense, the most thorough exposure you will get to a private equity house and their investment process is if you're in the M&A / sector team and acting as buyside M&A advisor, rather than if you're assisting purely with the financing. From what I've seen, the learning experience offered by the former role is likely to be more useful in helping one to transition to PE, compared to the exposure you get in leveraged finance
  • The above also applies if you're sell-side advisor and offering staple financing

To be clear, I still think that exiting from leveraged finance to PE is eminently possible and you do still see a number of juniors making this move; I just think that you'd be better suited being in an M&A or sector team if this is your end goal

The second point on this topic that I wanted to touch on was the evolution of exit opps seen from leveraged finance:

  • Since the financial crisis bank lending has dried up notably and the leveraged finance market also took a while to recover. Whilst the leveraged finance market is now in robust shape and receptive to the financing needs of large cap companies, the mid-market has found it more difficult to access the public credit markets and the bank market. As a result of this funding gap, a number of direct lenders have been established, many of whom act under the wider credit investing arms of the big private equity firms
  • This space has grown sharply in the past 4-5 years, particularly in Europe. Investors have ploughed money into the sector, which has thus far exhibited greater returns that traditional leveraged loans and high yield bonds
  • As these direct lending funds continue to grow in size, we're now seeing the biggest funds are able to write bigger and bigger tickets, often competing with leveraged loan or high yield alternatives, with a number of junior pieces of debt often being pre-placed with these funds too
  • These direct lending funds have attracted a large number of leveraged finance professionals and are, in my opinion, the most natural exit opportunity for lev fin analysts / associates, for the following reasons:
  1. You're primary focus should be on credit analysis in either leveraged finance or as a direct lender (although naturally more detailed analysis is required on the investing role, given the lack of syndication and illiquid nature of unitranche loans)
  2. The credit documentation skills that you pick up in leveraged finance will likely be transferable to those required in direct lending
  3. The whole process of an underwriting a loan as a direct lender will likely be similar to the process within a banks' leveraged finance team, from a high level perspective; receive an inbound from a sponsor about an opportunity they're looking at, sign the NDA and get the CIM, provide preliminary financing views, receive a grid from the sponsor and if you move forward, then you receive due diligence and negotiate term sheets, commitment papers and ultimately the facilities agreement
  4. I say this is the most natural exit (vs. CLO / high yield funds, which are also exit opportunities which suit leveraged finance professionals very well) due to the fact that there is still an origination element involved in direct lending, with sponsor relationships being a key differentiator amongst the increasing number of players within this space; which is very much like the job in leveraged finance

Distressed debt is probably the other main exit that I haven't touched upon yet. You do see this move but it's not as commonly seen in the current climate, for a few reasons:

  • There are so few distressed opportunities out there, with default rates at very low levels
  • Also, thinking about when the cycle turns, the number of companies that will quickly default will likely be less than in previous downturns. Why? For two reasons. One, because so many companies now have no maintenance covenants in their debt packages (with just springing covenants on their RCFs), so there won't be immediate covenant breaches. Two, though we are re-approaching those levels, leverage has not reached the levels that it was at during the run up to the previous crisis, meaning that a number of companies probably do have slightly larger buffers built into their businesses to withstand a downturn, without requiring a restructuring
  • Overall, distressed investing is very intricate, with an understanding of many complex topics required; capital structure, valuation, restructuring processes, creditor rights, security analysis, the list goes on.... My view is that whilst a leveraged financier could move into this role at a junior level, given the rudimentary understanding of capital structure and credit you should have, distressed roles are likely better suited to people with the following backgrounds (in no particular order): i) Restructuring ii) Private Equity or iii) Credit Funds with flexible strategies (i.e. long / short, mezzanine, stressed situations)

Leveraged Finance team structures - who does the model and does it really matter?

A question that frequently crops up when discussing leveraged finance exit opps, is whether the team you're in holds the pen on the LBO model, and how big an impact that will have on your exit opps. As suggested in other threads, ceteris paribus, being in a group that runs the model is certainly advantageous in terms of giving you a more rounded skill set. That said, for many of the exit opps mentioned above (i.e. those focused on performing credit, in the public or private credit space), the modeling tends to be less granular than it would be in either private equity, or stressed and distressed roles, and to that extent, not doing the model on a day-to-day basis is something that can be probably be compensated sufficiently by learning LBO and cash flow modeling yourself (you should have exposure to the models in any case, even if you're not the team running them). My view is that learning about credit more generally, documentation, structuring, etc. is the part of leveraged finance that takes longer to imbibe and understand. Understanding these elements comes with deal experience and is likely to be a more important factor than modeling, when pursuing the buy side roles mentioned above. As noted though, for those looking at distressed and private equity roles, having in depth LBO modeling experience is going to be advantageous and will undoubtedly be of higher relative importance

Conclusion

I hope people find this thread informative. As mentioned, the aim was to update some topics that I haven't seen discussed on WSO for a while, if at all, and to maybe clear up what I think are some common misconceptions out there. I'm sure people will have different views to those expressed - happy to hear them!

As a final point, I thought it'd be worth touching upon the prospects for anyone considering joining a leveraged finance team in the near term. Though there continue to be concerns about where we are in the credit cycle, the mindset of the market does not appear to have become overly exuberant to the point where a spate of irrational decisions are being made with regards to banks' underwriting and investors' risk appetite. I think it's still an opportune time as a junior to work in leveraged finance - as mentioned deal flow is likely to be strong in 2018 and there are a number of exit opps on offer that are almost tailor-made for leveraged finance bankers. Whilst you can never accurately forecast what the market will look like, the backdrop today remains favorable

Comments (16)

Dec 29, 2017

Great post, could not agree more with this. I did 3 years at a BB Lev Fin team and the PE exit ops were not as commonplace as say 5 years ago, however we saw a ton of guys go to MF credit arms and other direct lending shops as you mentioned. A lot of them would actually only recruit from Lev Fin teams

Dec 30, 2017

Very good thread.

As PE ops are not clear from Levfin, understandably given the credit focused work, would you say that it would make sense for an analyst in a top Levfin group to move to M&A, if set on moving to PE after a few years? Have you seen people move from Levfin to m&a? I have to say that I have seen many do the contrary i.e. from m&a to Levfin but wondering whether this move would make sense.

Thanks

Jan 1, 2018

Absolutely - I think it makes a lot of sense for someone from lev fin to look at an M&A role. The blend of experience across both would definetely be helpful for someone looking at PE

Likewise, I've seen moves from M&A to lev fin more often than the other way around, but I don't think there's much stopping you from moving from lev fin to M&A. As discussed, both require different skill sets so it's more just about showing your willingness to learn and if you're able to convince people internally about making the move

Best Response
Dec 30, 2017

Excellent post, I work in LevFin at a BB myself and agree with the points made above

Also would like to point out that the most marketable skillset for a Leveraged Finance banker at the junior level is to understand covenants / terms outlined in commitment papers, credit docs, bond indentures , fee letters, conditions precedent etc (too many to list but you get the point), more so than "LBO Modeling" which shouldn't take you too long to understand the mechanics

This might sound contrary to most college students here who may hold the view that LBO / financial modeling is the most important skillset you can get out of your analyst stint, and while I do not argue that it is important, for a LevFin banker there are other skillsets that I would say are just as important if not more so (as in the case of understanding papers/covenants). I work in a LevFin group that does hold the pen on the model (in sponsor financing scenarios at least) and I will tell you straight up that the process of "modeling" is not complicated at all in terms of the financing structure - usually just hardcoding numbers into a pre-built excel file - the real "modeling" really comes from the diligence behind the revenue / forecast assumptions which you'll update as you go through the 500+ pages of financial / commercial / legal (both buy-side and sell-side) due diligence that you receive from the sponsor. This is what your credit committee discussions will focus on, and what you'll be defending when your credit risk colleagues start grilling you on your assumptions

My advice for incoming analysts in LevFin - really try to dig in on the covenants as you go through grids. As a junior LevFin analyst, the most time-consuming work I had was spreading covenant comps across sponsor deals (i.e. covenant comps for the last 6 deals we led for Apollo, then last 6 deals for Blackstone, and so on), and I absolutely hated it in the beginning but I realized this is where the bulk of my LevFin-related learning / skillset mastery actually took place. Also note that it's when your senior bankers start tasking you on grids / covenant comps discussions, that you know that your seniors are starting to trust more in your ability, as they know that reading credit papers is not simple (took me at least 8 months on the job before I could talk about them somewhat confidently).

Just realized my post is a bit longer than I expected.. Well anyways hope this helps, just my 2 cents

    • 17
Mar 17, 2018

Do you have any resources/book/guides that would help an SA/1st Year understand credit/LevFin better?

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Apr 11, 2018

Second this

Jan 1, 2018

Very good post. As a Levfin junior I would agree with all the above except the exuberance level in the market. While not bitcoin crazy, the market is definitely at the top of a long credit cycle and that's evidenced by current pricing levels and especially the definition of Pro Forma EBITDA, which would be my primary concern for leaving to a credit fund at this point...

Apr 11, 2018

Did someone ring?

Mar 17, 2018

@lazerbear @crookedhillary @10x Leveraged Thank you for all of your insights on Lev Fin. How do you guys view Wells Fargo's Lev Fin group? Seems to be top 5 in the league tables, but I've also read on other threads that it is not as good as it sounds...?

Mar 22, 2018

This may be a dumb question, but is it possible to switch from equity research at a BB to lev fin in the same bank or competitor?

Apr 11, 2018

Insightful post.
I got a graduate analyst offer at a Hedge Fund with EU1bn+ AUM in the LevFin (LBO Debt & CLOs) strategy. What would be the exit opportunities?

Apr 11, 2018

Retirement.

On a serious note. I think you would do good in the direct lending arms of big PE's and distressed debt trading (sometimes called special situations/solutions).

Apr 11, 2018

Thanks for the very detailed post

Apr 11, 2018

Do LevFin analysts exit into credit funds like GSO?

Apr 11, 2018
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