Bonus-)Vault Guide to Leveraged Finance

8/10/2019 Bonus-)Vault Guide to Leveraged Finance

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2006 Vault Inc.

LEVEFINACAR

VAULT CAREER GUIDE TO

LEVERAGEDFINANCE


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2006 Vault Inc.

LEVEFINACAR

VAULT CAREER GUIDE TO

LEVERAGEDFINANCE

WILLIAM JARVISAND THE STAFF OF VAULT


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Copyright 2006 by Vault Inc. All rights reserved.

All information in this book is subject to change without notice. Vault makes no claims as tothe accuracy and reliability of the information contained within and disclaims all warranties.No part of this book may be reproduced or transmitted in any form or by any means,electronic or mechanical, for any purpose, without the express written permission of Vault Inc.

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ISBN 1-58131-502-3

Printed in the United States of America


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ACKNOWLEDGMENTS

We are extremely grateful to Vaults entire staff for all their help in theeditorial, production and marketing processes. Vault also would like toacknowledge the support of our investors, clients, employees, family andfriends. Thank you!


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Visit the Vault Finance Career Channel at http://finance.vault.com withinsider firm profiles, message boards, the Vault Finance Job Board and more. ix R E E RL I R R Y

INTRODUCTION 1

THE SCOOP 3

Chapter 1: The Background of LeveragedFinance 5

Leveraged vs. Investment Grade: An Important Distinction . . . . .6

The History of Leveraged Finance . . . . . . . . . . . . . . . . . . . . . . . .10

Leveraged Finance vs. Corporate Finance/Investment Banking .13

Types of Leveraged Finance Deals . . . . . . . . . . . . . . . . . . . . . . . .15

Opportunities In Leveraged Finance . . . . . . . . . . . . . . . . . . . . . . .16

Chapter 2: Major Industry Players 19

Investment Banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .19

Commercial Finance Companies . . . . . . . . . . . . . . . . . . . . . . . . . .26

Hedge Funds and Other Institutional Investors . . . . . . . . . . . . . . .28

Private Equity and Financial Sponsors . . . . . . . . . . . . . . . . . . . . .30

Chapter 3: The Products 33

The Leveraged Loan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .33

The High-Yield Bond . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .43

Capital Structures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .44

Chapter 4: Leveraged Finance Groups 45

Structuring/Origination . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .45

Credit/Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .45

Ratings and Capital Structure Advisory . . . . . . . . . . . . . . . . . . . .47

Corporate Banking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .48

Table of Contents


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Vault Career Guide to Leveraged Finance

Table of Contents

Commercial Banks and Commercial Finance Companies . . . . . .90

Chapter 9: The Leveraged FinanceCareer Path 95

Analyst . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .95

A Day in the life of a Leveraged Finance Structuring/Origination Analyst . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .96

Associate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .102

A Day in the Life of a Leveraged Finance Structuring/Origination Associate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .103

Vice President . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .106

Managing Director/Group Head . . . . . . . . . . . . . . . . . . . . . . . . .107

Final Analysis 111

About the Author 112

Visit the Vault Finance Career Channel at http://finance.vault.com withinsider firm profiles, message boards, the Vault Finance Job Board and more. xi R E E RL I R R Y


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Visit the Vault Finance Career Channel at www.vault.com/finance withinsider firm profiles, message boards, the Vault Finance Job Board and more. 1

R E E RL I R R Y

Right now, it seems like every other headline in The Wall Street Journal is a blockbuster M&A event, a multi-billion dollar LBO, or a rise from bankruptcy by a fallen corporate angel. Much as they did in the late 1990s, both investors and corporations have cash burning holes in their pockets because of positive economic conditions, and are subsequently pushing thefinancial markets near new heights. Like the late 90s, the result is recordM&A activity, a boom in hedge fund activity, a rise in venture capitalspending, a return to the buyout activity of the late 1980s, and a general

feeling of excitement on Wall Street. But unlike the late 1990s, this flurry of financial activity is somewhat tempered, as today bankers distinctlyremember the subsequent massive economic downturn of only a few yearsago and its effects on global financial markets. Nevertheless, the major forcesthat have spurred this investment activity, such as historically low interestrates, low credit default rates, and healthy cash balances are making WallStreet an exciting place to be.

Because of low interest rates, relatively few bankruptcies, and investorshesitation to invest in the equity markets, no area has seen more activity thandebt markets. This activity has manifested itself into record global

borrowings, as global credit issuance is expected to exceed $7 trillion in2006, dwarfing its $2 trillion level in 1995 and far surpassing its $4.5 trillionlevel in 2005.

A vast majority of this activity has been spurred by the field of leveragedfinance. With financial institutions eager to lend money and borrowers

excited to capitalize on market conditions, the effects in just the past fewyears are easily identified: the second, third, and fourth largest LBOs of alltime, record fundraising by hedge funds and private equity shops, M&Aactivity levels reaching the highs of 1999/2000, all-time-low borrowing costsfor companies, and off-the-charts volume in the high-yield bond andsyndicated loan markets. For all of these reasons and many more that we willdiscuss in this Vault Guide, leveraged finance is a good place to be.

Introduction


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The Background ofLeveraged Finance

The financial markets can be divided into two major sections: debt and equity.Under this overarching organization structure, think of leveraged finance asthe intersection of investment banking, commercial banking, hedge funds,

private equity, and sales & trading on the debt side of the financial markets.

Generally speaking, leveraged finance is a platform in all major investmentand commercial banks. It is a function that taps into two major financialmarkets (the high-yield bond market and the leveraged loan marketmore onthose later), is accessed by nearly all private equity shops and hedge funds ona regular basis, and has been one of the booming profit centers of Wall Streetfor the past two decades. For analysts and associates, it has become a primetraining ground for the most elite private equity shops and hedge funds.Subsequently, for careers on Wall Street, leveraged finance is one of the mostsought-after fields.

Why leveraged finance?

Along with its role as a potential springboard to careers in private equity andhedge funds, leveraged finance is also unique from a career perspective

because it provides a vantage point into most of the other areas of investment banking, as well as sales & trading. For analysts and associates, working inleveraged finance allows one to see what else is out there career-wise in thefinancial markets, without ever having to leave the field.

Another advantage of working in leveraged finance is that in general, it is anarea of investment banking that is focused on closing transactions. In acorporate finance role within a coverage team in an investment bank (a teamthat covers a specific industry and pitches deals to companies in thatindustry), one analyst might close one or two deals a year in an investment

bank. By contrast, in leveraged finance, its feasible to close five to 10transactions a year. Leveraged finance affords analysts and associates acontinually busy pace and good deal and client exposure along the way.

Visit the Vault Finance Career Channel at www.vault.com/finance withinsider firm profiles, message boards, the Vault Finance Job Board and more. 5 R E E RL I R R Y

CHAPTER 1


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Major deals

One of the great advantages to working in leveraged finance is that you will

typically work on notable transactions. As an analyst or associate in a major leveraged finance firm, you may even see at least one of your deals make thecover of The Wall Street Journal . Notable brands like RJR Nabisco, Burger King, United Airlines, Dominos Pizza, and Sony MGM have all accessed theleveraged finance markets. From multi-billion dollar leveraged buyouts tomajor corporate restructurings, there are plenty of headline transactionsacross the field.

Leveraged vs. Investment Grade: AnImportant Distinction

The difference between leveraged and investment grade debt is an extremelyimportant concept to understand. By definition, Leveraged finance is debtissued for clients that are considered leveraged, not investment grade bythe two major rating agencies, Standard & Poors and Moodys. In other words, it is debt for clients considered a higher credit risk by the ratingagencies.

A typical rating agency grid appears on the next page. The solid bold linesdenote the investment grade vs. leveraged threshold.

2006 Vault, Inc.6 C R E E RL I R R Y


The Background of Leveraged Finance


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Standard & Poors (S&P)

AAA

Moodys

Aaa

AA+AAAA-

Aa1Aa2Aa3

A+AA-

A1A2A3

BBB+BBB

BBB-

Baa1Baa2

Baa3

BB+BBBB-

Ba1Ba2Ba3

CCC+CCCCCC-

B1B2B3

B+BB-

Caa1Caa2Caa3

CCC Ca

C D/C

D C


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Hows your credit?

How are these ratings assigned? A company is analyzed by the rating

agencies and is assigned a rating(s) based on these agencies assessment of the companys credit risk. The rating agencies assess the quality of thecompanys operations, its future potential, past track record, and financialhealth. Once this analysis is completed, the agencies assign ratings to thecompany and monitor the company going forward. Anything under a certainrating threshold is considered leveraged. A company that chooses not to getrated is considered not rated. Also, companies that are rated investmentgrade by one agency and leveraged by another are considered crossover

credits.The words leveraged and debt normally have negative connotations. Butthis shouldnt necessarily be the case. Millions of people have loans for their homes. In this sense, they are borrowing money and are leveraged, as mostof them do not have the cash on hand to pay off their loans immediately. Just

because someone has a home loan or a car loan, or does not have much cashon hand, does not mean they are not worth lending to. If that were the case,no college student would have a credit card. The more debt someone has in

relation to their cash or future earnings potential, the more leveraged theyare.Investment grade companies are the least risky of those in the debtmarkets. They are typically your long-standing, exceptionally stablecompanies, such as General Electric, Pfizer, John Deere, and ExxonMobil.Their credit history is outstanding and they have the ability to borrow largeamounts of debt at any time, since they typically have the cash on hand to pay

back those loans at any given time. Of these thousands of companies, only ahandful have the highest debt rating (Triple A).

To illustrate the difference between investment grade and leveraged, consider the following example. Suppose you have a rich friend who asks to borrowmoney from you for lunch. Youd probably not hesitate to give him $10 or so, because you know youre likely to be paid back immediately (and

probably without having to hound him for the money). That friend would beconsidered investment grade. Now consider the college buddy who alwaysasks to borrow money for beer runs, yet amazingly can never remember to

pay you back. That college buddy would be considered leveraged.





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Ratings determine access to financial markets

Of course, there are advantages to being investment grade. Since investment

grade companies are consider much less risky, they have the ability to accessa number of other financial markets, including the commercial paper market.Furthermore, these investment grade companies are typically able to getmuch larger amounts of debt than their leveraged counterparts. For example,as a triple-A rated company, General Electric has syndicated loan facilities of over $20 billion, not to mention any other debt, such as bonds or commercial

paper. In contrast, the largest syndicated loan package for a leveragedcompany is probably somewhere near $6 to 8 billion.

It is important to note that entire financial markets exist for companies in bothof these buckets (investment grade and leveraged). When it comes to bonds,there is a high grade market for investment grade companies, and a high-yieldmarket (also known as junk bonds) for leveraged companies. For loans, thereis a high grade syndicated loan market (also known as the investment gradesyndicated loan market) for investment grade issuers and a leveraged loanmarket for those companies that are considered leveraged.

For companies that are not rated, their access to either market is determined by their financial ratios, while crossover companies typically access themarket that plays to the better of their ratings.

The field of leveraged finance is concerned with riskier companies thattypically seek funded debt as a necessary piece of their capital structures.Because syndicated loans and high-yield bonds are necessary for thesecompanies operations, leveraged finance can be a little more exciting andadventurous. In the leveraged finance world, you will encounter companies

that put together comprehensive financing packages to exit bankruptcy justhours before a federal court would have forced them to liquidate, privateequity shops that push the limits of corporate finance by strapping nearlyincomprehensible amounts of debt on companies, multinational corporationsavoiding hostile takeovers by issuing large amounts of debt in order toexecute share repurchase plans, and well-known organizations that needevery single dollar available to them in order to keep their lights on andfactories working. These types of complex transactions are part of the day-

to-day life of those working in leveraged finance.





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The History of Leveraged Finance

Loans for companies

Leveraged finance originated from what would historically be thought of ascommercial banking. As companies needed money, they would typically goto the loan officer of their local bank to obtain financing. Much like youmight need a loan to buy a house or car, companies have always needed loansto buy properties or even fleets of cars. Lending institutions generallydistributed these loans in certain sizes and interest rates to companies, based

on the companys risk and size. Very similar to how a JPMorgan Chase,Wachovia, Bank of America, or Citigroup would give a home loan with acertain interest rate to someone based on their personal credit score, theseinstitutions structured loans for corporate clients. Typically, the less creditrisk a company presented, the more money these banks would lend.

This type of lender-client relationship has existed for centuries. But in the past few years these lending institutions have evolved, as have the needs of their clients. In the late 1990s investment banks and commercial banks wereable to once again legally merge due to the repeal of the Glass-Steagall Act.This means that investment banks are now not only able to provide financialadvice to clients, but also utilize the know-how of their commercial bankingdivision to deliver that financial solution. Together, this has allowedcompanies to access the financial markets even more readily and hasfundamentally changed the investment banking relationships on Wall Street.

During the past few decades, the fundamental loan product has also changed.

The original loan between two parties, referred to as a bilateral loan, was becoming obsolete. Clients were becoming larger and their financing needswere growing. Subsequently, lending institutions started finding others to

provide the loans alongside them. Instead of bearing the risk of an entire $1 billion loan, they found they could significantly diminish their risk bysyndicating this loan exposure to others. With institutional investors alsoseeking new ways to place money into the financial markets, the syndicatedloan became a prime source of investment. Subsequently, the syndicated loan

market exploded in volume, so much in fact that a secondary loan tradingmarket was created out of it. Today, as opposed to a bilateral relationshipwith a single lending institution, a company that issues a loan can havehundreds of investors in its syndicated loan. This investor interest not only





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opened up the syndicated loan market, but it also made other financialmarkets more transparent, due to the emergence of the relative value of

products across asset classes. Although still issued in a very small number of situations, the bilateral loan for the multi-billion corporation is nowessentially obsolete.

The bond market

In addition to being able to take out loans from banks, companies that arelarge and stable enough have historically also had access to public bondmarkets. To do this, companies enlist investment banks to issue bonds to

investors that promise a set interest rate of return on investment. Investorsindependently analyze the company issuing a bond and determine the interestrate that makes it worthwhile for them to take on the risk of the company notmaking its scheduled payments. If acceptable to enough investors, the bondis issued; these investors have essentially lent the company money throughthis bond issuance.

Being able to issue bonds has made it possible for companies to raise moneyfor acquisitions, to invest in capital projects, or to refinance existing debt.Together, the bond and loan represent the major financial instruments in theworld of leveraged finance.

The expanding market of debt

The bond and the syndicated loan markets have also evolved and expandedover the past few decades. In 2005, the U.S. syndicated loan market reachedissuance volumes near $1.6 trillion, nearly doubling its $800 billion volume

in 1995. In 2005, the high-yield bond market also more than doubled involume in the past 10 years, reaching approximately $100 billion, versus $40

billion in 1995. A vast majority of this evolution is due to exceptional creditconditions, fewer bankruptcies, record low issuance rates, and the relativevalue of the asset classes as investment areas for institutional investors.

This relative attractiveness of the debt markets is especially strong in light of the equity market downturn in the early 2000s. With security and near-

guaranteed returns, the debt markets have seemed exceptionally moreattractive from an investment standpoint. If you knew that you could get 7 to10 percent annual return investing in the loan of a relatively stable company,wouldnt you put your money there, as opposed to buying shares in the equity





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markets, which present greater risk? Furthermore, if a company defaults onthe loans, they are typically secured by the assets of the company, whether those be airplanes, property, or even hamburgers. In contrast, if the stock of a company loses all of its value, there is little to no recourse. As for high-yield

bonds, although not typically as secure as investment grade bonds, theylltypically offer investors a return of 8 to 12%. Also, just like investment grade

bonds, high-yield bonds are senior to the equity of a company, and thus are paid off first in the event of a bankruptcy liquidation.

Good news for the banks

Also, it is important to note that these lending transactions are very profitablefor institutions that arrange them, not just the institutional investors. For thelargest deals, this can mean tens of millions of dollars in arrangement andsyndication fees. For example, it was estimated that the fees for the financingof the famed 1989 leveraged buyout of RJR Nabisco by Kohlberg KravisRoberts (immortalized in the book Barbarians at the Gate) were somewherein the hundreds of millions of dollars. Thus, armed with large balance sheetsand subsequently the ability to lend money to numerous companies, the bulge

bracket investment banks with historically strong commercial banking arms(JPMorgan, Bank of America, Citigroup) have become the dominant playersof the leveraged finance industry. Not only do these banks have the moneyto lend and the historical know-how to do so, but they also have the pricelessinvestment banking relationships which they can use to propose financings.

Increasingly, leveraged finance is attracting new and different players to theindustry. Competition for providing large financing solutions to companieshas become intense, with many companies even conducting auctions to seewho brings the best financing package to the table. Realizing that they might

be late to the game, large banks are rapidly bulking up their leveraged finance platforms in order to take advantage of the abundance of fees for arrangingthese transactions. Although the big firms continue to dominate the industryissuance in loans and bonds, smaller firms have realized they can make anexceptional return on their money and time by providing financing to middle-market companies (middle market is generally defined as a company withless than $500 million in annual revenues and/or less than $50 million inannual EBITDA). For example, by raising $25 million for a company byassembling a syndicate of lending institutions hungry to put idle cash to work,





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small lending shops are finding themselves with a few million dollars in feesand profitable new relationships.

In the future, this trend is expected to continue. Although interest rates have been rising over time, this will not deter companies from continuing to seek syndicated loans and high-yield bonds, which have become a necessary partof a firms capital structure. Although it will be unlikely that firms will wantto refinance their existing debt with more expensive (higher interest) debt,many issuers will still turn to these financing sources for general corporateneeds or to acquire other companies. Also, with the rise of interest rates hascome a rise in M&A volume, which fuels the issuance of debt to make those

mergers and acquisitions happen. Finally, to quote a tenet of basic corporatefinance, the cost of debt is often substantially less than the cost of equity. Soit seems likely that these leveraged finance shops will remain in business and

profitable for many, many years to come.

The leveraged finance markets are quite complex, but the underlying principle and motivationproviding financing for companiesis simple.Whether this financing involves a loan to refinance existing debt, or theissuance of a complex loan and high-yield bond package in order to executethe largest LBO of all time, these markets are quite often at the center of theaction on Wall Street. Companies still call their banks and loan officers for advice on syndicated loans, but at the same time are now speaking tomanaging directors at investment banks that can provide a number of complex financing alternatives, tapping a variety of financial markets. Withnearly $1 trillion of combined annual global volume in the U.S. in theleveraged loan and high-yield bond markets, these leveraged finance markets

provide ample access for investors to put money to work.

Leveraged Finance vs. CorporateFinance/Investment Banking

Are the leveraged finance and investment banking the same animal? Sort of.As leveraged finance was originally a commercial banking function, most of the premier leveraged finance shops can be found within the investment

banks of the largest finance institutions, such as JPMorgan Chase, Bank of America, and Citigroup. Because of the sheer amount of leveraged financedeal volume at these institutions, there will typically be entire floors and





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groups dedicated to originating deals (proposing deals to existing or newclients), following the capital markets, trading in and out of loan/bond

positions, selling these products to investors, and monitoring the firmsexposure to loans and bonds of issuers. Naturally, at pure investment bankssuch as Goldman Sachs or Lehman Brothers that do not originate as many of these types of debt transactions, there will typically be smaller groupsdedicated to following the markets, in more of a debt capital marketsgeneralist role. However, in both types of institutions, the leveraged finance

platform is typically part of a debt capital markets groupit just depends onthe volume of deals to determine how specific and/or large the groups will be.

A common misperception is that traditional investment banking only involves providing solutions and advice to companies (such as mergers andacquisitions advice). In this regard, leveraged finance is different frominvestment banking, since a leveraged finance bank is not only offeringadvice for a financial problem, but also a product as a solution. However,most people these days broaden their definition of investment banking toinclude both offering advice to companies, as well as executing a financialtransaction, such as an initial public offering (IPO). In this sense, leveraged

finance is identicaljust as an investment bank covers a company in anindustry coverage group and works with its equity capital markets team tostructure an IPO, so does it provide the same service for leveraged financetransactions. In the case of a leveraged finance transaction, the investment

bank also covers the company and works with people from its debt capitalmarkets team to structure a syndicated loan and/or high yield bond.

Unlike investment banking, however, there exist a number of other financialinstitutions, such as General Electric or CIT Group, that arrange these similar financing packages for companies, but do so without a coverage group or anindustry platform (which an investment bank would have). These financialinstitutions still have relationships with companies, but they dont typically

provide M&A or IPO advice like an investment bank. The loan market is a private market, and as such is not limited in terms of what type of firm can provide lending solutions. If youre a treasurer of a multi-billion dollar company and you need a large loan for an acquisition, youll go to the firmwith the best interest rate, regardless of whether its an investment bank or not. In this regard, leveraged finance is more similar to commercial lending(i.e., lending to a company so that they can buy copiers, printers, etc.) than itis similar to investment banking.





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Different experiences: working in the coveragegroup of an investment bank vs. leveragedfinance

Working in a coverage group or M&A at an investment bank differs greatlyfrom working in a debt capital markets (DCM) or equity capital markets(ECM). As mentioned earlier (and will be discussed in more detail later),there is more execution of deals in a DCM or ECM role. Whereas someonein this role may not be as familiar with every facet of an industry like their counterpart in a coverage group, they will generally have more breadth of financial market knowledge.

This breadth vs. depth tradeoff is directly related to the amount of transactionexperience offered in leveraged finance. For example, the day-to-day grindmight be a little more hectic in a leveraged finance role, as a deal team could

potentially be closing two multi-billion dollar transactions on the same day something that would be quite unlikely in a coverage role. However, thistransaction-oriented environment involves substantially less idea generationand pitching of ideas to clients than one would find in an investment bankingindustry coverage group. That is not to say that someone in leveraged finance

will not do any pitchingquite the contrary. While the industry coveragegroup might come up with and pitch the idea of a syndicated loan or high-yield bond to finance an M&A deal, they will surely bring along theappropriate people from the leveraged finance platform to comment on themarkets, comparable transactions, and provide other relevant advice.

If you are beginning your career in finance, it is important to think about your long-term career goals when considering a role in investment bankingcoverage versus leveraged finance. If your goal is to work in a specificindustrylets say running a health care companyyou would probably be

better served in a health care coverage group at an investment bank.However, if you are interested in working at a hedge fund or private equityshop, working in leveraged finance will give you the opportunity to interactwith many of these firms, as you close numerous deals of theirs.Furthermore, you will be trained in certain debt metrics (whats typicallycalled credit training), which are useful in understanding the industry andare not typically emphasized in the coverage side of the bank. This is not tosay that moving from a coverage group to a private equity shop or hedge fundcant happenit certainly does, and even the top tier PE shops and hedgefunds seek people with very specific industry knowledge. However, its





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definitely the case that your exposure (most likely in late-night financialmodeling revisions) to the private equity shops will be higher in leveragedfinance groups when compared to your exposure working in an industrycoverage group. In an industry where relationships are everything, thisexposure will definitely matter.

Types of Leveraged Finance Deals

There are a wide variety of deals executed within leveraged finance. Mostcommon are syndicated loans and high-yield bonds for working capital or

general corporate purposes (day-to-day financing needs). However, inleveraged finance youll also find leveraged buyouts, when private equityshops and financial sponsors use borrowed money to purchase companies.There are also corporate restructurings and DIP (Debtor-in-Possession)facilities, where companies are entering/exiting bankruptcy and are trying toavoid Chapter 7 bankruptcy (liquidation). In this case, the companies willwork with both the financial institutions leveraged finance groups and thefederal bankruptcy court to get financing packages in order to stay in

business. Leveraged finance also covers dividend transactions, whereloans/bonds are used to pay out the owners of a business, recapitalizations,where a companys financial structure is changed, IPO/spin-off financings,where the proceeds of a loan/bond are in tandem with an IPO or a spin-off of a business unit, and even general debt refinancings, where an existingloan/bond is taken out with a new loan/bond. Examples of each of these typesof deals is discussed in more detail in Chapter 5.

Opportunities In Leveraged Finance

There are so many different areas within leveraged finance and so manyrelated to the field that there is place for almost everyone. For example, thereis deal origination, for the person who enjoys managing numerous processessuch as putting together presentations, financial modeling, and pitching.There is also capital markets work (for both syndicated loans and high yield

bonds) for the person who enjoys understanding the flow of the markets andconducting research about the markets trends. For the person who enjoys theasset management aspect of managing a firms exposure to the syndicatedloan/high yield bond markets, there are positions in internal credit/portfolio





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management work. Finally, there is a sales & trading function for bothsyndicated loans and high yield bonds.

However, very generally speaking, leveraged finance refers to the dealorigination functionwhen a team goes out to pitch a client, wins themandate, structures the loan/bond, markets it to investors, sells it, and thencloses and funds the transaction. This role as an analyst or associate caters tothe individual who enjoys managing numerous deals throughout this process,who is a jack-of-all-trades from financial modeling to talking to investmentfirms, and who thrives in the pace of a seemingly never-ending day.Furthermore, when considering if leveraged finance is/is not the field for you,

it is important to realize that some firms are organized in a typical investment banking cubicle/office atmosphere, whereas some are organized liketrading floors. Some people feed off the energy from a football field-sizedarea crammed with people chatting all day long, while others would prefer thequieter nature of a cube or an office, where personal phone calls are not heard

by your neighbors and neighbors neighbors. This type of setup can make asubstantial difference in the day-to-day enjoyment of someones role inleveraged finance.

The culture of leveraged finance depends almost entirely on the culture of thefirm in general. At a pure investment bank such as Goldman Sachs, youmight find the culture to be almost entirely opposite from that of thecommercial lending arm of a larger financial institution, such as GeneralElectric Commercial Finance. Whereas one might be very rigid andhierarchical, the other might be golf-shirt and khakis on Fridays, where ananalyst can chat it up with any managing director at any time. This kind of specific nuance is covered in the next chapter.




EBITDA

In leveraged finance, there are some common terms and phrases, fromrevolving credit facility to senior debt, that you will learn as you readthis guide and learn more about the world of leveraged finance.However, no term is more important than the word EBITDA. Companieslive and die by it. The leveraged finance markets are built around it.

Basically, EBITDA is a relative measure of a companys financial health.It can be compared across industries and company sizes. Even you, asan individual, can calculate your own EBITDA. Called EBITDA, becauseit represents Earnings Before Interest, Taxes, Depreciation, and


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Amortization, it measures a companys earnings from its operations.What gets paid right after the costs of operating a company? The

interest on debtwhich is precisely why leveraged finance bankers anddebt players care. EBITDA is a proxy of how much debt any onecompany, or individual, can afford.

For example, lets pretend you operate a lemonade stand. You probablybought lemons, water, cups, ice, a stand, and some poster board foradvertising. Lets also say you paid someone to help you operate thestand. Finally, lets say you sold all of your lemonade. If you were tohave paid these costs and come out positive, you would have made anoperating profit. But you still have not paid interest on your credit card

for the stand, nor have you paid the taxes on your income. Ignoring thedepreciation on your lemonade stand (since you never factored that costin because it was not a real cost to you) the amount of profit you haveleft is your EBITDAbefore you pay either interest or taxes. EBITDA isyour cash flow available for all sorts of thingsbuying another lemonadestand, paying off debt on your credit card, or even just paying your taxesand pocketing the rest.

When comparing companies and evaluating their operating health, mostleveraged finance bankers are concerned with a companys adjustedEBITDA (the amount that can be considered regular EBITDA year-over-year, adjusted for abnormalities and one-time costs), as well as thecompanys revenue. The EBITDA margin (EBITDA / Revenue) is a simplecalculation of how adept a company is at converting its revenues intowhat really mattersEBITDA. From EBITDA, one can determine howmuch debt a company can support (leverage ratios), as well as howmuch interest it can pay (interest coverage ratios). This, in turn,determines purchase prices for LBOs, the size of bond/loan offerings,and even the size of exit financings. In the world of leveraged finance,

no other financial term is as significant.


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In order to understand the leveraged finance industry and determine whereyou would like to work within it, it is important to understand the different

players in the industry and the markets they serve. As in investment banking,in leveraged finance there are typically three types of players: those thatoriginate and structure deals (called the sell-side), those that invest intothose deals (called the buy-side), and the clients that receive the financing.The sell-side is comprised of investment banks and commercial financecompanies, the buy-side is comprised of investment firms such as hedge

funds and insurance companies, and the clients include both largecorporations and private equity shops. It is important to note that even thoughone firm might be a particularly large player (buyer, seller or client) in theleveraged loan market, it might not so be in the high-yield bond market.

In this chapter, well review some of the major players on both the sell-sideand the buy-side. The specific firms we mention are chosen based on theleague tables of the sell-side firms and on reputation for the buy-side firmsand private equity shops. Although a good starting point for considering

potential employers, these lists should be considered in light of a particular firms culture and the emphasis it places on its leveraged finance group versusits other operations.

As this book is more focused on sell-side firms than those on the buy-side, inChapter 4 you will find a more detailed discussion of the sell-side-anoverview of the typical groups/departments within those organizations. For a more comprehensive overview of buy-side firms and private equity shops,

check out the Vault Career Guide to Hedge Funds and the Vault Guide to theTop Private Equity Employers .

Investment Banks

There are a few distinct types of investment banks in the world of leveragedfinance: first, the bulge bracket investment bank with a large commercial

banking operation; second, the standalone investment bank that typically provides advisory solutions for clients; and third, the investment bank thatdoes have a commercial presence, but is considered boutique or regional.

Major Industry Players


CHAPTER 2


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The bulge-bracket investment bank with asubstantial commercial banking operation

These are truly the dominant players in the industry. These are firms that have been lending to companies for years; therefore, their relationships with

issuersboth on the investment banking side and the commercial bankingsideare very strong. In other words, they that not only have they been aclients commercial bank (lending institution) for many years, but they alsohave a history of providing financial and M&A type advice to thesecorporations. Therefore, when one of their clients needs a loan or bond, theseinvestment banks are typically called upon to provide their advice andexpertise-as they have been for many years. These investment/commercial

banks place a large amount of emphasis on their leveraged finance operations

because of the substantial amount of fees generated from these transactions.Most of these firms have dedicated leveraged finance professionals in all of themajor financial market locations: New York City, Chicago, Houston/Dallas,Los Angeles/San Francisco, London, and Hong Kong.

Typically, these firms will have an entire leveraged finance platform under the debt capital markets heading within the corporate finance section of theinvestment bank. Some of these firms have entire teams dedicated solely tooriginating deals, while others will align this origination responsibility into

their industry coverage groups. Regardless of how it chooses to structurethese operations within their organization, the bulge-bracket investment bank with a substantial commercial banking operation will have resourcesspecifically dedicated to:

Originating transactions Following the capital markets Monitoring the client portfolio and outstanding exposure to certain clients

and financial markets Interacting with the rating agencies Selling and trading both the syndicated loan and the high yield bond




Top firms Bank of America Citigroup Deutsche Bank

JPMorgan Chase Wachovia


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Because of the vast expansion of the field of leveraged finance, as well as theincrease in size and scope of the financial markets, these types of firms areredefining stereotypical investment banking: they are becoming one-stopshops for clients. As the commercial banking operations of these firms have

become more integrated with their investment banking operations, a clientcan rely on one banker to get nearly everything it needs, including M&Aadvice, a syndicated loan, a high-yield bond, an IPO, or even savings andchecking accounts. Furthermore, clients can now count on one banker toknow everything about their companies, which creates a very trustingrelationship. Since most of these clients started at one point or another witha small loan from one of these banks, it comes as little surprise that leveragedfinance contacts are very often the managers of these extremely valuablerelationships. Needless to say, this is very good exposure for a youngleveraged finance analyst or associate.

Also, generally speaking, because the leveraged finance operations of thesefirms started as part of their commercial banking operations, the leveragedfinance groups in these types of investment banks will typically have more of a commercial banking feel: a little more laid-back and a little bit less

hierarchical than their M&A counterparts. However, they still all fall under the same corporate finance umbrella within the investment bank and theyinteract with their corporate finance colleagues just about every minute of every day.

Typically, these firms will place analysts and associates directly from their corporate finance investment banking programs into their leveraged financedivision, just as they would place analysts/associates into any other industrycoverage group. Furthermore, analysts and associates are treated exactly thesame as their other corporate finance peers in just about every aspect.However, unlike at a coverage group, where an analyst or associate mighthave a substantial amount of down time during the afternoons beforeworking through the night, there tends to be more of a fire-drill, non-stopnature to the leveraged finance work environment. Working on multiple dealsand managing numerous processes from pitch to close is a non-stop, full-time

job.





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The standalone investment bank

Also players in the leveraged finance industry, albeit on a significantlysmaller scale, these firms have quite a different approach. Whereas aninvestment bank with a strong commercial banking presence (such as

JPMorgan Chase and the other banks discussed in the previous section) seeksto maximize the number of companies it lends to in order to broaden itscommercial banking presence, a standalone investment bank such asGoldman Sachs seeks to use its balance sheet in order to drive other fee-related events. Without a commercial banking presence, these pureinvestment banks would rather allocate their balance sheets to larger fee-events for revenue generation, such as proprietary trading, rather thaninvesting and structuring syndicated loans or high-yield bonds for their

clients.

This is not to say that these firms do not arrange syndicated loans and high-yield bonds. On the contrary, they do and they are quite good at it. As just a

pure matter of transaction volume, however, they just do not have the breadthof experience or leveraged finance market presence. However, they will seek to do this type of arranging of financing for firms where an obvious M&Arelationship, or other type of fee relationship, exists. For this reason, a muchlarger portion of the leveraged finance deals handled by a standaloneinvestment bank will be LBO, IPO, spin-off, or M&A-related. (The firms

bankers in other departments will be generating fees for work on these larger deals that have a leveraged finance component.) In contrast, a firm such asJPMorgan Chase or Bank of America will arrange a syndicated loan or high-yield bond for just about any client of the investment or commercial bank for any reason, whether it be as part of an LBO, IPO (or other larger deal), or something simpler like a debt refinancing that is not related to another fee-related event.

Also, as a syndicated loan tends to require more of a capital commitment thana high-yield bond due to the sheer size of the loans, these standaloneinvestment banking firms tend to be more active in the high-yield bond




Top firms

Credit Suisse Goldman Sachs

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presentations for lenders, and more intricate offering memorandums. Also,since this type of leveraged finance platform might span multiple debtmarkets, it is also possible that an analyst/associate here might see other typesof debt transactions, including high-grade bonds, private placements,investment grade syndicated loans, and even mezzanine debt tranches.

The regional or boutique investment bank witha commercial banking presence

These firms, which do have both investment and commercial banking presences, are also players in the leveraged finance market. However, theytypically arrange financings in the large cap space for clients where theyhave a distinct relationship, or they compete in the exceptionally profitablemiddle market space. Larger firms in this category (such as ABN AMRO,Barclays, and SunTrust) often have full-scale leveraged finance platforms,

but they might find themselves investing in these loans and bonds more oftenthan actually arranging them. The same is somewhat true of the smaller lending operations, such as Jefferies, yet they generally compete for financings in the middle market space.

A substantial difference between the large investment banks with commercial banking arms and the smaller investment and commercial banks is theseemingly limitless balance sheet ability the larger firms have to invest andseek to put to work. Although they still have tens or maybe even hundreds of

billions of dollars to potentially lend, these large regional banks will arrangefinancing typically only for local companies where they can leverage the

power of their relationship for future ancillary business, such aschecking/savings accounts or other treasury business, such as hedging and

foreign exchange. In this sense, their relationships, rather than the fees of event-financings, drive their lending rationale. Furthermore, they seek to

place their capital to work in other areas of the bank and opt not to enter thehighly competitive large cap leveraged finance space. At any rate, the




Top firms

ABN AMRO Jefferies & Co KeyBank National City

PNC SunTrust Wells Fargo


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financing packages are still comprised of leveraged loans and high-yield bonds and are structured for the same clients and for the same purposes as arethe large investment and commercial banks.

Even further down the scale of size, many smaller boutique investment bankshave formed lending units by raising a specific amount of funds (typically $1 to$5 billion) for the sole purpose of arranging financing packages for clients. Likethe pure investment banks, they too are not chasing a quantity of transactions;instead, they are typically seeking event-driven deals. In order to distribute their capital wisely, these firms tend to work with smaller companies in the middlemarket space. However, they still arrange financing for the same variety of

transactions that the larger players do and they tend to interact with the same top-tier private equity shops and hedge funds. On occasion, they will even work with venture capital firms, which is something that the larger leveraged financeshops very rarely do. Also, these smaller lending institutions tend to own alarger piece of the financing package than their larger leveraged financecounterparts and they tend to syndicate to a much smaller investor universe.

At these firms, the workplace culture is typically more laid-back than at the pureinvestment banks and in general is more similar to a commercial bankingoperation. Also, with less deal volume than their larger counterparts, one cangenerally expect to close fewer transactions at these firms, yet be much moreacutely involved in every piece of the leveraged finance process. With much lesstransaction volume, analysts and associates at these shops typically become evenmore involved in every aspect of the process and this will add to the depth of their working experience. . Also, with generally fewer people in the leveragedfinance groups, analysts/associates have an opportunity to take on a substantialamount of responsibility and even truly develop client relationships.

Junior resources at these firms are also sometimes considered part of corporate finance programs as investment bankers, and sometimes they arenot. This distinction depends entirely on the firm, as do the culture and hours.Hours tend to fluctuate with the peak times of a deal, such as the closing andfunding of a transaction





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Commercial Finance Companies

If you were to take a brief look at the descriptions of commercial financecompanies on their web sites, you would find that these firms pridethemselves on providing lending, leasing, and other types of financialsolutions for clients. This is quite a different approach from a standaloneinvestment bank that provides advisory work and securities products to itsclients. Subsequently, for the leveraged finance platform of a commercialfinance company, everything from the client base to the product offerings isdifferent from the investment banking firms. In no specific order, major

players in this field include GE Commercial Finance, CIT Group, andCapitalSource.

These firms typically work very frequently with smaller mid-cap companies, providing everything from financing for heavy equipment to multi-milliondollar revolving lines of credit. Due to the nature of these product offeringsand the size of these clients, most of these firmsleveraged finance teams playonly in the syndicated loan market, and stay out of the high yield bondmarket. Naturally, if a firm is already providing smaller loans for other types

of financing needs for a company, a syndicated loan makes sense to providefinancing for a companys larger financing need. However, it is notuncommon to find some of the larger players, such as GE CommercialFinance and CIT Group, to be co-leading a multi-billion dollar transactionalongside a large investment bank. These leveraged finance deals would besourced from their large cap teams.

On the whole, the leveraged finance platform at a commercial finance

company would be smaller than that of an investment bank. Whereas thelargest investment banks might have a few hundred individuals in the U.S.dedicated solely to sourcing and structuring deals, even the largestcommercial finance companies might have fewer than 100. With somewhatless volume, these professionals typically have more all-encompassing roles,as compared to their investment banking counterparts. Where someone couldexpect to find both a capital markets team and a sales team at a largeleveraged finance shop, these functions are typically combined in the

commercial finance companies and the smaller investment banks.Furthermore, at the smallest commercial finance shops, the deal origination,structuring, credit, capital markets work, rating agency presentation, andclosing responsibilities might all fall on the shoulders of a three- or four-





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golf shirts as opposed to Hermes ties and Gucci loafers. Lunch outside theoffice, as opposed to at ones desk, is a more typical occurrence at acommercial finance company. For many, this lifestyle tradeoff of acommercial finance atmosphere versus I-banking is worth every single

penny, and more.

Hedge Funds and Other InstitutionalInvestors

Hedge funds and institutional investors represent the buy-side of leveragedfinance. Responsible for a large amount of the growth in the leveraged loanand high-yield bond markets, these investors are now placing billions of dollars in the markets. As investors have chased places to put idle funds towork, the markets have responded with more liquidity than ever, increasinglycomplex products, and more innovative financial structures. Subsequently,these investors have put the supply/demand equation into a seriousimbalance, thus making this an issuers market. Now, companies that wouldordinarily find themselves bankrupt in any other market are finding

themselves with multi-million dollar syndicated loans and high-yield bondsat all-time record low interest rates.

One of the primary reasons institutional investors are interested in thesyndicated loan market and high-yield bond market is the relative value these

products offer to other asset classes. Furthermore, the products in thesemarkets trade off the underlying value of the creditthis means that a firmtypically only has to do their due diligence on a firm once, with the ability to

invest in multiple places in the capital structure of a firm. No longer areinvestors limited to playing in either the equity of a company or the bonddebt; instead, they have a variety of options. Whereas one investor might beinterested in debt of a company, it might find the risk/reward tradeoff of thesecurity of a syndicated loan more appropriate to its risk appetite, as opposedto an unsecured, higher-interest-paying senior note.

These same investors also have the option to play in the increasingly growing bond and loan secondary markets, as these markets have also boomed due to

the rapid expansion of their primary markets. Investors tend towards theleveraged loan and high-yield bond markets since they typically movetogether. For example, if a company is downgraded by the rating agencies,





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thus suggesting that its risk profile is greater than its peers offering debt at asimilar interest rate, the trading levels of its leveraged loan and high-yield

bond are likely to fall to reflect this negative change. Institutional investorsanticipating this change might seek to sell their positions in these firms and/or short these markets. This type of credit prowess rewards the institutionalinvestor that has done its homework.

Reflecting the global financial markets, institutional investors tend to belocated all across the globe. It is not uncommon for an investor to be locatedin Miami Beach, FL, Los Angeles, CA, or Greenwich, CT. Organizationally,these firms tend to run fairly lean, only hiring individuals that can add

immediate value to their firm. As a growing number are playing in both the primary and secondary leveraged loan and high-yield bond markets, they areseeking individuals with prior credit experience. Individuals working inleveraged finance have become a highly sought after commodity for hedgefunds. Some of these funds play entirely in the leveraged finance markets,while most of the large firms typically have a set amount of their assets under management invested into the markets.

For these institutional investors, the gateway to entry into the leveraged loanand high-yield bond market comes from either the firm originating thetransactions, or the firm administrating the transactions. When a leveragedloan deal is structured, marketed, and syndicated many of these investors aregiven the chance to invest in the loan. Similarly, when the high-yield bond ismarketed, these institutional investors are given the opportunity to buy intothese bonds. On the secondary side, as a firm finds an interest in theoutstanding leveraged loan or high-yield bond of a firm, it would call itsrelationship manager at its investment bank to place a trade. When placingsuch a trade, it is not atypical for the order amount to be multiple millions of dollars. So a one-point move in the trading level of a position can have amajor financial impact on a firm.

Without league tables to rank the buy-side firms, it should be noted that themajor institutional investors in the high-yield bond market are typicallyinsurance corporations, money managers, and investment corporations, suchas Fidelity, PIMCO, and AIG. Though hedge funds play in this financial

market quite frequently, only the large ones are generally targeted in theroadshow offering process. In contrast, on the leveraged loan side,institutional investors tend to include all of the above players, as well as quitea few hedge funds, including large firms like Highland Capital, Eaton Vance,





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Van Kampen, and SAC Capital. All of these investors, and more, are targetedin the loan syndication process.

Culturally, it is tough to stereotype the institutional investor universe, as thesize and investment nature of the firm can have a dramatic impact on their organization. ( The Vault Career Guide to Hedge Funds is a good resource for anyone seeking to understand more about these firms.) However, becausehedge funds generally represent an improvement in hours and, in some cases,also represent a step up in pay, many former leveraged finance analysts andassociates seek careers at hedge funds. With a firm understanding of credit,interaction with the leveraged finance markets, a wide arsenal of

relationships, and an understanding of a variety of transactions, the junior resources at top-tier leveraged finance shops are frequently contacted byheadhunters and other placement professionals for positions at top-tier buy-side shops. In these positions, these junior resources now become clients of their former leveraged finance peers, investing in transactions they very wellmight have structured when on the other side of the fence.

Private Equity and Financial SponsorsPrivate equity firms are the final major player in the leveraged financemarkets (aside from the companies that actually issue the high-yield bonds or leveraged loans). Typically using money from lending transactions in order to buy firms, private equity shops are clients of those arranging leveragedfinance transactions. Often, their funds are also investors in their own andothers transactions, further illustrating their dependence on the leveragedloan and high-yield bond markets.

When a private equity shop seeks to purchase a company through a leveraged buyout, it typically attains a syndicated loan and/or a high yield bond from aleveraged finance firm. Like individual homeowners who will pay 25% of the purchase price from his or her own pocket and borrow the remaining 75%,

private equity shops also borrow money when executing an LBO (this process is covered in greater detail in Chapter 5). With these borrowed funds, private equity shops are able to leverage their own money and execute

market-changing transactions. At the center of this execution is the leveragedfinance firm, lining up this necessary financing.





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Whether large or small, leveraged finance firms typically line up in droves to provide this financing, as it is generally a very large fee event for a firm. Theapproximately $25 billion LBO of RJR Nabisco by KKR in 1989 (still themost notable private equity transaction in the leveraged finance markethistorically), generated hundreds of millions of dollars of fees for the lendinginstitutions. Since those early LBO days, with the rapid expansion of theleveraged loan and high-yield bond market, there has been a flurry of buyoutactivity. Numerous private equity firms have raised multi-billion dollar investment funds in the past few years in order to continue to executemultibillion dollar LBOs, such as the $15 billion purchase of Hertz, or the$11.3 billion purchase of SunGard. With LBO volume nearly $150 billionannually, up from $40 billion in 2000, and private equity fundraising volumenearing $500 billion, up from approximately $200 billion in 2000, LBOactivity is only expected to continue long into the near future. Needless tosay, the field of leveraged finance is eagerly anticipating this activity.

No target is off-limits for private equity firms armed with such financing.These firms will even enlist the bank accounts of rival firms in order toexecute mega-LBOs. Recent corporate divestitures and secondary buyout

activity, where a firm is bought by one private equity shop and later sold toanother, have also become a rapid source of expansion in the private equitymarkets. Cross-border transactions have also boomed in the past few years.Finally, auctions, where multiple private equity firms compete to win aproperty have become a market standard for corporations seeking to findthe highest bidder. Needless to say, as the cash balances of these firms remainrobust, buyout activity will only continue to become more innovative andaggressive.

Leveraged finance firms execute many other types of transactions for financial-sponsor owned companies other than LBOs. Very common instrong financial markets, many private equity shops will seek to take some of their money off the table though leveraged loans or high-yield bonddividend transactions. Financial sponsors also will execute the sameleveraged finance transactions for their portfolio companies as any other corporation would, including debt refinancings, recapitalizations, IPO/spin-off financings, and M&A transactions.

Career-wise, private equity shops tend to be another major career alternativefor those in the leveraged finance field. An investment banking professionalwho has completed the analyst program at a top-tier leveraged finance group





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seeking a slight career transition might seek out a two-year program with the big names in private equity, including KKR, Blackstone, Bain Capital,Madison Dearborn, Carlyle, Texas Pacific Group, Hicks Muse, JPMorganPartners, and Thomas H Lee. With financial-sponsor transaction experience,a firm understanding of the lucrative buyout process, and interaction with theleveraged finance markets, a career in private equity can be a comfortablecareer fit for a former leveraged finance banker. Although the hours mightnot be drastically better than the in investment banking, private equity firmsgenerally pay at the top end of the Wall Street scale, assist with MBAapplications to top-tier programs such as Wharton and Harvard BusinessSchool, and many even allow carry in the firms funds (a share of the firms

profits). These are the typical reasons why some seek a change of pace intothe private equity field.

The leveraged finance players providing the bulk of the financing money for private equity transactions also happen to be the firms with the largest balancesheets and top-notch financial sponsor coverage teams. At the top of this listare familiar leveraged finance names, such as JPMorgan, Deutsche Bank,Bank of America, Citigroup, Credit Suisse, Goldman Sachs, and Lehman

Brothers. As the nature of LBO transactions tends to favor purchasing stablecompanies (whose earnings can be used to pay of the loans used to purchasethe company), there tends to be more activity in the large cap space when itcomes to LBOs. The major leveraged finance players in the industry alsohave the ability to offer their financial sponsor clients a wide variety of financing solutions across both debt and equity markets, which is not typicalof a large commercial finance operation.

Still, though they do not generally compete in the large cap LBO space because they place less emphasis on serving private equity shops, commercialfinance companies are active in the middle market LBO arena. Examples of these include GE Antares, CIT Group, CapitalSource, Ableco-Dymas, andMadison Capital.





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As discussed earlier, there are two major financial products that drive theleveraged finance industry: the leveraged loan and the high-yield bond. Inthis chapter, we take a detailed look at the key characteristics and the issuing

process for the leveraged loan, and compare it to the high-yield bond.

It should also be noted that mezzanine capital also plays a part in theleve

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Bonus-)Vault Guide to Leveraged Finance

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