This article is part of a series on the investment banking industry and careers within it. Leveraged Finance is an excellent organization to join if you’re interested in a career in investment banking. LevFin is an important group for investment banks that provides key functions to high-profile clients and multi-million dollar deals. We’ll go into detail about the leveraged finance analyst career outlook, exit opportunities, compensation, and more in this guide.
What is Leveraged Finance?
Leveraged finance is the use of more debt than usual to finance the purchase of investment assets, rather than equity or cash. Leveraged finance is used to increase the potential returns of an investment, assuming the investment increases in value. Private equity and leveraged buyout firms will use as much leverage as possible to increase the internal rate of return (IRR) on their investment.
Understanding Leveraged Finance
Investment banking has specialized departments called leveraged finance groups. Clients are provided with overall debt financing solutions by the LevFin division (LFD). This includes planning, structuring, and managing leveraged loans.
Private Equity Firms and Leveraged Buyout Firms aggressively finance their customized projects—they use high leverage in their portfolio to increase their returns. The present value of a company is determined by investors using the cost of equity capital.
Corporate debt proportions in private equity firms are higher than usual (instead of equity or cash). This has an impact on the company’s cash flow and net profit and may result in lower Earnings Per Share EPS and dividends for shareholders. However, to have the greatest impact on Profit after Tax.
For a given change in operating profits (EBIT), higher fixed costs are used. As a result, increasing Financial Leverage within a capital structure may improve some financial ratios such as return on equity.
The amount of financial leverage in a business is typically a strategic decision. In contrast, the amount of operating leverage in each industry is determined by the dominant business model. As a result, firms should limit the use of leverage in their capital structure to reduce risks. Otherwise, stakeholders would be concerned about potential insolvency. However, some companies use manufacturing plants, land, and equipment to secure loans; these companies use more financial leverage than their competitors.
Leveraged Finance Products
The various types of leveraged financing used in business are as follows:
#1. Institutional Term Loans and Leveraged Loans
Companies receive term B loans from institutional investors, and the borrowers repay according to the repayment schedule. The borrower pays a very small amount each year, and the remaining loan amount is due at maturity. Individuals and corporations with poor credit can obtain a leveraged loan as debt. Leading banks and lenders work together to provide commercial loans and syndicated loans.
#2. High Yield Bonds
These junk bonds are below investment grade, with credit ratings below BBB/Baa. The issuing companies are unable to access bond markets and thus cannot raise capital through this mode of financing. Because these bonds carry a higher default risk, they are issued at a higher coupon rate. Furthermore, some of these bonds may include negative covenants, which prohibit further borrowing until the previously issued bonds are repaid.
#3. Mezzanine Financing
Mezzanine financing is a hybrid method of raising capital for a business. The lender can convert debt into equity using this method. It serves as a link between short-term and long-term financing and is primarily used by small and medium-sized businesses. It is extremely cost-effective.
Leveraged Finance Example
Let’s look at an example to better understand the concept of LevFin:
Scenario 1: Purchase a company for $100 million in cash.
Suppose there is an investment opportunity to buy a company for $100 million in cash. Analysis indicates a resale value of $200 million after 5 years. The reseller could potentially earn a 2x return in five years. The internal rate of return for Scenario 1 is calculated to be 15%.
Scenario 2: 50% cash and 50% Debt Financing
Let’s assume a change; the deal is now funded with 50% cash and 50% debt. The asking price is still $200 million.
- We also assume that an annual payment of $5 million is made. This sum of five million dollars includes both the interest payment and the principal repayment.
- At the end of the five years, the remaining debt is $39 million.
- If the company is sold for $200 million, the reseller receives a net amount of $200 million minus $39 million, or $161 million.
- The IRR in this case is 21%. (much higher than an all-cash deal)
Predictable cash flows provide returns estimates and are thus critical for analyzing LevFin.
Advantages and Disadvantages
Leveraged finance is a high-risk, high-return debt with several advantages for both investors and borrowers. The following are some of LevFin’s benefits:
Advantages
- Strong capital access. Every dollar you put to work is multiplied by financial leverage. LevFin can accomplish far more than it could without the addition of leverage if used correctly.
- Ideal for acquisitions and buyouts. Because of the increased costs and risks associated with increasing debt, LevFin is best suited for short periods when your company has a specific growth objective, such as conducting an acquisition, management buyout, share buyback, or a one-time dividend.
Disadvantages
- Finance is a risky business. Debt is a type of financing that can help a business expand more quickly. Leveraged finance is even more powerful, but a higher-than-normal debt level can put a business in an unsustainable state of leverage, magnifying risk exposure.
- More expensive. LevFin products, such as high-yield bonds and leveraged loans, pay higher interest rates to compensate investors for taking on more risk.
- Complex. The financial instruments involved, such as subordinated mezzanine debt, are more complex. This complexity necessitates more management time and involves a variety of risks.
Deciding Factor
- Do you have a short-term financial need or are you in a unique situation, such as a buyout or acquisition, where you require a large sum of money for a short period?
- Are you comfortable with the increased cost, complexity, and risk of this type of financing?
Investment Banking Leveraged Finance
Investment banking includes the Leveraged Finance (LevFin) group. They are a product group in charge of assisting corporate clients in issuing additional debt to fund company investments or future growth. Debt refinancings, dividend recapitalizations, and the acquisition of a new company are all examples of common leveraged finance transactions (e.g., a leveraged buyout or LBO).
LevFin collaborates closely with the Debt Capital Markets (DMC) groups within investment banks. The primary distinction between the two investment banking groups is that DCM typically collaborates closely with sales and trading to offload debt securities into the open market. Furthermore, LevFin groups specialize in below-investment-grade issuances.
LevFin works with businesses that are already (or soon will be) heavily in debt. The higher the debt ratio, the riskier it is to issue additional debt. To properly handle the transaction, a specialized team is required.
Private equity firms are big “consumers” of LevFin services because they typically buy companies in leveraged buyouts, which means they use a lot of debt to finance the purchase.
What Is the Difference Between Leveraged Finance and Investment Banking?
An investment bank’s product or service is known as LevFin. The LevFin group, which is frequently linked to an investment bank’s Debt Capital Markets (DCM) team, works with companies to execute new debt issuances at low credit ratings.
The DCM team typically interacts with the buy-side debt investors who purchase debt securities in the issuance facilitated by the LevFin group.
The Leveraged Finance team collaborates closely with all other industry coverage teams at an investment bank because they are a product team. As an illustration, a hospital company might be the subject of a leveraged finance transaction. In this instance, the Healthcare Coverage Group and the LevFin group would collaborate to provide debt issuance advice.
You will gain exposure to numerous industries because you will work closely with industry coverage teams in LevFin.
What is Leveraged Finance at a Financial Institution?
Services related to a client’s leveraged buyouts are provided by a division in charge of leveraged finance within an investment bank. These services typically include structuring, managing, and advising on debt financing for acquisitions.
For example, if a private equity firm is looking into various financing options to acquire another company, the LevFin division would present various types of debt that the client firm could incur (bank debt, high-yield debt, syndicated loans, etc.). It would then assist the client company in determining the best option based on their capital structure and operations.
The leveraged finance department markets the offering(s) to debt investors after the firm has raised the debt, assisting the firm in raising the capital required for the acquisition.
Analyst Leveraged Finance
Banking is a sector where a leveraged finance analyst works. In the areas of leveraged finance and investment banking, they are in charge of providing analysis and support to banks and other financial institutions. A bachelor’s degree in business or economics is typical for a leveraged finance analyst. Some also have a law degree or a master’s degree in business administration (MBA).
What a Leveraged Finance Analyst Do
The analysis of leveraged finance transactions is the responsibility of a leveraged finance analyst. Leveraged buyouts, mergers, and acquisitions are examples of these transactions. In the areas of investment banking and capital markets, leveraged finance analysts also support banks and other financial institutions. The structuring and syndication of leveraged finance transactions may also involve a leveraged finance analyst.
Career Outlook
Deal originating, capital market research, asset/portfolio management, and the sale and trading of debt instruments are just a few of the many areas of expertise employed within leveraged finance divisions. Because leveraged finance divisions typically deal with less-established firms, there are many opportunities to connect and collaborate with private equity firms, which can be appealing to people with private equity interests and ambitions.
Leveraged Finance Salary & Hours
Although LevFin is closely related to DCM, your hours are much more akin to the long hours and abrupt changes you’d find in typical investment banking or even mergers and acquisitions (M&A).
This is because the majority of your clients are private equity firms that work long hours and expect quick responses from their investment bankers.
You also work on a high volume of deals that require more in-depth analytical work—the more complex the deal, the longer the hours.
LevFin can pay million-dollar salaries. Senior bankers such as managing directors can earn millions while analysts and associates will be paid similarly to those in other investment banking fields.
Leveraged Finance Exit Opportunities
Because of its exposure to in-depth modeling and finance topics, LevFin provides a diverse set of exit opportunities. Top exit opportunities include:
- Private Equity Firms: Your credit expertise makes you an invaluable asset to buyout and distressed private equity investors.
- Hedge Funds and Mezzanine Funds: These are excellent options if you have a lot of modeling experience with your LevFin group.
- Distressed Debt Funds: Distressed Debt is closely related to bankruptcy, which isn’t something you’re likely to encounter in LevFin. However, they rely heavily on credit analysis expertise, so it could be a good opportunity.
- Other Investment Banking Groups: If you like the investment bank environment but want to try something different, you can transfer internally and try out M&A or other groups. Transfers can also broaden your experience for future endeavors outside of investment banking.
Is it Hard to Get Into Leveraged Finance?
All investment banking careers are notoriously competitive and difficult to break into. Leveraged finance is one of the more popular groups for bankers to join because it offers so many appealing exit opportunities.
It is also competitive because of the extensive exposure to advanced corporate topics. You’ll learn everything there is to know about debt, credit agreements, balance sheets, leverage ratios, and more! Because these skills are in high demand, an experienced LevFin banker can choose from a plethora of new opportunities.
Is Leveraged Finance a Good Career Path?
Yes!
If you want to stay in the investment banking environment, a career in leveraged finance offers numerous opportunities for advancement. However, you will have numerous exit options.
Through LBOs and refinancing transactions, leveraged finance groups closely collaborate with private equity portfolio companies. So many LevFin bankers end up being hired by private equity firms, particularly to assist with buyouts.
What is leveraged loan finance?
Leveraged loans are loans made by banks or other financial institutions to businesses that are frequently used to refinance debt, fund mergers and acquisitions, or finance projects. Companies receiving these loans typically have credit ratings below investment grade.
Is leveraged finance risky?
Yes. These loans are considered risky because the total debt exceeds a multiple of the firm’s annual earnings and cash flows.
Is leveraged finance the same as investment banking?
Leveraged finance is a subset of investment banking, so no. A bank’s investment banking division has a group called leveraged finance.
Is leveraged finance good?
It is a risky method of financing. Debt is a type of financing that can help a business expand more quickly. Leveraged finance is even more powerful, but a higher-than-normal debt level can put a business in an unsustainable state of leverage, magnifying risk exposure.
What is the difference between debt and leveraged finance?
The key distinction is that DCM focuses on investment-grade debt issuances for everyday use, whereas LevFin focuses on below-investment-grade issuances (“high-yield bonds” or “leveraged loans”) that are frequently used to fund control acquisitions, leveraged buyouts, and other transactions.
Conclusion
Leveraged Finance is a solid organization that will put you in a good position for a variety of credit-related exit opportunities. You’ll have more options than in ECM or DCM, but in exchange, you’ll work a lot more. You’ll learn some useful skills, particularly reading and comprehending loan documentation, and you’ll work on large transactions that will be useful in deal discussions during interviews.
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