There's No Crying in Leveraged Loans
The loan market reminds me of an ecosystem, and the best one I can think of is the Serengeti. You’ve got your lions (PE fund): the kings of the jungle who have the (financial) muscle to hunt down gazelles (helpless companies getting acquired). You’ve got your water buffalo (lenders): generally docile, obedient creatures but have the power to freak the fuck out and attack when angered. And you’ve got your crocodiles (distressed debtors): sneaky but powerful predators and one of the few that actively seek out lion meat. Vultures are probably the more appropriate analogy for distressed debt guys, but that’s a little too on the nose. There’s also a shit ton of lawyers, but they are too nerdy/goofy to be compared to a majestic safari animal.
For a live battle scene involving all of our constituents, google Battle of Kruger. Tried to link it here but stupid Substack says I’m out of memory.
If you’re a total noob on leveraged loans or want to learn more about what I mention in this letter, here is the bible on this stuff : Loan Primer.
So when a PE firm buys a company, they usually want to do so with the scientific maximum amount of debt quantum (tangent: debt “quantum” is the perfect example of overcomplicated industry lingo that bankers use to feel superior. It literally just means amount of debt). So they call up a bunch of thirsty lenders, put them in a room, and throw a piece of meat in the middle of them to fight over. It’s quite literally the below scene from the Dark Knight where the Joker has “tryouts” to join his team. Makes me wonder if Christopher Nolan met a big dick Apollo principal one time, who inspired him to create the Joker (the insanity and ruthlessness checks out.)
Anyways, the lenders scramble back to their underwriting caves in an abandoned tunnel like mole people. They figure out how much debt they’re willing to provide, and at what price. They go to their ICs for approval, and come back to their PE overlord with feedback. From there, the PE guy picks the most aggressive proposal as the winner, known as “Lead Left” or “Agent”. Benefits of being the Agent include more fees, control of credit agreement documentation, better access to management, and league table credit which boosts your rep in the market.
It should be noted that the way PE sponsors treat lenders varies wildly. Typically, the better the fund, the less time they give lenders. A fund like Thoma Bravo will not let lenders attend management meetings or get access to dataroom. Calls will be short with brief answers and lots of “n/a” responses to data requests (narrator in the background: “the data request was, in fact available”.) An extreme example is Apollo, where screwing over lenders is an active part of their strategy and their debt trades below where it should given their nefarious fuckery. Now if you’re dealing with Who Gives A Shit Capital (started by three basement dwellers from Wall Street Bets in 2021 with $15MM of AUM), you’ll get much more attention. They’ll talk your fucking ear off about the deal. Only problem is, if they’re buying a company, it means a bunch of better funds turned it down. So pick your poison, but most lenders prefer the less info / better deals side.
Sometimes deals are small enough where the Lead Left Agent can take down the entire thing. More likely though, multiple banks (~1-10 others depending on deal size) are required to underwrite the commitment. These other underwriters are called Joint Lead Arrangers and they agree to backstop a smaller % of the loan than the Agent. Together, the Agent + JLA’s are sometimes called the “Syndicate” - the same as the bad guys in Mission Impossible, which is way too badass of a comparison as the two have nothing in common. The funny part of this situation is that all these banks are mortal enemies and rivals, but are forced to work together. A bunch of Agents working together? Shit, that actually kind of does sound like a Mission Impossible plot.
Think of the Admin agent as the engine of the car, while JLA’s are like the wheels. Both are necessary, but the engine does a lot more work. Along with fronting some of the backstop, the Agent is responsible for selling the loan to a bunch of banks that will actually hold it. The goal for the Syndicate is to sell all of their underwritten exposure, save for the small portion they intend to hold.
The Agent will put together a presentation and go out to a ton of potential lenders to gauge their interest in hold levels, and at what price. The potential lenders ask a bunch of annoying little diligence questions that the Agent is responsible for answering, and then (ideally) turn in a “ticket” (kind of like we’re at a carnival playing games, which actually isn’t so far off reality) for a certain dollar hold at a certain price.
Hopefully the Agent is able to herd enough cats to get to their promised debt quantum at the right terms. However, if they are unable to, shit can get a little sideways. This is where flex language comes in. When negotiating with the sponsor/borrower on underwriting terms, the Agent includes some wiggle room for itself to sell the loan at more attractive terms if shit goes sideways. So opening pricing might be SOFR+500, but if no one bites, the Agent might have the right to go up to SOFR+550. It’s funny to imagine this concept applying to other jobs. Imagine a bridge builder talking to a government official who hired them being like: “yeah dude, so this bridge will either be 100 yards long or 75 yards long. Kinda gotta just go out there and see which way the wind is blowing. Someone built a 105 yard bridge yesterday though so we’re hoping for the best!”
Once the Syndicate passes the stated threshold, they start to eat into their underwriting fees. This can sometimes lead to losses and a bank risk officer verbally abusing some esteemed capital markets professionals.
Could do more on this but that’s all for now.
Inside Baseball
Documentation Vibe check: King and Spalding put out a pretty interesting report discussing results of a middle market financing poll. I picked a couple below. Kind of feels like aggressive terms peaked last year and have held flat since.
Ukraine/Russia Conflict: Only what feels like days after COVID finally “ended”, we have a new panic on our hands! Not trying to provide news or political takes so I will stay in my lane. But from a finance perspective, it’s kind of weird how our IC had never mentioned a word of concern related to this conflict until this morning (2/24, right after Russia invaded), despite it brewing for weeks. So any poor deal team that presented today got smashed over the head with questions they weren’t ready for. Guaranteed we’ll all be filling out some sort of tracker with Russia/China exposure within the next week.
Q&A
Difference between senior sub debt and regular sub debt? Where do they rank in relation to 1L/2L debt? All sub debt is below secured debt, which is what 1L/2L is (“lien” = secured). For the first part of the question, senior sub debt is just more…senior than “regular” sub debt. Which means it has priority over the regular sub debt. It’s also likely cheaper and has full cash pay, while the more subordinated note is likely PIK pay. The regular sub note could also be structurally subordinated. An example is a HoldCo PIK note, which is held at the HoldCo level (as opposed to OpCo level like the rest of the debt, which is closer to the cash flowing assets) and is thus structurally subordinated to any subordinated debt incurred by the operating group but ranks ahead of all equity. Structural subordination is a different topic for a different day though.
How do the skills in direct lending translate to distressed debt investing? great question. Unfortunately I haven’t worked in distressed investing but know enough to be somewhat helpful. Just like how direct lending is like corporate/commercial banking on steroids, distressed investing is like direct lending on steroids. It seems like the amount of business diligence is fairly similar, while the complexity comes on the legal/restructuring side. In DD, you need to figure out why companies are struggling, what the chances of a recovery are, and how to make money (through recovery or a restructuring). The restructuring side opens up a can of worms that includes steering committees, game theory, and a whole bunch of other highly complicated matters. I would suggest reading the book Distressed Debt by Moyer if interested, it is regarded as the bible. Would also say IB and/or PE provide a better chance to break into DD rather than private credit.
HS senior here, interested in equity research. Advice how to get a head start at Uni? The fact that you even know what equity research is as a senior in high school tells me you’re more dedicated to getting one of those jobs than 99% of your fellow future finance peers. Join the mock investing clubs and get good grades along with banking internship, and you should be almost guaranteed to get it. Would also say, there is time to have fun as well. Don’t give up too many social activities this early (unless you’re struggling to keep up with school), you will regret it later.