Keely Lockhart speaks to Julia Hoggett, Managing Director in...
Managing director, leveraged finance
The leveraged finance department of RBC works with clients, who are quite often private equity companies, to help them acquire other businesses. In very simple terms, the private equity firm – known as the sponsor – will put up a certain amount of equity capital for the deal and will approach our team and ask them how much debt we can provide them with in order to make the purchase.
Leveraged finance deals use a higher amount of debt than what is considered normal for a company – it’s called leveraged for a reason. The debt can account for anything from 50 to 75 per cent of the capital structure. While that may not sound like much compared to a house mortgage, it’s a lot for a corporate deal. We use two kinds of debt instruments: loans and increasingly, high yield bonds.
Because of the high proportion of debt in the capital structure, leveraged finance deals are sub-investment grade, meaning they have a credit rating of BB or lower. This reflects the fact that they are riskier than standard loans and for this reason, the yields (the interest income a creditor gets from a bond) are high, meaning those providing the debt get high returns on their investment. So the main benefits are the enhanced returns for the sponsor – a simple analogy being, if you buy a house, you can improve it, sell it on and buy a bigger house – and the banks, due to the fees charged and interest earned.
There are three parts to a leveraged finance deal. The first part is the origination: we find a potential target company that some of our private equity clients may be interested in acquiring. They, in turn, may wish to finance it with debt provided by us. After we’ve found a company that we think is suitable, we pitch it to a potential pool of clients. The clients are often in the private equity sector and will be hoping we approach them with an investment or acquisition that could potentially be turned over at a profit.
The next step is the execution, which is an intense process where we work with accountants and consultants to carry out thorough due diligence on the target company. This process helps us confirm our initial views on the company, as well as helping prepare the papers we need to submit to the internal committees we need to go to, to convince the bank that the deal is a good idea. In parallel to this, we are negotiating legal documentation with the client. This documentation dictates the terms and conditions of the loan and can become very technical.
The third stage is syndication, when the debt with which the target company is to be bought is sold to investors. We work with our syndication team from a very early stage, as they speak to the investors on the buy side. We need to know whether what we’re pitching to clients is appropriate and whether there’s an appetite for it among investors. There’s a symbiotic relationship: we need them in order to make sure we’re doing the right deals and they need us because if we weren’t bringing in good deals, they wouldn’t have anything to sell.
Often, target companies are quite small and volatile to market changes. Many of them are valued at around the £200 million mark, which is far from being an industry leader. This can sometimes be why the credit rating is sub-investment grade (BB or worse) – if you’re relatively small, you’re more exposed to sharp changes. Nobody went shopping on the Jubilee weekend, for instance, and that would have had a dramatic effect on retailers of that size.
Saddling target businesses with too much debt can exacerbate the problem and the biggest challenge is finding the right level. If you push it too far, you may not be able to syndicate it because the risk is too high. Furthermore, if a business is too highly levered and it encounters a downturn, then it hits the bottom faster than it would without all the debt. It’s essential during the execution period, then, for us to find the right level of debt for the target: just enough to make it appetising to the sponsor, but not so much that we can’t syndicate it or so that it puts the company in jeopardy.
In Europe, the most pronounced trend over the last three years has been the emergence of the high-yield bond market, which has traditionally not been as strong here as it is in the US. Because of the fallout from the financial crisis in Europe, banks and other institutional investors have less money to put to work in sub investment grade assets. The high-yield market allows people around the world to invest in bonds, so it opens deals up to a much larger pool of investors. It’s a trajectory that will become increasingly prominent and positive for the leveraged finance market.
Managing director, head of loan syndications
Syndication is, simply put, a process of spreading risk. If RBC makes a large loan to a company and the company defaults on the payments, the loss may be too much for us to absorb by ourselves. So when we make a large loan, we try to find other banks, funds or institutions to contribute a portion of that loan. It means that the company receives its funding, but that there’s not too much risk concentrated with one lender.
The benefit of syndicated loans to the borrower is clear too. They provide companies with access to large pools of capital in an efficient manner. Syndicated loans start at around £100 million and can go into the billions. It’s not uncommon for there to be more than 50 creditors participating in the syndicate. Large corporates want access to these levels of liquidity, but they don’t want to have to negotiate with all of the institutions that are providing the loan. The structure of a syndicate means that the company only has to deal with one point of contact, which is the arranging bank or agent.
Usually, syndicated loans are used for leveraged buyouts – a private equity firm (or sponsor), buying a company (the target). They are made using as much debt as possible, so that when the sponsor sells the target on again, they can make a better return, since they’ve used less of their own equity for the initial investment. Our leveraged finance team have relationships with the people trying to do the deals, but will be in constant dialogue with the syndication team, who will be able to tell them how to structure financings so that they can be distributed into the market.
There is a well-known universe of debt investors, and the syndication desk spends a good part of its day mapping out what demand is. So when leveraged finance approaches us with a deal they’re working on, we’ll have a good feel for whether or not it can sell and who to go to in order to secure the funds. Some banks or institutions have a preference for a particular sector or have pre-existing relationships with the target or the sponsor. There’s one bank, for example, which is famous for being involved in every deal that’s food-related.
When it comes to the time to syndicate the deal, we’ll talk to investors and explain why we think it has merits, why it’s priced how it is, talk them through its credit strengths, and do our best to mitigate any potential risks they highlight. Because RBC usually acts as a lead bank (the banks arranging the syndicate), we initially take on a large portion of the debt ourselves.
One of our clients, a private equity sponsor called Advent International, bought Oberthur Technologies, a company which provides the security data that’s embedded in smart cards (credit cards, sim cards), last year. It was a large, international deal that involved about €700 million (about £548 million) of debt. Along with two other investment banks, RBC underwrote the debt – meaning the three banks were legally bound to provide the whole loan among themselves in the event they could not find investors to buy it off them.
Once the deal was underwritten, there was a large bank meeting, at which Oberthur was presented to potential investors by Advent and the lead banks, RBC included. For this deal, we had bank meetings in London and New York. After this, we got on the phone to investors and explained things further, selling them the deal. We ended up with about 60 different accounts, mostly in Europe but with some from the US as well.
In order to maximise profits, the sponsor will always want to take on as much debt as possible. The people who want to buy the debt, however, want it to be as conservatively structured as possible, and at a price as favourable as we can make it. So the art of syndication is to manage those conflicting demands: you want to make sure you give the sponsor enough debt to win the deal and at the same time, you need to make sure you can sell the debt once the deal’s been won.
As indicated by the Oberthur deal, syndication is becoming an increasingly international business. The banks that have transatlantic reach are in a much stronger position than those that don’t, since we’re seeing lots more deals which cover both regions. The trend has doubled the size of the potential investor base, which can lead to higher demand and in turn, a better price. With what’s going on in the European market, too, banks are more often looking to the US as a source of investment.
Associate, leveraged finance
After university, I joined another bank and did a rotation scheme for just under a year, after which I joined the leveraged finance team. When that bank closed most of its operations in London at the end of 2007, a number of people from that team were hired by RBC and that group forms most of the team I work for now. I chose to work in this area because of the responsibility you’re given, the variety of skills required and the fact that you can work across a number of different industries. As my career has developed, I’ve been given more responsibility and exposure to clients, which is what I enjoy the most about my job.
Our analysts are pooled across both syndication and leveraged finance, so they get to do a variety of work. On the leveraged finance team, they’re heavily involved in the all stages of the deal process. At the beginning they help to pull together the pitch books, which we send out to prospective sponsors. These contain all the key information that a sponsor uses to make its decision about whether to use RBC or not. A lot of work goes into coming up with the correct proposal, and the analysts manage most of this.
An important part of this is financial modelling, which involves projecting how the company will perform under our proposed debt financing, in a variety of scenarios. These models present us with a vision as to how the company will service the debt with its cashflows over the next seven or eight years and are essential to arriving at what we think is a sensible, but competitive proposal. Analysts might research how similar companies have been financed in the past, to make sure we leveraging too far. They’re also heavily involved in writing the memos we need to present internally to get approval to do the deal.
On the syndication side, the analysts support the team by producing the marketing materials that are sent out to investors, as well as answering any questions potential lenders have about the business. This gives them a good deal of external contact early on. Quite often, because an analyst will have been working on a deal for as long as anybody else in the team and has most of the analytical work on the company, they will be more knowledgeable about certain aspects of the deal than anyone else, which makes them a valuable part of the team.
Many of the traits that are useful in other areas of banking apply here, too. You need to be a fast learner and to pick things up quickly. You must be able to see the bigger picture and understand the incentives of the client, the bank and loan market investors. During the execution phase our deals often have a very short fuse so you need to be organised and able to respond quickly. You need to be numerical, but not necessarily from a statistical background – we have people from all sorts of backgrounds in the team.
Keely Lockhart speaks to Julia Hoggett, Managing Director in...
Craig O'Callaghan learns how the global bank is making a...
In the third of four extracts from...
In the second of four extracts...