Here are some leveraged finance interview questions.
Why are financial maintenance covenants important?
If a company underperforms, allows creditors to apply pressure or take action before there is leakage to other stakeholders or before the situation gets too bad
What are some factors to look at when lending money to a prospective borrower?
What are some key modeling outputs or assumptions you will want to see when doing credit modeling?
What are some key modeling outputs or assumptions you will want to see when doing credit modeling?
- Equity cushion and valuation versus leverage –
- For example, if company peers trade at 6x EBITDA and debt is at 3x EBITDA, there is substantial equity value beyond the debt.
- Deleveraging schedule and credit metrics over time
- Look at where debt to EBITDA is after what year
- Sensitivity of credit metrics if EBITDA goes up or down a certain percentage
- Depending on how detailed the model is, a variety of operational inputs can be sensitized
- Additionally, if things do not go well the first two years, is there a payment-in-kind (PIK) toggle for flexibility?
- Addressing the balloon or bullet payment at the end
- Is it fully amortized over the life of the loan?
- Is there an exit or sale of company?
- Can it be refinanced via debt capital markets or private debt?
What is Debt Capacity?
Debt capacity is the ability of a firm to service debt (scheduled payments of interest and principal).
What are some key credit ratios?
- Total Debt to EBITDA or Gross Debt to EBITDA
- Net Debt to EBITDA
- Net Debt is Debt less Cash
- However, total debt or gross debt leverage is also important because in theory the company could use the cash for other purposes that are credit negative (for instance share buybacks or dividends)
- Interest coverage ratio or coverage ratio
- Usually at a minimum should be 2x
- Fixed Charge Coverage Ratio (includes fixed payments such as leases)
- Debt Service Coverage Ratio (DSCR) = pre-financing cash flow / total debt service
- Total debt service means interest and principal
- Debt to Capitalization
What will influence the appropriate leverage level for a borrower?
- Where the company is on the cost curve for their industry
- Capital spending (capital expenditures) over the next couple of years
- A company with a large capital program to expand should not be allowed as much leverage
- The cyclicality of cash flows for the industry
- (a telecom will be able to sustain higher leverage than an oil and gas producer)
Typically, what is the minimum equity cheque for an LBO?
25-30% of the purchase price. Banks will not risk having a hung bridge loan by failing to syndicate debt capital markets issuance as they may receive punitive treatment from regulators.