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What is Debt Capital Markets (DCM)?

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Debt Capital Markets (DCM) is a financing group in Investment Banking which helps to connect debt issuers and debt investors depending on their respective needs pertaining to tenor/maturity, currency (issue in USD, CAD, GDP, CNY, JPY, EUR), coupon (fixed/floating), security/collateral, and other relevant aspects.

In their debt origination and syndication work, DCM desks will be involved in the structuring, marketing, and execution of debt sales as well as providing services such as ratings advisory (for external credit ratings), asset & liability management (ALM) and derivative solutions in conjunction with interest rates and FX teams.

Usually, DCM coverage is split between three groups:

  1. Financial Institutions
  2. Corporates – Energy, Industrials, Materials, Telecom, Utilities, Real Estate, Technology, Consumer, Healthcare, Infrastructure
  3. Supranational, Sovereign & Agency (SSA) / Governments (for non-global financial centres such as Canada)

Where a high-yield market exists, these will be broadly bucketed into Investment Grade (encompassing standard bonds, Commercial Paper, certain private placements) and High-Yield (Institutional Term Loan B, High-Yield Bonds). Sometimes, Securitizations and/or Infrastructure Debt will fall under the jurisdiction of debt capital markets.

DCM helps structure the theoretical debt security based on what they feel will clear the market at a price acceptable to both issuer and investor. DCM will be responsible for helping draft the terms and covenants of the debt and market the debt to investors – as well as provide constant market commentary to both sides.

When speaking to someone from DCM, expect to hear about CUSIPs, 5NC2 (call provisions), g-spreads (credit spreads to the risk-free benchmark) and floating legs (for fixed-to-float swaps and vice versa).

Debt Capital Markets Salaries and Exit Opportunities

Compensation will entail standard investment banking base ($70,000 – $90,000 starting as an analyst) but a smaller bonus of 75%-100% of salary. Generally, the intellectual demand of DCM is greater than ECM and many coverage groups as the average debt investor is far more sophisticated than the average equity investor (not to say there are not very bad bond investors – generally retail participants are priced out of the debt market due to the larger minimum ticket size and the lack of liquidity in the space despite there being larger debt volumes overall.

Exit opportunities are plentiful for debt capital markets professionals. Not only can they lateral to investment banking, DCM professionals can move to one of the many credit or fixed income funds. Another option for DCM bankers are rating agencies (DBRS etc.).


How Do Companies Issue Debt? How Do Governments Issue Debt?

In helping a government or a corporate market a bond issue, DCM will offer a good idea of where the issue will price based on the characteristics of the debt. For this, DCM will base this from investor appetite – do fund managers want 10-year floating rate exposure to industrials? Which ones want it? What is the investor’s risk tolerance and mandate? What is the bond investor’s benchmark? Is the asset manager asset driven or liability driven?

How flexible is the issuer? Is the issuer a corporate, a government or a financial? Will the debt be used for capital structure, spending or to lend out at a higher rate? Does the company need exactly that much and is there going to be room for the issue to grow? Can the issuer handle insufficient demand?

DCM has go and no-go days for issuance. With a big data release such as housing starts or job numbers, companies rarely market their debt as interest rates are volatile and they may not realize good pricing. This is why when one issuer raises debt on a certain day, a few more may follow – usually in the same industry. Releases that are widely followed include Fed minutes, comments by the Bank of Canada, non-farm payrolls, manufacturing indices, crude oil inventories and jobless claims.

When they do issue, if there is sufficient demand (how many times covered by demand is the supply) and the company feels the pricing is favorable (remember, debt is cheaper than equity), the issue may grow (the issuer may issue more debt than was planned as cheap funding). Pricing through a credit spread to the reference government benchmark (whether an actual Government of Canada bond or an interpolated curve) as that is perceived to be a risk-free asset. For floating rate bonds, it will usually be a spread to CDOR (which has credit risk, but the swap curve is much more liquid).

Debt Issuance Walkthrough

When a borrower taps into the bond market, the following data is important to know for the issuer, the banks and fixed income investors.

Bond Tenor

Usually bonds will be 3, 5, 7, 10 or 30 years. The bond tenor, along with the coupon, will give the duration of the bond, which is key for fixed income investors.

If a 5-year bond is maturing, it will usually be refinanced as a 5-year bond. However, bond issuers should be opportunistic in issuing to ensure that investor appetite is being met (not enough 10-year money for a certain industry). Timing can also be opportunistic in terms of maturity gaps for the company and its peer universe so that there is no competition for investor capital. Too many issues can exceed demand and investors will demand a higher yield.

Issue Size/Amount Issued

The amount of debt raised for a certain issue needs to be appropriately sized so that it meets investor demand. If demand exceeds the issue size, the issue can be upsized (plans change before) or at the discretion of underwriters (room to grow).

Ideally, the issue size is well met by investors so that the yield is priced tightly versus a benchmark government bond. However, the issue size will not have that much flexibility to grow as the debt is only needed to fundraise for certain corporate purposes and a much larger issue than planned will cause the borrower to deviate from its designated capital structure.

Bond Coupon

The coupon and the tenor will determine the yield. The coupon is the interest that the corporate is actually paying. The coupon will usually align with the par yield (the yield that makes the bond’s price equal to its face value).

External Credit Rating – Moody’s S&P Fitch and DBRS

Fixed income investors care about the borrower’s long-term outlook for senior unsecured notes if the notes are pari passu (equal in order of payments) with the rest of the senior unsecured debt (which is ahead of subordinated debt, preferred shares and common equity). Moody’s is the gold standard and some issues will not clear without a Moody’s rating, but usually S&P or even DBRS will suffice.

For certain issues that are secured against certain assets and have a first lien on them, agencies will rate that series of bonds separately, possibly at a higher rating.

Yield at Issuance

The yield on the bond at issuance. Competitors and investors will look at issue yields to see where a comparable bond could land. The yield will differ based on firm specific characteristics, however given the same credit rating range for leverage and coverage metrics yield should be similar.

Spread to Benchmark/G-Spread

This is the credit spread to the risk-free government bond benchmark. There may be a current comparable bond or it may have to be interpolated using different government benchmark bonds. The more risky the corporate the wider the spread.

Embedded Options and Features

If the bond is callable, putable, convertible, or has some other feature that can affect the price, this will be mentioned. There are no free lunches and an option that benefits the issuer will demand a higher coupon and vice versa.

Debt Market Updates and Trading Floor Cross-Sell

DCM works closely with interest rate solutions and FX – particularly for more sophisticated borrowers who can access these other trading floor products cheaply. This is because banks can advise on arbitrage opportunities where a corporate or government can realize better effective pricing if they issued in another currency or at a floating rate instead of fixed.

For pitches, DCM often goes hand-in-hand with interest rate derivatives. If maturity towers are coming up (one or a few notes are coming due and need to be refinanced) and rates are low, a bond forward (shorter than 1 year duration using a reference government bond) or a forward starting swap (longer than 1 year using the swap spread) can be proposed to lock in financing costs.

If floating rate issues have seen success, a floating rate bond with an embedded floating-to-fixed swap can be arranged. More popular in the US and Europe where treasury is taken more seriously as a bottom line function, fixed-to-floating swaps can be used to lower rate volatility and achieve lower rates on average over time (assuming that the interest rate curve remains upward sloping).

Of course, debt service for corporates needs to be fixed and in the currency of operations – so these risks will need to be hedged out (if a company has C$ revenue and gets US$ debt, that debt needs to be swapped to C$ or there will be interest volatility due to the FX exposure). Accordingly, the effective pricing is looked at on a swapped out basis. For very sophisticated treasuries, they can achieve the same thing by just putting on swaps themselves – however, all organizations have internal exposure limits for these derivatives.

Debt Underwriting and Syndication

For DCM, there is a distinction between bought deals and agency deals. When banks underwrite debt, the risk can be with the banks (bought deal) or with the issuer (agency deal). With a bought deal, the banks (usually a syndicate of banks, with the lead bank taking the biggest chunk of the issue) purchase the debt from the company at a discount and resell it to the market – so if the issue tanks, the banks are left holding a loss. In an agency deal, the bank is merely a broker in the transaction so if things go south, the company may pull the issue. The fees on a bought deal will accordingly be higher to compensate the bank for the risk.

For agency deals, investment grade issuers can expect to pay 50-100 bps on the fee. Bought deals can vary greatly, and private placements (most leveraged borrowers will utilize private placements, the actual high yield market in Canada exists but is tiny, possibly 1% of total volume) are often 250-300 bps. Since DCM issues do not cost the banks capital, banks like this fee based business. Private placements will have their own term sheets and may be bespoke to an investor group (usually pensions and insurers) and there is room for covenants to give comfort to private debt investors.

If banks lend money to a company (through the corporate banking division), they will expect to be leading in the DCM syndicate both for league tables pertaining to total volume ($billions issued in whatever industry, or overall) and number or leads. Banks are always looking for the bookrunner title, preferably a sole bookrunner instead of a joint bookrunner as then they get all the credit. These league tables are used for marketing purposes and bragging rights.

As such, DCM is in constant discourse with issuers, debt investors and other brokerages for market intelligence. DCM will figure out what debt the company wants and what is feasible from an investing standpoint (what type of debt and what structure is ideal is outlined by the company and primary coverage, or the investment banking team). DCM also bridges debt issuers and investors by taking clients on marketing presentations to investors in various cities – this is especially useful for investors in foreign markets, and a Canadian Natural Resources could benefit from being taken by Morgan Stanley to LA to see names like Western Asset Management.

This is determined by data and intuition based on proposed tenor, price and coupon (which will determine the effective interest rate paid by the company), amortization schedule, embedded options (is the bond callable, convertible – may have to do some work with ECM, putable) and legal effects in what will be the indenture or contract – make-whole spreads, covenants (maintenance or incurrence), events of default and cross-default or acceleration mechanics, quorum and extraordinary resolution.

Credit Ratings Advisory

Some issues will see lower demand if they do not have a credit rating assigned from one of the Big 3 (S&P/Moody’s and DBRS in Canada or Fitch in the US – Fitch/DBRS are often a distant third). Some issues will not see demand if the rating is not from Moody’s.

DCM is often tapped for ratings advisory – for new issues, if they are rated, where will they land? DCM may build a model that runs sensitivities over a known S&P or Moody’s ratings grid (which differ from industry to industry), which take into account many credit assumptions based on empirical data in the industry (a certain debt/EBITDA for a railway will be looked upon very differently against an oil and gas company (and the oil and gas company will see adjustments to their EBITDA so it is more like EBITDAX).

After grabbing an indicative grid-based rating, DCM will look at qualitative factors historically considered by the rating agencies to determine where the prospective issuer could land. For event-driven issuers (could be a merger or a recapitalization), DCM, along with classic investment banking, could run pro-formas to see what would change on the grid.

From there, DCM can determine the value of changes in leverage (in terms of incremental interest or incremental savings) and make recommendations.

Related Reading for Debt Capital Markets

Debt Capital MarketsWorking in Treasury · Debt Capital Markets Analyst and Associate Work ·

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