The Distressed Debt Desk: The Best Way to Combine Sales & Trading and Investment Banking?
Sometimes, you just can’t decide.
The public markets… or deal analysis?
One solution is to join the capital markets team, but another is to join the distressed credit desk – not as an execution trader, but in research.
You come up with the ideas, and the traders execute them.
Not only is the work more interesting than in many ECM/DCM roles, but you also gain access to more specialized exit opportunities.
Our reader today did just that and joined the distressed debt group following an S&T internship, and then successfully switched to a distressed hedge fund.
He can take it away from there:
Breaking In: The S&T Internship Race
Q: Can you summarize your story?
A: Sure. I was from a semi-target school, and I did school-year internships in wealth management and equity research in my first few years.
I won several S&T summer internship offers and accepted one at a bulge bracket bank.
I got interested in distressed debt because of exposure to a distressed name in an equity research internship.
After that, I started researching distressed issuances, attended a few conferences available to undergrads in the Northeastern part of the U.S. (e.g., the Wharton Restructuring and Distressed Investing Conference and the Ira Sohn Investment Conference), and began following distressed news via my university’s Bloomberg terminal.
I rotated through several desks in my internship, but always gravitated toward distressed debt, so I pitched a distressed idea for the infamous end-of-internship presentation.
I accepted a full-time role on the desk, stayed there for my analyst years, and then recruited successfully for distressed hedge fund roles.
Q: Great. So, what drew you to distressed credit?
A: I liked how it was a combination of fundamental and event-driven analysis; you have to know about a broad range of issues because legal problems and external events could impact your ideas far more than in equity investing.
Also, since liquidity is so limited, you always have to know what the counterparty is thinking: If you don’t know why he/she is exiting his/her position, chances are that you’re about to lose money.
Q: Any tips for winning a return offer on this desk, or in S&T in general?
A: All the other interns will be smart and well-adjusted, so the end-of-internship presentation is critical for standing out and winning an offer.
Stay late, come in on weekends, and do whatever’s necessary to make a well-structured and thoroughly researched presentation.
Also, master the technical side, but do not throw the jargon in peoples’ faces. Under-promise and over-deliver.
Keep it in your “back pocket” and be ready to answer questions, but never try to sound impressive unless they ask you a specific question.
If you go out of your way to show your technical mastery, someone will make a fool out of you for trying to sound smarter than you are.
On the Job in Distressed Credit
Q: Can you describe what your average day is like?
A: Sure. I get in around 7 AM, and I start by logging into Bloomberg to check the news on the 10-15 high-yield names I cover.
After those checks in the morning, I’ll spend the day updating our models for recent earnings reports and announcements, looking at covenants and credit agreements, and joining lender calls to learn about new issuances.
I also spend time writing 1-page credit summaries of companies’ capital structures, and I try to find opportunities when doing that.
For example, maybe the company is planning to issue a lot of Secured Senior Debt, and as a result of one specific covenant in that proposed Debt, the High-Yield seniority will fall by more than the market is expecting.
I speak with our institutional clients and my boss as well, but there’s probably a bit less client interaction than in equity research.
That said, sometimes I might spend the entire day speaking with institutional clients and comparing notes and ideas on topical names and events. Some buy-side firms find this very helpful, and you might end up joining a firm like this.
Despite the Volcker Rule, banks can engage in proprietary trading activities for hedging purposes, but there’s also a balance sheet limit, daily limit restrictions, and other caveats that differentiate these activities from pre-crisis.
These desks are not at all what they once were, and risk mitigation is on the top of everyone’s mind.
Q: OK, great. What’s the interaction with the execution traders like?
A: We run our ideas past the traders to see if they’re feasible – for example, we might ask a trader for the current liquidity or borrowing cost of an issuance, or about major market activities.
If we hear about a major high-yield name being traded, we might do additional research and see if we missed something.
The major benefit of my role over a pure research one is that I get a much better understanding of liquidity and how issuances trade.
People often overlook those points when making distressed credit investment recommendations, but they’re crucial in this role.
Q: And what types of technical analysis and modeling do you do to evaluate these issuances?
A: The biggest myth is that credit analysis is very different from equity analysis and normal valuation; but it’s not, really, at least regarding the models we build.
We still build an operating model or cash flow model for a company, and we’ll still create different operational scenarios and look at comparables.
The main differences are the metrics and multiples we focus on – leverage and interest coverage ratios instead of P / E or EV / EBITDA – and that we’re always looking for the next shoe to drop.
In equities, a company’s stock price might “trend down” or “trend upward” over time, but in distressed credit, you tend to see jumps rather than trend lines.
For example, if a bond is selling for 80% of its par value, we might examine all the covenants and say, “What’s the downside? If Covenant X is violated and secured bond holders accelerate interest payments, what will the unsecured bond’s price drop down to? What about if Covenant Y is violated?”
We spend a lot of time reviewing credit agreements and loan covenants, seeing how much more debt a company can legally take on, and then figuring out the specific events that might cause its value to change.
This is probably the biggest difference from both equity investing and pure research roles: Banks often hire lawyers into distressed credit Analyst roles so that they can be well-versed on the legal side.
Q: What are your impressions of the culture?
A: It’s more research-y and intellectual than a typical sales & trading desk.
We’re not quite as nerdy as the pure research team, but we’re also not as fratty as the execution traders.
Buy-Side Recruiting: Who Wants to Join a Hedge Fund?
Q: You mentioned that the buy-side recruiting process is quite challenging, even though you’re well-positioned for distressed funds. What makes it so hard?
A: First off, it’s far less structured than the IB to PE recruiting process.
Headhunters won’t necessarily come to you, and only about 20% of hedge fund recruiting is “on-cycle” vs. the 80% of private equity recruiting that’s on-cycle.
The on-cycle timing is similar to private equity: January through March for many of the largest funds.
But you have to be very aggressive in reaching out, pitching your ideas, and asking for explicit introductions to distressed funds.
The typical recruiting firms – Dynamics Search Partners, Amity, and SG Partners, for example – do these searches, especially for the bigger funds such as Blackstone.
Another challenge is that unlike in banking, you can’t just “disappear” from your desk for 2-3 hours; even disappearing for 1 hour might raise questions.
Finally, you have to be very careful with your networking efforts because the distressed credit world is small.
If you reach out to dozens of people via LinkedIn, one of them might know your sales guy or execution trader and say something.
Q: OK, so how do you overcome all those challenges?
A: You need to be extremely targeted in your search.
Talk to people at funds to figure out how they operate before going in for interviews or asking to be placed into the official process.
When you connect on LinkedIn or via email, be upfront and say that you’re more interested in learning what their fund does at this stage.
Good questions to ask include:
- How many names do you cover? Covering 50 names is very different from covering 8, and you’ll approach the analysis differently.
- Do you take an active role in restructuring situations? Funds like Apollo and Monarch might do this, but BlackRock would not.
- Do you do any private or direct lending deals? Some funds do long/short credit and also get involved in direct lending and opportunities with private companies. But others focus on one or the other.
- What’s it like to put on a position? Some funds might require you to present to the investment committee for a $10 million position, whereas others wouldn’t even bother for a position larger than that. The level of bureaucracy differs substantially.
Finally, you can assess the hours and lifestyle by checking when people are logged into Bloomberg.
If someone logs in at 8 AM and logs out around 7 PM every day, the lifestyle is fairly good.
There’s no “correct” answer to all the questions above. It depends on the work/life balance you want and the investing style you prefer.
For example, activist funds can be more interesting in some ways, but you’ll usually work longer and more unpredictable hours because you’re effectively working on deals there.
Q: That brings up a good point: Could you get into something other than distressed hedge funds coming from this desk?
A: You might be able to get into direct lending or private lending roles, such as the ones at Blackstone’s GSO division, but traditional private equity would be very difficult because you have no advantage over bankers for those roles.
You do have a built-in advantage over most bankers if you go for distressed hedge fund or direct lending roles since you’ll always have a good answer for “Why (distressed) credit?”:
“Because I’m in it now, I enjoy it, I’ve done well, and I want to be here long-term.”
Q: Thanks for sharing all that. Given all the changes in the industry, should students even bother with S&T at large banks anymore?
A: I think it always pays to start at a large bank, at least for distressed credit roles.
You’ll get more training, you’ll gain a wider network, and you’ll learn all the market players and the fundamentals of both research and trading.
S&T roles at banks are shrinking, but if Dodd-Frank gets repealed or partially repealed by the new administration, that trend may reverse.
Even lifting the arbitrary 6x Debt / EBITDA leverage limit for lenders may result in more deals and bigger teams, especially on the distressed side since many companies are highly leveraged.
It would also make Leveraged Finance a significantly better place to work.
Q: Thanks. Finally, do you have any recommendations for learning more about this industry?
A: The must-read is Distressed Debt Analysis by Moyer, which is very dense but essential for this role.
Margin of Safety also has a section on distressed debt, which I recommend.
To learn more on your own, look at simple cases first, such as J.C. Penney’s distressed bonds; stay away from complex situations until you’ve mastered the ropes.
Q: Great. Thanks for your time!
A: My pleasure.
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