Structured Finance: Debt Raising Made Easy, or Financial Weapon of Mass Destruction?
Last time around, there was some controversy over whether or not Structured Finance was evil.
“Evil,” of course, meaning that it caused the financial crisis.
This time around, our interviewee addresses that question and responds to even more of my passive-aggressive interviewing techniques – plus a whole lot more.
Here’s what you’ll learn in part 2 of our series on Structured Finance (Part 1 – Recruiting if you missed it):
- What an average day in the life of a Structured Finance analyst is like.
- How modeling is different in Structured Finance (bottling remains much the same).
- How much you get paid and what exit opportunities you get.
- Why you shouldn’t blame Structured Finance groups for the financial crisis… or at least, not everyone in Structured Finance.
A Day in the Life: Structure vs. Chaos
Q: Structured Finance sounds much closer to a DCM or LevFin group in banking than a trading desk – what about an average day in your life, though? Are you working market hours or banker hours?
A: It’s a mix of both. Sometimes I get in early – around 7 AM or earlier – for market update calls (i.e. if we need to hear where spreads are from the relevant trading desk).
But deals can take months to move from start to finish, so in that sense it’s similar to investment banking. And it’s not unusual to leave at midnight or 1 AM, so it’s different from trading.
Unlike investment banking, though, no one assumes that you’ll always be there on weekends – if you’re busy with a live deal and something needs to get done you may come in, but other than that there’s little-to-no “face-time.”
Most of the senior bankers here are married and have kids, so they have no interest in sitting around and seeing how long you’re at the office – they want to do their work and go home.
If there’s nothing to do at night, I’ll usually leave around 9 PM – if I’m busy with a deal or a pitch, that may extend until somewhere between 9 PM and midnight, or maybe a bit later than that.
Q: So it’s between standard hours in M&A / product groups and what you see in trading or capital markets groups.
What about the work itself? What do pitches and deals involve?
A: It’s a mix of the type of work you see on any other deal or pitch, and then a few points that are specific to Structured Finance.
Pitch work involves creating:
- Market update slides showing the spread, tenor, and ratings of bonds.
- Deal comps that show the rates competitors are pitching.
- League tables showing how all other banks “rank” in the market, often cut in “creative” ways.
- Loan performance tracking – this is specific to Structured Finance. We show how the collateral underlying structured notes is performing – defaults, overall credit quality, and so on.
Pitch books themselves are very similar to what you see in standard pitch books anywhere.
As far as deal work, it’s a lot of the usual administrative grunt work you’ve written about before – creating Working Group Lists, deal timetables, working with lawyers, rating agency teams, and so on.
Our main technical function on deals is structuring – we come up with the credit enhancements, figure out the “buffer” that investors should have, and then create marketing materials for the sales people to present to investors on the roadshow.
For Structured Finance, sometimes we just post the presentation online and people look at it over the Internet as well.
Once the roadshow is over, we’ll go to the syndicate and spend 2-3 days with them marketing the deal from launch all the way through pricing.
It’s extremely important to monitor the markets – if we’re doing an auto loan deal and 3 other auto loan deals are launching in the next few days, we might hold off on launching ours so that investors don’t get distracted.
Q: That makes sense. Speaking of the structuring work you do on deals, what exactly does it involve?
Are we talking standard modeling work with the 3 statements, or do you see radically different methods?
A: Sure. There are 2 types of modeling work in Structured Finance: more IB-esque modeling and then really heavy, quantitative, Monte Carlo-style Ph.D. modeling that “structurers” here do.
Similar to actuaries at insurance companies, these structurers work with probabilities all day and figure out how likely it is that borrowers will default on mortgages, auto loans, and so on.
The goal of any model in SF is to calculate the amount of cash flow available to pay interest and principal. Bankers work with the company to understand revenues and expenses so that they can understand and calculate cash flows.
We wouldn’t necessarily create a detailed 3-statement model for that, but we would need to model the cash flows and show what those would look like in the future.
Then we hand that work over to the structurers, who model out the payment waterfall of the notes for a given structure, and get their input on how risky they think the security is under different stress scenarios.
I’d be surprised if, during an interview, someone asked you what happens to the 3 statements when depreciation goes up by $10; you’re more likely to get questions on how to calculate cash flow given revenues and expenses.
Q: It sounds like the structurers do all the heavy lifting – do they also get paid more?
A: Nope. A few people have moved over from the banking side to the structuring side before, but most people prefer to stay in banking because you get paid more despite the easier technical work.
You earn more here because you’re responsible for bringing in clients and winning deals – and as with almost any other sell-side role, sales roles pay more than execution roles.
Culture, Hierarchy, Hours, Pay, Exit Opps, and Financial Crises
Q: That’s actually not too surprising, because you also see the same thing in areas like trading and hedge funds where the one bringing in returns or profits makes the most.
On that note, can you tell us about the pay in Structured Finance?
A: There’s minimal to no difference in pay at the junior levels: expect what you would get in any other investment banking group.
Our revenues are smaller since it’s a niche area, but we also have a much smaller group.
At the senior levels, MDs in the M&A group probably see bigger paydays than the MDs here because they can advise on much bigger deals and collect higher fees.
The fees for Structured Finance deals, just like M&A and capital markets deals, are based on the deal size and how risky and difficult it is to get the deal done.
We earn less on student / auto / credit card deals because they’re traditional and less risky – if we charged even a 0.05% higher fee, the client would instantly go to competitors.
For less conventional deals that require more custom work from us – solar power or alarm system securitization, for example – we might charge 1% or more in extra fees.
That sounds like a small amount, but it adds up to millions to tens of millions in extra fee revenue on deals worth hundreds of millions or billions of dollars.
Q: Right, interesting to hear how the fee percentage differs depending on the deal type.
You mentioned that the Structured Finance team is usually smaller than the other product and industry groups at a bank – what about the culture and hierarchy?
A: Our group is very flat, and the analysts go out to lunch with Directors on a daily basis. We toss around Nerf footballs after dinner. I help one guy set his fantasy football league every Thursday.
However, they also won’t hesitate to hand me a boatload of work at 7PM on Friday that’s due on Monday, so it’s a balance.
Q: What about those glamorous exit opportunities? I’m assuming that Structured Finance is not the place to be if you want to move into PE.
A: You have an extremely low chance of getting into private equity from here unless you’re in a unique situation – for example, you worked in M&A or Leveraged Finance before this, or you have other deal-related experience.
Most likely, you’ll stay in Structured Finance and move up the ranks.
Another possibility is moving to a normal company in a financing role and helping them issue securitized products to raise funds.
You could also go to an insurance company or an asset manager like Vanguard that invests in structured notes.
Q: What about hedge funds?
A: There are actually quite a few hedge funds that make investments in structured notes, so that’s another possibility.
Just don’t expect to get into a global macro fund or traditional long / short equity fund, because the strategies and securities traded there are completely different.
In addition to working at established hedge funds, some people also leave Structured Finance groups, go out to investors and raise $500 million on their own, and then find a company with relatively high CapEx that needs to raise capital.
Then they’ll act as the sole investor to that company and invest their funds directly, in exchange for a custom structured note related to the company’s pool of underlying assets.
These securities are ultra-high-yielding and you can potentially earn much higher returns than with traditional debt – assuming the company doesn’t go bankrupt, of course.
Or, you might just work with the company in question to issue the structured note and raise funds from 50+ different investors, acting as the company’s “mini-investment bank.”
So there are lots of possibilities on the hedge fund / investing side – just not with the traditional HF strategies, and certainly not in PE since you don’t buy and sell entire companies.
Q: That makes a lot of sense – so even if you’re interested in hedge funds, Structured Finance might be a good fit for you if you want to continue working with structured products.
Now I’m going to move into “bad cop” mode and ask you a more pointed question: many people blame securitization for the financial crisis and all the ensuing housing troubles.
How would you respond to this?
A: I would respond to that with 3 points:
(1) Blame: First, yes, the securitization of sub-prime mortgages was the vehicle created by Wall Street that drove the economy off a cliff and into the financial abyss.
However, if you’re going to sit here and blame the world’s ills solely on Wall Street bankers then I’m going to have to nail you with some pepper spray…
What about the people with no job and no income who bought a house for $500,000 with no down payment and a loan with an adjustable rate? Where’s their sense of responsibility? What about the rating agencies who got paid to rate these deals but didn’t even know how they really worked?
What about the shareholders of banks who would have penalized their CEOs and BODs for the profits that would have been lost by sitting on the sidelines? What about Congress who created the incentives for all this in the first place by mandating that loans be made to subprime borrowers?
There is surely enough blame to go around.
(2) Derivatives upon Derivatives: In addition to the securitized assets themselves, we also had CDOs being written on top of these bonds where a single default would have disastrous, exponential consequences throughout the financial system. The failure of one bond would have the effect of ten bonds failing.
(3) Complexity: And finally, almost no one had any clue what was going on with the complexity of these securities, and risk management at financial institutions and credit agencies fell apart.
So yes, structured products played a role in the financial crisis, but it’s incorrect to blame them 100% for what happened.
Today, people are much more conservative and you rarely see sub-prime loans being underwritten because everyone remembers what happened.
You don’t see derivatives upon derivatives upon derivatives anymore – so the industry is fundamentally different now. And the volume of securitized issuances has been cut in half compared to what it was at the peak, just before the financial crisis.
Q: OK, thanks for addressing that – I know a lot of readers are curious to hear your views.
Based on everything we’ve discussed so far, who do you think would fit in best with a Structured Finance group?
A: Well, I’ll start by explaining who would not fit in well with a Structured Finance group: stay away if you’re hyper-focused on the traditional Ivy League -> IB -> PE/HF -> Greatness path because SF is clearly a different path altogether.
The upside is that you could get promoted faster than your IBD peers because you won’t need an MBA.
If you’re genuinely curious about different companies and how they make money and you’re creative, you’d fit in well here.
There’s more creativity required than in M&A because you have to think about how to structure securities and how to provide buffers that appeal to investors – and you have to balance that with the company’s concerns as well.
You need to be outgoing and good at networking and sales as you move up – we pitch a lot of unconventional ideas to companies, so you have to be comfortable doing that.
Finally, if you’re a prestige whore, stay away because Structured Finance is not as “sexy” as M&A and you won’t be working on deals that make the front page of The Wall Street Journal – you need to be interested in the markets and actually like the work to do well here.
Q: Thanks for pointing that out – I think you could say the same about many other areas in finance, since you’re rarely working on anything “prestigious,” even at large banks.
What about your future plans? Are you going to stick with Structured Finance?
A: So far I’ve liked my group and fit in quite well here, but the economy is not so great and banks are thinking of cutting back in several different areas, including Structured Finance.
I’m not too worried personally because I’m just an analyst – AKA cheap labor – so I’m not as likely to be cut as the mid-level bankers.
Longer-term, whether I stay or leave is very dependent on pay. It is grinding and a lot of hard work, since you have to follow the markets and do deals.
So if the market goes sideways and bonuses plummet for a few years, I might potentially jump to a hedge fund or something else on the buy-side since I already have the CFA certification and the due diligence experience working with PE firms and HFs.
But right now, it mostly comes down to the pay-to-hours-worked ratio.
Q: Awesome, thanks for sharing your story. I learned a ton, and I’m sure everyone else reading did, too.
A: My pleasure!
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