Debt Capital Markets Banking

Debt Capital Markets

Debt capital markets (DCM) are a lot like the forgotten child of post-business school job options – no one knows what DCM bankers do, and we get a lot of unwarranted neglect and nose-turning. Luckily for me after working as a DCM banker for an entire summer, I don’t think we deserve the hate.

Boiling it down: debt capital markets professionals connect companies seeking funding to pools of money seeking a return on their investment. When Tesla needs money to build a new factory and the schoolteacher’s state pension plan has money to fund it, or Pepsi decides it wants to buy the energy drink maker Celsius and your 401k investment could make it happen, DCM bankers are the middlemen that evaluate the risk of those types of transactions and charge the borrowers accordingly. We spend much of our time watching the stock and bond markets day-to-day to get a gauge on how risk-seeking or risk-averse investors currently seem, and then relaying this information to companies thinking about raising cash.

This requires us to be competent in three functions:

·        Older Sibling

·        Appraiser

·        Negotiator

Not all of these happen every day, but all are necessary through the course of a relationship with a company to win business consistently.

Older Sibling

When companies come to us with their grand ideas for acquiring Company X or starting a yearslong R&D program for Drug Y, they less enthusiastically tell us how much it’s going to cost. Most companies don’t have billions and billions laying around for these types of ideas, and much of the time, they’re time-sensitive – the company doesn’t want to sit around and “save up” for their idea and execute on it five years from now.

In the same way that I, being an older brother, would tell my sister to wait until my mom was in a better mood before asking for cash to go bowling, DCM folks are the older brothers to these companies that tell them when investors are in better moods to fork over their cash.

How do we know when investors are in a good mood? We put ourselves in their shoes.

Step 1: The majority of an average investor’s personal wealth is in stocks. So, if the S&P 500 puked 3% in the morning before markets open, we can rest assured that SketchyPharma’s tanning pill trials aren’t getting a piece of the pie that day.

Step 2: If investors haven’t been offended by downside plunges in the stock market, maybe there’s hope for new debt as long as the bond market also finds itself in fair waters. To determine this, we look at how risky investors are saying corporate bonds are compared to the risk-free investment of a government bond, and compare this to what they were saying yesterday to see if investors have become more risk-seeking or more risk-averse. Risk-averse means again that SketchyPharma is fresh out of luck.

Step 3: Investors are human too, and still react to things in real-time just as we do. So, even if the stock and bond markets were doing great yesterday and into this morning, we need to be watching headlines and relaying important knowledge to companies that might affect their ability to raise the money they’re looking for. For example – most senior finance folks take a mandatory two-week vacation in the second half of August. Probably not the best idea to ask Mom for money when she’s sipping a Mai Tai on the beach trying to forget about her day job.

 

Appraiser

Say, that we do make it through the last three steps and our investors are still interested in lending our company the money for their grand idea. At this point, the DCM team makes sure the terms of the loan are fair. As agents of the company raising money first, we have to get them the lowest rate we think is possible on their debt – exactly the same way you’d want to get the lowest interest rate on a mortgage.

At the same time, we also know that if we were the investors, we would want to be compensated for the risk that the company we lend to might not be able to pay us back in the future. A logical investor would want a higher rate of return for parking money in SketchyPharma than in the United States government. So, we look at other bonds on the market of similar risk to SketchyPharma and see what investors demanded as a return from those bonds, make a few adjustments for how the markets have changed since when those bonds were issued, and arrive at a fair rate that both the investor and SketchyPharma can agree on.

We’re ‘appraising’ the other bonds on the market and extrapolating what we find to new bonds that haven’t been valued yet.

 

Negotiator

Just because we’re so great at telling companies when to ask for money and fiddling around in Excel to find a mathematically ‘fair’ rate for new bonds doesn’t mean the company will actually get to raise their money and wire us a chunk of the change as payment. My shop this summer was but one fish in a small, hyper-competitive pond of other banks trying to offer SketchyPharma the exact same thing we were.

Why would SketchyPharma choose us? This is where things get murky. Sometimes, it’s because the CEO and the head of our department were college roommates, or tennis partners. Other times, it’s because we understand something about the market that other banks haven’t caught onto yet. And still other times, we may have the best relationship and ideas for a company, but they still decide to do their business with another bank to spread the love and build relationships with as many banks on Wall Street as they can. Great for them, annoying for us.

This is where negotiation comes in. If we can communicate somehow that the grass isn’t greener with our competitors, or that the grass is greener with us, we win the business (and the customary bottle service that comes with it). 

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