Demystifying Investment Banking: Debt Capital Markets

Last week we introduced Equity Capital Markets (ECM) – an important product group that every investment bank worth their stripes will have. The same goes for Debt Capital Markets (DCM).

ECM and DCM provide equity and debt financing for large companies and countries, in support business growth, acquisition or refinancing. ECM and DCM are both capital markets product groups, helping companies raise money in the equity or debt capital markets, with each issuance traded in the secondary equity or debt market.

Great ECM and DCM bankers are brilliant at selling. Whether it’s selling a new equity follow-on, or a new bond issuance, bankers need to understand the company, issuance and wider market to create a compelling investment case for the new issuance.

To this end, both ECM and DCM teams act as hybrid product groups, sitting between trading floors and IBD industry groups, working closely with traders to better understand investor demand and market conditions, whilst providing a service to corporate clients across industry coverage teams.

However, this is where the similarities between ECM and DCM end. In fact, a great ECM banker is unlikely to be a brilliant DCM banker.

This is because ECM bankers are selling an upside-case story. When helping clients sell a new equity issuance, investors want to know about the upside – how quickly will the company, grow, is the share price about to take off. DCM bankers, on the other hand, are selling a credit story.

 When helping clients sell a debt issuance, investors want to know that they are very likely to get their money back, and that the risk they are taking on is compensated with an appropriate interest rate.

In fact, this is why DCM is known as a Fixed Income product group. Investment Grade bond issuances have a coupon rate – a fixed interest rate that will be paid to investors for the duration of the loan.

The skill of DCM bankers is to land on a coupon rate which gets investors excited, more than compensating them for a risk of issuer default. DCM bankers will naturally always be thinking about the downside case, putting in place appropriate protections, or covenants, to guard against future issuer risks.

Unlike M&A and, to and extent, ECM, DCM is a flow product. The bond market is far larger than equity markets, with issuances and debt refinancings taking place all the time. Also, countries issue debt, working with DCM teams for pricing and syndication.

In fact, a DCM team might be split between corporate and sovereign or, for larger teams, by sector and geography. DCM teams will usually have a syndication team, which is responsible for selling (syndicating) the issuance to investors.

DCM teams work closely with industry coverage, and product groups, in addition to corporate banking teams, which lend the bank’s money in the form of more vanilla Term Loans and Revolving Credit Facilities to corporates.

For example, the Healthcare industry group might arrange a strategy review with a large corporate client. This will involve the DCM, ECM, M&A and corporate banking teams working together to analyse the company’s capital structure, refinancing requirements and possible strategic actions, including acquisition and acquisition financing.

Not as much as you might think. Remember, DCM is all about credit risk. Happily, the major credit ratings agencies (Moody’s, S&P, Fitch) will spend hundreds of hours arriving at a credit rating for an issuer, which is relied upon by the industry.

This means that analysts can simply look at the pricing of comparable issuers with a similar credit rating to determine pricing.

Modelling does become useful when the issuer is considering a significant new issuance, which might could result in a change in credit rating, due to higher leverage (Debt/EBITDA) ratios.

Also, it might be worth modelling upside, base and downside scenarios to better understand an issuers forward-looking credit rating and ability to repay in the future.

Debt Capital Markets is a fascinating area of the investment bank. Because you are helping to structure and issue loan products, you will become an expert in understanding credit risk.

This means that career doors open across lending functions within the bank, from Leveraged Finance to Syndicated Lending. An early career in DCM might also pave the way for in-house treasury roles or fixed income research.

Also, the Private Credit market has exploded in recent years, which provides an excellent (and remunerative) off-ramp for DCM analysts.