JP Morgan CIB Risk Interview

Why JP Morgan?

The most important difference between JPMorgan and other investment banks is that they managed to merge commercial banking and investment banking in a way that made sense. Risk management is probably the best in the industry. JP Morgan was probably one of the most successful banks during this recession. They also are the only top tier US bank to maintain profitability throughout the height of the recession.

Why Corporate and Investment Bank risk management?

I wanted something a little more technical than wealth management. But I like that this role is also somewhat about relationship building. In a world that's getting more Complex than ever, risk management is needed, and would be a great place to start a career. I like that you take a macro view of industries. I also feel like I will be able to leverage my strong communications skills.

How do you calculate EBITDA, what is it?

EBITDA = Net income + interest expense + taxes + depreciation + amortization. EBITDA is a measure of a companies profitability

What are the line items on the income statement?

Sales Revenue

Cost of Goods Sold (or Gross Revenue)

Total or Specific General Expenses (SG&A)Depreciation Expense

Interest Expense

Tax Expense

What is beta?

Beta is a measure of the volatility of an investment compared with the market as a whole. The market has a beta of 1, while investments that are more volatile than the market have a beta greater than 1 and those that are less volatile have a beta of less than 1.

Explain CAPM.

The Capital Asset Pricing Model (CAPM) describes the relationship between systematic risk and expected return for assets, particularly stocks. CAPM is widely used throughout finance for pricing risky securities and generating expected returns for assets given the risk of those assets and cost of capital.

Walk me through a DCF Model?

Build a 5-year forecast of unlevered free cash flow based on reasonable assumptions, calculate a terminal value with an exit multiple approach, and discount all those cash flows to their present value using the company's WACC

Walk Me Through an Income Statement

The first line of the Income Statement represents revenues or sales. From that we subtract the cost of goods sold, which gives gross margin. Subtracting operating expenses from gross margin gives us operating income (EBIT). We then (add/subtract) interest expense (income), taxes, and other expenses (income) to arrive at Net Income.

How are the Financial Statements Connected?

- Net income from the income statement flows to the balance sheet and cash flow statement- Depreciation is added back and CapEx is deducted on the cash flow statement, which determines PP&E on the balance sheet- Financing activities mostly affect the balance sheet and cash from finalizing, except for interest, which is shown on the income statement- The sum of the last period's closing cash balance plus this periods cash from operations, investing, and financing is the closing cash balance on the balance sheet

What is WACC?

Overall cost of a company raising new capital. Representation of riskiness of an investment in the company.

Why Would You Unlever Beta?

By unlevering the beta, you remove the financial effects of debt in the capital structure. This unlevered beta shows you the risk of a firm's equity compared to the market.

How do you calculate the sharpe ratio?

Subtract the risk-free rate from the return of the portfolio. The risk free rate could be a U.S. Treasury rate or yield, such as the one-year or two-year Treasury yield.Divide the result by the standard deviation of the portfolio's excess return.

What is P/E and how would you use it to compare companies?

Why don't you tell me what valuation techniques you would use if I were to ask you to value a company?

Which is more expensive, debt or equity?

How does this role fit into the company?

Assume Inventory decreased by $10. How will it affect three statements? What about year 2?

Walk me through an LBO

Step 1: Make assumptions for the Purchase Price, Debt and Equity, Interest Rate on Debt, and Revenue Growth and Margins

Step 2: Create a Sources & Uses schedule to calculate the true price

Step 3: Adjust the Balance Sheet for the effects of the deal, such as the new Debt, Equity, and Goodwill

Step 4: Project the company's statements, or at least its cash flow, and determine how much Debt it repays each year

Step 5: Make assumptions about the exit, usually using an EBITDA multiple, and calculate the MoM multiple and IRR

What're the different types of risk?

What are the 3 main financial statements?

Income Statement

Balance Sheet

Statement of Cash Flows

income statement shows companys revenues, costs, expenses, altogether yield the companys net income

balance sheet shows a companys assets, liabilities, and equity

Cash Flow Statement starts with net income from the income statement and then adjusts for non cash expenses (add back depreciation/amortization) in order to calculate the companys ending cash balance.

If you could choose one one financial statement to evaluate the financial state of a company, which would you choose?

Statement of Cash Flows because it acts as a window to the actual liquidity position of the company as well as how much cash it uses and generates. Income statement can be misleading due to any number of non cash expenses that may not be actually affecting overall business balance sheet alone just shows a snapshot of the company at one point in time without showing how operations are affecting how they're changing.

How would a 10 dollar increase in depreciation expense affect the 3 financial statements?

First, the income statement: depreciation is an expense so operating income (EBIT) declines by $10. Assuming a tax rate of 40%, net income declines by $6. Second, the cash flow statement: net income decreased $6 and depreciation increased $10 so cash flow from operations increased $4. Finally, the balance sheet: cumulative depreciation increases $10 so Net PP&E decreases $10. We know from the cash flow statement that cash increased $4. The $6 reduction of net income caused retained earnings to decrease by $6. Note that the balance sheet is now balanced. Assets decreased $6 (PP&E -10 and Cash +4) and shareholder's equity decreased $6.

Why would a company issue equity rather than debt to fund its operations?

If the company feels the stock price is inflated they can raise a large amount of capital compared to how much theyd be giving up in ownership

If the projects the company plans to invest in with the proceeds may not produce immediate or consistent cash flows to pay debt

If the company wants to adjust their cap structure or to pay down debt

If the owners of the company want to sell off a portion of their ownership

What factors drive M&A activity?

motivating factors are to:

1. create synergies and save on costs

2. acquire new tech or product pipelines

3. grow share in the market by removing a competitor

4. buying a supplier or distributor to increase supply chain pricing power

5. improve financial metrics and numbers

What are the 5 C's of credit?

1. Character

General trustworthiness, credibility, and personality. Trying to lend to responsible people.

Assessed through credentials, references, reputation, and interaction with lenders.

2. Capacity (Cash Flow)

The ability to repay back the loan through businesses cash flows.

Assessed through debt/liquidity ratios, cash flow statements, credit score, and borrowing/repayment history3. CapitalHow much money is invested into a project by the business owner/management team to make sure they have enough skin in the game.Assessed by the amount of money they have invested themselves.

4. Conditions:

How the business intends on using the loan and how that could be affected by economic/industry trends.

Assessed by reviewing the competitive landscape, supplier and customer relationships, macro trends, industry trends, and making sure they can all be mitigated.

5. Collateral

Assets that can be pledged for security, acting as a backup source of assets to be used towards the loan repayment in case the borrower cant repay a loan.

Assessed by reviewing the value of hard assets (PPE), as well as accounts receivables and inventory, and sometimes even the borrowers own home.

What is the Formula for Enterprise Value?

Market value of equity (MVE) + debt + preferred stock + minority interest - cash.(MVE + D + P + minority interest - Cash)

What is minority interest and why do we add it in the EV formula?

When a company owns more than 50% of another company US accounting laws state that the parent company has to consolidate its books and is made to reflect 100% of the assets and liabilities of the subsidiary.

because the parent does not actually own 100% of the sub, we use minority interest to represent the portion of the parent companys claim on the subs net income that belongs to other investors (claims that it does NOT have claims on)

to counteract the subs 100% books appearing on the parent companys balance sheet, we add the value of the sub that the parent does not own to EV.This allows both the numerator and the denominator of our valuation metric to account for 100% of the sub making sure that were correctly comparing apples to apples

Why do you subtract cash in the EV formula?

2 reasons:

1. cash is considered a non-operating asset

2. cash is already implicitly accounted for within equity value

How to calculate the market value of equity?

MVE equals:

Share price X # of shares outstanding

Difference between basic shares and fully diluted shares?

Basic shares represent the number of common shares outstanding today

Fully diluted shares = basic shares + the potentially dilutive effect from any outstanding stock options, warrants, and convertibles.

In calculating MVE we always want to use diluted shares

What is goodwill and how is it calculated?

Goodwill is an intangible asset that reflects the value of a company that is not attributed to the assets/liabilities on its books.

Its calculated by subtracting the targets book value (fair market value of its BS) from the equity purchase price paid for the company.This is also known as Excess Purchase Price.

Why might a company want to acquire another company?

Buyer thinks the target is undervalued

Buyer is looking to grow the company through acquisitions in order to satisfy growth expectations

Expected Synergies

Buying company CEO wants to manage a larger company (for whatever reasons)

Explain the concept of synergies and explain the concept

When the sum of the value of the buyer and target combined is greater than their sums apart.

2 categories of synergies: cost and revenue

Cost synergies are the ability to cut costs of the combined companies due to the consolidation of operations

Revenue synergies refer to the ability to sell more products/services or the ability to raise prices due to the merger (increasing sales due to cross marketing, co branding, etc.)

Both have to do with economies of scale

What drivers to the LBO model will increase the return for the private equity firm?

1. reduce purchase price PE firms has to pay

2. increase leverage

3. increase the assumed exit multiple

4. increase the companys growth rate to raise operating income/cash flow/EBITDA in the projections

What are some characteristics of a company that is a good LBO candidate?

1. steady cash flows (most important to be able to satisfy interest expenses)

2. limited business risk

3. limited CapEx requirements4. strong management

5. high cost reduction opportunity and large asset base (to use as debt collateral)

Of the 3 financial statements, which do you think is the most important?

Statement of Cash flows, especially for credit analysis.

If were analyzing whether to extend a companies credit line or whether to extend one at all, its important to look through the companies cash flows in order to make certain that they have the capability to pay meet the debt obligations.

Net income can be misleading given all of the non cash items and accrual accounting methods that take place that can distort what the actual capability to meet these debt obligations really might be.

What is Credit Risk and what does the team do?

Credit risk is the risk of loss arising from the default of a client or counterparty

The team works to assess, permit, and manage credit and counterparty risks on an industry, client, geographic, and transaction basis to identify, measure, limit, manage, monitor, and mitigate risk

The different Risk Teams at JP Morgan

1. CIB and Wholesale North America Corporates:

Work with client base of diversified industrial, consumer, healthcare, retail, tech, media, communications, power, natural resources, and other corporate clients

2. Wholeale Multinational Corporations:

similar to #1, performing credit diligence on an ongoing basis for north american subsidiaries of MNCs headquartered overseas as well as recommending credit decisions

3. CIB and Commerical Real Estate:

client base of leading real estate, lodging, gaming, homebuilding, and real estate services companies, working to maintain knowledge of developments across real estate sectors nationally and provide expertise alongside them

4. CIB Financial Institutions:

client base of leading asset managers, banks, broker dealers, hedge funds, insurance companies, municipalities, and specialty finance or other non bank financial institutions

What is Credit Analysis?

The analysis and identification of risks wherein a potential for lending is observed by the banks to evaluate qualitative and quantitative metrics of their clients

Interest Coverage Ratio

EBITDA / Interest Expense

Shows the lender how able their client will be to pay their debt obligations. Higher the ratio the better.

Typical Credit Analysis ratios

D/E

Interest Coverage Ratio(EBIT or EBITDA/Interest Expense)

Tangible Net worth Ratio

Total Assets-total liabilities-intangible assetsFixed Charge coverage ratio(EBIT+FCBT)/(FCBT+i)

Debt/EBITDA

Debt/Capital

DSCR

NOI/Total Debt Service

What do credit ratings agencies do?

Help the market understand the creditworthiness of a business by looking at the outstanding debts and credit history

DSCR?

Debt Service Coverage Ratio

=NOI/Total Debt Service

gives an idea whether the company is capable of covering its debt related obligations with the net operating income it generates

DSCR

What are the types of credit facilities for companies?

2 types of credit facilities:

1. Short term loans - mainly for working capital needs (overdraft, letter of credit, bridge loans sometimes, etc)

2. Long Term, Loans - required for CapEx or acquisitions (bank loans, notes, mezzanine loans, securitization, bridge loans)

What is Value at risk (VaR)?

A statistic that measures and quantifies the level of financial risk within a firm, portfolio or position over a specific time frame.

What is a reasonable Debt/Capital ratio?

It completely depends on the industry. Some industries can sustain very low debt to capital ratios, typically cyclical industries like commodities or early-stage companies like startups. These might have a 0-20% debt to capital ratio. Other industries such as banking and insurance can have up to 90% debt to capital ratios.

What is Free Cash Flow?

Free cash flow is simply equal to cash from operations minus capital expenditures (levered free cash flow).

What are the most common credit metrics banks look at?

The most common credit metrics include debt/equity, debt/capital, debt/EBITDA, interest coverage, fixed charge coverage, and tangible net worth.

What are the most common credit metrics banks look at?

The most common credit metrics include debt/equity, debt/capital, debt/EBITDA, interest coverage, fixed charge coverage, and tangible net worth.