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Happy Tuesday, future bankers!

Hope that recruiting has been going well for everyone! In today’s newsletter, we’re going to be going through the mechanics of leverage, talking about passion projects, and discussing Jerome Powell’s comments about the potential for more bank failures.

🚀 Let’s get into it.

🔢 Technical Question

“What is leverage? How does its mechanics amplify returns in a leveraged buyout?”

In finance, leverage involves borrowing money (taking on debt) to increase the size of potential gains and losses. It's important to remember that leverage doesn't guarantee higher returns; it simply magnifies the outcome for an investment. Imagine buying a stock on margin - leverage allows you to buy more shares, potentially amplifying your profits, but also amplifying your losses if the stock price falls.

A leveraged buyout (LBO) occurs when a company that invests in other companies (private equity firm) buys another company using a large loan. They only put in a small amount of their own cash upfront, typically between 40% and 75%, and borrow the rest. This reduces their own financial risk and allows them to potentially make greater profits if the acquired company does well.

By using borrowed money, the private equity firm frees up more of their own cash. This is like having more money to invest elsewhere, potentially increasing their overall gain. Furthermore, they can use the profits generated by the acquired company (cash flow) to pay back the loan over time.

In the 1980s, LBOs often involved borrowing huge amounts of money, sometimes up to 90% of the purchase price. However, over time, investment strategies became more cautious, risk tolerance changed, and regulations were put in place. This reduced the amount of debt used in LBO deals today.

🗣 Behavioral Question

"Tell me about a time when you worked on a project that you were truly passionate about? What was the project and why did you enjoy it?"

Here’s how you could respond to the "Passion Project" interview question:

Here's how to tackle the "passion project" question in an investment banking internship interview:

1. Choose a relevant project:

• Select a project showcasing skills applicable to investment banking, like analysis, problem-solving, or teamwork.

• Highlight experiences that demonstrate initiative, dedication, and potential for learning growth.

2. Focus on the "why":

• Don't just describe the project; explain what ignited your passion and kept you motivated.

• Connect your passion to skills and traits valuable in investment banking (e.g., analytical thinking, attention to detail, communication).

3. Showcase results and impact:

• Briefly mention the project's outcome or your contribution to its success.

• Quantify achievements if possible, demonstrating your results-oriented approach.

Example Response:

"During my senior year, I participated in a stock market simulation competition with my university's investment club. As team leader, I researched and analyzed potential investments. I was passionate about this project because it allowed me to combine my interest in finance with strategic planning and teamwork. I enjoyed delving into company financials, 10-Ks, 10-Qs, learning valuation techniques for public companies, and collaborating with teammates to make informed investment decisions. Ultimately, our team placed second in the competition that was judged by several alumnus working in the asset management industry. This experience solidified my passion for finance and my desire to apply my analytical and collaborative skills in a professional setting, which is one reason why I'm highly interested in opportunities in investment banking."

Key points:

• The project involved analysis, strategic thinking, and teamwork, relevant to investment banking.

• The candidate explains their passion and connects it to valuable skills.

• They mention a quantifiable achievement, showcasing their results-oriented approach.

🗞 Industry News

Powell Warns of Another Banking Crisis 🚨

Federal Reserve Chair Jerome Powell predicts some small banks will likely close or merge due to commercial real estate issues, but emphasizes it's a "manageable" problem. His comments follow the turmoil triggered by New York Community Bancorp's stock plunge after reporting losses and slashing its dividend.

Powell acknowledged concerns about smaller banks with concentrated exposure to commercial real estate, particularly vulnerable due to rising interest rates and pandemic's impact on city-center properties. However, he believes larger banks are well-positioned with manageable challenges. Regional banks hold a higher average of these loans compared to larger rivals, making them more susceptible.

While acknowledging difficulties for some, Powell reiterated the overall issue is manageable, emphasizing the Fed's efforts to work with banks and their awareness of the situation. Analysts agree, attributing New York Community Bancorp's struggles to specific issues beyond broader market trends. They see manageable pain for most banks unless a "perfect storm" of inflation resurgence, prolonged high rates, and recession hits, making loan repayments difficult.

Overall, Powell's message downplays systemic risk from commercial real estate, while acknowledging manageable challenges for some smaller banks and regional players with high exposure.

Read more about this story below.