Most Common Houlihan Lokey Restructuring Interview Questions
Houlihan Lokey has the largest summer and full-time analyst class of any restructuring investment bank. Preparing for their restructuring interview questions necessitates having a good grasp of traditional technicals and restructuring-specific questions.
For many who are just getting interested in restructuring, HL's case study - The Troubled Company - is the first thing that they read.
I would certainly recommend reading it. However, there are a few things to keep in mind when going through it if you have no prior exposure to restructuring:
- There is an emphasis on asset sales (both out-of-court and in-court) in the case study that are reasonably uncommon in most deals
- There isn't much written about the potential out-of-court solutions that exist for the company (which is a reasonably large part of restructuring in practice)
The Troubled Company is a great place to begin and there's no reason not to go through it when you have time. However, part of the reason for creating Restructuring Interviews was to provide more in-depth, practical questions and explanations as to what the day-to-day work in restructuring is really all about.
With all that said, let's take a look at some of the most popular questions asked at HL:
What are The Characteristics of a Distressed Company?
Note: I've written a rather lengthy post about this already, which you can turn to afterwards if interested.
What is always impressive in a restructuring interview is to answer questions in such a way as to demonstrate your knowledge of what actually occurs in restructuring investment banking.
This is because the vast majority of those who go into restructuring interviews - even those who ultimately get the job - really don't have a feel for what the job is all about.
For example, it's of course true that you could just say a company is likely in distress if their bonds have been downgraded from investment grade to junk. Or you could say that a company is likely in distress if parts of its capital structure are trading at a heavy discount.
These are all signs of potential distress, to be sure. These things wouldn't be happening if a company was entirely healthy.
However, if you explain what the impetus for restructuring investment bankers getting involved in a particular situation is, that makes your answer really stand out because it shows your practical understanding of restructuring.
A distressed company that will ultimately be engaged by a restructuring investment bank like HL will not only likely have recent downgrades and debt that's trading low, they'll also have a reason for needing to get right-sized soon.
This reason primarily boils down to two things:
- Lack of liquidity
- Maturity walls coming due
A lack of liquidity will signal that the company may have trouble just coming up with interest expense for the debt currently in the capital structure. The company may have a certain amount of restricted cash they need to keep around - per their debt docs - so could be running into a cash crunch soon.
Maturity walls refer to points of time when various pieces of the capital structure come due. For healthy companies, these don't matter too much. Almost no company has enough cash on hand to just pay off the principal balance of their debt when it comes due (it likely wouldn't be prudent to do so!), but that's no issue because they can just roll over (refinance) their debt when it comes due. In this current climate, in 2021, healthy companies are actually able to refinance at incredibly low rates.
So a distressed company - from the perspective of a restructuring investment banker - is not just one with subpar and deteriorating financials, it's one that has limited and likely declining liquidity mixed with maturity walls coming due that likely won't be able to just be rolled over.
Of course, I should make clear that part of the reason why certain tranches of debt are trading low in the first place could be because maturity walls are coming up, the coming has limited liquidity, and the market is pricing in the need for there to be some kind of restructuring in the future.
What this particular way of answering this question does is show you implicitly understand the "Why?" behind why downgrades could be happening and debt is trading down.
How do you reflect $100 of PIK through the three statements?
PIK interest questions are some of the most common to get in restructuring interviews. Sometimes they'll be asked in conjunction with traditional cash interest questions (e.g. how do you reflect $50 PIK interest and $50 cash interest through the three statements?).
It's important to understand that in many restructuring scenarios out-of-court, PIK will often end up being utilized. For instance a debt exchange may involve the new debt instrument - that folks are exchanging into - having 5% cash interest and 4% PIK, for example. Obviously the reason why PIK is used is to try to keep the amount of cash interest flying out the door to a minimum thus protecting the likely already fragile liquidity position of the company.
If we assume a 40% tax rate, then $100 of PIK interest on the income statement will result in net income falling by $60. Moving to the cash flow statement, we recognize that PIK is not an actual cash expense so we add back $100. Now we're at +$40.
Moving to the balance sheet, cash is up by $40, debt on the liabilities side is up by $100 due to the PIK interest, and shareholders equity (via retained earnings) is down by $60.
What are the two sides of a restructuring? Who do we typically advise?
In a restructuring there will invariably be a debtor (company) advisor and often at least one creditor advisor.
HL has made its name for taking on many interesting creditor mandates. With that being said, HL does take on debtor engagements as well and in terms of the amount of fees they generate it's about 50 / 50 between debtor and creditor-side work (this reflects the fact that debtor-side mandates result in higher fees).
All RX shops will gladly take on debtor or creditor side engagements. Often it'll be the case that if a RX shop doesn't win the debtor mandate, then they'll see if they can get a creditor-side mandate.
HL is known for taking a higher proportion of creditor-side mandates than other Tier 1 restructuring firms (PJT, Evercore, Moelis, and Lazard). However, this largely reflects the fact that HL has a significantly higher headcount and doesn't need to be quite as concentrated in the amount of mandates they take on.
Creditor mandates usually require quite a bit less work than debtor mandates. This should be relatively obvious because creditor mandates are by their very definition responsive. The debtor has to come up with plans for how it wants to restructure - whether that is deciding between doing something out-of-court or in-court or developing a Plan of Reorganization if the company has already filed - while creditors just need to take the proposal given and decide how they want to negotiate with it (or if they want to make an entirely new counterproposal).
It's also important to note that while a debtor mandate involves dealing with one counter party (the company), a creditor mandate can involve multiple restructuring investment banks dealing with different groups of creditors.
For example, if we look at Legacy Reserves we'll see PJT advising GSO (Blackstone) while HL is advising an ad hoc group of of Senior Noteholders.
What kind of restructurings do we do here?
Whenever you go into any interview, you should have a few recent deals of theirs to talk about. Deals are relatively easy to find for HL because they do a lot of deals on both the creditor and the debtor side (many of which involve public companies, which makes them a bit more high profile).
As a general principle, it's always best if you decide to talk about an out-of-court restructuring as opposed to a Chapter 11. Reason being is that when you have a Chapter 11 there's a whole docket that you (hypothetically) could go through, whereas with an out-of-court the only public information available will generally be press releases discussing the proposal and what the results of it were. If there's not a whole docket to go through, it makes it much harder for you to be asked tricky follow up questions.
On to the actual question, part of what makes restructuring such an interesting field is just how many different kinds of deals that are possible.
Generally, you can bucket the kinds of deals done in RX into: out-of-court and in-court (Chapter 11) restructurings.
In an out-of-court restructuring you can do a simple amend and extend of a revolver or term loan to push out maturities, do a debt exchange (including fancy sounding things like a non-pro rate uptier), do a debt exchange with equtization, etc.
The key things to know for an interview about any out-of-court restructuring deal are the ultimate terms of the deal, how this has at least partly solved the company's problem (pushed out maturity wall, got rid of some cash interest expense, etc.), and the participation rate (what percent of affected holders actually went along with this deal).
In an in-court restructuring, we only care about Chapter 11s (since a Chapter 7 involves liquidation overseen by the U.S. Trustee). In a Chapter 11 you have traditional Chapter 11s - sometimes called free fall Chapter 11s - that involve the company filing and then, under the protection of the bankruptcy court, negotiating with creditors over what the ultimate Plan of Reorganization will look like.
Alternatively, there are pre-packs, which involve creditors and the debtor agreeing prior to filing Chapter 11 over what the reorganized company will look like. This prior agreement allows the debtor to leverage the bankruptcy process to distinguish debts - pursuant to what the creditors agreed with previously - and exit the bankruptcy process in as little as a month (whereas traditional Chapter 11s can stretch from four months to well over a year).
Nearly every restructuring is slightly different and things get complicated quite fast. Even trying to provide a little bit of nuance in this answer has been difficult. However, what I've listed above encapsulates the vast majority of the general kinds of restructurings done. Like anything though, the devil is in the details.
Let's say we have EBITDA = 30, a multiple of 5x, Term Loan A of $100 and Senior Notes of $100. What's the recovery value throughout the capital structure? Would equity trade at zero prior to filing?
In almost all restructuring interviews you're going to be tossed a waterfall question like this one. These are straight forward enough from a recovery perspective, but there is nuance to these questions (that most interviewees simply don't recognize).
From a simple recovery perspective, you have an EV of $150 (30*5). That fully covers the TLA with $50 remaining. We have Senior Notes of $100 and thus a recovery for them would be $50. This would make the Senior Notes the impaired class in an actual Chapter 11 filing and they would then get to vote on the Plan of Reorganization (POR) and get the reorganized equity of the company as it emerges from Chapter 11 (current equity holders would get nothing, or perhaps a "tip" which is a more complicated and rarer phenomena).
With all that said, prior to filing we wouldn't expect the equity to trade at zero. There are always quite a few real companies that have financials quite like what I've outlined above where they still have actively traded equity at surprisingly high prices.
This is because as equity prices tend toward zero, much of the value of equity is in its underlying optionality. Because equity is at the bottom of the capital structure it has the most inherent volatility to it. Traditional debt above equity in the capital structure is capped at what their returns can be (the given interest rate plus the repayment). However, with equity there is a defined downside (zero) and an unlimited upside.
So as equity trades closer to zero, the value of equity begins to look much more like a call option. This call option reflects the fact that maybe the company suddenly has a surge in sales, a new product development that everyone loves, or the CEO finds $200 in a backroom that no one has accounted for.
More realistically, if no restructuring has yet been done the price of equity reflects the fact that maybe the debt holders above (in this case the Senior Notes) really don't want the company to file. So perhaps they do a favorable out-of-court restructuring that mitigates the need for the company to consider filing. In this case, you'd expect equity to pop as now there's even more time for the company to turn things around (and the longer you have to wait for a better tomorrow, the more the value the equity will have just as would be the case with a call option).
These are some of the more common questions from HL. Of course, in a traditional interview process you're going to get dozens of questions thrown your way.
Restructuring interviews are daunting, but in reality the most important thing is to show your interviewer that you have contextual understanding about what restructuring investment bankers really do all day.
Many who interview for restructuring jobs can recite the formulaic accounting answers perfectly, but then have trouble describing how exactly restructuring works (this is why the equity value question above is so common) or what a distressed company really is.
I hope this little overview has been helpful. If you'd like a nearly 100-page guide detailing exactly what restructuring investment banking is in practice with separate guides containing over 500 additional Q&A, be sure to check out the Restructuring Interviews course.