Banking Exam Commercial Lending Principles 2 — Questions and Answers
Question 1: A borrower's Debt Service Coverage Ratio (DSCR) is 1.15. What does this indicate?
- The borrower has insufficient cash flow to service debt
- The borrower generates 15% more cash flow than needed to cover debt obligations (Correct answer)
- The borrower's debt equals 115% of its assets
- The loan-to-value ratio is 115%
Correct answer: The borrower generates 15% more cash flow than needed to cover debt obligations
A DSCR of 1.15 means net operating income is 1.15 times the total debt service, providing a 15% cushion above required payments.
Question 2: Which type of commercial loan structure requires the borrower to pay interest only during the draw period and then repay principal upon maturity?
- Term loan
- Construction loan (Correct answer)
- Revolving credit facility
- Equipment financing
Correct answer: Construction loan
Construction loans typically have an interest-only draw period while the project is being built, followed by conversion to permanent financing or a balloon payment at maturity.
Question 3: When a lender takes a 'blanket lien' on a borrower's assets, what does this mean?
- The lender holds first-priority security on one specific asset
- The lender has a security interest in all of the borrower's business assets (Correct answer)
- The lender waives its right to foreclose on collateral
- The borrower's personal assets are excluded from collateral
Correct answer: The lender has a security interest in all of the borrower's business assets
A blanket lien grants the lender a security interest in all present and future business assets of the borrower, providing broad collateral coverage.
Question 4: What is the primary purpose of a loan covenant in a commercial lending agreement?
- To set the interest rate for the life of the loan
- To establish borrower behavior standards that protect the lender's position (Correct answer)
- To define the government regulations applicable to the loan
- To specify the appraisal method for collateral valuation
Correct answer: To establish borrower behavior standards that protect the lender's position
Loan covenants are contractual conditions that require borrowers to maintain certain financial metrics or behaviors, protecting the lender from deteriorating credit quality.
Question 5: A commercial borrower has current assets of $500,000 and current liabilities of $350,000. What is the current ratio?
- 0.70
- 1.43 (Correct answer)
- 1.50
- 2.00
Correct answer: 1.43
The current ratio is calculated by dividing current assets by current liabilities: $500,000 ÷ $350,000 = 1.43.
Question 6: Which loan pricing method sets the interest rate at a spread above a benchmark rate such as SOFR?
- Fixed-rate pricing
- Prime-based pricing
- Floating-rate pricing (Correct answer)
- Fee-based pricing
Correct answer: Floating-rate pricing
Floating-rate pricing ties the loan's interest rate to a benchmark like SOFR plus a spread, causing the rate to adjust as the benchmark moves.
Question 7: In commercial real estate lending, what does LTV stand for and what does a lower LTV generally indicate?
- Loan-to-Value; a lower LTV indicates higher risk for the lender
- Loan-to-Value; a lower LTV indicates less risk and more equity cushion for the lender (Correct answer)
- Leverage-to-Value; a lower ratio means the borrower is more leveraged
- Lien-to-Value; a lower ratio means fewer liens on the property
Correct answer: Loan-to-Value; a lower LTV indicates less risk and more equity cushion for the lender
LTV (Loan-to-Value) measures the loan amount relative to the property's appraised value; a lower LTV means more borrower equity, reducing the lender's risk.
Banking Exam Commercial Lending Principles 2
A borrower's Debt Service Coverage Ratio (DSCR) is 1.15.
What does this indicate?