Banking Credit Analysis 2 — Questions and Answers
Question 1: Which ratio measures a borrower's ability to service debt from operating cash flow?
- Debt-to-equity ratio
- Debt service coverage ratio (DSCR) (Correct answer)
- Current ratio
- Return on assets
Correct answer: Debt service coverage ratio (DSCR)
DSCR compares net operating income to total debt service, indicating whether cash flow is sufficient to cover loan payments.
Question 2: A company has EBITDA of $500,000 and total debt of $2,000,000. What is its leverage ratio?
- 0.25x
- 2.5x
- 4.0x (Correct answer)
- 5.0x
Correct answer: 4.0x
Leverage ratio = Total Debt / EBITDA = $2,000,000 / $500,000 = 4.0x.
Question 3: What does a negative working capital position typically indicate?
- Strong liquidity
- High profitability
- Potential short-term liquidity risk (Correct answer)
- Excellent asset management
Correct answer: Potential short-term liquidity risk
Negative working capital means current liabilities exceed current assets, signaling potential difficulty meeting short-term obligations.
Question 4: Which credit analysis framework uses Character, Capacity, Capital, Collateral, and Conditions?
- CAMELS
- 5 Cs of Credit (Correct answer)
- SWOT Analysis
- Basel III Framework
Correct answer: 5 Cs of Credit
The 5 Cs of Credit is a widely used framework for evaluating a borrower's creditworthiness across five key dimensions.
Question 5: In the context of commercial lending, what is 'enterprise value'?
- Book value of equity only
- Total market value of a firm including debt and equity (Correct answer)
- Annual revenue of the business
- Net income after taxes
Correct answer: Total market value of a firm including debt and equity
Enterprise value represents the total value of a business, calculated as market cap plus debt minus cash, used to assess collateral in leveraged lending.
Question 6: Which of the following is a leading indicator of credit deterioration?
- Stable revenue growth
- Declining accounts receivable turnover (Correct answer)
- Improving gross margins
- Reduction in long-term debt
Correct answer: Declining accounts receivable turnover
Declining accounts receivable turnover suggests customers are taking longer to pay, which can signal cash flow stress and credit risk.
Question 7: What is the primary purpose of a loan covenant in credit analysis?
- To set the interest rate on the loan
- To establish legal boundaries that protect the lender (Correct answer)
- To determine the loan amortization schedule
- To calculate the borrower's credit score
Correct answer: To establish legal boundaries that protect the lender
Covenants are contractual conditions that restrict borrower behavior or require maintenance of financial ratios to protect the lender's interests.
Banking Credit Analysis 2
Which ratio measures a borrower's ability to service debt from operating cash flow?