Banking Credit Analysis 3 — Questions and Answers
Question 1: A borrower's quick ratio is 0.6. What does this suggest?
- The borrower has strong short-term liquidity
- The borrower may struggle to meet immediate obligations without selling inventory (Correct answer)
- The borrower is highly profitable
- The borrower has excessive long-term debt
Correct answer: The borrower may struggle to meet immediate obligations without selling inventory
A quick ratio below 1.0 indicates that liquid assets (excluding inventory) are insufficient to cover current liabilities, signaling liquidity risk.
Question 2: In credit underwriting, what does 'seasoning' of a loan refer to?
- The interest rate adjustment period
- The length of time a loan has been outstanding with a payment history (Correct answer)
- The collateral appraisal process
- Annual review of borrower financials
Correct answer: The length of time a loan has been outstanding with a payment history
Loan seasoning refers to the time elapsed since origination, with more seasoned loans providing actual payment performance data to assess credit quality.
Question 3: Which financial statement is most useful for assessing a company's ability to repay debt over time?
- Balance sheet
- Income statement
- Cash flow statement (Correct answer)
- Statement of retained earnings
Correct answer: Cash flow statement
The cash flow statement shows actual cash generation and usage, making it the best indicator of a borrower's ability to service debt obligations.
Question 4: What is 'credit migration' in portfolio credit analysis?
- Moving loans between lenders
- A borrower's shift in credit rating over time (Correct answer)
- Transferring collateral between facilities
- Changing loan terms mid-agreement
Correct answer: A borrower's shift in credit rating over time
Credit migration tracks how a borrower's credit rating changes (upgrades or downgrades) over a period, reflecting changing credit quality in a portfolio.
Question 5: A bank requires a loan-to-value (LTV) ratio of no more than 80% for a commercial real estate loan. The property is appraised at $1,000,000. What is the maximum loan amount?
- $750,000
- $800,000 (Correct answer)
- $850,000
- $900,000
Correct answer: $800,000
Maximum loan = LTV × Appraised Value = 80% × $1,000,000 = $800,000.
Question 6: Which of the following best describes 'credit concentration risk'?
- Risk from lending to borrowers with high FICO scores
- Overexposure to a single borrower, sector, or geography (Correct answer)
- Risk of interest rate changes affecting loan values
- The probability of a borrower defaulting within one year
Correct answer: Overexposure to a single borrower, sector, or geography
Credit concentration risk arises when a lender has excessive exposure to a single borrower, industry, or region, amplifying potential losses.
Question 7: What is the purpose of stress testing in credit analysis?
- To calculate average historical default rates
- To evaluate how a borrower or portfolio performs under adverse economic scenarios (Correct answer)
- To determine optimal loan pricing
- To verify collateral ownership documentation
Correct answer: To evaluate how a borrower or portfolio performs under adverse economic scenarios
Stress testing simulates adverse conditions such as recessions or interest rate spikes to assess whether borrowers or portfolios can withstand economic shocks.
Banking Credit Analysis 3
A borrower's quick ratio is 0.6.
What does this suggest?