Banking Credit Analysis 4 — Questions and Answers
Question 1: What does a high days-sales-outstanding (DSO) figure indicate about a borrower?
- Efficient receivables collection
- Strong revenue growth
- Slow collection of receivables, potential cash flow issue (Correct answer)
- High inventory turnover
Correct answer: Slow collection of receivables, potential cash flow issue
High DSO means the company takes longer to collect payment from customers, which can strain cash flow and indicate credit risk.
Question 2: In leveraged lending, what is a 'term loan B' (TLB)?
- A short-term revolving credit facility
- A long-term senior secured loan with minimal amortization sold to institutional investors (Correct answer)
- A subordinated mezzanine debt instrument
- A government-guaranteed small business loan
Correct answer: A long-term senior secured loan with minimal amortization sold to institutional investors
Term Loan B is a senior secured credit facility with minimal scheduled amortization (often 1% per year), held predominantly by institutional investors like CLOs and hedge funds.
Question 3: Which of the following is an example of a negative pledge covenant?
- Requiring the borrower to maintain a minimum DSCR
- Prohibiting the borrower from pledging assets to other creditors (Correct answer)
- Mandating quarterly financial reporting to the lender
- Restricting the borrower from making acquisitions above a set threshold
Correct answer: Prohibiting the borrower from pledging assets to other creditors
A negative pledge covenant prevents the borrower from using assets as collateral for other debt, protecting the existing lender's security position.
Question 4: What is 'loss given default' (LGD) in credit risk modeling?
- The probability that a borrower will default
- The proportion of exposure the lender loses if a default occurs (Correct answer)
- The total outstanding balance at time of default
- The expected time to default after credit deterioration begins
Correct answer: The proportion of exposure the lender loses if a default occurs
LGD represents the percentage of the exposure at default that the lender cannot recover, after accounting for collateral and recoveries.
Question 5: Which credit metric is most relevant when analyzing a startup company with no historical earnings?
- Historical EBITDA margin
- Revenue run rate and projected cash burn rate (Correct answer)
- Debt-to-equity ratio
- Dividend payout ratio
Correct answer: Revenue run rate and projected cash burn rate
For startups, revenue run rate and cash burn rate are critical because they reveal how long the company can operate before needing additional funding.
Question 6: What is the primary difference between recourse and non-recourse lending?
- Recourse loans have higher interest rates than non-recourse loans
- Recourse loans allow the lender to pursue the borrower's other assets beyond the collateral if default occurs (Correct answer)
- Non-recourse loans are only available to government entities
- Recourse loans require no collateral
Correct answer: Recourse loans allow the lender to pursue the borrower's other assets beyond the collateral if default occurs
In recourse lending, the lender can go after the borrower's other assets if collateral is insufficient, while non-recourse limits recovery to the pledged collateral only.
Question 7: Which component of the CAMELS rating system specifically evaluates the quality of a bank's loan portfolio?
- Capital adequacy
- Asset quality (Correct answer)
- Management competence
- Earnings performance
Correct answer: Asset quality
The 'A' in CAMELS stands for Asset Quality, which assesses the credit risk in the loan portfolio including non-performing loans and provisioning levels.
Banking Credit Analysis 4
What does a high days-sales-outstanding (DSO) figure indicate about a borrower?