Credit Analysis & Risk Assessment Flashcards

A company's Accounts Payable Days (DPO) has increased from 30 days to 75 days over two years. What is the MOST concerning credit interpretation?

Answer: The company may be stretching payables due to cash flow pressure, risking supplier relationship damage

A sharp DPO increase can signal cash flow distress where the company is delaying payments to preserve liquidity, which may ultimately damage supplier relationships and supply chains.

What is 'zombie debt' in the context of credit risk and portfolio management?

Answer: Non-performing loans kept on the books beyond their useful recovery timeline, distorting portfolio quality metrics

Zombie debt refers to loans that are effectively uncollectible but remain on the books, masking true portfolio health and tying up capital that should be charged off.

Which of the following BEST describes 'springing' financial covenants?

Answer: Covenants that only become active when a triggering event occurs, such as exceeding a borrowing threshold

Springing covenants remain dormant until a specific condition is met (e.g., utilization exceeds 35% of the revolver), at which point they activate and must be tested.

When underwriting a loan to a holding company, why is it critical to analyze the cash flow at the operating subsidiary level?

Answer: Because the holding company's ability to service debt depends on dividend or management fee upstream from subsidiaries

Holding companies typically lack independent cash flow and rely on upstreamed funds from subsidiaries, so structural subordination and subsidiary cash flow capacity are critical to assess.

A borrower's quick ratio is 0.6. What does this indicate, and why might it concern a credit analyst?

Answer: Current liabilities exceed liquid assets, meaning the borrower cannot cover short-term obligations without selling inventory

A quick ratio below 1.0x means liquid assets (cash + receivables) are insufficient to cover current liabilities, indicating potential short-term liquidity stress.

What is 'structural subordination' and why is it a key concept in holding company credit analysis?

Answer: Holding company creditors rank behind subsidiary creditors in claims on subsidiary assets, reducing recovery in default

Structural subordination means holding company lenders are effectively subordinate to subsidiary-level creditors because they can only access subsidiary assets after subsidiary creditors are paid.

Which of the following is the PRIMARY purpose of a Uniform Commercial Code (UCC) lien search before closing a commercial loan?

Answer: To identify existing liens on the borrower's assets that may impair the lender's security interest

A UCC search reveals prior perfected security interests, ensuring the lender understands its lien priority position and that collateral is not already encumbered by another creditor.