Exam 20: Managing Credit Risk on the Balance Sheet

If you were a loan officer evaluating a small business credit application for a loan and you wanted to ensure that the applicant had more than sufficient cash flow to pay off its existing debt,the applicant's cash flow to debt ratio would have to be greater than

Business credit-scoring models suffer from several weaknesses. These include which of the following? I. Credit-score models are not statistically sound tools to use in making a lending decision. II. The appropriate weights on a credit-score model are likely to change unpredictably over time. III. These models ignore nonquantifiable behavioral factors,such as a relationship with the bank and reputation. IV. Credit-scoring models discriminate against minorities.

If you are a lender evaluating a loan application and you calculate the following ratio: (EBIT + Lease Payments)/[Interest + Lease Payments + (Sinking Fund/(1-T))],then you are calculating a debt service ratio and it should be less than one in order to approve the loan.

Altman's Z-score model is Z = 1.2X₁ + 1.4X₂ + 3.3X₃ + 0.6X₄ + 1.0X₅ X₁ = Working Capital/Total Assets X₂ = Retained Earnings/Total Assets X₃ = EBIT/Total Assets X₄ = Market Value Equity/Book Value Long-Term Debt X₅ = Sales/Total Assets Using the Altman's Z model,Big Valley's Z-score is

A bank is using the RAROC to evaluate large business loans. The benchmark rate of return is 7.55 percent. The one-year loan interest rate is 8.00 percent and the bank must pay 7.40 percent to raise the funds. The cost to service the loan is 0.3 percent. If the loan defaults,92 percent of the money lent will be lost. Based on historical default rates,the extreme worst-case loss scenario is about 5 percent. Should the bank make the loan? Why or why not?

In analyzing credit risk for a loan to a major diversified corporation,the bank typically has which of the following advantages? I. Market-based models to analyze credit risk II. Greater negotiating power due to the size of the loan required III. Ratings agency measures of default risk

Explain how the Moody's Analytics Model predicts bankruptcy probability.

A $40,000 one-year loan with a 1 percent origination fee and a 7.50 percent interest rate is funded with money on which the bank owes 3 percent. What is the expected pretax dollar spread on the loan? If the bank needs to net at least 3.5 percent on the funds lent to make its ROE,how many dollars can the bank spend on credit investigation,loan servicing,and so forth? Would the bank be able to spend more if the loan amount was greater? What does this example suggest about credit analysis?

Non-performing loans are loans that are past due ___________ that are not accruing interest.

Before allowing the lender to actually acquire the funds for a mid-market collateralized loan,what must the lender ensure? What type of monitoring occurs by the lender after the loan is granted?

As long as overall cash flow growth is positive,a bank loan officer would not be concerned if cash flow from operations was projected to be negative over the term of the loan.

Individual credit scoring models typically include all of the following information except

A firm with a low Z-score has high

As a business lender,you would prefer that the borrower have stable or growing cash flows resulting from which part of the statement of cash flows?

Collateral on a mortgage is normally only considered if the applicant has enough income to service the loan.

The base loan rate accounts for I. the firm's cost of funds. II. the firm's required return on equity. III. the credit risk of the loan.

Issuance of short-term debt would result in an increase in cash flow from operations on the statement of cash flows.

If you were a loan officer evaluating a small business credit application for a loan secured by working capital,you would generally want to see a higher (rather than lower)number of days in inventory and number of days' sales in receivables.

The five Cs of credit are financial capacity,collateral,conditions,connections with the bank,and capital.

Describe the credit analysis process for a mid-market corporate loan applicant.