03 Credit Analysis

Question 1

Structure of Loan Agreement
*A loan agreement
i. specifies the …
ii. makes certain warranties
iii. usually …

Details:
– Principal: amount to be borrowed
– Maturity: …
– Pricing formula (fixed/floating rate, closing fee, etc.)
– …

Answer 1

obligations of borrower and lender
places certain controls and restrictions on the borrower

short- (below 1 year), intermediate- (1 to 5 years), long-term (more than 5 years)
Provisions (conditions precedent, warranties, covenants and events of default)

Question 2

Standard provisions
* Conditions precedent
– …
– Examples: business transactions that must be completed or …

Answer 2

Requirements the borrower must satisfy before the bank is legally obliged to fund the loan

events that must have occurred, certificate of no defaults

Question 3

• Warranties
  – Information and assumptions about the …
  – Examples: …, that borrower has a valid title of all assets, etc.

Answer 3

borrower’s legal status and creditworthiness

warranties that all financial statements submitted are genuine and fairly represent the borrower’s financial position

Question 4

Standard provisions
* Loan Covenants:
* Clauses in loan contracts designed to … and prohibit …
* Reduce moral hazard
* Violation of covenants creates …and gives the bank the right to …

Answer 4

protect the bank; borrower from taking actions that could adversely affect the likelihood of repayment.

an event of default
accelerate the required payment

Question 5

Types of loans covenants
* Affirmative covenants
– … on the borrower
– Examples: provision of periodic financial statements, maintenance of minimum working capital, management acceptable to the bank
* Restrictive clauses
– …
– Examples: …

Answer 5

Obligations imposed;

Limits on the borrower’s actions
restrictions on dividends, salaries, bonuses, investments (e.g. purchases of fixed assets)

Question 6

Types of loans covenants
* Negative covenants: what are those?

• Default provisions: what are those?

Answer 6

– Prohibitions on the borrower
– Examples: negative pledge clause, prohibitions on mergers, consolidations, and sales of assets

– Conditions under which the entire loan is made immediately
due and payable
– Acceleration clause that specifies events of default

Question 7

Credit analysis
* why?

• How to do credit analysis?
• Examine …
• Look at the borrower’s past record (reputation), economic prospects
  *…
• Forecast future cash flows

Answer 7

To determine the ability and willingness of the borrower to repay the loan

factors that may lead to default in the repayment of a loan
Look at the present economic condition

Question 8

The five Cs what are they for?
Capacity:

Character:

…: Resolves private information and moral hazard problems.

Collateral: Includes both … These resolve … problem. Also directly reduces bank’s risk. Moreover, collateral can eliminate underinvestment problem.

Conditions:
These are … that affect borrower’s ability to repay the loan.

Answer 8

Ensures that borrower has legal and economic capacity to borrow.

Refers to borrower’s reputation and hence desire to settle debt obligations.

Capital:…

“inside” and “outside” collateral; private information and moral hazard

economic conditions

Question 9

Capacity
* Legal capacity to borrow:
– In the case of partnerships, whether …
– In the case of corporation, need to check …
* Financial capacity to borrow:
– Evaluating … available to service the debt
– Financial statements analysis (hard information), qualitative assessment of managerial capacity (soft information)
– …?

Answer 9

all the signing partners have the legal authority to borrow

the corporate charter and bylaws to determine who has the authority to borrow

borrowers’ future cash flows

Who else has claims on the borrower, and what’s the seniority of such claims

Question 10

Character
* …
* Borrower’s past record in debt repayment
* … is a key indicator in credit analysis
* External sources (e.g., …)
* Internal source (e.g., …)

Answer 10

Borrower’s reputation for meeting payment obligations

Credit history

credit bureaus, Findeks

bank records

Question 11

Capital
* what is it?
* Helps to resolve moral hazard by … for poor project outcomes.
* Signals the … and the confidence in the firm’s future prospects.
* Interest rate inversely related to the …

Answer 11

Equity capital (as a fraction of total assets) the borrower has invested in the firm – first line of defense.

imposing a greater loss on the borrower

profitability of the borrower’s project

borrower’s equity-to-total- assets ratio

Question 12

Collateral
* Lender has …
* Risk reduction: Collateral provides the lender …
* Moral hazard: Collateral can help resolve moral hazard problems:
* Costs of using collateral:
* Ongoing …
* …which costs?

Answer 12

first claim to collateral in the event of default.

greater protection against loss in the event of default

monitoring of the collateral

Liquidation costs, including legal costs of ownership transfer, costs of carrying and selling.

Question 13

Conditions
* Economic conditions that …
* …
* Company conditions
* Need analysis of …

Answer 13

affect the borrower’s ability to repay

Industry outlook

borrower’s financial statements as well as its management