Credit Analyst Interview Questions

Introduction

Hello, readers. In this article, we will see some credit analyst interview questions. The questions will be solely technical in nature. Needless to say, technical knowledge is only a part of the desirable candidate. Your personality and communication skills also matter in the interview. So, prepare well for that. 

Most Common Credit Analyst Interview Questions

1. Define Credit Analysis.

Credit analysis is the process through which banks examine, identify, and analyze risks that could affect their ability to lend money. Banks evaluate their customers both qualitatively and quantitatively.
 

2.  What does "interest coverage ratio" mean?

A business must pay interest when it takes on debt. The interest coverage ratio demonstrates how well it can cover its interest costs. Divide EBIT (Earnings before Interests and Taxes) by interest expense is all required. The ability of the corporation to cover interest costs increases with the ratio, and vice versa.
 

3. How is a firm valued?

Financial analysts can evaluate a corporation in a variety of ways. Discounted cash flow (DCF) and relative valuation techniques are the most often used valuation methods. We must first determine the free cash flow before determining the present value of a company. In the second approach, we examine other businesses similar to ours and conclude their metrics and data.
 

4. Do banks target a specific debt-to-capital ratio?

There is no fixed debt-capital ratio because it might vary from business to business.

For new businesses, the debt would be minor or nonexistent. Therefore, the debt-to-capital ratio for startups would be in the range of 0 -10%.

But when it comes to small enterprises, the debt-to-capital ratio is slightly higher, hovering between 10 and 30 percent.

Although the debt-to-capital ratio is significant, many analysts and investors also use the debt-to-equity ratio. And the debt would be excessive if you considered the banking or insurance businesses. The debt-to-capital ratio would then be between 70 and 90 percent.
 

5. Name some typical Credit Analysis Ratios.

The most popular ratios include the debt-equity ratio, interest coverage ratio, tangible net worth ratio, fixed charge coverage ratio, debt-EBITDA ratio, and debt-capital ratio. The ratios that banks must utilize the most are those that make it simple to depict the financial condition of organizations.
 

6. How do credit rating companies operate?

Credit agencies use data on outstanding debts to assist the market in determining a company's creditworthiness. However, it would be wise to put only some faith in credit rating companies' ratings. To determine whether or not to issue a loan to a company, we must consider its risk profile and the ratings from several credit agencies.
 

7. How would you decide whether or not to lend to a business?

There are many things that I would look at.

• First, examine the company's financial performance over the last 5 years using the 4 financial statements.
• After that, look at the whole amount of assets to decide which can be used as collateral. Additionally, I will learn how the company has been using its resources.
• Next, determine whether the cash flow is sufficient to pay off the debt plus interest by examining the cash coming in and going out.
• Verify other measures, such as debt to EBITDA, debt to equity, interest coverage ratio, and debt to capital ratio.
• Verify that all of the company's measurements are in accordance with the bank's requirements.
• Lastly, consider additional qualitative elements that could differ from the financial data.
   

8. What is DSCR?

DSCR stands for Debt service coverage ratio. DSCR is calculated as Net Operating Income/Total Debt Service. It shows the company's ability to pay off its debt-related obligations from net operating income.

• Case 1: If DSCR<1, it signifies that the net operating income generated by the company is not adequate to satisfy all the debt-related obligations of the organization.
• Case 2: If the DSCR is more than 1, the business is making enough money from operations to pay all of its debt-related commitments.
   

9. How is a bond's rating determined?

The rating reveals the bond's creditworthiness and the likelihood of being successfully repaid when it matures. It is a crucial element since the rating is displayed when the bond is issued and immediately conveys the caliber of the instrument issued.

According to the rating agency's division, the ratings are further categorized as "AAA+," "AA," "BBB+," and so on. The ratings give the investor a quick understanding of the issuer's position. The issuer's likelihood of repaying the demand increases with the better grade while yield decreases. 

10. What various corporate credit facilities are there?

Credit facilities come in two varieties:

• Working capital needs are primarily met by short-term loans. Short-term loans include overdrafts, letters of credit, factoring, export credits, and more.
• For Capex or acquisition, long-term loans are necessary. Bridge loans, mezzanine loans, securitization, bank loans, and notes are all included.
   

11. How would you respond to a long-term business client that requests a loan that your analysis seems risky?

In typical circumstances, you might reject the loan application since you would value your judgment and need to consider the possibility of the bank. In this case, you would accept the loan application; instead, you'd look for a compromise.

Offer him a little loan that won't hurt the bank, and then advise a step-by-step repayment plan that takes the evaluation into account for the balance since you cannot risk losing a client worth a lot while also putting the bank's future in danger.
 

12. What qualifications should a Credit Analyst possess?

Credit analysts have excellent accounting and financial skills and should be detail-oriented. They also excel at financial modeling and excel forecasts.
 

13. Define WACC.

The Weighted Average Cost of Capital (WACC) of a company is the sum of its costs of capital from all sources, including debt, preferred shares, and common stock. Each type of capital's cost is weighted by how much of the total capital it makes up before being added together.
 

14. What are debentures?

Debentures are a sort of financial instrument that typically have terms longer than 10 years and are not secured by any kind of collateral. Only the issuer's creditworthiness and reputation are used to support debentures. Debentures are commonly issued by both businesses and governments to raise cash or money.
 

15. What are Bonds?

Bonds are fixed-income investments representing loans made to borrowers by investors (typically corporate or governmental). A bond is comparable to a contract between a lender and borrower stating the conditions of a loan and the related payments. Bonds are used by businesses, communities, states, and sovereign governments to finance operations and projects. Bondholders are creditors or borrowers of the issuer.
 

16. What is Free Cash Flow?

The money that remains after a corporation pays its operational costs and capital asset maintenance is known as free cash flow (FCF). The money left over after a company pays its operating expenses (OpEx) and capital expenditures are known as free cash flow (CapEx).
 

17. What do credit rating companies do?

By assigning a credit score to debtors according to their ability to pay off their outstanding debt commitments, rating agencies are meant to contribute to the trust and confidence in the financial markets. To determine the risk profile of a borrower, they should not be relied upon blindly as they may encounter conflicts of interest.

18. What is Equity Risk Premium?

Equity Risk Premium (ERP) is the additional yield that can be obtained by investing in the stock market over the risk-free rate. Subtracting the risk-free return from the market return is a straightforward method for estimating ERP. Usually, this information is sufficient for most simple financial analyses. ERP estimation can, however, be a far more intricate undertaking in practice.  

19. In a DCF valuation, what is the discount rate?

When estimating free cash flows to the firm, the Weighted Average Cost of Capital (WACC) is typically used as the discount rate. You use the cost of equity when forecasting free cash flows to equity.

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20. In a DCF valuation, how do you calculate the terminal value?

Terminal value is estimated either using an exit multiple or the perpetual growth approach.
 

21. What is LIBOR?

LIBOR, which stands for London Interbank Offer Rate, is the interest rate UK banks charge to other financial institutions for short-term loans. Loan maturities range from one day to a year. LIBOR serves as a benchmark for short-term interest rates for the pricing of assets such as currency swaps, interest rate swaps, and mortgages.
 

22. How LIBOR Works?

LIBOR rates are simply benchmarks, not trading rates. As a result, banks may trade at different rates throughout the day than the LIBOR rate posted early in the morning, usually at 11 a.m. (London Time). The maturity duration of these rates might range from a single day to a year. LIBOR has seven maturities, one for each of the five major currencies: CHF (Swiss Franc), EUR (Euro), GBP (Pound Sterling), JPY (Japanese Yen), and USD (US Dollar).
 

23. What is the FCCR (Fixed-Charge Coverage Ratio)?

The Fixed Charge Coverage Ratio (FCCR) measures the company's capacity to generate adequate cash flow to satisfy its fixed charge obligations, such as the needed principal and interest payments on debt. It may include leases and other fixed expenditures. It is an important financial measure that affects the company's capacity to incur or refinance debt from lenders when it is a debt covenant.
 

24. Is the FCCR and the DSCR (Debt Service Coverage Ratio) the same thing?

They are not; however, they are utilized similarly by lenders and analysts looking to evaluate a company's financial health. In theory, both ratios attempt to assess a company's potential to create enough operating profit to cover its fixed liabilities (including debt repayment).
 

25. Which is cheaper, debt or equity?

Debt is less expensive because it is paid before equity and is backed by collateral. When the business is liquidated, debt takes precedence over equity. A company must weigh the benefits and drawbacks of financing with debt vs. equity. Debt financing is only sometimes preferable merely because it is less expensive. If any follow-up is required, a good answer to the inquiry may highlight the tradeoffs.
 

26. What is working capital?

Working capital is often described as the difference between current assets and liabilities. Working capital is typically defined in banking as current assets (excluding cash) less current liabilities (excluding interest-bearing debt).
 

27. Name three financial statements.

The balance sheet displays the assets, liabilities, and shareholders' equity of a corporation. The income statement summarizes the business's earnings and expenses. The cash flow statement summarizes the cash flows generated by operations, investments, and financing.