What are early warning indicators that a borrower may deteriorate?

• A. Declining DSCR, rising leverage, covenant breaches, missed payments, cash flow volatility, shrinking liquidity, and management changes
• B. Increasing cash reserves
• C. Stable debt service coverage
• D. No changes in leverage

Answer: (A)

Early warning indicators of potential borrower deterioration are signals that cash flow and financial flexibility are eroding. A declining debt service coverage ratio means operating cash flow isn’t keeping up with debt payments, diminishing the cushion to meet obligations. Rising leverage shows a heavier debt load and tighter financial flexibility. Covenant breaches indicate the borrower is not meeting agreed metrics, often triggering lender remedies. Missed payments are direct evidence of liquidity strain. Cash flow volatility points to unpredictable earnings, increasing default risk. Shrinking liquidity reduces the ability to weather shocks, and management changes can disrupt operations and oversight, potentially undermining repayment capacity. Together, these signals reflect worsening credit quality and the need for closer monitoring or proactive action. In contrast, increasing cash reserves suggests improved liquidity, stable DSCR implies steady ability to cover debt service, and no change in leverage indicates no added debt burden—none of these signal deterioration.