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FRM Part II · FRM Exam Part II · Distress Symptoms and Remedies

A lender to a stressed company grants a covenant waiver and extends a loan's maturity by two years as part of an out-of-court workout. From a risk management perspective, which action best protects the lender's position in return for these concessions?

The lender should demand extra collateral, tighter reporting and monitoring, and a fee or higher spread in exchange for the waiver and extension. Releasing guarantees, removing covenants or subordinating without compensation would weaken its recovery prospects and reduce its control over a deteriorating borrower.

  1. AObtaining additional collateral, tighter reporting and a fee or higher spreadCorrect
  2. BReleasing existing guarantees to encourage owner cooperation
  3. CRemoving all financial covenants to avoid future defaults
  4. DSubordinating its claim to new unsecured creditors without compensation

Explanation

Concessions should be exchanged for improved protection: more collateral, enhanced monitoring and information rights, and compensation via fees or spread. Releasing guarantees, dropping covenants or subordinating for free all weaken the lender's position.

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