Chapter 07 credit process in banks
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Transcript of Chapter 07 credit process in banks
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TERM LOANSTERM LOANS
• Also referred as Term Finance, represents a source of debt finance, which is generally repayable in more than one year and less than ten years.
• Employed to finance acquisition of
Fixed Assets and WC margins.
• Carry fixed interest rates, monthly or
quarterly repayment schedules and a
set maturity date
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TERM LOANTERM LOANAcquisition of New P &M, Expansion, Modernization, Technology up gradation; Debt swap
SHORT TERM LOANRepayable within 3 years
MEDIUM TERM LOANRepayable in more than 3 years and
less than 6 years
LONG TERM LOANRepayable in more than 6 years
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ADVANTAGES & ADVANTAGES & DISADVANTAGES OF TERM LOANDISADVANTAGES OF TERM LOAN Advantages:
1. Cost of capital lower than cost of private equity and preference capital.
2. TL do not result in dilution of control.
3. TL are preferred since they are backed by security.
Disadvantages:
1. TL do not carry voting rights.
2. Generally do not represent negotiable securities.
3. Upon failure to repay or delay in payment beyond
1 years entails serious consequences.
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BASIC FEATURESBASIC FEATURES 1. Generally maturity period is 6 to 10 years.
In some cases grace period of 2 year may be granted.
2. Borrower company or any of Directors should not violate Sec 274 (1) (g) of CA
3. It avoids underwriting commission and other flotation costs.
4. Provided on the basis of general agreement (Term Loan) containing terms and conditions.
5. Granted after detailed Project appraisal of the.
6. Secured, specifically by the assets acquired using the term loan funds. This is called Primary Security.
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Basic Features (contd.)Basic Features (contd.)6. Generally also secured by company’s other F/A and
C/A. This is called Secondary security.
7. Some times, Promoters` Guarantee/their shareholdings are given; called Collateral security.
8. Fixed or Floating charge on assets of borrower company.
9. Restrictive Covenants: usually put for monitoring of deployment of funds:
a. Asset-related covenants: Capital employed, minimum asset base, provision in
AOA for Nominee Directors Minimum Current Ratio to be maintained Not to dispose off Assets without lender’s permission
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Basic Features (Contd.) Basic Features (Contd.) b. Liability related covenants:Restrained from incurring additional debtRepay existing loan; Acceptable D/E Ratioc. Cash-outflow related covenants:Restricting dividends outflow Restricting
capital expenditures.Restricting salaries and perks of managerial
staff, etc. d. Positive covenants:Furnishing of periodical reports/statementsMaintenance of a min. level of working capital.Creation to sinking fund, andMaintenance of certain Net Worth
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FACTORS THAT BANKS CONSIDERFACTORS THAT BANKS CONSIDER
• Credit worthiness of the borrower• Integrity/reputation• Credit risk profile• Sensitivity to economic and market
developments• Liquidity• Solvency• Profitability of business• Resource efficiency
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CREDIT DECISIONSCREDIT DECISIONS• Safety of loans is directly related
basis on which decision to lend is taken type and quantum of credit to be
provided terms and conditions of the loan
• Two-pronged approach Pre-Sanction appraisal To determine the ‘bankability’ of each
loan proposal Post-Sanction control To ensure proper documentation,
follow-up and supervision
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PRE-SANCTION CREDIT DECISIONS- PRE-SANCTION CREDIT DECISIONS- FINANCIAL APPRAISALFINANCIAL APPRAISAL
• Concerned with measurement of risk(iness) of a loan proposal Financial Analysis – past and projected Cash Flow Analysis Credit Rating Assessment of credit needs Income tax and other tax returns/
assessments Confidential reports from other banks and
financial institutions• Credit Report (CR) needs to be regularly
updated• Appraisal should reveal whether a loan
proposal is a fair banking risk
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Financial Appraisal (Contd.)Financial Appraisal (Contd.)• The objectives of Financial Appraisal:
Assess credit risk profile of the borrower Stipulation of terms and conditions Assess utilization of credit facility Establish sound well defined credit
granting criteria Ensure safety of bank funds
• Purpose of analysis of financial ratios Ascertaining overall financial position of a
business organisation Interpretation of key information in the
financial statements
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MEASURES OF LIQUIDITYMEASURES OF LIQUIDITY
• Net Working Capital = investment required to be made by borrower in Current Assets
• Current Ratio = Current Assets/ Current Liabilities
• Quick Ratio = Current Assets- Inventory/Current Liabilities
• Net Working Capital/Current Assets = contribution of Long Term funds towards financing Current Assets
• DSCR =( Net profit +Dep.+ Annual amount of int. on LTLs)/Interest + principal
• RoA = PBIT/Total Assets• Interest Coverage Ratio = PBDIT/Annual
Int. Obligation
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CASH FLOW ANALYSISCASH FLOW ANALYSIS
• Provides an excellent forecast of when funding is needed
• Typically, cash disbursements are high at the beginning of the project life cycle and diminish gradually
Outcome of AnalysisOutcome of Analysis• Statement of financing needed• Amount of funds• Timing• Sources and application of funds
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LOAN SYNDICATIONLOAN SYNDICATION• Provided by a group of Lenders is
structured, arranged and administered by
one or several commercial or investment
banks known as Arrangers
• Arrangers serve investment-banking
role of raising the amount for an issuer in
need of capital.
• Issuer pays Arranger a fee for this service,
this fee increases with the complexity and
risk factors of the loan.