CREDIT APPRAISAL IN BANKING SECTOR

WHAT IS CREDIT APPRAISAL?

Credit appraisal means an investigation/assessment done by the bank prior before providing any loans & advances/project finance & also checks the commercial, financial & technical viability of the project proposed. Proper evaluation of the customer is preferred which measures the financial condition & ability to repay back the loan in futureCredit appraisal is the process of appraising the credit worthiness of the loan applicant

WHAT IS CREDIT APPRAISAL? (CONT’D)Factors like:- » Age » Income » Number of dependents » Nature of employment » Continuity of employment » Repayment capacity » Previous loans, etc. are taken into account while appraising the credit worthiness of a person. 3 ‘C’ of credit are must be kept in mind for lending funds:- » Character » Capacity » Collateral If any one of these are missing in the lending officer must question the viability of credit

RESEARCH METHODOLOGY

PROBLEM STATEMENT:To study the Credit Appraisal System in SME sector, at

State Bank of India (SBI), Ahmedabad.

OBJECTIVES:To study the Credit Appraisal at SBITo check the commercial, financial & technical viability of the project proposed & its funding patternTo check the primary & collateral security cover available for recovery of such funds

RESEARCH METHOLOGY (CONT’D)

» RESEARCH DESIGN :

Analytical in nature

» DATA COLLECTION :

Secondary Data:E-circulars of SBIBooks & JournalsDatabase at SBILibrary researchWebsites

RESEARCH METHODOLOGY (CONT’D)

LIMITATION OF THE STUDY:

Due to the constraint limited study on the project has been doneAccess to data (Credit Appraisal data in detail is not available)As the credit appraisal is one of the crucial areas for any bank, some of the technicalities are not revealed which may cause destruction to the information

BRIEF OVERVIEW OF LOANS

Loans can be of two types fund based & non-fund based:

» FUND BASED includes: Working Capital Term Loan

» NON-FUND BASED includes:  Letter of Credit  Bank Guarantee

Debt Equity Ratio

Debt Service Coverage

Ratio Concept Proportion of Debt fund of a company in relation to its equity

FormulaLong Term Debt

Tangible Net worth

CommentsThis ratio is an indicator of leverage

of a company It measures a company’s

ability to borrow and repay money

Concept The amount of cash flow

available to meet annual interest and principal payments

FormulaNet Operating Income

Total Debt Service

CommentsDSCR less than 1 means negative

cash flows

MEASURES

CREDIT RISK ASSESSMENT (CRA) The CRA models adopted by the Bank take into account

all possible factors into appraising the risks, associated with a loan.

These have been categorized broadly into financial, business, industrial & management risks are rated separately.

These factors duly weighted are aggregated to arrive at a credit decision whether loan should be given or not

Financial parameters:

The assessment of financial risk involves appraisal of the financial strength of the borrower based on performance & financial indicators. which assessed in terms of static ratios, future prospects & risk mitigation .

CREDIT APPRAISAL PROCESS

Receipt of application from applicant|

Receipt of documents(Balance sheet, KYC papers, Different govt. registration no., MOA, AOA,

and Properties documents)|

Pre-sanction visit by bank officers|

Check for RBI defaulters list, willful defaulters list, CIBIL data, ECGC caution list, etc.

|Title clearance reports of the properties to be obtained from empanelled

advocates|

Valuation reports of the properties to be obtained from empanelled valuer/engineers

| 

CREDIT APPRAISAL PROCESS (CONT’D)

Preparation of financial data|

Proposal preparation|

Assessment of proposal|

Sanction/approval of proposal by appropriate sanctioning authority|

Documentations, agreements, mortgages|

Disbursement of loan|

Post sanction activities such as receiving stock statements, review of accounts, renew of accounts, etc

(on regular basis)

CREDIT APPRAISAL STANDARDS QUALITATIVE:

The proposition is examined from the angle of viability & also from the Bank’s prudential levels of exposure to the borrower, Group & Industry

View is taken about bank’s past experience with the promoters, if there is a track record to go by

Opinion reports from existing bankers & published data if available

CREDIT APPRAISAL STANDARDS (CONT’D)

QUANTITATIVE:

(i)Working capital

(ii)Term Loan

Technical Feasibility

Economic Feasibility

Financial Feasibility

Managerial Competency

Sector/ Parameters

Mfg. Others

Current Ratio (min.)

1.33

1.20(For FBWC limits above Rs. 5cr)1.00(For FBWC limits upto Rs. 5cr)

TOL/ TNW (max.)

3.00 5.00

DSCR Net (min.)Gross (min.)

2:11.75:1

2:11.75:1

Debt/ EquityRatio (max.)

2:1 2:1

Promoters’ contribution* (min.)

30%of

equity

20% of equity

RATING SCALES FOR GIVING LOANS

S. No. Borrower Rating

Range of scores

Risk level Comfort Level

1 SB1 94-100 Virtually Zero risk Virtually Absolute safety

2 SB2 90-93 Lowest Risk Highest safety

3 SB3 86-89 Lower Risk Higher safety

4 SB4 81-85 Low Risk High safety

5 SB5 76-80 Moderate Risk with Adequate Cushion

Adequate safety

6 SB6 70-75 Moderate Risk Moderate Safety

7 SB7 64-69

8 SB8 57-63 Average risk Above Safety Threshold

9 SB9 50-56

10 SB10 45-49 Acceptable Risk

(Risk Tolerance Threshold)

Safety Threshold

RATING SCALES FOR GIVING LOANS

Banks has introduced New Rating Scales for borrower for giving loans. Rating is given on the basis of scores out of 100. Bank gives loans to the borrower as per their rating like SBI gives loans to the borrower up to SB8 rating as it has average risk till SB8 rating. From SB9 rating the risk increases. So banks does not give loans after SB8 rating.

11 SB11 40-44 Borderline risk Inadequate safety

12 SB12 35-39 High Risk Low safety

13 SB13 30-34 Higher risk Lower safety

14 SB14 25-29 Substantial risk Lowest safety

15 SB15 <24 Pre-Default Risk (extremely

Vulnerable to default)

Nil

16 SB16 - Default Grade

SBI NORMS FOR CREDIT APPRAISAL

LOAN ADMINISTRATION – PRE SANCTION PROCESS

Preliminary appraisal:Sound credit appraisal involves analysis of the viability of operations of a business and the capacity of the promoters to run it profitably and repay the bank the dues The company’s Memorandum and Articles of Association should be scrutinized carefully to ensure that there are no clauses prejudicial to the Bank’s interests

SBI NORMS FOR CREDIT APPRAISALTowards this end the preliminary appraisal will examine the following aspects of a proposal. Bank’s lending policy and other relevant guidelines/RBI guidelines:

•Industry related risk factors•Credit risk rating•Profile of the promoters/senior management personnel of the project•List of defaulters•Caution lists•Government regulations impacting on the industry• Financial status whether it is acceptable

 •

SBI NORMS FOR CREDIT APPRAISAL

Whether the project cost acceptable or notDebt/ Equity ratio whether acceptableOrganizational set up with a list of Board of Directors & indicating the qualifications & experience in the industryDemand and supply projections based on the overall market prospects together with a copy of the market survey report Estimates of sales, cost of production and profitabilityProjected profit and loss account and balance sheet for the operating yearAudited profit loss account and balance sheet for the past three years

SBI NORMS FOR CREDIT APPRAISAL

LOAN ADMINISTRATION – POST SANCTION PROCESS

The post-sanction credit process can be broadly classified into three stages:

Follow-up

Supervision

Monitoring

which together facilitate efficient and effective credit management and maintaining high level of standard assets

CASE STUDY - 1

Company:- Janak Transport Co. Firm:- Partnership established in 1982 for carrying a

transport business. Industry:- Transport Activity Banking with SBI :-16 years as a current A/C holder Project / Purpose: To purchase 59 new Mahindra

Bolero under tie-up arrangement with ONGC. The total project cost estimated to be Rs. 363.44 lacs. Proposed Credit Requirement:Fund Based=Rs.295

lacs The company is in this business since incorporation &

good contracts and repo with ONGC since last 26 years. 

Deviations in Loan Policy/ Scheme

Parameters Min/Max level as per Scheme

Company's level as on 31/03/2008

Liquidity Min. 1.33 1.42

TOL/TNW Max. 3.00 12.80*

DSCR Min. 2.00 2.002

Promoters contribution (under tie-up)

Min. 10 % 18.86%

profits in the last two years

Min. Rs.3.00 lacs with rising trend

Actual profit Rs. 1.20 lacs for year 2006-07 and Rs.2.90 lacs for year 2007-08*FGHFG

ANALYSIS OF THE CASEJanak Transport Company is an existing profit making unitThe main chunk behind giving loan is that Janak Transport Company is doing contract with ONGC since incorporationThe promoters are having considerable experience as transport contractor with ONGCThe unit has got confirm order/ tie-up with ONGCThe promoters contribution to the project is 18.86% which is above the margin requirementThe current ratio is 1.42 that is satisfactory

ANALYSIS OF THE CASE (CONT’D)

Profits in the last two years:- Min. Rs. 3 lacs with rising trendTOL/TNW should be max. 3 which is 12.80 here, as the co. has done multiple banking it has o/s loans with other banks also but the co. is regularly making the payment of principal amount along with the interest so the loan is given. The bank checks commercial viability of the company & found that the DSCR for term loan is 2.02 which is satisfactory The net sales & PAT of the company is increasing year after year so overall profitability is goodThe overall projected performance & financial of the unit are considered satisfactory

CASE STUDY - 2

Company:- Akshat Polymers Firm:- Partnership Firm (M/S Umiya Polymers) Industry:- Manufacturing Activity:- Maufacturing of HDPP woven sacks, which

are widely used as packaging material in cement, fertilizer, etc.

AKSHAT POLYMERS (AP) has been established as a partnership firm on 19th November, 2007 at Kadi.

The partnership was constituted for manufacturing and selling of HDPP woven sacks to be manufactured from HDPP granules.

Proposal for sanction of FBWC limits of Rs.2.25 crores and Fresh Term Loan of Rs.2.00 crores.

PRISING/ RATE OF INTEREST

Proposal:

Sanction for;

i) FBWC limits of Rs.2.25 crores

ii) Fresh Term Loan of Rs.2.00 crores

Approval for:

i) CRA rating of SB- 6 (71 marks) based on

projected financials as on 31.03.2010.

ii) Pricing for WC facilities @1.00% above SBAR @13.75and for TL 1.50% above SBAR @14.25%

Deviations in Loan Policy

Parameters

Indicative Min/Max levelas per loan policy

Company's level as on 31.03.2009 @

Company's level as on 31.03.2010

Liquidity Min. 1.33 1.34 1.52

TOL/TNWTOL/Adj. TNW

Max. 3.00 4.112.64

2.501.80

Average gross DSCR (TL)

Min. 1.75 2.54 2.54

Debt / equity

Max. 2:1 2.01:1 1.03:1

ANALYSIS OF THE CASE

The unit will have installed capacity of 2520 MTThe unit is projected to achieve capacity utilization of 80% during the year 2009-10 and accordingly the sale for the year is projected at Rs.19.77 crores. The unit plans to initially market its product in Gujarat, Maharashtra, Rajasthan and sale to Central Govt. who purchases the HDPP woven sacks for grains through open tendersAs per ICRA report, grading and research services Flexible packaging sector is expected to grow at the rate of 12.40%.

ANALYSIS OF THE CASE

The promoters have sufficient experience of 15 years in the line of activityThe firm has also started marketing activity for their products & are having very good market contacts for the sales of the Finished GoodsThe orders worth Rs.2.50 crores is expected to be finalized by end of August, 2008Projected financials are in line with the financials of the some of the unit in similar line of activity and production level

FINDINGS SBI loan policy contains various norms for sanction of

different types of loans These all norms does not apply to each & every case SBI norms for providing loans are flexible & it may differ

from case to case After case study, we found that in some cases, loan is

sanctioned due to strong financial parameters From the case study analysis it was also found that in

some cases, financial performance of the firm was poor, even though loan was sanctioned due to some other strong parameters such as the unit has got confirm order, the unit was an existing profit making unit & letter of authority was received for direct payment to the bank from ONGC which is public sector

CONCLUSION

Credit is the core activity of the banks & important source of their earnings which go to pay interest to depositors, salaries to employees & dividend to shareholdersCredit & risk go hand in hand Bank’s main function is to lend funds/ provide finance but it appears that norms are taken as guidelines not as a decision makingA banker’s task is to indentify/assess the risk factors/parameters & manage/mitigate them on continuous basis

Thank You…..