loan appraisal

SME Gyanshala – Capsule Training Programme for Officials handling SME Credit – 9.1

State Bank of India

TERM LOAN APPRAISAL


State Bank of India

SESSION OVERVIEW Term Loans – Features Guidelines in Loan Policy Credit Appraisal Standards Purpose of Term Loan Term Loan Vs. Working Capital Appraisal of Term Loan:

1. Prima facie acceptability 2. Technical Feasibility3. Economic Viability4. Financial Feasibility5. Commercial Viability6. Managerial Competency7. Other Parameters8. Miscellaneous Issues

Deferred Payment Guarantees


State Bank of India

TERM LOAN & ITS FEATURES A Term Loan is an advance which is granted usually

against the security of the borrower’s Fixed Assets for a fixed term of not less than 3 years, is intended normally for financing acquisition of Fixed Assets, with a repayment schedule normally not exceeding 8 years.

Term Loans may be drawn / disbursed in lump sum or in instalments depending on the nature of the project.

Term Loans are repayable out of the future earnings of the unit, in instalments, and as per a pre-arranged schedule.


State Bank of India

TERM LOAN & ITS FEATURES.…. An element of risk is inherent in any type of loan

because of the uncertainty of the repayment.

The longer the duration of the credit, greater is the attendant uncertainty of repayment and consequently higher risk to banks.

Thus, risk involved in Term Loans is greater.


State Bank of India

GUIDELINES IN LOAN POLICY Term Loans (Loans with residual maturity of over 3

years) should not in the aggregate exceed 35% of the total advances of SBI.

The Bank shall endeavour to restrict the Term Loan exposure to infrastructure projects to 10% of the Bank’s total advances.

Maturity of Term Loans, including moratorium, should not normally exceed 8 years, except under CDR / rehabilitation packages approved by the Bank, Infrastructure Loans, Housing Term Loans to individuals, Education Loans & ATL under approved schemes. AC is required beyond 8 years.


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CREDIT APPRAISAL STANDARDS Quantitative Parameters: ii) Term Loan / DPG:

i. Technical Feasibility & Economic Viability : To be vetted by the Bank. If required, second opinion from TCC / Consultants of Bank / SBI Caps may be sought.

ii. Promoter’s Contribution : To be at least 30% (Mfg.) (20% for others) in the total equity. However, this is not a definitive benchmark.

iii. DSCR (Net) : Not to be normally below 2.

iv. DSCR (Gross) : Not to be normally below 1.75.

v. Margin : This would depend on Debt / Equity gearing for the project. To be maximum 2 : 1. Deviations may be permitted very selectively.


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PURPOSE OF TERM LOAN Acquisition of Fixed Assets such as Land, Building,

Plant & Machinery.

Modernisation / renovation / expansion / diversification of an existing unit.

Strengthening NWC.

Other Long Term Requirements – VRS.

Purchase of second hand machinery.

Acquisition of balancing equipments.

Replacement of high cost debt (For residual period only).


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TERM LOANS Vs. WORKING CAPITAL Purpose of TL is for acquisition of FA.

Advance is not repayable on demand, but in instalments ranging over a period of years.

Repayment is not out of the sale proceeds of the goods, but out of the future earnings of the unit.

Security (FA) not readily saleable.


State Bank of India

APPRAISAL OF TERM LOANS The purpose of Term Loan appraisal is to ascertain

whether the project is sound – technically, economically, financially and managerially and is ultimately viable as a commercial proposition.


State Bank of India

APPRAISAL OF TERM LOANS Appraisal of a project involves the examination of:

1. Prima facie acceptability.

2. Technical Feasibility.

3. Economic Viability.

4. Financial Feasibility.

5. Commercial Viability.

6. Managerial Competency.

7. Other parameters.

8. Miscellaneous Issues.


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1. PRIMA FACIE ACCEPTABILITY Bank’s Lending Policy / RBI Guidelines.

Prudential Exposure norms.

Substantial Exposure norms.

Individual & Group Exposure norms.

Industry Exposure norms.

Credit Risk Rating norms.

RBI Defaulters List.

ECGC Specific Approval List.


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1. PRIMA FACIE ACCEPTABILITY Takeover norms, if applicable.

Government regulations.

MA in respect of cos., to know the scope of activity and borrowing powers.

AA in respect of cos., to know authorised signatories; no prejudicial clauses.

Project cost.

Proposed Debt / Equity.

CoProdn., Profitability, etc.


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2. TECHNICAL FEASIBILITY “To determine the suitability of the technology

selected and the adequacy of the technical investigation and design”.

It consists of an assessment of the various requirements of the actual production process.

It is in short a study of the availability, cost, quality and accessibility of all the factors required for production.


State Bank of India

2. TECHNICAL FEASIBILITY The factors to be considered are:

• Location of plant & accessibility to critical inputs.

• Size of the plant.

• Type of technology.

• Manufacturing process.

• Labour.

• Technical report.


State Bank of India

3. ECONOMIC VIABILITY “To determine the conduciveness of economic

parameters to setting up the project and their impact on the scale of operations”.

This has reference to the earning capacity of the project. Since earnings depend on the volume of sales, it is necessary to determine how much output of the unit or additional production from an established unit the market is likely to absorb at given prices.


State Bank of India

3. ECONOMIC VIABILITY The factors to be considered are:

• Thorough market analysis

• Future trends in volume and patterns of Supply & Demand

• Demand forecast, Supply position, Gap

• Intermediate product

• Ancillary industry

• Export oriented units


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4. FINANCIAL FEASIBILITY “To determine the accuracy of cost estimates,

suitability of the envisaged pattern of financing and general soundness of the capital structure”.

This involves analysing the data received from the borrower to ensure that the project meets the following minimum financial criteria:

Estimated project cost is reasonable and complete and has a fair chance of materialising as per anticipations.

Financial arrangement is complete, without any gaps, and ensures cash is available as and when needed.


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4. FINANCIAL FEASIBILITY Estimates of earnings and operating costs are as

realistic as possible.

Borrower’s repaying ability as judged from the project operation is demonstrable with a reasonable margin of safety.

The basic data required would be:

• Cost of the project, including WCL.

• Means of finance.

• Cost of Production & estimates of profitability.

• Cash Flow estimates and sources of finance.


State Bank of India

4. FINANCIAL FEASIBILITY Cost of the project includes:

• Land (Including site development).• Building.• Plant & Machinery.• Other Fixed Assets / Misc. Assets.• Technical know-how fees, etc.• Power connection & installation charges.• Preliminary & Pre-operative expenses.• Contingencies.• Margin on WC requirements.


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4. FINANCIAL FEASIBILITY Means of Finance includes:

• Equity Share Capital from promoters / other shareholders.

• Preference Share Capital from Preference shareholders.

• Debentures.• Unsecured Loans.• Deposits.• Loans from Friends & Relatives.• Term Loans from Banks & FIs.• Government subsidies.• Internal accruals.


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5. COMMERCIAL VIABILITY “To determine the extent of profitability of the project

and its sufficiency in relation to the repayment obligations pertaining to term assistance”.

Cash Flow estimates help in determining the disbursal of the Term Loan.

Estimate of profitability & BEP help in drawing up the repayment programme, start-up time, etc.

Profitability estimate also helps in arriving at estimated DSCR, the single most important factor in Term Credit.


State Bank of India

5. COMMERCIAL VIABILITY A study of the projected Balance Sheet is essential

to ensure that the unit will continue to have a sound financial position even after the implementation of the proposed project.

BEP:

In a mfg. unit, if at a particular level of production, the total mfg. cost equals the sales revenue, this point of ‘No Profit-No Loss’ is known as BEP.

Mathematically, BEP =

Fixed Cost

Unit Sale Price - Unit Variable Price


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5. COMMERCIAL VIABILITY BEP is expressed as a percentage of sales / capacity.

A good project should have BEP not higher than 70%.

DSCR:

Serves as a guide to determining the period of repayment of a loan.

This is calculated by dividing cash accruals in a year by amount of annual obligations towards repayment.

Gross DSCR =

Cash Accruals + Interest on Term Loan

Maturing annual obligations + Interest on Term Loan


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5. COMMERCIAL VIABILITY SMCR =

WDV of Fixed Assets - Term Loan outstandings

WDV of Fixed Assets

Security Margin Cover Ratio is computed to verify that the minimum margin stipulated is maintained.

The contribution of promoters to the project cost is to be ascertained.

Margins to be arrived at.

Debt Equity Ratio is to be calculated.


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5. COMMERCIAL VIABILITY Sensitivity Analysis:

Is the capacity of the project to absorb various shocks, i.e., changes in critical factors like Cost, Volume & Price.

Funds Flow Analysis to be done to ensure that:

• Internal cash accruals are sufficient to meet the requirement for the additions in the Fixed Assets during the period of the loan.

• Adequate long term surplus is available during the currency of the loan to meet margin for WC.


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6. MANAGERIAL COMPETENCY “To ascertain that competent men are behind the

project to ensure its successful implementation and efficient management after commencement of commercial production”.

In a dynamic environment, the capacity of an enterprise to forge ahead of its competitors depends to a large extent, in the relative strength of its management.

Integrity, track record, credit worthiness, initiative, competence and experience of the management should be examined.


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7. OTHER PARAMETERS Examination of environmental regulations – To

ascertain whether the project is in full compliance with the various environmental provisions in force.

Examination of Government policies.

Examination of other statutory obligations.


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8. MISCELLANEOUS ISSUES Return on Investment or the Rate of Return: This

should not be less than what would have been earned in long term investment of funds in a bank.

Internal Rate of Return (IRR) : It is the rate at which the sum of the discounted cash flows is equal to the investment outlay. It gives an idea about the rate of return that a project is likely to earn over its useful life.

IRR = + xLower

Discount Rate

Diff. betweenthe two

Discount rates

Net Present Value at the lower Discount rate

Absolute difference between theNet Present values at the

two Discount Rates


State Bank of India

DEFERRED PAYMENT GUARANTEES (DPG) A DPG is a contract to pay to the supplier the price

of machinery, supplied by him on deferred terms, in agreed instalments with stipulated interest, on the respective due dates, in case of default in payment thereof by the buyer.

As servicing of DPG obligations can be done only out of future cash accruals, the economics of the project, its technical feasibility and economic viability will have to be assessed in detail, exactly as in case of a TL, and the standards of appraisal are therefore, the same as those applicable to TL.


State Bank of India

SESSION RECAP Term Loans – Features Guidelines in Loan Policy Credit Appraisal Standards Purpose of Term Loan Term Loan Vs. Working Capital Appraisal of Term Loan:

1. Prima facie acceptability 2. Technical Feasibility3. Economic Viability4. Financial Feasibility5. Commercial Viability6. Managerial Competency7. Other Parameters8. Miscellaneous Issues

Deferred Payment Guarantees


State Bank of India

THANK YOU

loan appraisal

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