[Submitted by Mr. Bipin Mehta (Ex-Banker) & CA Bhavik Mehta,
Mumbai, Maharashtra]

July 25, 2011

Bank finance is very important for growth of the business. Can you imagine companies like Reliance & Tata to become biggest business groups in our country without bank funding? Certainly not! Business cannot become big without bank finance. Financial management is the heart of business. It is very important to understand whether your project / business is eligible for bank funding.

Promoter Profile
Bank funds only those projects / business that have strong promoter background. Businesses are run by people. Therefore, bank will ensure that promoter has sound / requisite experience in managing the business. Strong promoter profile of atleast 3-5 years in the same business is very much essential. Bank is averse to funding new businesses unless it is backed by key people managing the business that have strong technical understanding about the business. Banker will see whether promoters / key personnels are capable of managing the business during crisis or recession. Banker will also check for net-worth of the promoters to see whether promoters are capable of repaying the debt from personal sources incase the business fails. Net-worth statement needs to be certified by a CA. Networth statement will help the bank analyze that from where the promoter will put his contribution in the business/ project. Banker would also check whether promoters are technically qualified to do the business. Family background of promoters is also very important. Banks check the CIBIL report of every director and promoter to analyze whether they have been regular in payment of all dues. Business Banker would check whether there is growth in business every year. They would be satisfied in case there is increase in sales and profit in last 3 years. Banker would understand the business model in detail. They would see whether the business is scalable and has prospects of growth in future. Banks have exposure limits in various industries and sectors. They would see whether the business falls within the mandate of RBI. Bankers frame their policies for finance based on the master circulars issued by RBI. Banks generally are averse to Real-Estate projects, Hospital projects, Share Brokers, business with irregular income, Diamond businesses, Hotel projects, etc. Bank would see whether the account is regular and not a NPA or restructured account. An Industry analysis is done to evaluate the market
potential, dynamics of the industry, entry barriers, and intensity of competition. risk analysis, etc.

Project funding
Project is analyzed 3600 by the bankers in following manner:

Term Loans for Manufacturing entities (new or expansion projects):
Land:
Banks normally do not lend money for buying land. Land has to be bought by the promoters. Bank would check the following things:

  • Whether the land is NA or not?
  • Whether the seller is related to the promoter?
  • Whether the title documents of the property are clear and marketable/ mortgagable?
  • What is the total area?
  • Are there any development expenses like leveling, fencing, road making, etc.?
  • Whether the area is sufficient for the project and will be able to take care for future expansion?
  • What is the cost of land including charges of stamp duty, registration, brokerage, etc.?
  • How far is the railway station, airport, highway, river near the project?
  • Whether there is approach road towards the project site?
  • Is Raw Material, power, water, manpower, fuel, transportation and all other infrastructure is easily available in nearby area?
  • Which are the nearby factories and whether they are funded by any bank?

Building:

Bank normally funds 75% of the building cost. Bank would check the following things:

  • Whether the building is ready/to be constructed?
  • Who is the architect?
  • Which developer is constructing? What is their experience?
  • What is the carpet, built-up area?
  • Whether it is owned or rented?
  • Whether necessary permissions have been taken for construction?
  • Is the building mortgagable?
  • Is there sufficient space for machinery installation, godown for storage, transport vehicles, proper electrification, etc?
  • What is the total cost of building p.s.f? This will be compared to average construction cost in market.
  • How much advance is given vis-à-vis total cost?

Plant & Machinery:

Bank normally funds 75% of total cost of new machinery and 60% for old machineries including old imported machineries. Bank would check the following things:

  • What is Cost of machinery?
  • What are the terms and conditions of payment –FOB / CIF?
  • What is the condition of machineries?
  • Incase of old machineries, certificate from chartered engineer would be required for value of machine and expected life of the machine. Bank would not fund incase expected life is less than 10 years.
  • Are there satisfactory arrangements for repairs and maintenance of machines?
  • What is the capacity of the machines?
  • Is there matching capacity continuity in the production flow?
  • Are the machines adequate for planned production?
  • Whether orders are already placed with suppliers?
  • Is there requirement of LC for purchase of machineries?
  • Whether the machines are already hypothecated to any institution?

Products:

  • Particulars & specifications of products manufactured, brochures, pamphlets, etc.

Process:

  • Manufacturing process flow-chart
  • Rate of production per hour/day
  • Number of shifts
  • Quantities produced
  • Quality comparison with competitors
  • Whether the company has in-house testing and lab facilities for quality control?

Inventory:

  • Which raw materials are required?
  • Who are the suppliers?
  • What is the credit period available?
  • What is the frequency of time gap between placing of order and delivery?
  • Whether adequate Insurance cover available/taken?
  • What is inventory holding period – Raw Materials, WIP, Finished goods.
  • Is any advance given or received on purchases or sales?

Market for products:

  • Whether there is sufficient demand for products manufactured
  • Who are the competitors?
  • Are there any Orders in hand?
  • Are there any substitute products available in the market?
  • Present and future demand- industry outlook and analysis, survey by research companies
  • Targets and achievability
  • Marketing Strategy adopted by the company

Capital Structure:

  • How will be promoter contribution be brought into the company-equity capital, preference capital, quasi-equity, unsecured loan, debentures?
  • What would be the authorized and paid-up capital of the company?
  • What would be the shareholding pattern of the company?
  • What is the Understanding of voting rights of shareholders?
  • Are there any shareholders agreements signed?

Financial Aspects:

  • Whether Project report is prepared? Projections till the tenure of term loan.
  • Whether CMA data is prepared? CMA data is standardized format prescribed by RBI. (Though RBI has now not made it mandatory, but by and large, to make the analysis more comparable and easy banks do follow.)
  • Whether the margins, profitability and growth in business is maintained.
  • What is the Break-even analysis -quantity and sales
  • Ratio analysis –
    • DSCR (Debt Service Coverage Ratio shows whether there is sufficient profit to repay debt and interest) of atleast 1.4
    • Current Ratio (Whether there is enough liquidity into business) of atleast 1.33 after including 1 year term loan installments in current liabilities.
    • Payback period calculated the period in which the project would return the invested capital in the business.
    • Internal rate of return is the rate at which project gives return taking into consideration the time factor.
  • Sensitivity analysis incase sales reduce by 5%/10% or expenses increase by 5%/10% or both. It shows whether business will be profitable in adverse scenario and will be able to fulfill its commitments.

Time schedule of implementation:

  • By what time will the stages of the project like acquisition of land, conversion into NA, construction of building commencement, completion, placement of order for machines, delivery and installation of machines, trial production, operation commencement date; be started and
    completed.

Working capital for manufacturing industries/projects:
Bank normally funds 75% of the working capital requirements of the business or 20% of turnover whichever is less. Incase, the business model is able to justify WC more than 20%, then also it can be financed. Working capital is calculated as: Current assets minus Current Liabilities.

Current Assets normally includes : Debtors + Inventory + Advance paid
Current Liabilities normally includes : Creditors + Advance received

Bank requires CMA data for assessment of working capital requirements. The working capital requirements are assessed as per Method 1 and Method 2 prescribed by Tandon Committee. Initially for some period Method 1 was applied. Now only 2nd method is applied to find out the maximum quantum for which finance can be given by banking industries. Justification of working capital requirements is very essential for the banks.

Drawing power is calculated by the bank every month which can be lower than the sanctioned limits of working capital. DP is calculated by bank based on the stock value after considering the margin. The maximum DP is limit or stock which is lower. Drawing power is calculated by funding only 50% of debtors (debtors more than 90 days are not funded by bank) and 75% of stock. In which case, assuming sanctioned working capital limit is Rs. 100 and drawing power is Rs. 75, then only Rs. 75 will be allowed by the bank for working capital use.

Cash Credit, overdraft facility against property, export finance including pre-shipment finance and postshipment finance, bill discounting facility, buyers credit, etc. are all different types of working capital loans.

Non-fund based limits including Bank guarantee and letter of credit assessments are done similar to working capital facility because anytime they may get converted into fund based limits.

Real-estate projects
Currently the situation is such that RBI has issues guidelines to banks to go slow in funding real-estate projects. Commercial real-estate is in meltdown therefore no bank will touch commercial construction projects. Residential Real-Estate projects of reputed builders are funded by some of the banks. The issue with real-Estate debt is that the exposure limits of banks get exhausted very soon every year. Incase, of Real-estate projects banks fund 50% of the total cost of project. Banks fund on the basis of cash flow requirement of the project.

Foreign Currency Loans (ECB/FCTL)
Project loans can be Rupee Loans or Foreign Currency Loans depending on the availability of foreign currency with the banks. Foreign currency loans can be either External Commercial Borrowings (ECB) or Foreign Currency Term Loans (FCTL). ECB are also given by Indian Banks that have their branches abroad. FCTL is nothing but allocation done by banks in foreign currency. Pricing is done in terms of FX but repayment is converted and made in INR.

Foreign loans are priced in terms of LIBOR plus rates. Processing of the ECB proposal is done from India and disbursement is done from abroad. Specific RBI intimation and approvals are required in terms of foreign currency funding.

Security
Prime Security are the assets for which bank has given loan. Term Loans are financed for fixed tenure of loan for purchase/construction of building, equipments, machineries, etc. These assets are called prime security and are mortgaged with the bankers. For Real-Estate projects, security can be land,
current structure, receivables, unsold stock, etc.

Collateral Security are the assets which are mortgaged to the bank on which no funding is taken from the bank. These assets give cushion to the bankers for funding the project as the project will be fully secured. These include land, residential house of promoters, shares, fixed deposits, commercial
properties, LIC policies, any other assets, etc. Collateral security can be 25% to 100% depending on negotiation and comfort of the bankers. For Real-Estate projects it can 100% to 300%.

Personal guarantee of promoters/ directors and/or third party guarantee is also required by the bankers. The margin given by promoters and personal guarantee will ensure that directors retain their interest in the business as there is risk attached to loan default. Incase, the balance sheet of associate company or parent company is strong, then corporate guarantee of that company can also be given to bank.

Value of the security is determined by third party independent valuer.

Loan against property (LAP)
Finance can be taken from banks against mortgage of free property. Loan can be taken at 60-65% of market value of property. Loan can be given for upto 15 years depending on age of the borrower. Income of the borrower should be sufficient to pay the EMI of the loan.

Lease Rent Discounting (LRD)
In case, you have let out your property, then you can discount the monthly rents for future years and get loan today itself. An escrow account will be opened and there will be tripartite arrangement wherein the lessee will deposit the rent in escrow account from which EMI will be deducted and balance amount will be transferred to borrower in current/savings account. The rented property and future receivables will be mortgaged to be bank. Many borrowers try to save tax by making two different agreements for
property and furniture where the furniture rent is more than property rent. One must be careful that all banks do not finance furniture rentals unless there is cross linkages in both the agreements. Banks would get comfort incase there is lock-in-period in the lease agreement.

Commercial Property Purchase (CPP)
Banks also give finance for purchase of commercial properties. Care should be taken that some banks do not fund commercial properties located in malls and shopping complexes.

Tenure
Following is the tenure for different loans that are available

Term Loans - Moratorium period (project gestation period during which only interest is paid) from 0-18 months and repayment tenure of 1-7 years.

Working capital – It is a Continuous loan. Renewed every year and limit can be enhanced every year.

LAP – 15 years.

LRD- As per the tenure of lease agreement. It can be extended by issue of sight letter.

CPP – 10 years.

Pricing
Pricing of loan is very important. Bankers price the loan depending on credit rating assessment done by the bankers. You will generally know the pricing at the time of sanction or credit rating.

Following are the current market rates for various products.

Term Loans – 13-15%
Working Capital – 13-15%
Export Finance – 9-11%
ECB / FCTL – Libor (Currently Six month LIBOR is 0.50) + 500 bps spread plus hedging cost of 500 bps. All in cost 10.5 to 11%
LAP – 13%
LRD – 13%

Loan process

Repayment of loan
Repayment of loan is generally in EMIs in case of Term Loans. However, it can also be structured in case there is seasonal business then more repayment can be done during the peak season when cash inflow is high like incase of wind energy projects wherein there is more winds during the some months. Repayments can also be ballooning i.e. increasing every year as the business picks up pace.

Disbursement:
Bank would check whether promoter has brought his contribution in the project. This would be certified by CA. Disbursement would be done only after creation of mortgage and signing of documentation by promoters like promissory notes, undertaking, loan agreement, undated post-dated cheques in favor of banks, guarantee letters, etc.

Appointment of consultant
Considering the above factors involved in closing a debt funding deal, it would be advisable to retain an expert for bank liaisoning purposes as they have the requisite relationship with the bankers and handle the proposal professionally to help you get the best bankers for your requirements, faster processing and least cost of debt. They will ensure that their relationship manager takes care of all your requirements.