Term Loan: Meaning, Feature and Appraisal Procedure

After reading this article you will learn about Term Loan:- 1. Meaning of Term Loans 2. Features of Term Loans 3. Financial Institutions 4. Appraisal Procedure for Granting Term Loan.

Meaning of Term Loans:

The medium or long-term loans are popularly known as ‘Term loans’ which are provided by the specialized financial institutions specially set up for the purpose.

But the participation of commercial banks becomes necessary due to their network of their branches and their intimate connec­tions with the borrowers that facilitates close follow-up and supervision in this type of financing. This term lending is known as ‘development banking’ which has gradually developed in India

The traditional classification of financing industrials needs are:

(1) Long-term; and

(ii) Short-term.

Needless to mention that medium or long-term financing is required in order to establish, renovate, expand, and modernize industrial units.

The said financing can be raised from:

(i) Capital funds, i.e., by issuing equity and preference shares;

(ii) Medium or long-term loans,

(iii) Securities, such as bonds and debentures.

And, the short-term financing means financing current asset, viz, working capital, which is being financed by commercial banks to a great extent. In actual practice, however, combination of the above sources of funds is adopted.

At recent times, the significant role is being played by borrowed sources which has considerably been increased. In some cases, greater emphasis is also being placed on term loans since there is a considerable growth of term lending institutions and growing participation made by commercial banks.

Term Lending by Institutions:

From the discussions presented above, it becomes clear that the basic difference between term loan and working capital loan (short-term) is that the term loan is granted for a fixed period and the same is repaid out of the proceeds generated from business operation. Working Capital loan, on the other hand, is to be repaid out of the proceeds of current assets.

That is why, at the time of appraising a term loan proposal, the fundamental question which is determined is that whether sufficient profit can be earned during the period of the term loan in order to repay the principal together with the arrear interest.

At present, there are a number of financial institutions which are set up for providing term loans to different industrial units.

They, however, come under the following groups:

(i) All India Financing Institutions:

It includes the Industrial Development Bank of India, (IDBI), the Industrial Finance Corporation of India (IFCI) and the Industrial Credit and Investment Corporation of India (ICICI).

(ii) Commercial Banks i.e:

All Commercial banks.

(iii) Investing Institutions:

It includes Life Insurance Corporation of India (LIC). General Insurance Corporation of India (GICI) and the Unit Trust of India (UTI).

(iv) State Level Financial Institutions:

I.e., the State Financial Corporation, State Industrial Development Corporation etc.

The requirements of terms loans by various industrial units are gradually increas­ing and as such, the loans are provided by various institutions, stated above, at a certain specified rate of interest according to their own terms and conditions.

Features of Term Loans:

The distinguishing features of term loans are noted below:

(a) Purpose:

It has already been stated above that the medium or long-term loans are required in order to set up new industrial units as also for renovation, modernization or extension and replacement etc. Generally, these loans are taken by the company for the acquisition of new plant and machinery, construction of factory shed and building, purchase of land etc., i.e., for the purpose of capital expenditure.

Moreover, term loans are also sanctioned by financial institutions and commercial banks for the purpose of financing current asset, viz , to meet working capital requirement.

(b) Security:

Generally, the term loans are secured by:

(i) A first legal mortgage of the fixed assets both existing and those which are to be acquired in future.

(ii) A first charge by hypothecating the movable assets subject to the prior charge created or to be created in favour of the banks of the company in order to secure finance for the purpose of working capital requirements.

(iii) Equitable mortgage, in appropriate cases, and a second charge on immovable property may also be made.

(iv) If necessary, unconditional and irrecoverable personal guarantee of the pro­moters or directors may also be secured.

If it is found that the term loans are provided by a number of financial institutions, the charge and mortgage shall rank paripassu inter se.

(c) Period:

Generally, term loans are repayable over a period of time by equal/unequal installments. Repayment may also be made in accordance with the specified terms and conditions imposed by the banks/financial institutions which may extend from 8 to 10 years. Usually, loans are repayable by half-yearly installments and amortization starts2 to 3 years after the loan is taken.

(d) Commitment Charge:

A commitment charge is a charge which is imposed on the unutilized portion of the loan which has already been sanctioned from the date of execution of the loan agreement in addition to the interest payable on actual amount.

The said charge may be imposed at the following rates:

(e) The Project-Oriented Approach:

No doubt, the approach of the various lending institutions is project-oriented That is, the ability of the borrower for repayment of loan is considered by the flow of expected income from the said project and not on the liquidity position of the borrowing unit.

As such, the various lending institutions examine thoroughly the viability and profitability of the project for the purpose of assessing the repayment capacity of the borrower. That is why, a thorough appraisal procedure is followed before sanctioning term loans which is granted to the borrowers.

(f) Follow-Up and Supervision:

The term-lending institutions keep a constant watch over the functioning of the borrowing unit taking appropriate follow-up measures. For this purpose, they keep a close touch with the borrowing units till the whole amount of loan is repaid.

At times, there may be an agreement between the borrowing unit and the financial institutions that the former will not declare and pay dividends till the entire amount (principal plus interest) is paid.

(g) Re-Finance Facility:

The Industrial Development Bank (IDBI) provides with the refinance facility to the commercial banks on the basis of term loans which are sanctioned by them, i.e., the Commercial banks do not block their own funds to a greater extent in term loans. Of course, risk is to be borne by the lending banks.

(h) Convertibility Clause:

A clause is being imposed on most of the term loans, i.e., the loan agreement take a convertibility clause. Under this clause, the lending institution will have the right to convert a certain sum of the rupee loan into fully paid up equity shares of the borrowing units at par. Such right can be exercised in one or more times within the specified period.

(i) Bridge Loan:

We know that granting term loans requires some time. But the borrowing unit requires the immediate funds which will meet their immediate needs, for example, to make payment for an imported machinery or to meet the needs for working capital etc.

The borrowing unit makes an arrangement with the commercial banks or lending financial institutions for temporary short-term loans from them for the purpose, which is known as ‘Bridge Loan’.

Such loans are secured by hypothecating movable assets of the borrowing unit or such loans are granted on the personal guarantee given by promoters or directors. These ‘Bridge Loans’ are repaid immediately after sanctioning the term loans.

Financial Institutions of Term Loan:

1. The Industrial Finance Corporation of India (IFCI):

The IFCI also grants loans of less than Rs. 30 lakhs where these are required in conjunction with other facilities, e.g., underwriting shares and debentures, sub-loans in foreign currency etc. The IFCI has secured lines of credit in foreign exchange.

It grants loans in order to meet the capital expenditure requirements which have already been stated above and not for the requirements of working capital finance, i.e., purchase of raw materials, repayment of current liabilities etc. In short, it provides financial assistance to industrial units for the purpose of setting up a new industrial enterprise, renovation, modernization etc.

Eligibility for financial Assistance etc.:

A co-operative society or any public limited company incorporated and registered in India and who is engaged in the manufacturing, processing or preservation of goods or in mining, shipping and hotel keeping or in generation and distribution of electricity or other forms of powers, transport services, is eligible for financial assistance from this IFCI. Public sector projects, as also public limited companies, are also eligible for financial assistance like private sector undertakings.

Terms for Advancing Loans:

Generally, the loans are secured by a first charge 011 the fixed asset of the industrial unit, both existing and those which are to be acquired 111 future If there is any joint project which require joint financing paripassu charge 011 the assets mortgaged is conceded for other institutions.

It should be remembered that current assets (i.e,. stock of raw materials, work-in progress or finished goods etc ) are not included in the list of IFCTs security since they can be pledged with the banks for the purpose of working capital finance.

In case of existing industrial unit which are going to undertake expansion or renovation, IFCI, in that case, will provide 50% of the total capital cost for such expansion or renovation or the WDV of existing fixed assets.

However, in certain special cases, IFCI may provide more than 50% of total capital cost. But in case of co-operative societies, IFCI may provide up to 65% of total capital cost provided the unit must be guaranteed by the State or Central Govts.

Loans are to be repaid by half-yearly installments over a period of 7 to 10 years. Of course, the IFCI allows a grace period of up to 3 years from the date of sanctioning loans.

2. Industrial Reconstruction Corporation of India (IRCI)

The IRCI was set up as a public limited company in April, 1971 primarily as a result of IDBI’s initiative It provides financial assistance for renovation of sick and closed industrial units. It has been registered as a company under the Companies Act, 1956.

Its authorized capital is Rs. 25 crores and its issued capital is Rs. 10 crores which has been subscribed by the IDB1, IFCI, ICICI. LIC State Bank and the nationalized banks The Govt. of India has granted to the corporation an interest free loan of Rs. 10 crores

In addition -to granting of term loans IRCI also operates a scheme for hire purchase of diesel generating sets for the benefit of assisted units which are affected by power cuts.

It has also started lines of credit to state level agencies to enable them to assist small scale units Till March 1983, it has sanctioned reconstruction assis­tance of Rs 201.1 crores to different sick or closed units in textiles, engineering, mining, and foundry industries etc.

The sole proprietorship, partnership, co-operative and limited companies are eligible for assistance from the IRCI. Actually, the corporation suggests to convert the sole proprietorship firms and partnership firms into limited companies.

It charges interest @ 8½% p a. In case of a small scale group, the rate of interest is taken at 7½ % and ½ % concession is granted to units which are situated in backward areas. Charges are restricted to 1% p a. in case of guarantee.

Loans are repayable between 4 and 12 years depending on the facts of the case. It postpones its dues for a certain period for which the sick units are not required to pay the principal plus interest.

Industrial Development Bank of India (IDBI):

Share Capital:

The authorized share capital of the Corporation is Rs. 500 crores. The issued and paid up share capital as on 30.6. 1984 was Rs. 385 crores which are held by the Central Government.

Management:

The IDBI has a board of director appointed as under:

(i) A chairman and a managing director are both appointed by the Central Government;

(ii) A deputy governor of the RBI nominated by it.

(iii) Not more than 20 directors nominated by the Central Government as follows:

(a) Two directors who are the officials of the Central Government.

(b) Five directors from the financial institutions, viz., ICICI, IFC, IRCI, LIC. and UTI.

(c) Two directors amongst the employees of IDBI and the above mentioned financial institutions — one from the officer employees and the other from workmen employees.

(d) Six directors from the State Bank, nationalized Banks and State Finance Corporations.

(e) Five directors having special knowledge and professional experience in science, technology, economics, industrial co-operatives, law, industrial finance, investment, accountancy, marketing or any other matter useful to IDBI.

Financial Resources:

The IDBI raises its funds both from the Indian rupee and from foreign currencies in different ways. The most significant source is the borrowings by rupee bonds which are issued by the bank in the Indian capital market. Moreover, the bank can borrow funds from RBI out of National Industrial Credit Fund and along with the lodgment of usance bills. The IDBI also borrows funds from the Central Government.

Borrowings in foreign currencies are in the form of public issue bonds in foreign currencies.

Refinance Scheme:

The salient features of the scheme of IDBI against refinancing the industrial loans are noted below:

(a) Institutions eligible to obtain refinance:

The following banks and corporations are eligible to obtain re-finance:

(i) State Co-operative Bank;

(ii) Urban and Central Co-operative Bank;

(iii) Regional Rural Bank;

(iv) State Financial Corporation;

(v) State Industrial Development Corporation,

(vi) Commercial Banks.

(b) Generally, minimum amount of re-finance loan is Rs. 2 lakhs which may be relaxed in case of projects already assisted. However, the minimum limit in case of small-scale industries has been fixed at Rs. 10,000 which is guaranteed under the Credit Guarantee Scheme and Rs. 20,000 has been fixed for small road transport operators.

(c) The term loans should be used for financing fixed assets but a portion of it may also be used for the purpose of working capital requirements.

(d) The maximum period of loans may be granted by Commercial Bank for a period of 10 years and the minimum period of loans for re-finance scheme should be for 3 years.

(e) The IDBI provides re-finance by the amount of 75% of the loan granted by commercial banks. But w.e.f. 5th August, 1986, the said percentages have come down to 60% for all categories of borrowers. However, in case of composite loan schemes, and loans for projects promoted by scheduled castes/tribes, and the physically hand­icapped entrepreneurs (up to Rs. 25,000 per project) 100% re-finance is to be provided.

In case of other primary lenders (i.e., SFC, SIDCs, State Co-operative Banks and Regional Rural Bank, the amount of refinance has been brought down to 75% in case of medium sized unit and to 85% in case of small scale units.

(f) IDBI provides refinance to the commercial banks for which it charges interest @ 10% p a. and to SFC @ 10.5% p a. IDBI also stipulated the rate of interest to be charged by these institutions from the borrowers @ 14% although the IDBI presented the concessional rate of interest for units which are situated at backward areas, small scale units and road transport operators.

(g) The IDBI also introduced Automatic Refinance Scheme (ARS) in July 1978. Under this scheme, term loan up to Rs 5 lakhs is made automatic, i.e., fresh appraisal is not required by the IDBI and at the same time no separate loan agreement for refinance proposal is needed. Therefore, refinancing has been made possible on a group basis. A post facto scrutiny of the loan so refinanced on a random sample basis is to be made.

(h) The IDBI has extended certain facilities which are noted below about the refinance scheme to the units of backward areas provided lending banks itself offers such concessions

(i) No commitment charge is imposed;

(ii) Longer repayment period with an initial moratorium for 2 to 3 years or more;

(iii) Deferment of payment of interest in the initial years.

Term Lending — Reserve Bank’s Guidelines:

The RBI urged the commercial banks to increase their term lending to projects which are of high priority for stimulating investment in the month of May, 1975.

For this purpose, commercial banks were advised to give particular importance to the following cases at the time of stepping up term lending:

(i) Deferred payment exports;

(ii) Industries where a substantial part of the output is meant for export or where new potential for export could be quickly made up;

(iii) Industries with short gestation period, (particularly in core sector), and those producing man consumption goods;

(iv) Agricultural sector;

(v) Industries in industrially backward areas;

(vi) Small-scale industries which involve an investment upto Rs. 25,000;

(vii) Capital goods industries and deferred payment arrangements for purchase of capital goods in the domestic market.

Appraisal of Term Loan Proposals:

Since the period of term loans is longer and funds are advanced/lent in order to establish a new unit or to expand an existing unit, the degree of risk involved in it is comparatively high than the short-term which are normally given for working capital purposes.

It is not desirable that the said loan (term loan) is expected to be repaid by liquidating the assets that are acquired but by the proceeds of increased earning of the borrowing unit which results from a higher level of utilisation of existing installed capacity to it.

As such, the lending institution, before granting term loan, must be satisfied by itself that there is a wide scope of expected profits in future years from which the term loan can easily be repaid by the borrowing unit which, in other words, requires a dynamic approach which involve the following among others:

(i) Projected future trend of output;

(ii) Projected sales and estimated cost;

(iii) Projected return and flow of funds.

These estimates and projects are nothing but simple approximations and the same proves to the lending institutions about the future prospects.

The following steps are to be carefully considered:

(i) To ask for the submission of a detailed application form by the borrowing unit;

(ii) To make an appraisal of the loan proposal;

(iii) To set out the appropriate terms and conditions and

(iv) To follow-up and supervise constantly.

Application Form:

The following form has been prescribed by the all-India financial institutions which are to be filled in by the borrowing unit.

The details of which are given below:

(i) Promoters;

(ii) Particulars of Industrial Concern,

(iii) Particulars of the project;

(iv) Cost of the project;

(v) Means of financing;

(vi) Marketing and Selling arrangements;

(vii) Profitability and Cash flow;

(viii) Economic consideration;

(ix) Government consent.

However, the above application form must be accompanied by the following statements:

(i) Estimates of cost of production;

(ii) Estimates of working results;

(iii) Estimates of production and sales;

(iv) Cash flow Statement;

(v) Estimates of the cost of the project;

(vi) Calculation of margin money;

(vii) Means of financing

Separate details are also required about the security offered.

The enclosures to the application form must contain details about:

(i) Existing and project unit cost of production,

(ii) Past Balance Sheet,

(iii) Cost and profitability analysis,

(iv) Sources and uses of funds;

(v) Estimated cost of the scheme etc.

Appraisal Procedure for Granting Term Loan:

Before granting term loans the financial institutions conduct the feasibility study on the following aspects:

(a) Technical Feasibility;

(b) Economic Feasibility;

(c) Commercial Feasibility;

(d) Financial Feasibility; and

(e) Managerial Competence.

(a) Technical Feasibility:

It means the project must be technically feasible, i.e., the requirements of the actual production process are to be evaluated.

The following points are to be carefully considered by the term lending institutions:

(i) Review of infrastructure facilities, i.e., raw material, power, transport, labour etc.

(ii) The location of the project.

(iii) The proposed size of the plant and equipment capacity;

(iv) The process of manufacture and the product-mix;

(v) Technical know-how, if imported, its applicability in Indian conditions.

(vi) The construction schedule — that is, the lending financial institution should see that the project can be completed as stipulated Because, if there is any delay, the same will increase the cost as also create financial cash losses.

(b) Economic Feasibility:

Before granting loans it becomes necessary to see that the project is very useful one from the standpoint of national economy but also from the standpoint of mar­ketability of its products, which in other words, depends on market forecast of the product together with the price at which the products are to be sold in the country and abroad.

The project of demand for the product is a highly complicated matter as it involves future uncertainties. Different factors including statistical forecasting models are required in order to forecast demand for the products. Moreover, the employment potential to create a climate for industrialization, in underdeveloped or backward areas is to be taken into consideration.

(c) Commercial Feasibility:

The financial institutions should examine the arrangement that is made by the borrowing units for the purpose of acquisition of machinery, raw materials and for sale of the product since they are purely commercial in nature. The financial insti­tution should see that the assets are purchased by the borrowing unit on the basis of competitive bidding, i.e., proper price is to be paid

(d) Financial Feasibility:

This is the most important part of the appraisal of a term loan proposal.

It includes the following:

(i) Whether cost estimates of the proposed projects fully cover the total expen­diture or not and whether the same is realistic or not?

(ii) Whether the funds provided by the sponsors of the project are adequate and necessary finance will be made available during the period of construction as per schedule?

(iii) Impact of the project of the borrowing unit of the level of production, i.e., purchases, sales cost, earning etc.

It is needless to mention that the time of repayment and the total period within which the repayment is made, depend on the expected increased output and the earnings of the borrowing unit. The financial positions of the borrowing unit must be reviewed by the lending financial institutions over a period of years till the loan is repaid.

As such, basic information about the borrowing unit is required by the financial institutions in the form of the following:

(i) The cost of the project;

(ii) The cost of production and profitability;

(iii) Cash flow estimates, and

(iv) Proforma Balance Sheet

(e) Managerial Competence

No doubt, an important part of assessment which is conducted by the lending institution is to examine the competence, skill, and reliability of the management. It is ensured that the concern possesses qualified and experienced technical and administrative personnel keeping in view the professional qualifications, abilities past records and integrity.

The Cost of the Project:

It becomes necessary to make a comprehensive and critical survey of the capital cost estimates for the project. It must be examined in order to know that all items of expenditures including various contingencies are also properly provided for in detail.

The cost of the project includes the total cost relating to the project — viz., cost of Land and Building, Plant and Machinery, various expenses, like technical know-how, consulting fees, intangibles, preliminary expenses, interest during con­struction etc. Besides, the above, the same should also include a portion of working capital which is required and which should be financed from this term loans as long- term.

Cash Flow Statement:

The lending institution should also know at what time the money actually will be needed for different purposes and the different sources for such fund. This information should be presented with the help of a Cash Flow Statement.

A Cash Flow Statement actually informs the cash incomings and cash outgoings over a period of time. It reveals the availability of cash and application of the same in order to meet various requirements of the projects. Its purposes to the Lending Banker

The cash flow statement is very useful to the lending bankers due to the following:

(i) It helps sound financial planning since funds should be available as and when they are required for meeting capital cost of the project in the form of cash, i.e., the funds not only be the sufficient but also the same must be available at the proper time so that the project must be completed as scheduled.

(ii) It serves as a guide in order to determine:

(a) At what time the repayment of loan should start and

(b) The period of repayment of loan.

Thus, a cash flow statement helps the lending bankers/institutions while assessing a proposal and determining the terms of payment.