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Credit refers to Short Term Loans & Advances repayable within 3 years MEDIUM TERM LOAN Repayable in more than 3 years and less than 6 years LONG TERM LOAN Repayable in more than 6 years Off-Balance Sheet Transactions Revolving Credit Loans can be of two types fund base & non-fund base: FUND BASE includes: Working Capital Term Loan NON-FUND BASE includes: Letter of Credit Bank Guarantee Bill Discounting Section 5 of B. R. Act defines secured and unsecured loans Secured Loans and advances made on security of assets the market value of which is not at any time less than the amount of the loan or advances Unsecured Means a loans or advance not so secured Security taken as an insurance against unwarranted situations
Term loans
TERM 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 A term loan is granted for the purpose of capital assets, such as purchase of land, construction of, buildings, purchase of machinery, modernization, renovation or rationalization of plant, & repayable from out of the future earning of the enterprise, in installments, as per a prearranged schedule. Thus the following differences between a term loan & the working capital credit afforded by the Bank are apparent: The purpose of the term loan is for acquisition of capital assets. The term loan is an advance not repayable on demand but only in installments ranging over a period of years.
Disadvantages :
TL do not carry voting rights. Generally do not represent negotiable securities.
Upon failure to repay or delay in payment beyond 1 years entails serious consequences
BASIC FEATURES
Generally maturity period is 6 to 10 years. In some cases grace period of 2 year may be granted. Borrower company or any of Directors should not violate Sec 274 (1) (g) of CA It avoids underwriting commission and other flotation costs. Provided on the basis of general agreement (Term Loan) containing terms and conditions. Granted after detailed Project appraisal of the. Secured, specifically by the assets acquired using the term loan funds. This is called Primary Security . Generally also secured by companys other F/A and C/A. This is called Secondary security. Some times, Promoters` Guarantee/their shareholdings are given; called Collateral security. Fixed or Floating charge on assets of borrower company. Restrictive Covenants : usually put for monitoring of deployment of funds: 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 lenders permission
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b . Liability related covenants: Restrained from incurring additional debt Repay existing loan; Acceptable D/E Ratio c. 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/statements Maintenance of a min. level of working capital. Creation to sinking fund, and Maintenance of certain Net Worth
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Appraisal of term loan for, say, an industrial unit is a process comprising several steps. There are four broad aspects of appraisal, namely Technical Feasibility - To determine the suitability of the technology selected & the adequacy of the technical investigation & design; Economic Feasibility - To ascertain the extent of profitability of the project & its sufficiency in relation to the repayment obligations pertaining to term assistance; Financial Feasibility - To determine the accuracy of cost estimates, suitability of the envisaged pattern of financing & general soundness of the capital structure; & Managerial Competency To ascertain that competent men are behind the project to ensure its successful implementation & efficient management after commencement of commercial production.
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What do banks look for when making decisions about term loans?
Credit capacity. The bank will conduct a full credit analysis, including a detailed review of financial statements and personal finances to assess ability to repay. Collateral. This is the primary source of repayment. Expect the bank to want this source to be larger than the amount that is borrowed Capital. What assets are owned that can be quickly turned into cash if necessary? The bank wants to know what is owned outside of the business-bonds, stocks, apartment buildings-that might be an alternate repayment source. If there is a loss, the companys assets are tapped first, not the bank's. Or, as one astute businessman puts it, "Banks like to lend to people who already have money." Banks also take a personal guarantee. Comfort/confidence with the business plan. How accurate are the revenue and expense projections? Expect the bank to make a detailed judgment. What is the condition of the economy and the industry--hot, warm or cold? This can be summarized as:
Capacity (ability to pay); Character (willingness to pay); Capital (wealth of borrower); Collateral (security, if necessary); Conditions (external, economic).
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NON-FUND BASE
LETTER OF CREDIT A Letter of Credit (LC) is an arrangement whereby a bank (the issuing bank) acting at the request & on the instructions of the customer (the applicant) or on its own behalf, is to make a payment to or to the order of a third party (the beneficiary), or is to accept & pay bills of exchange (drafts drawn by the beneficiary); or authorizes another bank to effect such payment, or to accept & pay such bills of exchanges (drafts); or authorizes another bank to negotiate against stipulated document(s), provided that the terms & conditions of the credit are complied with. Parties to the LC Applicant The buyer who applies for opening LC Beneficiary The seller who supplies goods Issuing Bank The Bank which opens the LC Advising Bank The Bank which advises the LC after confirming authenticity Negotiating Bank The Bank which negotiates the documents Confirming Bank The Bank which adds its confirmation to the LC Reimbursing Bank The Bank which reimburses the LC amount to negotiating bank Second beneficiary The additional beneficiary in case of transferable LCs
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BANK GUARANTEES
A contract of guarantee is defined as a contract to perform the promise or discharge the liability of the third person in case of the default. The parties to the contract of guarantees are: Applicant: The principal debtor person at whose request the guarantee is executed Beneficiary: Person to whom the guarantee is given & who can enforce it in case of default. Guarantee: The person who undertakes to discharge the obligations of the applicant in case of his default. Thus, guarantee is a collateral contract, consequential to a main contract between the applicant & the beneficiary. Purpose of Bank Guarantees Bank Guarantees are used to for both both preventive & remedial purposes. The guarantees executed by banks comprises both performance guarantees & financial guarantees. The guarantees are structured according to the terms of agreement, viz., security, maturity & purpose.
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Revolving credit
A line of credit where the customer pays a commitment fee and is then allowed to use the funds when they are needed. It is usually used for operating purposes, fluctuating each month depending on the customer's current cash flow needs. Revolving credit is a type of credit that does not have a fixed number of payments, in contrast to installment credit. Examples of revolving credits used by consumers include credit cards. Corporate revolving credit facilities are typically used to provide liquidity for a company's day-to-day operations. Revolving lines of credit can be taken out by both corporations and individuals. The bank that is in agreement with the customer guarantees a maximum amount that can be loaned to the customer. Along with the commitment fee there are also interest expenses for corporate borrowers and carry forward charges for consumer accounts. A revolving credit arrangement allows you to borrow up to your credit limit without having to reapply each time you need cash. As you repay the money you have borrowed, it is available to be borrowed again.
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Characteristics
The borrower may use or withdraw funds up to a pre-approved credit limit. The amount of available credit decreases and increases as funds are borrowed and then repaid. The credit may be used repeatedly. The borrower makes payments based only on the amount they've actually used or withdrawn, plus interest. The borrower may repay over time (subject to any minimum payment requirement), or in full at any time. In some cases, the borrower is required to pay a fee to the lender for any money that is undrawn on the revolver; this is especially true of corporate bank loan revolving credit facilities.
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Loan Syndication
Syndication is an arrangement where a group of banks, which may not have any other business relationship with the borrower, participate for a single loan There has been a sharp rise in loan off-take recently, with the credit growth being 25% higher than the previous year. As India Inc. goes on a capital expenditure and expansion spree, the financial system is witnessing a subtle change in the way credit is mopped up. More and more corporates are looking at loan syndications - a common phenomenon in the West. "Syndication is an arrangement where a group of banks, which may not have any other business relationship with the borrower, participate for a single loan. "A syndicated facility is a lending facility, defined by a single loan arrangement, in which several or many banks participate. The standard theory for why banks join forces in a syndicate is risk diversification. The banks in the syndicate share the risk of large, indivisible investment projects. Syndicates may also arise because additional syndicate members provide informative opinions of investment projects or additional expertise after the funding has been extended. Most syndicated loans are floaters, paying a spread over Libor, but other structures abound. Fixed-rate term loans, revolving lines of credit and even letters of credit are syndicated. Loans may be structured specifically to appeal to institutional investors. These might have two tranches:
a Tranch A structured as a typical bank loan, such as a floater or revolver, and offered to bank lenders, and a Tranch B structured as a fixed-rate term loan and offered to non-bank institutional investors. 18
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Indian transactions
A recent example has been the Rs. 1,300 crore loan syndication of Hutch done by ABN Amro, HSBC and Standard Chartered for three years. The issue was underwritten by the three banks equally and was thrown open for book building. It was pitched at a rate of 7.10%. However, on the back of demand from banks, the interest rate was brought down to 7%. It was distributed among 10 banks. Hindalco raised around Rs. 6,000 crores, which was leadmanaged by IDBI Bank. The loan has tenure of 10 years with a reset after five years. It was priced at 5-year G Sec plus 65 bps. Thirty banks participated in the issue. The largest syndication deal in the market currently is Reliance Ports at around Rs. 4,200 crores. There are also two deals in the pharmaceutical sector for Rs. 1,000 crores each, and two in the telecom sector for above Rs. 1,000 crores. Also, Delhi-based DLF is looking at raising Rs. 1,000 crores for 10 years. In India, most corporates in the market are looking at raising money for Greenfield projects.
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Comparison
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