A Project Report On

Credit appraisal Of Term Loans and Working Capital Limits

Submitted by

M Laxmana Swamy (DM-72)

BIMTECH (2011-2013)

At Andhra Bank, Head Office, Hyderabad

In partial fulfilment for the award Of
POST GRADUATE DIPLOMA IN MANAGEMENT (2011-13)

Under the guidance of Industry Mentor: R.V.Raju Senior Manager, Mid Corporate Department Andhra Bank-Head Office Hyderabad. Faculty Mentor: Prof. Kamal Kalra BIMTECH

Contents
Contents............................................................................................................... 1 List of tables........................................................................................................... i Summer Project Certificate..................................................................................iii Andhra Bank Certificate....................................................................................... iv Acknowledgement................................................................................................. v Executive Summary............................................................................................ vii Letter of Transmittal............................................................................................ ix Letter of Authorization.......................................................................................... x About the company............................................................................................... 1 Literature review................................................................................................... 3 Statement of the problem..................................................................................... 5 Methodology and Process Description..................................................................6 Data and Process Analysis.................................................................................... 9 Credit Facilities.................................................................................................. 9 About the borrower firm and their proposal.......................................................9 Step 1: Calculating credit exposures to individual/group borrower:................11 Step 2: Calculating Term loan eligibility: ........................................................12 Step 3: Primary and collateral security:...........................................................13 Step 4: Credit Risk rating and pricing..............................................................15 Credit risk rating model:............................................................................... 16 CRISIL Rating and Industry analysis:............................................................22 Step 5: Calculating applicable interest rate and tenure:..................................26 Step 6: Working capital assessment................................................................26 Step 7: Credit investigation, due diligence & verification of defaulters list:.....29 Step 8 Financial analysis and compliance:.......................................................31 Step 9 Term and conditions:............................................................................ 35 Results................................................................................................................ 39 Credit risk rating results..................................................................................39 DSCR results:................................................................................................... 39 Sensitivity analysis results:..............................................................................40 Working capital Results:.................................................................................. 41 Compliance to policy........................................................................................ 41 1

Conclusions......................................................................................................... 42 Limitations.......................................................................................................... 44 Recommendations.............................................................................................. 45 References.......................................................................................................... 46 Appendix I........................................................................................................... 47 Appendix II.......................................................................................................... 49 Appendix-III......................................................................................................... 50 Glossary of abbreviations.................................................................................... 52

List of tables
Table 1 Term loan I............................................................................................. 10 Table 2 Term loan II............................................................................................ 10 Table 3 Working capital limits............................................................................. 11 Table 4 Exposure ceilings................................................................................... 11 Table 5 Exposures to Individual and group.........................................................12 Table 6 Margin money calculation......................................................................12 Table 7 Collateral available................................................................................. 15 Table 8 Collateral required..................................................................................15 Table 9 Net worth of individuals.........................................................................15 Table 10 CRRM rating and their meaning...........................................................17 Table 11 Factors considered under Industry risk................................................17 Table 12 Factors considered under Business risk...............................................18 Table 13 Factors considered under financial risk................................................18 Table 14 Factors considered under Management risk.........................................19 Table 15 Factors considered under facility risk...................................................20 Table 16 Factors considered under project risk..................................................20 Table 17 weight associated with each risk parameter........................................20 Table 18 Parameters considered under CRAS model and their weights..............21 Table 19 Parameters under CRS model..............................................................21 Table 20 Credit rating and their meaning in CRS model.....................................22 Table 21 Factors considered by CRISIL for industry score...................................23 Table 22 Operating margins for commercial real estate.....................................25 Table 23 Applicable spread................................................................................. 26 Table 24 Turn over method calculations.............................................................27 Table 25 II method calculations..........................................................................28 Table 26 Cash deficit method of the borrower....................................................29 Table 27 Defaulters list....................................................................................... 30 Table 28 conduct of the borrower.......................................................................31 Table 29 key financial indicators.........................................................................31 Table 30 Remarks on key financial indicators.....................................................32 Table 31 sales receipts....................................................................................... 33 Table 32 Auditors comments..............................................................................35 i

Table 33 Rating given to the borrower................................................................39 Table 34 Other ratings........................................................................................ 39 Table 35 DSCR estimations................................................................................. 40 Table 36 Sensitivity Results................................................................................ 40 Table 37 Working capital build up.......................................................................41 Table 38 Compliance to loan policy guidelines...................................................42

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Summer Project Certificate

This is to certify that Mr. M Laxmana Swamy, Roll No. 72, a student of PGDM (Finance) has worked on a summer project titled Credit appraisal of Term loans and Working Capital limits at Andhra Bank after Trimester-III in partial fulfilment of the requirement for the Post Graduate Diploma in Management programme. This is his original work to the best of my knowledge.

Date: ____________ _______ (_____________________) Kamal Kalra BIMTECH SEAL Faculty mentor

Signature

Prof

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Andhra Bank Certificate Date: June, 09, 2012 TO WHOMSOEVER IT MAY CONCERN Sub: Training Certificate We hereby certify that Mr M Laxmana Swamy a Full Time Student of Post Graduate Diploma In Management Course, 2011-2013, of Birla Institute of Management Technology (BIMTECH) has undergone his Summer Internship as mandated for the completion of his above course from BIMTECH, for a period of 8 weeks starting from April, 16,2012

The title and scope of his project was Credit Appraisal of Term Loans and Working Capital Limits. The project was carried out under the guidance of Mr. R V Raju, Senior Manager.

We found him to be a dedicated and diligent student. We take this opportunity to wish him success in his future endeavours.

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Sincerely, Mr. R V Raju Senior Manager Andhra Bank- Head Ofiice, Hyderabad.

Acknowledgement
I would like to gratefully acknowledge the contribution of all the people who took active part and provided valuable support to me during the course of this project. To begin with, I would like to offer my sincere thanks to R.V Raju, Senior Manager, for all his support at Andhra Bank. Without his guidance and valuable suggestions during the research, the project would not have been accomplished. My heartfelt gratitude also goes to S T Sridhar, Chief Manager at Andhra bank for his valuable assistance. I also sincerely thank Prof Kamal Kalra, my faculty mentor at BIMTECH, who provided valuable suggestions, shared his rich corporate experience, and helped me script the exact requisites.

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Executive Summary
Term loans and working capital limits are the major source of funding for the corporates. For availing either term loans or working capital limits from a bank, the borrower has to satisfy certain conditions and follow the process prescribed by the bank. Andhra Bank has got its own loan policy method for evaluating the Credit proposals. Mid Corporate Department at Head Office deals with Credit proposals ranging from Rs. 2560 crores. Branches/Zonal Offices of Andhra Bank after initial scrutiny of the proposals, they forward the proposals with their recommendations for sanction to the Head Office. The objective of my project work at Andhra Bank is to appraise one loan proposal received by the Mid-corporate department at Head Office. The scope of this project is to study the credit approval process followed by Andhra Bank. The credit approval process at Andhra Bank starts with checking the exposure limits as per the bank guidelines. The next step is credit rating of the borrower and decide the applicable interest rate. Andhra bank follows its own internally developed method called Credit Risk rating method (CRRM) for the purpose of credit rating of the borrower. Andhra bank also avails CRISIL rating for the purpose of industry analysis and industry score. The financials of the borrower are checked and various ratios are calculated for the purpose of checking the financial compliance of the borrower as per bank guidelines. Working capital assessment also needs to be done. For the purpose of assessing the working capital, methods such as turnover method, II method and cash budget method have been prescribed. Out these methods, cash budget method has been used for the borrower as he belongs to Commercial Real estate. For purpose of availing term loans, the eligibility is calculated based on margins as stipulated by the banks policy guidelines. Margin means a fixed amount of money that must be brought in by the borrower. As security for availing term loan the borrower has to provide collateral security along with primary security. Collateral security is taken for the purpose of recovering the funds given by the bank in case the borrower defaults.

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Results such as risk rating, interest applicable, EMI payable and working capital limits approved would be mentioned. The conclusion of the project report includes comments on methodology followed. Recommendations would also be provided. The borrower in the case study is a privately held construction company. The borrower has asked for term loan of 15 crores and Working capital limits of 7 crores for the purpose of construction of a Mall in Chennai.

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Letter of Transmittal
Date: June, 09, 2012 Mr. R V Raju, Senior Manager, Mid corporate department, Head Office. Hyderabad. Dear Sir, Re: Summer Project Report Attached herewith is a copy of my summer-project report Credit Appraisal of Term loans and Working Capital limits which I am submitting in order to mark the completion of an 8 week summer project at you organization. This report was prepared by me using the best of practices and summarizes the work performed on the project and is being submitted in partial fulfilment of the requirements for award of diploma. I would like to mention that the overall experience with the organization was very good, and helped me to know how work is carried out in real practice with the help of your esteemed organization. I feel honoured that I got an opportunity to work with Andhra bank, a company of great repute. I hope I did justice to the project and added some value to the organization. Suggestions/comments would be appreciated. Yours truly, M Laxmana Swamy

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Letter of Authorization
I, M Laxmana Swamy, a student of Birla Institute of Management Technology (BIMTECH), hereby declare that I have worked on a project titled Credit Appraisal of Term loans and Working Capital limits during my summer internship at Andhra Bank, in partial fulfilment of the requirement for the Post Graduate Diploma in Management program. I guarantee/underwrite my research work to be authentic and original to the best of my knowledge in all respects of the process carried out during the project tenure. My learning experience at Andhra Bank, under the guidance of Industry Mentor R V Raju, Senior Manager, and Faculty guide Prof. kamal Kalra has been truly enriching.

Date: June, 09, 2012 M Laxmana Swamy

About the company

Andhra Bank is one of the leading banks in the country among the mid size public sector banks. Andhra Bank has been founded by Late Mr Dr Bhogaraju pattabhi Sitaramayya in 1923 in Machilipatnam, with a paid up capital of 1 lakh rupees and authorised capital of 10 lakhs rupees. In April 1980 the bank was converted to wholly owned government bank. Government of India holds up to 51.55 % and Life Insurance Corporation owns nearly 10 % of the shares. The bank has its head quarters situated in Saifabad, Hyderabad. Since 2002 Shri B A Prabhakar is chairman and Managing director of the bank. Andhra bank has a global presence with over 1729 branches globally including developed nations such as USA and UAE. The bank also started a joint venture with Bank of Baroda and L&G a foreign partner to form the India first Life insurance Company limited. Andhra Bank has got around 14,000 employees working with it. The Head office of Andhra Bank located at Hyderabad is divided into various departments namely SME sector, Mid and Large Corporate department, Retail department, Legal department, and Integrated Risk department. Vision of the bank: Envisions being a Trustworthy, Efficient and Strong Bank committed to increase market share by generating innovative Customer-Centric services and products igniting the Passion and Creative talents in Human resource leveraging Technology to expand the clientele & deliver Quality and Value Leading to Customer Delight. Mission of the bank: Amplify the front line capabilities to Serve Customers develop Processes leveraging Technology dynamically locate & empower People fast-cycle knowledge into innovative Products create Possibilities to reach the business goals & position the Bank as a rising star in the Financial Horizon. Key financials: 1. Total deposits by March 2012 stood at Rs 105851 crore as compared to Rs 92156 crore by the end of March 2011.
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2. Advances showed a year on year growth of 17% till March 2012 reaching a level of Rs. 84684 crores as compared to Rs. 72154 crore by the end of March 2011. 3. CASA deposits increased to Rs. 27947 crore in March 2012 compared to Rs 26779 by the end of March 2011. 4. CASA share in total deposits stood at 26.4% in March 2012. 5. Total income during Q4 FY11-12 rose by 21.3% to Rs 3220 crore. 6. Total income during the FY 11-12 rose by 32% and stood at value of Rs. 12,199 crore. 7. Net interest income during the Q4 FY 11-12 improved to Rs. 914 crore recording a growth of 6.2 % compared to Q4 FY10-11. 8. NII for the FY11-12 improved by 16.7 % and rose to Rs. 3759 crore. 9. Operating profit for the 12 month of FY11-12 grew 16.7% and stood at Rs. 2815 crore compared to Rs 2413 crore in FY10-11. 10. Net profit for the 12 month ended March 2012 stood at Rs 1345 crore with a growth of 6.1% from previous month. 11. Gross NPA ratio stood at 2.12% as at March 2012 compared to NPA of 0.91% by the end of March 2011. 12. Net interest margin stood at 3.34 % for the quarter ended March 2012 and 3.67 % for 12 months ended March 2012. 13. CRAR of the bank stood at 13.18% under BASEL-II (Tier I capital: 9.02% and TierII capital: 4.16%) 14. Priority Sector Advances improved to Rs.27027 Crore as on 31.03.2012 from Rs.23,082 Crore as on 31.03.2011, recording a growth of 17.1%. 15. Advances to Agriculture have gone up to Rs.12, 459 Crore as on 31.03.12 from Rs.10, 369 Crore as on 31.03.11, recording a growth of 20.1%. 16. MSME Advances registered a growth of 18.3% and stood at Rs.13132 Crore as at the end of March 2012 as against Rs.11,105 Crore in March 2011. 17. Retail Credit Portfolio of the Bank increased to Rs.11, 301 Crore as on 31.03.2012 compared to Rs.10, 479 Crore as on 31.03.2011, registering a Y-o-Y growth of 7.8%.
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Literature review
Risk management has become one of the most important aspects for any corporate entity. Financial institutions must be more prudent as far risk management is concerned. In Master circular prudential norms on capital adequacy-Basel I Frame work RBI has defined credit risk in the following way: Credit risk is most simply defined as the potential that a banks borrower or counterparty may fail to meet its obligations in accordance with agreed terms. It is the possibility of losses associated with diminution in the credit quality of borrowers or counterparties. The importance of credit risk management has emphasised in the same document. Maximising the banks risk adjusted rate of credit would be the goal of credit risk management. Maintaining the exposures within acceptable level would also come under credit risk management. Banks apart from managing credit risk at portfolio level, Credit risk should also be managed at individual transaction level. A proper credit management system would also be a part of credit risk management. Report of the Committee on Comprehensive Regulation for Credit Rating Agencies (2009) highlighted the importance of Credit rating agencys. Credit rating agencies and the ratings given by them help allocate capital efficiently across all sectors of the economy by pricing risk appropriately. Though not compulsory, banks get their loan portfolio rated by external agencies due to the fact that increased risk weight must be assigned to unrated loans. According to the Basel II guidelines (Credit requirement directive-CRD) banks are required to implement either standardised or internal rating based approach. Since RBI has not come out with final guidelines regarding Internal Based Approach, all banks in India are required to follow Standardised approach where the risk weights are given by RBI. RBI had however issued guidelines asking banks to put in place systems to measure credit risk, market risk and operational risk to ensure capital adequacy. Pending the issue of final guidelines, RBI has asked to parallel run both systems (standardised approach and internal rating based approach) and furnish CRAR (Capital to Risk weighted assets). Hence Andhra Bank is doing a parallel run of both systems. Basel II norms state that for internal based approach parameters such as probability at default (PD), exposures at default, maturity are required. The basic requirement for calculating
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probability at default (PD) is a robust rating model. Hence, Andhra Bank with the help of NIBM, Pune has developed CRRM model. Prior to Tandon committee report recommendations (1974) banks followed securitized method for working capital lending. Tandon committee report for the first time came up with the concept of maximum permissible bank finance. Tandon committee report clearly mentioned that banks should only finance a part of working capital need. The rest of funds must be brought in by the borrower using long term sources. Tandon committee report recommended three methods of lending which are discussed in the report. Tandon committee also emphasised that the corporates should maintain less in current assets. The committee also suggested holding norms for different classes of current assets. Of three methods suggested by the Tandon committee, only the first and second methods of lending are broadly used. However the third method of lending is not widely used due to the complexities involved in the method. Chore committee report which later came up in 1979 worked within the framework of Tandon committee. Chore committee emphasised the importance of bill discounting in working capital of the company. The committee also came up with many recommendations regarding such as quarterly submission of current assets details by the company; maintain current ratio of 1.33:1, peak and non peak limits and etc. Marathe committee which came up later had come up with various factors effecting working capital management. The committee report emphasised that borrowers must reduce the dependence on bank funds for working capital requirement. Borrowers must try to reduce the working capital requirements from 1.33:1 to 1:1.

Statement of the problem

Andhra Banks offer various credit facilities to corporate for their requirements. Term loan is one such facility offered to the corporates. A term loan can be either short term or medium or long term. For the purpose of sanctioning term loan, there is prescribed procedure to be followed in order to ensure the credibility of the project and the borrower. The process of credit approval includes risk rating the borrower. Risk rating is done using CRRM under internal risk approach as per RBI guidelines. Applicable interest rate is decided based on the rating obtained. The borrower however can ask for finer rates of interest if he satisfies certain stipulated conditions. Security requirements needs to be calculated based on the bank guidelines. Required primary and collateral security needs to be calculated. The working capital limits that can be availed by the borrower will also be calculated. For this purpose suitable method must be selected first. Apart from all the above steps it also very important to check the credit worthiness of borrower. RBI stipulates every bank to go through various defaulters such as RBI caution list, RBI defaulter list, RBI wilful defaulters list, SAL wilful defaulters list. The scope of the project work at Andhra bank would be to appraise one credit proposal and study all the above mentioned steps.

Methodology and Process Description

Andhra Bank provides Credit services both fund based and non fund based. The Credit facilities includes term loan, demand loan, Overdraft, cash Credits, WCDL, advances against bills, letter of Credit, guarantees, etc. To receive sanctioned advices from Head Office, a proper appraisal system is required. Andhra Bank has got its own loan policy method for evaluating the Credit proposals. The Credit appraisal to be done has following stages mentioned below: I. The process starts with checking the overall fund and non fund based limits that can be given. Limits applicable to the unit, group and the industry segment on whole are checked as per Banks loan policy guide lines/RBI guidelines. II. Verifying the technical and market feasibility of the project/proposal and undertaking SWOT analysis of the borrower. III. Risk Rating the borrower (e.g. A+++, A++, A+, A, B, C, D) based on the CRRM (Credit Rating Risk Model) model followed by the Bank. For various parameters such as management risk factors, financial risk factors, industry risk factor are rated. Then based on the Credit rating the applicable interest rates and repayment period is decided. IV. The past, present and projected financials of the borrower are verified: a. Balance sheet. b. Profit and loss account. c. Fund flow statements. d. Cash flow statements V. Calculations of the ratios such as a. Debt service coverage ratio(DSCR) b. Capital gearing ratio
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c. Current ratio d. Debt equity ratio e. TOL/TNW ratio VI. VII. Calculating required primary and collateral security required. Performing sensitivity analysis on Debt service coverage ratio(DSCR) by a. Increasing and decreasing cost of raw material b. Increasing and decreasing the projected sales c. Increasing and decreasing the applicable interest rates VIII. IX. Calculating of the drawing power of the borrower. Assessment of working capital limits or requirement based on turnover method or II method or cash budget method whichever is applicable. Sources of data: Data regarding the borrower would be collected from the borrower itself. The borrower has to submit various financial statements to the bank when he wants to avail certain credit facilities from the bank. Various RBI documents are also referred for understanding various policies.

Data and Process Analysis

Credit Facilities Andhra bank provides various credit facilities to individuals and corporate entities. These facilities can be fund and non fund based. Some of fund based facilities are mentioned below Term loans: Term loans include short, medium and long term loans. Long term loans are loans with maturity greater than 8 years while loans with maturity 1 to 8 years are called medium term loans. Term loans are taken generally for capital requirement. The interest applicable for a term loan depends upon the risk involved in the project and varies from case to case. For the purpose of short term requirements either bridge loans or short term loans are given. These loans have a maturity less than 1 year. Generally the short term loans carry higher interest rate compared to long term loan. Bridge loans are generally obtained as an intermediary source of fund before getting funds from a new and large source of funds. The money from new source of fund is used to repay the bridge loan. Working capital limits: For the purpose of meeting the working capital requirements various facilities are offered by the banks. These facilities include various Open cash Credit limit (OCC) and Overdraft facilities. Over draft facilities can be clean overdraft and secured overdraft. Non fund based facilities: Non fund based facilities include various facilities like letter of credit (LC), letter of comfort (LOC) and bank guarantees (BG). About the borrower firm and their proposal M/S ABC builders, engineers and contractors is a registered partnership firm dealing with Andhra Bank since 2003. The firm in engaged in the development of residential and commercial flats in Chennai and Bangalore. Mr XXX is the main promoter and managing director of the firm. He is a qualified civil engineer and from 1995 he is in civil construction line and having vast experience. This company has been doing construction work almost since a decade.
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Proposal: ABC builders and engineers and constructors have approached Andhra Bank for the purpose of availing term loan as well as working capital limit renewal. The proposal under consideration comes under Commercial real estate (CRE).The details are given below: 1. Recommendation for renewal cum enhancement of Secured Over Draft(SOD) from Rs 4.50 crores to Rs 7 crores 2. Sanction of term loan I (project funding) for Rs 8.00 crores and term loan II for 7.00 crores.

Facility Limit purpose Margin

Table 1 Term loan I Term loan I(project funding) Rs 8 crore To construct commercial spaces In

two basement and

ground and first floor 50% Repayable in Three years, Interest to be serviced as and when debited. The loan is to be repaid as and when the

repayment period shops are registered in favour of the buyer. interest/Commission BR+4%+0.25 % i.e. 15% p.a. presently

Facility Limit purpose Margin Repayment period Interest/ Commission

Table 2 Term loan II Term loan II 7 crore to construct and lease out commercial space for halls in second to fifth floor 50% Repayable in 60 EMI of Rs 16.66 lakhs each with a period of 24 months BR+4 %+0.25% i.e. 15% p.a. presently

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Facility Limit purpose Margin Repayment period Interest/ Commission

Table 3 Working capital limits SOD(Against Real estate) Rs. 7 crore Working capital 50% One year BR+7.25 % i.e.18 % presently

Table 1, table 2, table 3 show the credit facilities requested by the borrower. It can be seen that total term loan has been divided into 2 different loans. It is the different purpose and different amortization schedules of the loan that made the company to differentiate the loan into 2 types. Term loan I has been for the purpose of construction of 2 basements, ground and first floor. The term loan II has been for the purpose of construction of second to fifth floor where the proposed cinema theatres are planned to be constructed. For the purpose of credit appraisal there is a step by step procedure to be followed as explained below.

Step 1: Calculating credit exposures to individual/group borrower: RBI guidelines very clearly indicate the banks to maintain certain fixed amount of exposure per borrower and to the group. Apart from exposure limits to individuals and groups, there are exposure limits set for industry/segment. The exposure ceiling limits would be 15% of the capital funds (of Andhra Bank) in case of a single case borrower and 40% of the capital funds in the case of a borrower group. The capital funds for the purpose will comprise of Tier I and Tier II capital. However there are various norms that allow deviations depending upon the sector. For example infrastructure companies may be allowed a deviation of 5 % and 10% to individual and group borrower respectively. The industry wise credit exposure limit to commercial real estate has been fixed at 7% of total fund based advances of previous quarter.

Table 4 Exposure ceilings Particulars Fund Non fund

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based Exposure ceiling as 30.09.2011 Exposure as on 03.12.2011 Add present proposal Total

based 480.72 157.15 157.15

5217.42 3517.73 17.5 3535.23

Table 5 Exposures to Individual and group Constitution wise Ceiling as per RBI norm To the unit To the group 1479.17 3944.47 ceiling as per bank policy 30 40 Banks exposure existing proposed 4.5 22 4.5 22

Ceiling applicable to partnership firm are Rs 30 crores to the unit and 40 crores to the group or 6 times the net worth which is 6.25*6=37.50 crores. Table 4 and table 5 shows the total loan amount given to commercial real estate and to the proposed borrower. The proposed exposure is within the ceiling norms. Step 2: Calculating Term loan eligibility: The bank calculates term loan eligibility based on margins as stipulated in term loan policy of the bank. Margin basically means the percentage of contribution that must be made by the borrower. Table 6 shows the margins and margin money that must be brought in by the borrower.

Table 6 Margin money calculation Particulars cost Margin (%) term loan Additional money paid to the land owners 0.75 50 0.38 Ground+ 5 floors 18.01 50 9.01 basement and others 7.49 50 3.74 other charges inclusive of upfront fee and 3.14 50 1.57
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other charges/fees like CMDA plans approval charges, TNEB charges deposits and TL interest during construction period contingencies Total 0.6 29.99 50 0.30 15

As can be seen from above table, the total cost of the project is 30 crores. Out of the total cost 15 crores is bought in by the borrower, the rest in proposed to be brought in as term loan. Step 3: Primary and collateral security: Repayment capacity of the borrower and economic viability of the project will be the prime consideration while evaluating the proposal. Security and guarantee offered by the borrower shall be considered as secondary source of payment. In order to obtain either a fund based or non fund based facility from the bank, security must be given. In case the borrower defaults in paying back the borrowed funds, then banks will have the right to liquidate the security and recover the funds given by them to the borrower. Security offered by the borrower to the banks is divided into primary and collateral security. The assets acquired out of the bank finance shall be taken as primary security for the exposure. Anything offered/pledged apart from primary security is taken as collateral security. Collateral security can be anything such as land, building, etc. Collateral security can even be from members who are not stake holders in the deal/company. While extending finance for acquisition of fixed assets or working capital finance against current assets, prescribed margins shall be ensured in tune with norms prescribed by the bank. Security can also be given in the form guarantees. In cases where collateral securities are given by third parties guarantees or co-obligations are taken from the borrower. In case when real estate is given as collateral security, sometimes the promoters may be required to give guarantee to the extent of land value. In case of public companies guarantees are taken from the directors. Taking personal guarantee makes borrower more accountable and responsible. In proposed project, the details of primary and secondary security offered are given below: Primary security:
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For term loan I and II: 50% of undivided share of land situated in Mahabalipuram Road and 50 % share in the super structure to be built there upon.

For Secured Over Draft (SOD) security: Real estate valuing 19.23 crores (Which is also extended to term loans)

Collateral Security-Proposed: Vacant land of about 7392 sft located at poonamalle high road, Nerkundram, Chennai600107 with Market value is 5.54 crores. Further to the discussion where in Zonal office had highlighted the positive factors about the proposal, requested the promoter to offer additional security and the borrower has agreed to give the following additional securities: 1. Land to an extent of 2697 sq. ft with the building at Venkatesm Street , T Nagar, Chennai belonging to father-in-law and mother-in-law of Mr AAA worth Rs 4 crores. 2. Vacant land to an extent of 8100 sft at site no 11, sarjapur belonging to Mr AAA worth 4 crore. Thus the total value of collateral security offered is valued at 13.54 crores (5.54 +4+ 4).Table 7 and table 8 shows the amount collateral available and total amount of collateral required. As can be seen the collateral available is greater than collateral required.

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Table 7 Collateral available Amount SI. No Particulars (crores) 1 Value of existing security 19.23 2 Total value of new security proposed to be given ( Rs 5.5 + Rs 4+ Rs 4) 13.54 3 Total security offered 32.77

SI.No 1 2 3 4 5

Table 8 Collateral required Particulars Collateral security required at 200 % of SOD limit of 4.5 crore 200 % for short term loan of 8 crores 100 % for term loan of 7 crores Total term loan requested Security coverage

Amount(crores) 9 16 7 32 102%

Guarantors- Joint and several liabilities of partners: Since the firm is partnership firm, all partners have their liability status is unlimited. The net worth of the all the partners has been given below in table 9. Table 9 Net worth of individuals Name Net worth( in crores) 16 2.17 5.85 1.5

AAA BBB CCC DDD

Step 4: Credit Risk rating and pricing Bank has its own policy for risk rating of the borrower. Andhra follows different models depending on the credit limit. For all advances with credit limit between 5 crores and 50 lakhs CRAS (Credit Risk Assessment System) model is followed. CRS (Credit rating system) model is followed and when the limits are between 5 lakhs to 50 lakhs. For all credit limits above 5 crores, CRRM (Credit rating risk management) model is used for credit rating. For credit limits less than 5 lakhs various other systems are used for risk rating.

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Initially CRAS model was used even for credit limits greater than 5 crores. But based on RBI guidelines to implement the BESEL-II guidelines, CRRM model has been implemented. For the purpose of rating a borrower, past financials are made use of. In case the borrower is implementing a new project, then projected financial are made use for the purpose of risk rating a borrower. In case the borrower is new to the bank, it is mandatory that he must secure an overall minimum score of 40% with a minimum of 40% score in each of the parameter. For considering finer rates of interests the borrower should be rated B and above under CRS/CRAS and should be rated above B++ under CRRM. Credit risk rating model: Andhra Bank with help of NIBM, Pune has developed an Internal rating system called as CRRM based on the RBI guidelines. For development of the model risk parameters such as Probability of default (PD), Loss given default (LGD), exposure at default and exposure at maturity are used. This new model is software driven and BASEL compliant model capable of providing rating migration statistics, PD calculations apart from several useful reports for management information. Under the New Capital Adequacy framework [ Based on BASEL II document], the concept of Credit Risk, Market Risk and Operational Risk is introduced with guidelines on classification of assets, methodologies for measuring these risks and the approaches available to banks are furnished. As mentioned earlier CRRM model is used for rating when credit limits are greater than 5 crores. CRRM model is used for both fund based and non fund bases. CRRM model is a very comprehensive model. CRRM model is a software based model. All sanctioning authorities and Zonal offices have this software loaded into their systems. In CRRM model various types of risks are indentified. Under each risk, several parameters are selected and under each parameter, several risk factors are taken up for evaluation and rating on a 1 to 6 scale, with 6 being the highest score and 1 the least. Weights are attached to Parameters/ Factor. Final ratings are assigned based on the weighted average scores. Table 10 shows various grades that can be obtained and their meaning under CRRM. The internal and external risks are evaluated under the following heads:
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a) Financial Risk Evaluation b) Industry Risk Evaluation [External Risk] c) Business Risk Evaluation d) Management Evaluation e) Security/Conduct of account f) Project Risk Evaluation (in respect of Term Loan accounts) Table 10 CRRM rating and their meaning Rating Description An exceptionally high position of strength. Very high A++ A+ A B++ B+ B degree of sustainability A high degree of strength on factors among peer groups. High degree of sustainability A moderate degree of strength with positive outlook A moderate degree of strength with stable outlook A moderate degree of strength with stable and marginally negative outlook Weakness on a parameter in comparison with peers. Unstable outlook A fundamental weakness with regard to the factor. Unlikely to improve under normal conditions. Defaulter

Score 6.0-5.4 5.39-4.9 4.89-4.2 4.19-3.6 3.59-3.0 2.99-2.4

2.39-1.0 C 0 D

Industry Risk Evaluation: The Industry risk section evaluates the outlook for the industry over the medium term. Three Distinct risk parameters have been identified and a number of risk factors within each risk parameter have been identified. Under industry risk the following factors are considered under which further properties are considered. Table 11 gives the factors that are considered under industry risk evaluation. There a total of 3 factors with each factor having many sub factors considered. Table 11 Factors considered under Industry risk SI.NO Name of factor Number of parameters 1 Industry 4 parameters 2 3 Characteristics Competitive forces Industry Financials 8 parameters 3 parameters

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The department handling the Credit Risk Rating at the Head Office will rate the Industry Parameters either using Internal Industry Intelligence or using External Industry Database and communicate the data on the Industry parameters to the credit rating officers at the 9 Branches or Zones. The Industry Ratings will be reviewed periodically to keep them in tune with the changes in the environment. The Branches and Zones do not have the facility to change the Industry ratings once it is predetermined by the Head Office. The rating officers at Zones or Branches have to select the appropriate Industry for the Company/Borrower under consideration and the corresponding Industry data will be automatically retrieved from the Industry database and Industry rating will be generated automatically. Andhra Bank has subscribed to CRISINFACs Industry Risk Scores, who provides the inputs to the Industry scores. According to CRSINFAC, the industry score is 2.3 on a scale of 6, which indicates unfavourable. However as per the background of the promoter and feasibility of the project, ZO has recommended for the credit limits. Business risk: Business risk is measured through parameters that determine the companys business position within the industry and its sustainability. Table 12 gives factors considered. Table 12 Factors considered under Business risk SI. No Factor Number of parameters 1 5 Market position 2 3 operating efficiency 3 4 Growth Financial risk: By measuring the financial risk the overall risk involved in the financial system of the company is measured. The following factors are taken into account while measuring the financial risk. The factors considered under financial risk are given in table 13. SI. No 1 2 3 4 Table 13 Factors considered under financial risk Number of parameters Factor 3 Quality of financial statements 5 past financial performance 2 financial flexibility 5 Cash flow adequacy projections
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Management risk: This risk parameter tries to access the management quality and the risk that can arise due to management. Factors considered under management risk are given in table 14. SI. No. 1 2 3 4 5 6 7 8 9 10 Table 14 Factors considered under Management risk Factors Number of years of experience in industry quality of management personnel Percentage of actual sales achieved to projection made last year Percentage of net profit achieved to projections made last year Percentage of actual net working capital to projections made last year Payment record to bankers/Institutions group support management succession Corporate governance credibility

Facility risk/ Security risk: This risk parameter tries to access the possible risk that can arise due to securities such as guarantees and collateral security that are given the borrower. Factors considered under facility risk are given in table 15.

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Table 15 Factors considered under facility risk SI. No. Factor 1 Collateral security 2 Personal or corporate guarantee 3 Past payment record 4 compliance with terms of sanction 5 Operations in account Project risk: This risk parameter tries to estimate the risk involved in the project for which the borrower is borrowing funds. Factors considered under project risk are given in table 16. Table 16 Factors considered under project risk Factor Average debt service coverage ratio for the project Repayment period for the project including moratorium Asset coverage ratio for the project

SI. No. 1 2 3

Table 17 gives the weights given to each parameter under CRRM model. Based in these weight final score is computed. Table 17 weight associated with each risk parameter Category weight Financial risk 5 Business risk 2 Industrial risk 1 Management risk 1.5 facility risk 0.5 Project risk 1

Credit Risk Assessment System (CRAS) Model:

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As mentioned earlier CRAS model is used for the credit limits between 50 lakhs to 5 crores. In CRAS model the following parameters are considered are given in table 18. Table 18 Parameters considered under CRAS model and their weights Weight of each Parameter (A) Management Risk Factors (B) Industry & Unit Risk Factors (C) Financial Risk Factors (D) Operational Experience Total 20 parameter 10 50 20 100

Credit Rating System (CRS) Model: CRS model is a very simple model. CRS model is considered for credit limits between 5 to 50lakhs. Table 19 gives the parameters are considered CRS. Table 20 shows the ratings that can be obtained and their meaning. Table 19 Parameters under CRS model Parameter Total Debt equity Ratio DPG/TL/LC/BG/ interest commitments Compliance with terms & conditions of sanction Total Sales Inventory + Sundry debtors Submission of MSOD/Stock statements/Renewal Data Achievement of projected sales Supported by collateral security including II nd charge on Fixed Assets Operational Experience in cash credit Financial Risks not transparent Unhedged Forex Risks

SI.NO 1 2 3 4 5 6 7 8 9 10 11

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Table 20 Credit rating and their meaning in CRS model Marks Credit Grade secured Rating Acceptable Credit Rating: Above A+++ Prime 95% >90 95% >80 90% >70 80% >60 70% >40 to A++ to A+ to A to B to C Excellent Very good Good Satisfactory Average

60% Unacceptable Credit Ratings: 40% & D Poor Below

CRISIL Rating and Industry analysis: Andhra bank has also subscribed to CRISIL for the purpose of risk rating the borrower. Even though Andhra Bank has its own method for rating the borrower, CRISIL ratings are used for cross checking the rating obtained using its own rating system. Industry: commercial Real estate (Commercial real estate has been defined as the construction of office and retail spaces (including malls and multiplexes). The main players in this industry are real estate developers. Small regional players continue to dominate the commercial real estate market, while large players have been trying to expand beyond cities in which they have traditionally operated. The industry is predominant unorganised, but less as compared to residential housing industry. However, the unorganised nature of the industry has resulted in high finance costs, which have further raised its risk profile. Table 21 gives the factors considered by CRISIL and the weights given to them.

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Table 21 Factors considered by CRISIL for industry score Weight Factor 85 Industry characteristics 35 Demand supply gap -Fluctuation in demand supply gap - Growth potential -Cyclicality 20 Government policy -Importance to economy -Sensitivity of government policies 30 Input related risk 15 Extent of competition -Threat of imports/Substitutes/Unorganised sector - Barriers to entry -Technology risk -International competitiveness -Bargaining power of buyer industries -Bargaining power of supplier industries Total Score

Score

2.4

For purpose of evaluating Industry risk score, the factors mentioned in the above table are considered. The industry risk score obtained for commercial real estate is 2.4. Demand and supply scenario: Demand for commercial space has shown signs of revival with improvement in economy and absorption levels have improved slightly. Many large occupiers in IT/Ites sector are evaluating tier i/ii cities for setting up new offices but are adopting a cautious approach before selecting a location or property. An improvement in demand has led to many of the projects that were postponed witnessing fresh interest. However, the supply in office space and retail space exists and hence lease rentals for both commercial office space and retail space are expected to remain more or less stable across the tem major cities that CRISIL tracks in 2011. Key drivers: 1. The demand for office space is mainly driven by IT/ITES sector, BPO and call centres.

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2. Increasing disposable incomes, faster growth in urban population and rising demand for branded products are the man drivers for growth of malls and multiplexes in India. Output/capacity: The commercial real estate industry is relatively more organised as compared to the residential segment. This is primarily because, unlike residential segments where in the project is partly sponsored by the customer advance, commercial projects have to be funded largely by the way of promoter contribution and debt. More over the asset starts generating revenue only after it is leased. Both funding difficulty and the underlying risk with regard to leasing the property have been discouraging developers to enter this segment. As a result, only established players with strong brand images have ventured into commercial properties. The industries organised nature improves its overall rating. Track record and reputation acts as important differentials among players. Thus while developers with a brand image are able to sell their office, small players face intense competition. Falling demand and excess supply has increased competition. There by putting considerable pressure on the margins and rentals. Outlook: 1. Rentals for commercial spaces are likely to remain more or less stable in 2011. 2. Demand for commercial sector would remain muted over next one year. Increase in prices of major inputs like steel and cement are expected to increase construction cost. The proposed levy of 18.5 % minimum alternate tax on developers of special economic zones will impact the profitability of developers. 3. The oversupply position is expected to increase competition; hence the medium term outlook for the sector continues to be unfavourable. Price realization: The average value of operating profit that is generally available for commercial real estate is given in table 22.
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Table 22 Operating margins for commercial real estate Year 2004-5 2005-6 2006-7 2007-8 2008-9 Operating profit margin (%) 36.81 34.75 59.79 58.44 54.5 Return on capital employed (%) 12.8 19.17 13.86 16.91 9.48

2009-10 51 10.4

1. Land is the major component of costs accounting for nearly 30-50 % of the total project costs, with construction accounting for the rest. In the residential real estate segment, the developer benefit from customer advances as a source of finance. 2. On the other hand, developers in the commercial real estate segment first have to construct and then lease or sell the property. Hence they have to bear the risk themselves. Increased volatility in commodity prices and problems in land acquisition have increased input related risks for developer. 3. The prices of major inputs namely cement and steel are expected to increase apart from the increase in the excise duty. Government policy: 1. With the importance of the sector in aiding gross fixed capital formation and employment generation, the government had recently relaxed norms for FDI in real estate. 2. Funding by banks for commercial real estate used to be assigned a risk weight of 150 per cent which has a major deterrent in the financing of commercial projects. However the reserve bank of India has relaxed the risk weight from 150 per cent to 100 percent for loans given to real estate companies by the bank. This change in risk weight is expected to boost fund availability for commercial developers in long term. 3. While the urban land ceiling and regulation act(ULCRA) and rent control act(RCA) have created scarcity of land in urban markets, other regulations such as coastal regulatory zone (CRZ), mill land regulation and property taxes and stamp duties have further affected growth in real estate. Fiscal policy:

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1. In union budget 2009-10, the tax holiday for software companies in software technology parks was extended by one year. Foreign direct investment norms have been relaxed for this sector. 2. But in the union budget 2011-12 a levy of 18.5 % minimum alternate tax on developers of special economic zones has been proposed which will negatively impact the sector. Also the tax holiday for software companies are major drivers of demand for office space in urban areas. Risk factors: 1. Impact on profitability on account of cost and time overturns due to the volatility in land prices, disputes in title, eviction of tenants. 2. High finance cost 3. Adverse economic conditions Step 5: Calculating applicable interest rate and tenure: The applicable rate of interest in decided based on credit rating secured by the borrower. Table 22 shows the applicable spread that can be applied under various rating obtained. Table 23 Applicable spread Credit rating under CRRM Applicable spread for commercial real estate A++ 6.5%-7% A+ 7.25%-7.5% A 7.5% B++ 7.5% B+ 7.5% B 7.5% C 7.5% Step 6: Working capital assessment Working capitals limits are asked in order carry out day to day operations of the bank. There are 3 methods used by the bank for the purpose of assessment of working capital requirements. The working capital gap can also be funded using bank facility like overdraft or open cash credit. Each type of financing has its own pros and cons. It is up to the management team of
26

the company to decide which type of funds they would want to avail. For the purpose of availing working capital facilities assessment needs to be done. This assessment of Working capital assessment would be done as prescribed by RBI depending upon the applicability. Turn over method or I method: The bank is following Turnover method for assessment of credit limits for all sectors (manufacturing & trading) with fund based working capital limits up to Rs. 6 crore from the banking system. Under this method three months of turnover is financed as working capital irrespective of level of inventories, maintained by the constituent. Banks finance can be availed up to 75% of the working capital gap. The rest 25 % should be brought out from long term sources of funds. Under this method working capital eligibility has to be arrived based on 25% of turnover projected less 5% of turnover or actual NWC available whichever is more. If actual NWC is less than required NWC, the borrower has to bring in the shortfall and sanctioning Authority has to ensure the same. Actual NWC means NWC available as per latest audited balance sheet. The assessment of working capital limits should be done both as per Turnover Method and Inventory Method and higher of the two is to be sanctioned depending upon the need. Table 24 shows the methodology followed under Turn over method. Table 24 Turn over method calculations Turn Over Method A. Turnover B. 25% of (A) C. Margin Required at 5% of (A) D. Margin (NWC) E. (B - C) F. (B-D) G. MPBF ( E or F whichever is lower) H. Excess borrowing

II method of working capital assessment: Under this method the borrower should provide for at least 25% of the current

assets from long term sources of funds (equity and long term loan). This also means that total of current assets including banks borrowings should not exceed 75% of the current assets. Under this system current assets and current liabilities are calculated. The gap between current assets and current liabilities is called as working capital gap. Then the procedure explained in the table below is followed by the bank in calculating the working capital requirement or Maximum bank permissible funds (MPBF). Table 25 gives the methodology followed under second method.

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Table 25 II method calculations A) Current Assets( without bank funds) B) Current liabilities(Without bank funds) C) Working Capital Gap ( A-B) D) Minimum stipulated. NWC (25% of E) F) G) H) CA excl. Export receivables) Actual/Projected NWC Item C Minus Item D Item C Minus Item E Eligible Credit (Item F or G whichever is lower) Cash budget method: This method is used in calculating cash deficit that exists throughout the year. This method is also used in seasonal sectors such as agro-based like sugar, food, tea, tobacco, fertilizers and etc. This method is also applicable to seasonal industries such as air conditioning, cotton textiles. This method is also applicable for construction industries. For the before mentioned industries other method of working capital assessment or II method are not applicable as the fluctuation levels of current assets and current liabilities in high. Under Cash budget method maximum gap between total receipts and total payment is covered by the banks finance. Disbursement are allowed based on monthly cash budgets

The borrower is a builder and contractor and the working capital assessment is worked out based on the cash budget method.

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Table 26 Cash deficit method of the borrower Month Surplus/Deficit Apr-11 -700.93 May11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 -700.63 -700.31 -700.14 -700.24 -700.57 -700.16 -700.12 -700.15 -700.27 -700.49 -700.86

The maximum deficit is 7.01 crores in noticed during the months as can be seen from table 26. The borrower is eligible for SOD limit of Rs 7 crore. The firm requested for sanction of SOD limit of 7 crores at finer rates of 7 crore as they are executing projects of 23.3 crores apart from the proposed OMR project cost of Rs 29.99 crore The firm working capital limits are renewed by Head Office, where in the enhancement of SOD limit from 4.5 crores to7 crores was not considered in view of the NIL sales booked in the year 2010-11. Branch/Zonal office recommends for enhancement of SOD limit from 4.5 crores to 7 crores keeping in view the various projects on hand.

Step 7: Credit investigation, due diligence & verification of defaulters list: Whenever credit limits are requests are to be considered, it is necessary to conduct a credit investigation before taking up such proposals for evaluation. This process of preliminary study needs to be undertaken invariably before detailed evaluation. a) Areas of credit investigation:

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Integrity of the borrower has no substitute. Before entering into any agreement with the borrower it is very imperative that the bank understands the borrower and his propose properly. Banks generally carry out interviews with the borrower and enquire about his past record, details of associates, sister concerns and etc. Apart from quantitative aspect like past financials, qualitative aspects such as market reputation are also checked. Know your customer principle is equally important in the case of borrower. If the bank comes to know about the unethical practices and illegal activities with which a firm or borrower is linked then the bank tries to distance itself from the borrower. Pre sanction and post sanction of unit are also a part of credit investigation. b) Defaulters list: It is mandatory for the bank to cross the names of borrowers with that of the names in the previous wilful defaulters list. Table 27 gives the list of defaulters list to be checked. Table 27 Defaulters list Name of the list Yes/No RBI defaulters list dated March 2011(Rs 1 crore and above) no Caution list dated June 2011 no Wilful defaulters list dated June 2011,(Rs 25 crore and above) ECGC SAL list dated 12.12.2011 CIBIL suit filed Rs 1 core and above 30.06.11 CIBIL suit filed (wilful) Rs 25 lakhs and above 30.06.2011 no no no no

Areas of strengths and weakness of the borrower Strengths: The managing director Mr AAA is in this line of activity for more than a decade. He is also a qualified civil engineer. The overall conduct obtained by borrower in table 28. Weakness: 1. All partners are from single family 2. Normal business competition which can be, however be overcome by maintaining quality in the works better customer care and the reputation it has built up for itself all over the years.

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3. Heavy competition, government policies, natural calamities will influence the industry and the damages if any costs heavily Table 28 conduct of the borrower CONDUCT REPUTATION CONDITION prudent shrewd sound steady honest progressive conservative tricky stagnant overtrade dishonest declining speculative

ABILITY capable experienced incapable inexperienced

Step 8 Financial analysis and compliance: Key financial Indicators: Table 29 shows various key financials obtained. Table 29 key financial indicators Audited Audited Projection Audited provisional 31-03-2009 31-03-2010 31-03-2011 31-03-2011 31-09-2011 1.33 7.34 0 0 3.03 0 0.04 0.11 0.14 0.08 0.14 0.25 0.97 0.39 0.92 0.12 0.24 0.97 0.39 0.92 0.04 0.05 0.06 0.06 0.03 0.16 0.29 1.03 0.45 0.95 1.65 2.43 6.15 6.25 7.07 1.65 2.43 6.15 6.25 7.07 4.07 0.32 0.51 0.45 0.48 0.42 0.28 0.46 0.39 0.42 0.39 2.93 1.27 2 1.99 2.51 0.25 0.21 1.9 1.9 1.18 2.68 1.06 0.09 0.09 1.33 0 0 0 2.18 0 8.1 10.03 22.18 20.99 26.87 5.98 8.97 16.61 15.35 19.91 2.12 1.06 5.57 5.64 6.96 1.35 1.12 1.34 1.37 1.35 5.4 4.21 3.02 2.77 3.17 4.26 1.78 0.52 0.32 0.32 0.35 1.43 1.6 3.31 2.05 3.06
31

Financial indicators Net sales Other income Profit before tax Profit after tax Depreciation Cash generation paid up capital Tangible net worth Adjusted TNW Gross Fixed assets Net fixed assets Term liabilities Banks Friends and relatives Investments Current assets Current liabilities Net working capital Current ratio TOL/TNW Adjusted TOL/TNW Debt equity ratio Interest coverage ratio

Net profit / net sales

9.02 3.27 (Table 29 contd.)

3.29

As can be seen from the above table, the key financials are presented. Table 30 gives remarks on key financials. Table 30 Remarks on key financial indicators Remarks on retained profits The firm retained 100% of the profit earned during the year 2009-10 in the business. The firm has introduced additional capital of Rs Remarks on tangible net worth 3.50 crore during 2010-11 TNW of the firm increased from Rs 2.43 crores as on 31.3.10 to Rs 6.25 crores as on 31.3.2011 due to retention of profits and Remarks on Net working capital infusion of capital of Rs 3.50 crores The NWC has increased from Rs 1.06 crores as at 31.3.2010 to Rs 5.57 crores by 31.3.2011. The increase in the NWC is due to retention of profits of Rs 3.50 crores and Remarks on Current ratio increase in tem liability. The current ratio of the firm as at 31.3.2011 is 1.37 and satisfactory which is above the Remarks on Total outside liabilities to TNW minimum required level of 1.33 TOL/TNW as at 31.3.2010 is 4.21 and as at 31.3.2011 is 2.77. The decrease in the ratio is on account of increase in TNW due to Remarks on debt/equity ratio infusion of additional capital into the firm Debt equity ratio marginally improved from 0.52 as on 31.3.10 to 0.32 as on 31.3.2011 on Remarks on interest coverage ratio account of increase in TNW Interest coverage stood at 2.05 as per ABS

31.3.2011 and is satisfactory Remarks on Investment/advances to associate The firm owns a property at Gandhi bazaar, concerns Remarks on diversion of funds Bengaluru and is shown as investment, amounting to Rs 2.18 crores There is no diversion of funds from short term sources to long term uses in the FY
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Remarks on borrowings from friends and relatives Remarks on overdue statutory liabilities Remarks on contingent liabilities not provided for Remark on EPS and share value Does the account show sign of incipient sickness

2011 Unsecured loans reduced from Rs1.06 crores as on 31.3.10 to Rs 0.09 as on 31.3.11 Nil Nil Not applicable No

(Table 30 contd.)

Achievability of estimated/Projected production sales Table 31 sales receipts Actual/estimate Year 2008-2009 2009-2010 2010-2011 30.09.201 1 2011-2012 2012-2013 s Actual Actual Actual Provisional Estimates Projection Receipts 1.33 7.34 0 3.03 21.32 21.75

Table 31 provides the details of sales achieved and projected. The firm has estimated sales of Rs 21.32 crores for the year ending 31.3.2012 and projected Rs 21.75 crores for the year ending 31/3/2013.

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The recessionary trend is slowly reversing and the projections can be achieved as they are having sufficient projects on hand and new OMR projects. During the year 2010-11, the sales booked are Nil. The profit after tax is 0.39 crores. The firm has three ongoing projects at Old Mahabalipuram road, Chennai. The firm has recognised 10% profit on the total cost incurred on the above projects after deducting administrative and other expenses. Auditors comments: Auditors comments are submitted by the auditors after going through the financials of the company. Table 32 gives the details of the auditors comments submitted by the borrower. Auditors comment on the companys balance sheet:

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1 2 3

Table 32 Auditors comments On revaluation of fixed assets On change of method of depreciation On loans and advances given to the concerns within the group On position of unserviceable stores/obsolete stock On position of overdue / irrevocable debtors On disputed liabilities not provided for On valuation of inventory Others

Nil Nil Nil

4 5 6 7 8

Nil Nil Nil Nil Nil

Step 9 Term and conditions: Special terms and conditions: 1. Disbursement of term loan shall be based on the work completion certificate by our approved engineer and CA certificate for the amount spent on the project. The release of term loan shall be in the ratio 1:1:2 i.e. capital: booking money: term loan. 2. Branch has to maintain ESCROW account to credit the proposed sale proceeds of the shops for term loan I and a separate ESCOW account for lease rentals for repayment of term loan II. 3. As and when the sale of the commercial establishment takes place and advance amount is received, the company shall remit the same into ESCROW account and any amount received in excess of rupees 7.49 crore shall be utilised for repayment of the loan. Our bank will have a charge on the ESCROW account and withdrawal from

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escrow account will first be for the payment of interest on the term loans and towards repayment of the term loans availed. 4. The binding letter of intent is duly modified by extending the due date of handing over the possession to the cinipolis by the applicant builder as there might be delay in handing over the project. 5. Branch may be permitted to issue NOC after repayment of Rs 5000 per sft and to release the proportionate mortgaged land/undivided share along with shops to be registered in favour of the customers duly ensuring availability of sufficient security coverage to the loan amount outstanding at the time of each realization

Pre disbursement conditions: Before seeking the disbursement of term loan or SOD, the firm has to comply the following: 1. The owners Mr zzz and his wife shall execute a sale deed alienating their 50% share of undivided land in favour of M/S builders, and the firm should offer the said property as security. 2. The firm to submit a notarised letter of undertaking to the bank to the effect that the firm/builder should not alienate or encumber any part or parts of the 50% share of the property sold to them without written consent from the bank. 3. The owners of land to give a notarised letter to the bank to the effect that the GPAs dated 17.10.2007 and 09.07.2008 are valid and subsisting and they will not be cancelled till the completion of project. 4. The lessee to the firm M/S kkk India PVT limited who had executed binding letter of agreement on 7.10.2010 shall inform the bank by the way of letter of acknowledgement that the Binding letter of agreement (BLA) dated 7.10.2010 has been approved by their Board and the same is subsisting and agreed to execute agreement to lease as per terms of BLA. Issues raised by the HO:
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1. The personal guarantee of all persons giving their property as security against loans to the firm to be obtained. 2. The party to agree for applicable rate of interest, no logic of concession for commercial property as risk is high. 3. Promoters to bring more equity and the loan to be reduced proportionately. No deviation in margin money is desirable. 4. Nothing is mentioned about clear and marketable title, how the firm will mortgage 50 % share of the land when they have not paid for it upfront. Land owners should join as co-borrowers. Reply by the Zonal office Chennai: 1. The personal guarantee of all the persons giving their property as security against the loan to the firm will be given and the land owners will give guarantee limited to the value of property being mortgaged by tem. As and when sale of office space is affected the guarantee of the owners is to be reduced proportionately. 2. The firm is agreeable to rate of interest levied by the bank. 3. The form agreed to bring in margin of Rs 149895 lakhs and also bring additional margin as decided by us. 4. The total extent of land where the office space and multiples is proposed is 45306 sft out of this, 16954 sft being the undivided share of land pertaining to multiplex will be transferred to the applicant firm by the way of sale deed and the same deposited by the firm. An extent of 7248 sft being the proportionate undivided share of land pertaining to the office space will be mortgaged by the present owner of the land to the extent of sales made; the bank is requested to issue NOC for building and corresponding undivided share of land. 5. ZO recommends for sanction of term loan for Rs 7.32 Cr (reduced from 8 crores) and TL II for 7 crores.

37

38

Results
Credit risk rating results The borrower is rated as B as per CRRM. The applicable rate of interest for the term loan is BR+7.50+TP. Borrower is requesting rate of interest for term loan at BR+4+0.25 i.e.10.75+4+0.25=15%. TP here stands for Term premium. The value of TP is 0.25 is a fixed value and is applicable only when the tenure of credit facility is greater than 3 years. Table 33 and and table 34 show the ratings obtained by the borrower. The borrower is rated B under CRRM as per ABS. The credit rating rationale is furnished below: Table 33 Rating given to the borrower Parameter Score A)Financial risk evaluation 3.04 B)Business risk evaluation 1.46 C)Industry risk evaluation assessment 3.1 D)Management evaluation 3.35 E)Security/conduct of accounts 5.25 Overall rating including facility 2.89 Projected risk evaluation 2.33 Overall rating including facility & project 2.84

Rating B+ C B+ B+ A+ B C B

Apart from the above ratings as per CRRM, the ratings mentioned below are also obtained.

Table 34 Other ratings Internal company rating: Company rating(w/o size criteria) Company rating(with size criteria)

2.72 B 2.76 B 2.76 B

DSCR results:
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DSCR ratio has been calculated for the using the past and projected data. DSCR results obtained have been shown in table 35. Table 35 DSCR estimations YEAR DSCR ratio Mar-11 provisional 1.77 Mar-12 estimates 2.03 Mar-13 estimates 1.6 Mar-14 estimates 1.51 Mar-15 estimates 1.41 Mar-16 estimates 1.42 Mar-17 estimates 1.73 Mar-18 estimates 2.13 Mar-19 estimates 2.56

Average DSCR=1.8. This means that the company will be able to service its debt effectively. Sensitivity analysis results: Sensitivity analysis results are given below. In sensitivity analysis the variations in DSCR are found out by varying the input parameters such as cost of production, sales and interest rate. The table below gives the sensitivity details. Results obtained in sensitivity analysis have been shown in table 36. Table 36 Sensitivity Results Sensitivity analysis Parameter Normal 5 % increase in cost of production 15% decrease in receipts/sales realization Increase on TL & WC increase by 2.5% DSCR Average Min Max 1.77 1.41 2.56 1.36 1 2 1.76 1.67 1.37 1.33 2.45 2.42

1. According to the policy, DSCR ratio should be given 1.5 to 2. 2. It is observed that the activity in insensitive to the extent for the given situation for the above level of variations and the firm will be stable to service the interest

40

/instalment of the term loan and working capital. Normal weighted average DSCR is 1.71 which is comfortable and complied with policy guidelines. Working capital Results: Build up net working capital: For financing working capital long term sources such as equity and term loans are made use of. Table 37 gives the working build up, which has been done by adding funds from long term sources and deducting funds to long term used. Table 37 Working capital build up Audited Audited 31.03.10 31.03.11 Actual NWC at beginning of the year ADD: Retained Profit for the year (Net Profit after tax and dividend) Depreciation Additional Long Term Funds: Increase in Capital/Share Application Money Increase in Deposits Increase in Term Loans Others SUB TOTAL LESS: Long Term Uses: Reduction in Deposits Reduction in Term Liabilities Increase in Fixed Assets Others SUB TOTAL NWC as at the end of the Year 2.12 0.24 0.05 0.78 1.06 0.39 0.06 3.38.

Estimates 31.03.12 5.64 1.67 0.06 1.03

0.00 0.00 2.91

0.72 0.00 5.61

6.17 0.00 14.57

1.66 0.19 0.00 1.85 1.06

0.00 -0.03 0.00 -0.03 5.64

0.00 0.05 0.00 0.05 14.52

1. Net working capital at the end of the year is arrived by adding long term sources of fund and subtracting long term uses of funds. As can the Net working capital at the end of financial 2009-10 year is 1.06 crores which increased to 5.64 by end of financial year 2010-11. The value of projected estimates by the end of financial year 2011-12 is estimated to be around 14.52 crores. Compliance to policy

41

The borrower needs to comply with various policy guidelines. Table 38 shows various parameters and required level of each parameter. Table 38 Compliance to loan policy guidelines As per policy (in crores) Exposure applicable to category(borrower wise) Group wise exposure current ratio TOL/TNW capital gearing ratio Pre sanction unit inspection credit rating 30 1.33 6 10 4.5 1.37 2.77 B yes N.A yes yes N.A yes Yes present proposal compliance Yes or No

Conclusions
1. The methodology followed at Andhra bank is a very comprehensive and is in accordance to guidelines issued by RBI. 2. The bank follows Tandon committees recommendations for working capital assessment. 3. The risk evaluation process currently followed at Andhra Bank is compliant with the Basel III guidelines.

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4. The interest rate charged to borrower is completely justified in accordance to the risk. 5. The pre disbursement and post disbursement conditions are completely justified and are as per the loan policy of the bank.

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Limitations
1. The data used is mostly secondary data and is submitted by the borrower. All calculations and estimations are done based on the data provided by the borrower. 2. Projected financial statements are used. However there might be deviations in future which again put financial strain on the borrower. 3. Dependence on third party for the purpose of estimating the industry risk. 4. No direct contact with the borrower. All the communication with the borrower has been through Branch Office at Chennai.

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Recommendations
Recommendations for credit appraisal process: 1. Bank can follow Tandon committee recommendations regarding holding norms for different current assets classes that borrowers should hold 2. In granting facilities like Open Cash Credit (OCC) and Over Draft, bank can set separate limits for peak and non peak season which can be indentified using the past information. This ensures proper utilization of funds. 3. In case of green field projects, risk rating and pricing is done purely based in projected financial statements. Under such circumstances the quality of projection must be ensured. 4. Andhra bank uses Debt Service Coverage Ratio (DSCR) ratio for calculating the debt servicing ability of the borrower. Apart from this the bank can also consider using Fixed Asset Coverage ratio (FACR). This ratio will help the bank in estimating the recovering ability of the borrower in case he defaults. 5. Andhra Bank can encourage the borrower for maintaining a debt service reserve. 6. Andhra Bank may also encourage hedging for significant cost items in order to protect the borrower from supply side constraints 7. Andhra Bank may encourage off take contacts for green field projects Recommendations for the proposal: 1. Sanctioning term Loan I of 8 crores and term Loan II of 7 Crores 2. Renewing the already existing working capital limit of 4.5 crores

45

3. Not sanctioning expansion request the working capital limit from 4.5 crores to 7 crores

References
1. Mayur Sharad Joshi, 2004, BASEL-II, Three steps of Governance. 2. Oesterreichische Nationalbank-2004, Guidelines on credit risk management-Rating models and validation , Vienna, Austria 3. BI, DBOD.No.BP,2011, Implementation of the Internal Rating Based Approaches (IRB) for Calculation of Capital Charge for Credit Risk - Draft Guidelines-RBI

4. Reserve Bank of India, DBOD.No.BP.1163,2005, Prudential Guidelines on Capital Adequacy- Implementation of the New Capital Adequacy Framework 5. Report of the Committee on Comprehensive Regulation for Credit Rating Agencies, 2009, Ministry of Finance, Capital Market Division,India. 6. Satish B Mathur, 2002, Working capital managaement and control, New Age International Publishers.

46

Appendix I
Balance Sheet-Assets
PARTICULARS Audite d 31.03.0 9 1.65 0.00 Audited 31.03.1 0 2.43 0.00 Audited 31.03.1 1 6.25 0.00 Estimates 31.03.12 8.90 0.00 Projectio ns 31.03.13 12.03 0.00

1 2

LIABILITIES Share Capital Share application money Reserves and Surplus (Excl. Revaluation Reserve) Shareholders' Fund (A) Preference share capital Debentures Term Deposits from public Income Tax Deferred Appropriation Term loan from banks/FI Loan from Directors/relatives Other Term Liabilities (sales tax deferment) Total term liabilities (B) Current Liabilities Short term borrowings from bank (incl.WCDL) Borrowing from bank by way of bills purchsed/discounted

1.65

2.43

6.25

8.90

12.03

3 4 5 6 7 8 9

0.25 2.68 0.00 2.93 0.88

0.21 1.06 0.00 1.27 4.58

1.90 0.09 0.00 1.99 2.86

8.01 0.15 0.00 8.16 7.00

15.00 0.15 0.00 15.15 7.00

10 11

47

12 13 14 15 16 17 18 19 20 21 22

Working Capital Term Loan Sundry Creditors (Trade) Sundry Creditors for expenses Advances/Progress payments from customers Unsecured borrowings from others Deposits maturing within 1 year Interest and other charges accrued but not due Provision for taxation (Net) Customers Deposits Other statutory Liabilities Other current liabilities/provisions Total Current Liabilities (C) Total Liabilities ( A + B + C)

0.35 0.01 3.33

0.20 0.03 0.94

0.34 0.00 12.15

0.46

0.48

7.75

14.00

1.41

3.22

0.00

0.75 0.12

0.84 0.13

5.98 10.56

8.97 12.67

15.35 23.59

16.08 33.14

22.45 49.63

Appendix-I (Contd.)
Balance Sheet-Liabilities
S.NO PARTICULARS Current Assets Cash and bank Balances Investments a) Govt/Other trusty securities b) Fixed Deposits with banks Quoted Investments Receivables a) Outstanding below 6 months b) Outstanding above 6 months Inventory a) Raw material - Indigenous b) Raw material - Imported c) Stores and spares d) Stock/Work in Process e) Finished Goods Advances recoverable in cash or kind Advances to suppliers Advance to Income tax (Net) Other Current Assets Total Current Assets (D) Audited 31.03.09 0.10 Audited 31.03.10 0.11 Audited 31.03.11 0.61 Estimates 31.03.12 0.62 Projections 31.03.13 0.63

1 2

3 4

0.19

0.17

0.12

1.58

1.41

6.95 0.73 0.10 0.02 0.01 8.10

4.22 0.45 4.96 0.03 0.09 10.03

13.50 1.91 4.09 0.07 0.69 20.99

22.32 0.00 5.33 0.75 0.00 30.60

40.43 0.00 3.82 0.84 0.00 47.13

6 7 8 9

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10 11 12

13 14 15 16 17

18 19 20

Fixed Assets Gross Block (Less Revaluation) Less: Depreciation Add: Capital Work in Progress Net Fixed Assets (E) Non Current Assets Investments in subsidiaries/affiliates Other Investment Margin on DPGs Adv to suppliers of capital goods Others/Miscellaneous Assets Total Non Current Assets (F) Intangible Assets Miscellaneous Expenditure Deffered revenue expenditure Accumulated Losses Total Intangible Assets (G) Total Assets ( D + E + F +G )

0.32 0.04 0.28

0.51 0.05 0.46

0.48 0.06 0.42

0.53 0.17 0.36

0.53 0.21 0.32

2.18

2.18

2.18

2.18

2.18

2.18

2.18

2.18

2.18

2.18

0.00 10.56

0.00 12.67

0.00 23.59

0.00 33.14

0.00 49.63

Appendix II
DSCR Calculations
Mar-11 provisional net profit after tax Depreciation interest on Andhra Bank SOD Interest on Term loan 1 Interest on Term loan 2 Interest paidothers Interest paid on LIC HFL loan (A) interest on Andhra Bank SOD Interest on term loan 1 Interest on term loan 2 26.56 6.5 Mar-12 estimates 167.84 5.81 Mar-13 estimates 188.27 3.6 Mar-14 estimates 297.97 115.46 Mar-15 estimates 437.9 103.92 Mar-16 estimates 530.57 93.53 Mar-17 estimates 540.83 84.17 Mar-18 estimates 583.99 75.76 Mar-19 estimates 614.69 68.18

10.55

112.86 42.5

120.75 120 76.25

120.75 113.72 104.55 2.7

120.75 81.43 99.7 2.7

120.75 41.47 90.37 2.7

120.75 3.67 71.62 2.7

120.75

120.75

43.88 2.7

7.28 2.7

6.02

2.36

2.7

26.36 75.99

10.2 341.57 511.57 755.15 846.4 879.39 823.74 827.08 813.6

10.55 0 0

112.86 42.5 0

120.75 120 76.25

120.75 113.72 104.55

120.75 81.43 99.7

120.75 41.47 90.37

120.75 3.67 71.62

120.75 0 43.88

120.75 0 7.28

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Interest paidothers Interest paid on LIC hfl loan Repayment of term loan 1 Repayment of term loan 2 (B) DSCR ratio

6.02

2.36

2.7

2.7

2.7

2.7

2.7

2.7

2.7

26.36

10.2

0 146.28 10.45

0 248.57 45.31 598.46 1.41

0 288.53 76.87 620.69 1.42

0 116.62 159.76 475.12 1.73

0 0 220.08 387.41 2.13

0 0 187.53 318.26 2.56

42.93 1.77

167.92 2.03

319.7 1.60

498.45 1.51

Appendix-III
Cash Flow Deficit Cash budget Opening cash balance Add: Cash inflows Other receipts Flat advances Total inflow Less: payments Secured loans repaid Purchase of material & labour payments Apr May -11 -11 700. -450 93 Jun11 700. 63 Jul11 700. 31 Aug Sep- Oct-11 11 11 700. 700. 700. 14 24 57 Nov -11 700. 16 Dec -11 700. 12 Jan- Feb12 12 700. 700. 15 27 Mar -12 700. 49

1.18 25 423. 82

1.18 95 604. 75

1.18 105 594. 45

1.18 146 553. 13

1.18 170 528. 96

1.18 205 494. 06

1.18 240 459. 39

1.18 265 433. 98

1.18 280 418. 94

1.24 315 383. 91

1.24 325 374. 03

1.24 330 369. 25

0.8

0.5

0.5

0.3

0.3

0.3

0.3

0.3

0.3

0.3

0.3

0.3

245

64

73

114

138

173

207

232

251

305

315

320
50

SOD interest Others Total outflow

10.0 6 21.2 5 277. 11 700. 93

10.0 6 21.3 2 95.8 8 700. 63

10.0 6 22.3 105. 86 700. 31

10.0 6 22.6 5 147. 01 700. 14

10.0 6 22.9 2 171. 28 700. 24

10.0 6 23.1 5 206. 51 700. 57

10.0 6 23.4 1 240. 77 700. 16

10.0 6 23.7 8 266. 14 700. 12

10.0 6 19.8 5 281. 21 700. 15

10.0 6 1 316. 36 700. 27

10.0 6 1.1 326. 46 700. 49

10.0 6 1.25 331. 61 700. 86

Surplus/ Deficit

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Glossary of abbreviations
CA: Current Assets CIBIL: Credit Information Bureau (India) Limited CRM: Credit risk management CRAS: Credit rating assessment system CRRM: Credit risk rating model DSCR: Debt Service Coverage Ratio ECGC: Export credit guarantee corporation of India FACR: Fixed Asset Coverage Ratio FI: Financial Institution HO: Head office LC: Letter of credit LGD: Loss given default: MPBF: Maximum permissible bank finance NWC: Net working capital PD: Probability of default RBI: Reserve bank of India SAL: Specific approval list SOD: Secured over draft TL: Term loan

52