A PRESENTATION ON TERM LOANSUBMITTED BY1 Prashant2 Sidharth3 Rounak4 Yogesh5 Rahul6 John Sachin7 Rakshith
CONTENTS INTRODUCTION INDIAN SCENAIRO OF TERM LOAN CHARACTERISTICS OF TERM LOANS ADVANTAGES & DISAVANTAGES OF TERM LOANS THE TERM LOAN CAN BE AVAILED BENEFITS OF TERM LOAN SPECIALIZED FINANCIAL INSTITUTIONS IN INDIA PURPOSE OF TERM LOAN 2
INTRODUCTIONDebt capital of a company may consist of either debentures orbonds which are issued to public for subscription or term loanswhich are obtained directly from the banks and financialinstitution. Term loans are sources of long term debt. In India,they are generally obtained for financing large expansion,modernisation or diversification projects. Therefore, this methodof financing is also called project financing.
The repayment of the loans and facilities is normally fixed on case to case basis depending on projected cash flow of the borrower. Term loans are a good way of quickly increasing capital in order to raise a business’ supply capabilities or range. One thing to consider when getting a term loan is whether the interest rate is fixed or floating
Indian scenario of term loan1. India has 2 tire structure of financial institution comprised of A.Indian financial institution -Term lending -specialize institution - Invest institution B. State level institution -corporations providing -other term lending facilities2. Since independence there are not that many changes3. Few operation & restrictions.4. After liberalization.5. Change must be done because of default in repayment. 7
Example of term loan in India (Bank of Baroda)SME Short Term LoansPURPOSE: To meet temporary shortfall / mismatch in liquidity, for meeting genuine business requirements only.ENTERPRISES GROUP: Micro, Small & Medium Enterprises as per Regulatory definition and all other entities with annual sales turnover of Rs. 1/- crore to Rs. 150/- crores.ELIGIBILITY CRITERIA Satisfactory credit rating for the last three years Latest Balance Sheet etc. should be available. Satisfactory financial performance in terms of sales / turnover and profits. Negative variance, if any, should not be more than 10%. Satisfactory dealings with the Bank for at least three years. 8
LOAN AMOUNT: Upto 25% of the existing Fund based Working capital limits (depending on the Credit Rating), subject to a minimum of Rs. 10 Lakhs and maximum of Rs. 250 Lakhs.PERIOD: Not exceeding 180 days – minimum 90 daysSECURITY First charge / Equitable mortgage of fixed assets of the company / firm or extension of existing first charge / equitable mortgage of fixed assets, ensuring that there is a minimum asset cover of 1.25. Extension of Charge on current assets for the additional facility ensuring that adequate drawing power is available. Extension of all existing guarantees of Directors / Third party guarantees to cover the additional facility.RATE OF INTEREST: As applicable to existing working capital facilities. PROCESSING CHARGES: 25% concession in applicable charges. 9
CHARACTERISTICS OF TERM LOANS Time to maturity Interest. Security Repayment Schedule.
Time to maturityBanks and specially created financial institutions are main source of term loansin India. FIs provide term loans generally for a period of 6 to 10 years InterestThe general rate of interest on term loans in India is above 14 or 15 %. Forcompanies undertaking their projects in specified backward areas, loans atconcessional interest rate (usually 1 and half % lower)
SecurityTerm loans are always secured. Specifically the assets acquired using term loan fundssecure them. This is called Primary security. The company’s current and future assetsalso generally secure term loans. This is called secondary security or collateral security.Also the lender may create either fixed or floating charge against the firm’s assets.
Repayment Schedule The principal amount of a term loan is generally repayable over a period of 4 to 7 years. Typically, term loans provided by financial institutions are repayable in equal semi-annual instalments or equal quarterly instalments The interest burden declines over time, whereas the principal repayment remains constant. This means that the total debt servicing burden (consisting of interest payment and principal repayment) decline sover time. This pattern of debt servicing burden, typical in India, differs from the pattern obtaining in western economies where debt is typically amortized in equal periodic instalments
QUESTIONSuppose a company negotiates a RS 3 crore loan for 8 yrs. from FIs. The interest ratewill be 14 % annum on the outstanding balance. The principal will be repaid in 8 equalyr. - end instalments . What is the payment schedule?Solution –the payment schedule will include both interest and principal payment.Interest will be calculated on the outstanding balance on loan. Note that Rs 3 crore wasborrowed in the beginning of 1st yr. therefore, the interest charges at the end of the yr.will be1. Interest is 14% 0.14x3=Rs 0.42 crore.2 Instalments 8 yrs.3/8= Rs 0.375 crore.Thus, loan balance at the end of 1st yrs. Will be 3.0-0.375= Rs 2.62 15
Advantages & Disadvantages of Term LoansTerm loans provide you with the money you need, but they have some risks.Banks routinely offer various types of loans that cover the cost of whatever a person or business needs.One type of loan a company or individual may consider is a term loan. A term loan is a loan in which theborrower pays interest only for a set period. These loans have both advantages and disadvantages thatthe lender needs to weigh before signing any paperwork and committing to the loan agreement.FlexibilityTerm loans are more flexible when compared to other types of loans. With a term loan, the borrowerdoesnt have to make a payment toward both the interest and the principal balance. He can do so if it isfinancially feasible, but it isnt required. Thus, a term loan better accommodates changes to a personsbudget due to unexpected life or business changes.InterestTerm loans usually have a fixed interest rate, but this is not always the case and depends on the type ofthe bank. If a term loan does have a fixed interest rate, then the term loan is extremely beneficial to theborrower because it lets the borrower predict the payment theyll need to make. This is good forbudgeting. Term loans that have unfixed interest rates still can be advantageous, but they are riskierbecause the borrower has no real control over how much interest they will pay in the future. This cantranslate into more money paid toward the loan in the long run. 18
Penalty AgreementsEugene F. Brigham and Louis C. Gapenski, authors of "Test Bank: Financial Management: Theory andPractice," claim that the agreements for term loans often contain penalty clauses. These clauses give theissuing bank the right to issue additional charges if the borrower is late or deficient in payments. Sincepeople who take out term loans generally do so because they cannot afford a regular loan, this is notdesirable.PredictabilityA term loan specifies when the interest on a loan will be completely paid. For example, a five-year termloan will have the interest paid predictably in five years. This is different from a regular loan in whichaccumulated interest may draw out the payoff date. This can be extremely beneficial for budgeting andreceipt of future loans, since an individual has some proof that her debt will be repaid within a givenperiod.Assumption of AssetsTerm loans work by having the principal balance come due in full once the interest is completely paid.Therefore, people generally use a term loan to get the capital they need to generate additional funds thatwill pay off the loan. However, that a borrowers venture will succeed and that they can generate theprincipal amount is not guaranteed. If a person cannot generate the principal with the loan funds, thenthey have to figure out how to repay a large amount of money very quickly. 19
The term Loan can be availed toPurchase of Fixed AssetsThe term loan can be used to purchase fixed assets like premises, plant & machineryetc. The usage or performance of assets increases the business performance andhence the profit and makes the repayment of the loan easier. Even the term loan issettled the assets procured continue the productivity as asset life span is certainly longerthan the term loan span. If a premises is purchased then the value of premises is alwaysappreciated and in that case the business leverages higher value of premises whichfurther can be used to raise funds for business expansion or diversification.
Mortgage Term LoanA Term Loan can be availed by mortgaging a kind of security like home, office premisesetc. This type of loan is borrowed for longer period of time that is 10, 15 or 20 years. Therepayment of the principal amount and interest may be fixed in nature or it may varyover the course of repayment. The borrower may avail the revised rate of interest laterand may be benefited by saving in interest.
Switching of Higher Interest LoansMany a time’s business owners opt to raise business loans at higher rate of interest.Such loans are processes and sanctioned faster but result in heavy burden interest. Thisinterest payment becomes a fixed monthly expenses and starts leaking the profit. Toarrest the growing rate of interest and penalties the higher interest loan can be switchedto lower rate of interest loans or term loans. This way a borrower reduces the growingburden of interest on business loan and can save a considerable amount of money. Italso benefits in maintaining the credit rating as the borrower closes one loan liability andopens another in form of term loan with lower rate of interest and easier repaymentconditions
BENEFITS OF TERM LOAN Fixed rate - Enjoy the peace of mind of fixed monthly repayments. Variable rate - linked to base rates (Rates can rise or fall). Repayment holidays - Improve your cash flow by making no loan repayments or repaying only interest for a fixed term after drawing down your loan.
Specialized Financial Institutions in IndiaCommercial banks offer a wide range of corporate financial services that address thespecific needs of private enterprise. They provide deposit, loan and trading facilities butwill not service investment activities in financial markets.The list of specialized financial institutions in India mainly includes, IFCI, IDBI Bank,Export-Import Bank Of India, Board for Industrial & Financial Reconstruction, SmallIndustries Development Bank of India, National Housing Bank. They are governmentundertakings established with a view to offer financial as well as technical assistance tothe Indian industries.
PURPOSE OF TERM LOAN Term Loan is sanctioned for acquiring Fixed Assets like, land, building, Plant & Machineries, Electrical installations , computers, furniture-fixtures etc. in connection with a project undertaken by the proponent.The various types of projects can be broadly classified as under : 1.New products , Diversification projects by existing units (Green Field) 2.Expansion of existing products (Brown Field) 3.Backward & forward integration projects 4.Replacement/ Modernization of equipment or buildings 5.Others viz., Research and development and miscellaneous items, such as the expenditure of funds to comply with certain health standards or the acquisition of a pollution-control device. 29