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Project financing is an innovative and timely financing technique that has been used on
many high-profile corporate projects, including Euro Disneyland and the Eurotunnel.
Employing a carefully engineered financing mix, it has long been used to fund large-scale
natural resource projects, from pipelines and refineries to electric-generating facilities
and hydro-electric projects. Increasingly, project financing is emerging as the preferred
alternative to conventional methods of financing infrastructure and other large-scale
projects worldwide.
Project Financing discipline includes understanding the rationale for project financing,
how to prepare the financial plan, assess the risks, design the financing mix, and raise the
funds. In addition, one must understand the cogent analyses of why some project
financing plans have succeeded while others have failed. A knowledge-base is required
regarding the design of contractual arrangements to support project financing; issues for
the host government legislative provisions, public/private infrastructure partnerships,
public/private financing structures; credit requirements of lenders, and how to determine
the project's borrowing capacity; how to analyze cash flow projections and use them to
measure expected rates of return; tax and accounting considerations; and analytical
techniques to validate the project's feasibility
Project finance is different from traditional forms of finance because the credit risk
associated with the borrower is not as important as in an ordinary loan transaction; what
is most important is the identification, analysis, allocation and management of every risk
associated with the project.
The purpose of this project is to explain, in a brief and general way, the manner in which
risks are approached by financiers in a project finance transaction. Such risk
minimization lies at the heart of project finance.
In a no recourse or limited recourse project financing, the risks for a financier are great.
Since the loan can only be repaid when the project is operational, if a major part of the
project fails, the financiers are likely to lose a substantial amount of money. The assets
that remain are usually highly specialized and possibly in a remote location. If saleable,
they may have little value outside the project. Therefore, it is not surprising that
financiers, and their advisers, go to substantial efforts to ensure that the risks associated
with the project are reduced or eliminated as far as possible. It is also not surprising that
because of the risks involved, the cost of such finance is generally higher and it is more
time consuming for such finance to be provided.
Project finance is the financing of long-term infrastaructure and industrial projects based
upon a complex financial structure where project debt and equity are used to finance the
project. Usually, a project financing scheme involves a number of equity investors,
known as sponsors, as well as a syndicate of banks which provide loans to the operation.
The loans are most commonly non-recourse loans, which are secured by the project itself
and paid entirely from its cash flow, rather than from the general assets or
creditworthiness of the project sponsors. The financing is typically secured by all of the
project assets, including the revenue-producing contracts. Project lenders are given a lien
on all of these assets, and are able to assume control of a project if the project company
has difficulties complying with the loan terms.
Generally, a special purpose entity is created for each project, thereby shielding other
assets owned by a project sponsor from the detrimental effects of a project failure. As a
special purpose entity, the project company has no assets other than the project. Capital
contribution commitments by the owners of the project company are sometimes
necessary to ensure that the project is financially sound. Project finance is often more
complicated than alternative financing methods. It is most commonly used in the mining,
transportation, telecommunication and public utility industries.
Risk identification and allocation is a key component of project finance. A project may be
subject to a number of technical, environmental, economic and political risks, particularly
in developing countries and emerging markets. Financial institutions and project sponsors
may conclude that the risks inherent in project development and operation are
unacceptable (unfinanceable). To cope with these risks, project sponsors in these
industries (such as power plants or railway lines) are generally completed by a number of
specialist companies operating in a contractual network with each other that allocates risk
in a way that allows financing to take place. The various patterns of implementation are
sometimes referred to as "project delivery methods." The financing of these projects must
also be distributed among multiple parties, so as to distribute the risk associated with the
project while simultaneously ensuring profits for each party involved.
Chap 2: AN OVERVIEW
2.1 Banking Sector
There have been major structural changes in the financial sector since banking sector
reforms were introduced in India in 1992. Since then Banks have been lending
aggressively providing funds towards infrastructure sector. Major policy measures
include phased reductions in statutory pre-emption like cash reserve and statutory
liquidity requirements and deregulation of interest rates on deposits and lending, except
for a select segment. The diversification of ownership of banking institutions is yet
another feature which has enabled private shareholding in the public sector banks,
through listing on the stock exchanges, arising from dilution of the Government
ownership. Foreign direct investment in the private sector banks is now allowed up to 74
per cent.
The co-existence of the public sector, private sector and the foreign banks has generated
competition in the banking sector leading to a significant improvement in efficiency and
customer service. The share of private and foreign banks in total assets increased to 31.5
per cent at end-March 2007 from 27.6 per cent at end-March 2006 and less than 10.0 per
cent at the inception of reforms.
The nationalized banks have more branches than any other types of banks in
India. Now there are about 33,627 Branches in India, as on March 2005.
India's retail-banking assets are expected to grow at the rate of 18% a year over
the next four years (2006-2010).
Retail loan to drive the growth of retail banking in future. Housing loan account
for major chunk of retail loan.
banking with the Core Banking branches of the Bank. In addition to regular banking
facilities, today customer can also avail variety of value added services like cash
management service, insurance, mutual funds, Demat from the bank. Today there are
more than 26,000 employees in Union Bank of India.
UBI has been ranked at 5th position among the nationalized bank in India.
Overview on banks deposits and advances
Items
2003-04
2004-05
2005-06
2006-07 2007-08
Deposits
Investments
Advances
2.2.1
Offering credit is an operation fraught with risk. Before offering credit to an organization,
its financial health must be analyzed. Credit should be disbursed only after ascertaining
satisfactory financial performance. Based on the financial health of an organization,
banks assign credit ratings. These credit ratings are used to fix the interest rate and
quantum of installment.
This study aims to analyze the credit health of organizations that approach Union Bank of
India for foreign exchange credit facilities. After analyzing credit health, the credit rating
is determined. On the basis of credit rating, the interest rate guidelines circular is
consulted to fix a price for the credit facilities i.e. determine the interest rate.
2.2.2
This project was undertaken at the Industrial Finance Branch of Union Bank of India, at
the Credit Department. Financial requirements for Project Finance and Working Capital
purposes are taken care of at the Credit Department. Companies that intend to seek credit
facilities approach the bank. Primarily, credit is required for following purposes:1. Working capital finance
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To assess the financial health of organizations that approach Union Bank of India for
credit for import export purposes. This would entail undertaking of the following
procedures:
To assess the suitability of the company for disbursement of credit. This would involve
the following actions:
Determination of interest rate: This would entail the following sequence of actions.
Choosing the interest rate from the circular on the basis of financial health and credit
rating
If not approved
if approved
Preparation of proposal
Project Rejected
If queries raised
Communication of Sanction
Terms & Condition
Acknowledgement of Sanction
Terms & Condition
Application to comply with
Sanction Terms & Condition &
execution of Loan Documents
Disbursement
Outline the general business model (ie. how the business will make money).
Specify the time horizon from the time the project is initiated until it is up and
running at capacity.
MARKET FEASIBILITY
Industry description.
Describes the size and scope of the industry, market and/or market segment(s).
Estimates the future direction of the industry, market and/or market segment(s).
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Describes the nature of the industry, market and/or market segment(s) (stable or
going through rapid change and restructuring).
Industry Competitiveness.
Determines
concentration
and
competitiveness
of
input
suppliers
and
product/service buyers.
Market Potential.
Identifies the demand and usage trends of the market or market segment in which
the proposed product or service will participate.
Assesses estimated market usage and potential share of the market or market
segment.
Sales Projection.
Identifies and assess the accuracy of the underlying assumptions in the sales
projection.
Projects sales under various assumptions (ie. selling prices, services provided).
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Identifies the potential buyers of the product/service and the associated marketing
costs.
Outline alternative business model(s) (how the business will make money).
Identify availability of consultants and service providers with the skills needed to
realize the project, including legal, accounting, industry experts, etc.
Managerial Personnel
Managerial Personnel play a key role in directing the working of the company. It is
important for an organisation to have a pool of eficient personnel who bear the capacity
to bail the company out from crisis situation and work towards optimum utlisation of
organisational resources. Such capacity of the personnel can be determined by having
complete details on following key aspects:
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Ability of the promoters / management to bail out the company in case of crisis (for
Is any group company in default / Any Directors on RBIs negative list / Borrowers
track-record in honouring financial commitment
Length of relationship with the bank
TECHNICAL FEASIBILITY
Technology plays an important role in maintaining a competitive position in this highly
competitive market conditions. Investing in the proper technology is the key to success it
irrespective of size of business thus for achieving its projected performance, it is
important for it to have sound technological background. Such technical competence of
the project can be determined by having detailed study done on following key aspects:
Determining Facility Needs.
Access to markets.
Access to transportation.
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Raw materials.
Investigates the current and future availability and access to raw materials.
Assesses the quality and cost of raw materials and markets of easily substituted
inputs.
Other inputs.
Investigates the availability of labor including wage rates, skill level, etc.
FINANCIAL FEASIBILITY
Estimate the total capital requirements.
Assesses the capital needs of the business project and how these needs will be
met.
Estimates start-up capital needs until revenues are realized at full capacity.
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Estimates
contingency
capital
needs
(construction
delays,
technology
Identifies and assess alternative credit sources -- banks, government (ie. direct
loans or loan guarantees), grants, local and state economic development incentives.
Assesses expected financing needs and alternative sources -- interest rates, terms,
conditions, covenants, liens, etc.
Estimates the returns under various production, price and sales levels. This may
involve identifying "best case", "typical", and "worst case" scenarios or more
sophisticated analysis like a Monte Carlo simulation.
Identifies project an expected income statement, balance sheet, etc. when reaching
full operation.
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Study Conclusions
The study conclusions contain the information you will use for deciding whether to
proceed business. The major categories this section should include are:
Compare and contrast the alternatives based on the goals of the producer group.
Next Step
After the feasibility study has been completed and presented, a carefully study and
analysis the conclusions and underlying assumptions. Next, you will be faced with
deciding which course of action to pursue.
Potential courses of action include:
Deciding that a viable business opportunity is not available and moving to end the
business assessment process.
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Financial Risk
Management Risk
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It is aslo important for the lender bank to assess the firms debt paying capacity over a
period. Such capacity is derived by calculating ratio like Debt Serice Coverage Ratio
minimum acceptable level is 1.50.
It also necessary for the lender to determine the ability of the firm to achieve the
projected growth by evaluating the projected sales with actuals.However such parameter
remains non applicable if the business is new.
Finacial risk evaluation is oly one of the parameter and not thje only parameter for
determining the risk level. It is important to evaluate the Management Risk also while
evaluating the risk relaing to borrower.
It is the management of the company that acts as guiding force for the firm. The key
managerial personnel should bear the capacity to bail out the company frm crisis
situation. Inorder to remain competitive it is essential to take initiatives. Such skills are
developed over years of experience, thus for better performance it is required to have a
team of well qualified and expirienced personnel.
2) Market potential / Demand Situation
A Company does not operate in isolation there are various market forces that acts in
either favourable or unfavraouble manner towards its performance. Thus the rating would
not give true picture if does take market or demand situation in consideration.
The demand supply situation / market Potential plays an important role in determining
the growth level of the company like
i) Level of competition : monolpoly , favourable , unfavourable
ii) seasonality in demand : affected by short term seasonality, long term seasonality or
may not be affected by seasonality in demand.
iii)Raw Material Availablity:
iv)Locational Issues like proximity to market,
neutral, unfavourable.
v)Technology ie, proven Technology- not to be changed in immeditate future, technology
undergo change, outdated technolgy.
vi)Capacity utilisation
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CR- 9
In UBI, a business receiving Credit Rating above level 6 are not considered good from
point of investment and thus are avoided.
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Good Client
The organization is a long term client and brings good business to the bank.
The organizations actions show that it intends to become a long term customer of
the bank
Banking Consortium
The organization is seeking credit from a consortium of banks. In some cases like
this, the lead bank might decide the interest rate and all the member banks of the
consortium follow this interest rate.
Account Details
Financial highlights for immediate previous two audited years and projection for
proceeding year
Nature of Project
Cost of Project
Means of finace
1. Nature of Facility
2. Purpose
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Door to Door Tenor ie.the period within which the entire amount I sto be
disbursed.
o Repayment Terms
o Prime Security
o Collateral Security
o Upfront fees ie the charges levied by the bank for processing the
documents.
3.5 PROPOSAL
An approved term sheet leads to preparation proposal. A proposal is prepared in standard
format, this enables the bank to keep a proper track record and also facilitates proper
comparision. A proposal a full fledged document providing details on project submitted
and requesting finance from bank. A proposal contains information on following aspects:
* Securities:Lenders often feel more confident about a loan if they are given a security
interest in the assets of a business. Then, if the borrower does not repay the loan as
promised, the lender can take the property the borrower pledged, sell it and use the
proceeds to repay (or partially repay) the borrowed amount.it provides detailed
information on nature of securities given in lieu of the Loan.they are of two types Prime
securities, Collateral Secuties
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Prime Securities: Pari Passu is a term used in banking transactions which means that the
charge to be created is in continuation of an earlier charge which might be held by the
same institution or by an other institution.
Collateral Securities: In lending agreements, collateral is a borrower's asset that is
forfeited to the lender if the borrower is insolvent --- that is, unable to pay back the
principal and interest on the loan. When insolvent, the borrower is said to default on the
loan, in which case the lender becomes the owner of the collateral. It includes details on
Value in Rupees.
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* Evaluation of Industry :
This Section gives brief details on the
1. Scope of the industry
2. Growth level and overall performance of the industry
3. Recent Developments and Trend Evaluation
Financial Statements
CMA Data
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Percentage of share for the fund based and non Fund based Limits
Amount in Rs.
Non Fund based credit are in form of gaurantees like Letter of Credit (L/c), Letter of
gaurantee (L/g)
Letter of Credit
A Letter of credit also known as documentary credit is the most commonly accepted
instrument of settling international trade payments. A letter of credit is an arrangement
whereby a bank, acting at the request of a customer, undertakes to pay a third party by a
given date, on documents being presented in compliance with the conditions laid down.
Letter of Guarantee
A letter from a bank stating that a customer owns a particular security and that the bank
will guarantee delivery of the security. A letter of guarantee is used by an investor who is
writing call options when the underlying stock is not in his or her brokerage account. A
Call Option is an agreement that gives an investor the right (but not the obligation) to buy
a stock, bond, commodity, or other instrument at a specified price within a specific time
period.
Financial Guarantee:
A non-cancelable indemnity bond guaranteeing the timely payment of principal and
interest due on securities by the maturity date. If the issuer defaults, the insurer will
pay a fixed sum of money to holders of the securities. Financial guarantees are
similar to a Standby Letter of Credit, but are issued by an insurance company. A
Standby Letter of Credit is a form of insurance on an underlying agreement or
obligation (contract), insuring all parties to the contract against failure to perform or
pay on the part of one or another party to the contract. Standbys are issued by banks.
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3.6 DISBURSEMENT:
After submission Proposal to Designated/ Sanctioning Authortiy for sanctioning the Term
Loan. the authorities may raise querries, if any relating to projects and thereby convey it
to the processing officer the processing officer inturn addresses them to the borrower for
necessary step to be taken, such querries are required to be solved to the earliest by the
applicant for further proceesing of the proposal.
If the authoritiees are satisfied and have no further querries with respect to proposal,the
Loan gets sanctioned and the disbursement would be released in as per the terms
decided.
3.7 FOLLOW-UP:
This is most cruicial stage in process of term loan assesment. Since amount of credit
required is usually high, such amounts are disbursed in one installment, they are paid in
installments.this helps the lender bank to understand and assess the utilisation of funds
disbursed by the lender Bank. Such evualtion is done by obtaining Lenders Engineer
Report, it is report that provides complete details of the status of the project. It is prepared
on monthly basis. It also provides CA Report, it verifies the Finacial details furnished to
bank for further disbursement.this is known as renewal of account.
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