Module 2 - The Appraisal Process

Objectives
On completion of this module, you will be able to:
Describe the appraisal process
List the steps performed in the preliminary and detailed appraisal processes
Create detailed appraisal, inter-firm comparison etc.
Identify the present relationship with the Bank
Determine credit risk rating
Review the draft proposal
Prepare the final proposal for sanction

Overview to Appraisal
As the name indicates, Appraisal is a process that determines the value of the proposal
submitted by a Borrower for credit. The Appraisal process consists of the following stages:
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Preliminary Appraisal
Detailed Appraisal
Present relationship with the Bank
Credit Risk Rating
Opinion Reports
Existing Charges on assets of the unit
Structure of facilities and Terms of Sanction
Review of the proposal
Proposal for sanction
Assistance to Assessment

Preliminary Appraisal Prima Facie Acceptability

In order to establish the prima facie acceptability of a proposal, the Branch should examine
the following aspects:
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Banks lending policy and other relevant RBI guidelines

Prudential exposure norms
Industry exposure restrictions
Group exposure restrictions
Industry-related risk factors
Credit Risk Rating
Profile of the promoters / senior management personnel
RBIs list of defaulters
Caution lists
Acceptability of the promoters
Compliance regarding transfer of Borrower accounts from one bank to another, if
applicable [Takeover Norms]
Government regulations/ legislation impacting on the industry

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Applicants status vis--vis other units in the industry

Financial status in broad terms and whether it is acceptable
MA and AA of the company

Preliminary Appraisal

In case the proposal is obtained for Project Finance, Branches need to examine the
following, in addition to the aspects discussed on the previous screen:
o The Branches need to evaluate whether the project cost is prima facie acceptable.
o The Debt/equity gearing proposed; whether it is acceptable.
o Promoters ability to access capital market for Debt/Equity support.
o Whether critical aspects of the project Demand, Cost of Production, Profitability,
etc. are prima facie in order.
After analysing the above aspects of the proposal, the Branch will arrive at a decision as to
whether to support the request or not.
Preliminary Appraisal

In case the Branch finds the proposal acceptable, it will call for a fully comprehensive
application in the prescribed proforma from the applicant.
In addition a copy of the proposal/ project report, covering specific credit requirement of the
Company and other essential data/ information is required. The other essential data include
the following:

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Organizational set-up with a list of Board of Directors

Demand and supply projections along with a copy of the market survey report
Current practices for the particular product/ service
Estimates of sales, Cost of Production and Profitability
Projected Profit and Loss Account and Balance Sheet for the operating years
during the currency of the Bank assistance
If the request includes project financing, Branch should obtain additionally (i)
Appraisal report from FIs in case they have done appraisal; (ii) NOC from term
lenders if already financed by them and (iii) Report from Merchant Bankers in case
capital market is being accessed, wherever necessary.

In addition in respect of existing concerns, particulars regarding the history of the concern,
its past performance, present financial position, etc. should also be evaluated.
This data/ information should be supplemented by the following supporting documents:
o Audited Profit and Loss Account and Balance Sheet for the past 3 years
o Details of existing borrowing agreements, if any
o Credit information reports from the existing bankers on the applicant company
o Financial statements and borrowing relationship of Associate/ Group companies
The evaluation of all the aspects discussed till now constitutes the Preliminary Appraisal
stage. After the Preliminary Appraisal stage, the next stage is Detailed Appraisal.

Detailed Appraisal

After a pre-sanction inspection of the project site or factory in the case of existing units, the
Branch may take up the Detailed Appraisal exercise using the appropriate format. The
following aspects should be evaluated in Detailed Appraisal stage:
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The viability of a project should be examined to ascertain that the company would
have the ability to service its loan and interest obligations out of cash accruals from
the business.
While appraising a project or a loan proposal, nothing should be taken for granted.
All the data/ information should be checked and wherever possible counter checked
through inter-firm and inter-industry comparisons.
Summarise the conclusions of the financial analysis carried out on the basis of the
Companys Audited Financials for the last 3 years.
The method of depreciation followed by the company SLM, WDV Method or any
other method and whether the Company has changed the method of depreciation in
the past and, if so, the reason thereof
Whether the Company has revalued any of its FA any time in the past and the
present status of the Revaluation Reserve, if any, created for the purpose
Record of major defaults, if any, in repayment in the past and history of past
sickness, if any
The position regarding the Companys tax assessment whether the provisions
made in the Balance Sheets are adequate to take care of the Companys tax
liabilities
The nature and purpose of Contingent Liabilities, together with comments thereon
Pending suits by or against the Company and their financial implications
Qualified/ adverse remarks, if any, made by the Statutory Auditors on the
Companys accounts

Following aspects should be commented upon while making a Detailed Appraisal:

o Dividend policy
o Apart from financial ratios, other ratios relevant to the project
o Trends in sales and profitability, past deviations in sales and profit projections and
estimates/ projections of sales values
o Production capacity and use, past and projected
o Estimated Working Capital Gap with reference to acceptable build-up of Inventory/
Receivables/ Other Current Assets
o Projected levels whether acceptable
o Compliance with lending norms and other mandatory guidelines as applicable
o Assess ABF/ MPBF and determine FB facilities required
o Assess requirements of NFB (Off-B/S) credit facilities

Detailed Appraisal Project Financing

In case the proposal involves Project Financing, examine the commercial, economic and
financial viability and other aspects as listed below:
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Statutory clearances from various Government Departments/ Agencies

Licenses/ permits/ approvals/ clearances/ NOCs/ Collaboration Agreements, as
applicable
Details of sourcing of energy requirements, power, fuel, etc.
Pollution control clearance
Cost of Project and Means of Finance
Build-up of FA (requirement of funds for investment in FA to be critically examined
with regard to production factors, improvement in quality of products, economies of
scale, etc.)
Arrangements proposed for raising Debt and Equity
Capital structure (Position of Authorised, Issued/ Paid-up Capital. Redeemable
Preference Shares, etc.)
Debt component i.e. Debentures, Term Loans, DPGs, Unsecured Loans, deposits
etc.
It should always be borne in mind that all Unsecured Loans/ Deposits raised by the
Company for financing a project should always be subordinate to the Term Loans of
the Bank/ FIs and should be permitted to be repaid only with the prior approval of
all the banks/FIs concerned
Where Central of State Sales Tax loan or developmental loan is taken as source of
financing the project, furnish details of the Terms and Conditions governing the loan
like the rate of interest (if applicable), the manner of repayment, etc.
Feasibility of arrangements to access capital market
Feasibility of the projections/ estimates of sales, Cost of Production and profits
covering the period of repayment
BEP in terms of sales value and percentage of installed capacity under a normal
production year
Cash flows and Fund flows
Proposed amortisation schedule, if applicable
Whether profitability is adequate to meet stipulated repayments with reference to
DSCR, ROI
Industry profile and prospects
Critical factors of the industry and whether the assessment of these and
management plans in this regard are acceptable
Technical feasibility with reference to report of technical consultants, if available
Management quality, competence and track record
Companys structure and systems
Applicants strength on inter-firm comparisons

Detailed Appraisal Inter-Firm Comparison

For the purpose of inter-firm comparison and other information, where necessary, source
data from Stock Exchange Directory, financial journals/ publications, professional entities
like CRIS-INFAC, CMIE, etc. with emphasis on the following aspects:
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Market share of the units under comparison

Unique features
Profitability factors
Financing pattern of the business
Inventory/ Receivable levels

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Capacity utilisation
Production efficiency and costs
Bank borrowing patterns
Financial ratios and other relevant ratios
Capital Market perceptions
o Current price
o 52-week high and low of the share price
o P/E Ratio or P/E Multiple
o Yield (%) Half-yearly and Yearly

Also, examine and comment on the status of approvals from other Term Lenders, market
view (if anything adverse) and project implementation schedule.

Present Relationship with the Bank

Compile existing customers profile of present exposures:
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Credit facilities now granted

Conduct of the existing account
Utilisation of limits FB and NFB
Occurrence of irregularities, if any
Frequency of irregularities, i.e. number of times and total number of days the
account was irregular during the last 12 months
Repayment of term commitments
Compliance with requirements regarding submission of Stock Statements, FFR
Reports, renewal data, etc.
Stock turnover, realisation of book debts
Value of account with break-up of income earned
Pro-rata share of non-fund and Forex business
Concessions extended and value thereof
Compliance with other Terms &Conditions
Action taken on comments/ observations contained in:
o RBI Inspection Report(s)
o Statutory Audit Report(s)
o Credit Audit Report(s)
o Corporate Centre Inspection and Audit Report(s)
o Circle Audit Report(s)
o Concurrent Audit Report(s)
o Stock Audit Report(s)
o Spot Audit Report(s)

Credit Risk Rating

The Bank has introduced the revised Credit Risk Assessment (CRA) system for an effective
administration of Banks exposure to Credit Risk. w.e.f 19 th October, 2007, which has been
revised on 09/01/2010. The new CRA model shall be applicable to all accounts with
Aggregate Exposure (Fund Based + Non Fund Based) of Rs 25.00 Lacs & above, for both
Non Trading Sector (C&I, SSI & AGL Segments) and Trading Sector (including Services).
While accounts with exposure above Rs 5.00 crores shall be covered under the regular
model, those with exposures upto Rs 5.00 crores shall be covered under the simplified
model.

CRA is central to the credit appraisal process. Assets, which are classified as Standard
Assets Performing Assets only, are to be risk rated. Major parameters that are
considered for appraising the risk associated with a loan are categorised into Financial,
Business, Industry and Management risks. All these categories of risks are rated
separately. In order to arrive at the overall risk rating, the factors duly weighted are
aggregated and calibrated on a score of 100, to arrive at a single point indicator of risk
associated.
The revised CRA envisages a Two Dimensional Structure for risk rating Borrower Rating
and Facility Rating. A borrower may thus have one Borrower Rating and several Facility
Ratings e.g if there are multiple term loan exposures each exposure shall be rated
separately. The Facility Ratings are applicable only in the Regular Model i.e exposures
above Rs 5.00 crores.
The overall score for risk rating is rated on a 16 point scale:
sed / Non Fund Based Facility) is given on
a rating scale of FR 1 to FR 16.
Entry Barrier:
All credit proposals are required to be rated first under two parameters of Compliance of
Environmental Regulations and Integrity, which have been termed as entry barriers. Any
credit proposal getting ZERO (0) score in the Entry Barriers would not be processed
further and would be declined.
No deviation has been envisaged in the Entry Barrier conditions.
The Score in the Range of 45-49 corresponds to SB 10 / FR 10 which has been
designated as the HURDLE RATE in CRA2007.

Opinion Reports
Opinion Reports are compiled
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Company
Partners/ Promoters
Proposed Guarantors

Branches should compile opinion reports on the borrowers and guarantors at the time of
sanction/renewal/enhancement. Opinion Reports should also be compiled at periodic
intervals (say annually) irrespective of the renewals. In respect of borrowers falling
under the purview of the BIFR/ Banks own rehabilitation cases and in respect of nonperforming assets timely compilation of opinion reports is significant. This would enable the
Bank to initiate timely action to protect its interest.
The detailed opinion report consists of three
parts:
Part I consists of basic information of the firm as received from the firms financial
statements, reports of branch officials and information gathered from other sources
e.g. firms and its associate concerns, etc. It also includes the estimate of the Branch
Manager/ Manager of the Division of the total means and break-up worth of the firm
and the proprietor/ partners, as also his report on the firm.
Part II gives information on the Balance Sheet of the firm on a date nearest to the date
of the compilation of the opinion report.
Part III contains information on the proprietor/partner(s) of the firm. This part indicates the

financial position of the proprietor or the individual partners outside the business, and
will not include the share of the partner in the business of the firm.

Existing Charges on the Assets of the Unit

As a part of the pre-sanction survey, a search is undertaken at the office of the Registrar of
Companies to ensure that the securities being offered by a Company are not offered as
securities against another credit from another Bank/ Financial Institution. The search is
also
undertaken before the documentation and disbursement of the sanctioned facilities and
annually thereafter to ensure that the charges of the Bank are sustained in future.
In case the proposal is received from a company, report on such charges with RoC is
prepared.

Structure of Facilities and Terms and Conditions of Sanction

The following terms and conditions (T&C) for exposures proposed facility wise and
overall, should be fixed well in advance:
Limitforeachfacility/sub-facility
Sub-limits for inventory and receivables within the overall assessed fund based Working
Capital credit limits are fixed for operational convenience. In cases where large build up of
any item of inventory or receivables is required and the reasons are acceptable, sub-limits
should be fixed in a flexible manner. In case of borrowers with credit rating SB 1 and SB 2,
if the borrower desires, no sub-limits are fixed.
Within the overall assessed credit limits, branches should fix separate limits for financing
inland credit sales. In respect of borrowers enjoying credit limits of Rs. 5 crores and above
from the Banking system, minimum of 25% of the finance for inland credit sales as Bill
Purchase limits should be stipulated. To determine the quantum of finance for inland credit
sales, the aggregate credit limits will comprise of all types of credit facilities extended for
financing inland credit sales such as cash credit/ sub-limit against book debts, bills
purchased/ discounted limits, overdrafts/ cash credit limit/ sub-limit against Government
supply bills, as may have been made available within the overall Bank finance limits
sanctioned.
Security
Credit provided by Banks creates assets, which are called Primary Assets or Securities.
Any additional security provided is commonly known as Collateral Security. Collateral
securities could be in the form of tangible collateral securities such as liquid collaterals or
mortgage of immovable properties or intangible collaterals such as Third Party Guarantee.
The bank officials verify the securities offered by the borrower before they are accepted for
covering the credit facilities and are stipulated as a part of the recommendation of the loan
and as the terms and conditions of sanction.
Margin
The margin stipulations as per the extant guidelines that are also dependent on the nature
of the current assets offered as primary security are stipulated as a part of the terms and
conditions.
The bands of the margin are stipulated by the Bank within which, depending on the risk

perception of the primary security being offered such as Raw Materials, Stocks in process,
Finished Goods and Receivables, margins are fixed by the recommending authorities for
approval of the sanctioning authorities.
RateofInterest
The rate of interest will be generally based on the Credit Risk rating. In specific cases,
however, rate of interest can be fine tuned depending on the value of connections/ potential
for business development and profits and other strategic reasons. The necessary
recommendations for seeking concessionary rates of interest should form a part of the
Credit Proposal and put up to the appropriate authorities for necessary approval / sanction.
In case of loans up to Rs. 2 lacs, RBI regulates interest rates.
RateofCommission
Depending on the value of connections, potential for business development and profits and
other strategic reasons, these rates are recommended as a part of the credit proposal for
approval of the appropriate sanctioning authorities.
ConcessionalFacilitiesandValueoftheCredit
As per the recommendations and the approvals obtained from the sanctioning authorities,
the terms and conditions would stipulate the concessions offered.
RepaymentTerms
In respect of term loans sanctioned, the installments of the term loans and the moratorium
or start up period, which are permitted for the repayment of the loan, are stipulated.
ECGCCover
In respect of units which have been sanctioned, export packing credit, which includes Preshipment facilities and Post-Shipment facilities, the facilities are covered under the ECGC
Guarantees / Policies as per extant guidelines.
OtherStandardCovenants
Apart from the usual terms and conditions of sanction of credit facilities, as contained in the
standard covenants of the Bank's loan documents, depending on the degree of financial
discipline required to be imposed, reasonable additional conditions are considered
necessary, in view of more than the normal risk perception of the loan proposal. However,
while recommending or sanctioning a loan, onerous terms and conditions that are difficult
for the borrowers to fulfill should not be stipulated. Special covenants in any particular case
should be discussed with the concerned borrowers, explaining the implications, so as to
avoid the necessity for modifying them subsequently. These covenants should be indicated
in the Appraisal Memorandum highlighting the rationale behind the stipulation.
Review of the Proposal

The review of the proposal should cover:

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Strengths and weaknesses of the exposure proposed

Risk factors and steps proposed to mitigate them
Deviations proposed from usual norms of the Bank and the related reasons

The draft proposal is put up to the assessing officer who gives a macro look to the proposal
and suggests various changes and inputs. Thus the gaps in the proposal, if any, are
covered so that the final proposal in the required format of submission to the sanctioning
authorities is prepared.

Proposal for Sanction

Prepare a final proposal, incorporating the changes proposed by the assessing officials, in
prescribed format with required back-up details and with recommendation for sanction.
Assistance to Assessment
In order to help Assessor, interact with the Assessor, provide additional inputs arising from
the assessment, incorporate these and required modifications in the draft proposal. Finally,
generate an integrated final proposal for sanction.