Project Finance Explained #1 – Correct Calculation of Term loan Margin

This is Ramit. and welcome to my
presentation on Margin in Term Loan Part 1 in this part of the
presentation we will learn some basic concepts on margin in term loan. The more advanced topics will be covered in the subsequent part of this presentation so
friends what kind of loans are covered in this
series of presentation we will cover the MSME loans and project finance for
large corporate borrowers. Now let us see what are the things you will learn in
this presentation? We will learn what is the margin, the importance of analyzing
sources of fund, equity or capital versus unsecured loan, stages of assessing the
margin, tools for assessing the margin and finally how to safeguard your bank's
interest. All these will be covered in my series of presentations.

But let us begin
our discussion with what is a margin? let's start our discussion with a case
study. You have financed a project of 200 lakhs where the margin is stipulated as 20%. What does it mean? it means bank loan is 160 lakhs and capital or equity of the
promoter is 40 lakhs. Margin of 20% means the promoters
contribution to the project cost is pegged at minimum of 20 percent of the
project cost that is 40 lakhs in this case so the bank finance should be
restricted to 160 laks and capital or equity that has to be brought in by the
promoters should be 40 lakhs. I hope this is clear. Now let us continue with our
definition of margin in our earlier example the company has approached you for releasing a loan of 20 lakhs now can you tell me how much promoters
margin shall we ensure? is it four lakhs? 5 lakhs? 8 lakhs? or none of the
above? now the correct answer will be 5 lakhs.

But how?
20% of 20 lakhs is 4 lakhs only isn't it? so how come the margin is 5 lakhs? Let us once again get back to the basics just now we have learned that margin is
always on the overall cost since the company is requesting for 20 lakhs
disbursement we presume that the anticipated expenditure will be 25 lakhs
of which 5 lakhs should be brought by the promoters and the balance amount of
20 lakhs should be financed by the bank. I hope this is clear always remember the
disbursement is never equal to expenditure, disbursement is always a
percentage of the expenditure and in this case the percentage is 80 percent
only, so friends when the margin is to be brought? margin can be upfront that is before any kind of disbursement, this is applicable for
one-time purchase of machinery or fixed asset or margin can be brought in
a phased wise manner that is along with the implementation of the project untii
the commercial activity commences so whenever there will be multiple
disbursement associated with a term loan margin shall be always brought in a
phase-wise manner.

Now what are the things you have to ensure? Simply
requesting a release of 20 lakhs means nothing at all the company or the
promoters must submit an estimation of 25 lakhs clearly stating the nature of
expenditure they are likely to incur. This information has to be cross-checked
with the sanction terms in order to verify that expenditure quoted by them
are at all eligible for finance. The company or the promoter has
to deposit five lakhs in the account maintained with you and a combined NEFTor RTGS of 25 lakhs shall be initiated after disbursing rupees 20
lakhs of loan from his loan account. Now let us quickly glance at what is the
expenditures eligible for finance? For this you have to understand a concept called hard cost This is nothing but mainly comprising of the construction cost,
plant and machinery, electrical installations and furniture and fixtures.
There is also something called a soft cost which is comprising of interest
during construction, preliminary and pre operative expenditure, patent,
technical know-how. Now items which we consider as primary security are taken
as hard cost for remembering purpose you can consider them as items that you can touch and feel.

I hope it helps. Banks are generally financing the hard cost only,
until and unless specifically permitted by sanctioning authority to finance a
soft cost. Always remember the financing of soft cost is involved with
very big sized projects 100 crores or 200 crores generally. No bank is
financing the soft cost. Now comes a bitter truth-
most of the companies we deal with have no idea how to request for a release, they
feel that the term loan account is just like a cash credit or OD account. They
straightaway walk in with the RTGS or NEFT form and sometimes even
without the seal of the company. So what is the solution? Let's educate them. In my
early days of credit I used to prepare extensive disbursement schedules by
collecting the necessary documents from the customer. Now that is a very
a cumbersome process as a credit officer, you have to take care of 10-15 accounts
at a time where disbursements are taking place simultaneously, however from the company's point of view or the promoters point of view they are
the owner of only one account so it is quite easy for them to present the case
properly in front of you, if you educate your customer on how to
prepare a release schedule, how to request for a release,
I think 80% of your job is done.

I have prepared a release request format that I
generally provide to my customers and they give the request in this format.
I will give the link in my description in the description of this video you can
download this format from there it is just a sample request by a company it
says that release request of term loan, we request you to release a 20 lakhs from
our sanction term loan of 200 lakhs we request you to collect our margin of
five lakhs from account xxx maintained with you computation of our
margin releases availed so far are enclosed with this letter. now let us go to
what does the annexure speaks ? the annexure annexure says about the disbursement made so far. It has all the elements that you need for recording the transactions and
it also speaks about the previous requests, finally it calculates, it
says the total disbursement of the term known including the present release,
promoters margin brought so far, total payment made to the vendors and overall
percentage of promoters margin. Don't forget to get a signature with the seal
of the managing director or the partners and always get it signed by your branch
head or whoever is in charge of the branch.

Now as we come to the end of this presentation I will leave you the googly this is the live case in my branch
where I faced a strange situation and so I call it a googly. We have financed a
loan of 85 lakhs with a margin of 25% for scarf holding materials mainly used
for construction of buildings, the loan was yet to be released when the promoter
made an advance of 2 lakhs to the vendor through his current account maintained
with us, this was to be considered as margin at a later stage he came with the
first release request of 3 lakhs we did not collect margin this time
since he already paid two lakhs up front he was so happy
next he came with a second payment request of seven lakhs where he computed his margin all on his own, as discussed in the next slide, you remember I always
try to educate my customer, but this time the customer tried to apply my education
on myself or my bank.

Now I will present the calculation which was given to me by
the customer I call it a reverse sweep. Amount invested so far by the customer
two lakhs, bank release so far is three lakhs, present payment request is of
seven lakhs, so the margin till date should be 25% of 10 lakhs that is 2.5 lakhs
since he has already paid 2 lakhs we have to collect a balance amount of
50000 only, this was his version it looks apparently right, correct? so what is the
opinion on the above calculation submitted by the party? I will keep this
discussion open and I will answer this reverse sweep in the next of my
presentation I hope the concept the basic concept of margin I was able to
clear and I will be covering the more advanced topics in the few next series
of my presentations I I thank you all for listening Thank You, Bye.

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