Credit Appraisal A Banker s perspective May 30 2015

Credit Appraisal. A Banker’s perspective May 30, 2015 Prafulla Shenoy, DGM & Aniket Mendhe, Manager SIDBI, Rajkot SME Development Centre 1

Small Industries Development Bank of India [SIDBI] • SIDBI is an Apex Financial Institution set up for promotion, financing and development of Micro, Small & Medium Enterprises (MSME) in the country. • Set up by an Act of Parliament in April, 2 1990 • SIDBI has successfully completed 25 years on April 1, 2015 • One among the Top 50 Development Banks in the world SME Development Centre

Definition of MSME ? AS PER MSMED ACT 2006 : (Rs Lakh) Enterpri ses Manufacturing (Investment in P&M) Proposed revision Manufacturing (Investment in P&M) Services (Investment in Equipment) Proposed revision in services sector (investment in equiment) Micro 25 50 10 20 Small 500 1000 200 500 1000 3000 500 1500 Medium SME Development Centre 3

SIDBI : Sphere of Activities • Direct Finance: Assistance to MSMEs, Service sector entities, Resource support to NBFCs/Other intermediaries, Infrastructure, etc. • Indirect Finance : Refinance/STL to Banks, SFCs, etc. • Micro Credit : Pioneers in micro credit movement in the country. Developed several leading MFIs. Assistance through MFIs • Associate Institutions: SVCL, SMERA, CGTMSE, ISARC and MUDRA. • Nodal Agency : For Go. I schemes like CLCSS, TUFS and TEQUP. • Promotional and Development Activities SME Development Centre 4

Retail Credit Schemes – Fund based Schemes • Schemes for Energy Saving Projects • Service Sector schemes • Privileged Customer Scheme • GROWTH CAPITAL FOR MSMEs (GEMs) • Credit Delivery Arrangement with NBFCs • SIDBI-IDBI Working Capital Arrangement • MSME Receivable Finance Scheme SME Development Centre 5

GROWTH CAPITAL FOR MSMEs (GEMs) § Growth Capital could be offered as mezzanine funding (between equity and secured debt) • Objective : To provide risk capital to well performing SME units having high potential for growth. • Eligibility : Existing MSME customers of SIDBI. • Instruments: Equity/quasi equity type of instruments • Assistance is Sub-ordinated (i. e lower or junior) in security & payments to senior lenders (i. e secured lenders). • Cure period : in case of temporary cash tightness. • Max Amount : Half of net-worth • Benefits of equity : SIDBI treats it as Quasi equity for DER purposes. MSMEs can leverage sub-debt to borrow more secured loans from SIDBI. SME Development Centre 6

GROWTH CAPITAL Product - Subordinate debt…. (improving leverage) Net Worth 250 0 80 Secured loans 500 660 Total LT funds 750 990 Sub-debt SME Development Centre

MSME Receivable Finance Scheme Purpose Mitigating the problem of delayed payments to MSME vendors / eligible service providers in respect of their sales / services rendered to large purchaser companies by offering them finance against bills of exchange / invoices arising out of such sales Eligible MSME vendors Manufacturing units/ Transporters/ IT vendors Form of assistance Discounting of Bills of Exchange / invoice accepted by purchasers Advantage to seller Immediate payment against receivables. Improves cash flow cycle Service providers/ Advantage to Purchaser Several creditors replaced by one creditor (bank) There might be instances of increase in credit period SME Development Centre 8

MSME Receivable Finance Scheme Secured limits Clean limits Considered for purchasers having : • External rating Min BBB+ / CR 3, • Turnover : Rs 30 crore relaxable upto Rs. 20 cr. Or • Networth : Rs 6 crore relaxable upto Rs. 4 cr. Considered for purchasers of higher level having : • External rating- Min A- (Long term rating) • Turnover : Rs 500 cr. • Networth : Minimum Rs 125 cr. • Internal rating : CR 3. • 7 years of commercial production and three years of • Profitable track record. SME Development Centre 9

Service sector activities eligible for assistance • • • – – Hotels, Resorts, Convention halls, Shopping malls, Hospitals, Nursing Homes, Cinema theater, Multiplex, etc. ; IT / IT enabled services ; BPO & other knowledge based activities like, call centres Bioinformatics ; Contract research ; Telecom services like setting up of mobile/ radio frequency transmission/ receiver towers, Stand alone service sector projects, promoted by existing companies/groups in the following areas are also covered : Organized retailing Logistics, including supply chains, material handling, warehousing, storage etc ; Project Developers / Construction contractors Transport operators ; SME Development Centre

Subsidy Schemes of Government Assistance under Govt. of India Schemes Ø Credit Linked Capital Subsidy Scheme (CLCSS): • To facilitate technology upgradation • Capital subsidy for induction of proven technologies in 49 sectors. • Subsidy will be limited to 15% of the purchase price of P & M with a ceiling of Rs. 15 lakh per unit. Ø Technology & Quality Upgradation Programme for MSMEs (TEQUP) : • To sensitize the manufacturing MSME sector in India to the use of energy efficient technologies and manufacturing processes. • The second objective will be to improve the product quality of MSMEs and to encourage them towards becoming globally competitive by obtaining Certification of products • The Government of India will provide financial support to the extent of 25% of the project cost for implementation of Energy Efficient Technologies (EET). The maximum amount of GOI assistance from the scheme will be Rs. 10 lakhs. Ø TUFs: -Technology Upgradation Fund Scheme • 10% capital subsidy and 5% interest reimbursement SME Development Centre 11

SIDBI : initiative – Small. B. in – Virtual mentor & handholding forum for budding entrepreneurs – Informative , interactive & exhaustive web site – encourages entrepreneurship as an alternate avenue to job seeking – Demystifies & simplifies process of setting up a MSME. – Fills information gap – List out Business ideas for small businesses – Details of Franchise opportunities in India – Particulars of financing schemes of various banks – Checklist for starting a new business – Details relevant to women entrepreneurship SME Development Centre

MUDRA • Micro Units Development Refinance Agency [MUDRA] – corpus of Rs 20, 000 crore, and credit guarantee corpus of Rs 3, 000 crore. – Refinance to Micro-Finance Institutions through a Pradhan Mantri Mudra Yojana. – Banking the un-banked, also funding the un-funded. Sr. Scheme For Amount (Rs) 1 Shishu Starters 50, 000/- 2 Kishor Mid Stage Finance 50, 000/- to 5, 000/- 3 Tarun Growth Seekers 5, 000/- to 10, 000/- SME Development Centre

Application Form • Fully filled (half filled application form creates confusion and consumes executive time which leads to delay in sanction) • SIDBI application form is a complete project report, no need to submit separate project report • Signed on all pages SME Development Centre

Application Form • Project Cost – Clearly defined with all heads and final contractors / machinery suppliers. – Major changes in project items are very painfull for Banker • Means of finance – Internal accruals (availability? ) – Interest Free Unsecured loan (ratio 3: 1) • Details such as – Associate concern, its Bankers, Power requirement, Raw Material, Capacity, Management, Shareholding, Repayment Schedule SME Development Centre

SL No Means of finance 1 Land including registration cost 1 Additional Partners / Share Capital 2 Building & Civil construction 2 Interest free unsecured loans 3 Plant & Machinery 3 Internal Accruals 4 Misc. Fixed Assets 4 Term Loan from SIDBI SL No Cost of the project 5 Preliminary & Pre Op expenses 6 Contingency provisions 7 Margin Money for WC 8 Others SME Development Centre 16

Application Form – Product and Process – Marketing and Selling arrangement • Main buyer, order in hand , competitors etc – Pending litigation, Tax proceeding, contingency etc. has to be reported upfront – Realistic estimate of expected date of commencement of commercial operations (Concern of technical NPA) SME Development Centre

CMA data / Profitability Projections/Cash Flow – No absurd increase in sales or profit, it should be inline with past data. – In most of the cases, we find the projections submitted by the applicant as highly optimistic. – DSCR : up to 1. 5 to 2 is ok – Projected cash flow should be in tandem with the industry norms in terms of revenue vs capacity as well as profit margins. – Before lending we always compare the projected cash flows in a project with industry trends and wherever differences are found, we prepare fresh cash flows to align it with the industry and present market trend. – We use only two methods to assess the WC limit ie. , 2 nd method of lending for all limits and Nayak Committee (turnover method) method for limits upto Rs. 5 crore. SME Development Centre

• • Application form of SIDBI is very thorough and covers almost all the aspects of the unit. It gives opportunity to promoters to present itself on firsthand basis Some aspects may not be applicable – Write ‘Not applicable’. SME Development Centre

Retail Credit Schemes – Term Loans Benchmark norms Sr. No. Benchmark Financial norms Desirable norms [wherever applicable] A Applicable for term loans 1 DER (For the company as a whole, incl. proposed assistance) 2 Projected DSCR 3 Promoter’s contribution 2: 1 1. 5: 1 (a) New Projects 33% (b) Others 25% 4 Overall asset coverage (a) New Entity 1. 4 (b) Existing Entity 1. 3 (c) Service Sector 1. 75 (d) CRE 2. 00 SME Development Centre 20

Other documents • Audit report – Not only P&L and B/S but also all the annexure including IT returns – Signed – Provisional report to be CA certified • Net worth Statement of promoters and guarantors – Complete description of property with supporting documents – Surrender Value of insurance policy • CA certificate – Simple format – IBA clause SME Development Centre

Other documents • Status of various statutory approvals – GPCB, RUDA, RMC, various other licenses • Right to Access • MOA-AOA - Borrowing powers and Business of company • DIC Regn. / CA certificate certifying MSME status SME Development Centre

Due Diligence • Valuation and Title Investigation of collateral properties (if any) • KYC documents – Low Risk, Medium Risk, High Risk (Guidelines of RBI) • Due diligence of machinery suppliers/contractors involved in the project SME Development Centre 23

Documentation • All documents are prepared by SIDBI • CA certificate for non pendancy of taxes or litigation • PAS 3, SH 7, CHG 1 (erstwhile form 2, 5 and 8) to be filed properly with ROC • Registration of mortgage with Subregistrar SME Development Centre

Disbursement – All pre-disbursement conditions to be complied before disbursement (All terms and conditions are already discussed before sanction) – CA certificate for project cost and means of finance supported by documentary proof to ensure the required investment by promoters in the project. – Disbursement request letter should be signed by proper authority – Change in project heads should be kept at minimum level as possible – Utilization certificate after disbursement to be submitted within one month for advance disbursement made in the account of customer SME Development Centre

Post Disbursement – Stock statement to be submitted before 10 th day of each and every month – Audit observation to be complied, if any – Filing of Subsidy • Implementation of project • Documents such as tax invoices, visit report • Time limit is crucial for filling the subsidy – List of final plant and machinery SME Development Centre

What is Credit Appraisal • Credit appraisal is a process of collecting relevant information of customer and projects to undertake risk assessment exercise by the bank prior to providing any loans/advances. • It also checks the technical, economical & financial viability of the project proposed. • Credit Appraisal thus ascertains the risks associated with lending functions in banks. • In general, it is the process of appraising the credit worthiness of the loan applicant and the project. SME Development Centre 27

Credit Appraisal……. • Financial analysis and preparation of projected cash flow based on industry trend. • Assessment of Management, Business, Industry in addition to the financial position. • A banker must look into 3 C’s before lending; that are “Character”, “Capacity”, and “Collateral”. SME Development Centre 28

Rating - Credit Appraisal tool • Rating of the applicant and project by assigning scores to each parameters under Industry, Business, Financials and Management risks. • Rating the proposed facility by assessing the proposed securities to arrive at a combined rating. • Propose the pricing based on the risk rating and stipulate terms and conditions for sanction which includes certain risk mitigants as proposed in the credit appraisal. Submit the case to respective Sanctioning Authority. SME Development Centre 29

Credit Appraisal…. . • Thus, Credit Appraisal is a tool to a) Understand the customer b) Assess the capacity to repay (Viability of the project) c) Understand the risks involved in lending. d) Appropriately price the financial assistance to match with the risk involved. e) Propose the risk mitigants including that by way of adequate collateral security. SME Development Centre 30

With whom we would like to deal • • Background, Reputation, Market Standing, Experience of promoters Profitable Business Model Increasing Turnover No earlier bad track record with Banks No tendency to default Transparency and Honesty SME Development Centre

Please avoid • • Promoters with malafide intentions Promoters with Fraudulent reputation Cooked-up Financial reports Diversion of funds SME Development Centre

What is at stake • Reputation of CA • Career of an honest hardworking people • Relationship with Bank – CA relationship does not end with sanction of loan – It continues with disbursement and till entire loan is repaid. – CA should inform bankers about the conduct of the account. • CA should play a role of whistle blower SME Development Centre

Thank You SME Development Centre 34