Term Loans as a Project Financing Method

Project financing may be defined as the raising of funds required to finance a capital  investment proposal which is economically separable. The assets, contracts cash flows  are separated from the parent company and the assets acquired for the projects serve as  collateral for loans. The repayments are made from the revenue generated from the  projects. Also, the lending institution has to ensure that the  investment on the proposed project will generate sufficient returns on the investments  made and that loan amount disbursed for the implementation of the project will be  recovered along with interest within a reasonable period of time.

Term loans are meant for tying up the capital cost of the project. The primary source of such loans is  financial institutions. Commercial banks also provide term finance in a limited way. The  financial institutions provide project finance for new projects as also for  expansion/diversification and modernization, whereas the bulk of term loans extended  by banks is in the form of working capital term loan to finance the working capital gap.  Though they are permitted to finance infrastructure projects on a long term basis, the  quantum of such financing is marginal. The term may be 6 to 10 years.

Terms and Conditions

Terms loans are granted subject to the following terms and conditions.

1. Clear title to land as security.
2. Insure all the assets, building and machinery separately.
3. Scrutiny of Articles of Association to ensure that it does not contain any  restrictive clause against covenants of the financial institutions.
4. Lien on all fixed assets.
5. Personal and corporate guarantees of major shareholders and associates  concerns.
6. Approval of appointment of managerial personnel by Financial Institution.
7. Payment of dividend and issue of bonus shares subject to the approval of  financial institution.
8. Undertaking for non-disposal of promoters shareholding for a period of 3 years.

Before the loan is disbursed, documents have to be executed and submitted. Stamp duty  and registration fees have to be paid.

Loan Disbursement

After the loan has been sanctioned, the security documents should be obtained and  charge on the assets — present and future —created in  favor  of the bank. Thereafter,  suitable disbursements may be made, keeping in view the following aspects:

1. The bank should verify the status of implementation of the project. If no  progress at all has been made the reasons should be ascertained and satisfactory  answers obtained.
2. As far as possible, disbursement should be made direct to the supplier of  machinery or other services in order to ensure that the proceeds of the term loan  are not diverted for unauthorized purposes.
3. It is preferable to disburse the loan in installments instead of in one lump sum.  Lump sum disbursement of the entire loan will be permitted if the project or  scheme involves one-time acquisition of machinery.
4. It should be ensured that the projected debt-equity ratio of the project is  maintained at all stages of disbursement.
5. If the loan is sanctioned by a number of lenders to the project, the concerned  bank’s disbursement should be in proportion to its share in the loan.
6. After the disbursement of one installment, the next installment should be  disbursed only after verifying whether the earlier installment had been properly  utilized.
7. Sometimes the borrower would request for interim loans or bridge loans, before  the security and other formalities are completed. Such requests may be acceded  to by granting interim advances for short periods of, say, 3 months, provided the  bank is satisfied that the requisite formalities would be completed within a short  period.

After these requirements are complied, disbursements are made on the basis of assets  created at site. There has to be security matching, every disbursement starting with land  and buildings. As machines arrive, term loan is disbursed at 75% of their value, the  cheque being made in the name of the supplier. In case of large projects, disbursements  are need based. In such cases, promoters have to bring in their entire contribution.

Monitoring and Follow-up

The most important and yet quite difficult part of any loan is to monitor proper  utilization of the loan and follow-up the borrower’s performance and working results, so that the borrower does not default on his financial commitments to the lender.  The follow-up can be split into: (a) follow-up during the implementation stage of the  project; (b) follow-up after commencement of commercial production.

The objectives of the follow-up during the implementation stage are:

1. To ensure that the borrower mobilizes the various sources for the project in time.
2. To ensure that the physical progress of the project is in accordance with the  project implementation schedule; and
3. To ensure that, in the event of an escalation in the  cost  of the project, due to  reasons beyond the control of the borrower, the promoters bring in their  proportionate share.

The above follow-up could be done by obtaining periodical reports from the borrower  on the progress — both physical and financial of the project.

Once the project is set up and commercial production commences, the bank should put  in place a suitable mechanism to follow-up the performance of the project.

1. To ensure that the assets created or acquired for the project are put to effective  use and well maintained.
2. To monitor periodically the borrower’s financial position and working results by  comparing the actual performance with the earlier projections; if there is  substantial variance, especially negative, the reason thereof should be critically  analyzed.
3. To ensure such corrective action, as may be warranted, on the basis of warning  signals thrown up during the course of monitoring.
4. To ensure that the borrower conforms to the terms of the loan more particularly  periodical payment of interest and repayment of loan.