CREDIT APPRAISAL AT DHANLAKSHMI BANK

Credit Appraisal – Initial due diligence & financial analysis

The process of credit appraisal would begin with the selection of the borrower. The

process would broadly cover:

(i) Appraising the borrower/business

(ii) Appraising/assessing the credit requirement and structuring the credit

delivery, security, covenants etc. Appraisal of the borrower would include

background check and assessment of managerial, commercial, technical and

financial capability/strength, project execution/management ability, success in

joint venture for technology/ market, retention of professional talent at various

levels, management control, promoters’ shareholding etc.

Both the above aspects need to be appraised/ examined at the time of the initial entry of a

customer to the Bank as also at the time of subsequent periodic reviews. Naturally, the

appraisal would be different in respect of:

- Retail segment like personal loans for consumer durables, house etc

- Small business like loans to business enterprises

- Farming sector/agriculturists

- MSME sector

- Corporates in manufacturing, infrastructure, services, wholesale trade and

other sectors.

Background of the borrower/management

Background of the borrower needs to be done through scrutiny of antecedents, experience

in the line of business, managerial, marketing, technical competence, organizational

strength, integrity etc. Track record with us, status report from the other banks, reports in

the sector from our borrowers in similar business, RBI/CIBIL reports on

defaulters/willful defaulters/SAL of ECGC, Corporate action taken by SEBI/NSE/BSE,

reports from their vendors/dealers who may be our customers, reasonability of CMA

projections, actual performance vs estimates, frequent overdrawing, history of

restructuring/OTS etc.

In case of adverse report in any of the above areas, there could be

justifications/mitigations which should be looked into. If need be the appraising officer

may personally visit the other bank for personal discussions. The gist of such oral

discussion may be recorded in the file of the borrower and brought out in the proposal.

KYC guidelines as framed by RBI and adopted by Bank are to be followed by the

branches.

Commercial appraisal

The nature of the product, demand for the same, the existing and perceived competition

in the segment, ability of the proponents to withstand the same, government policies

governing the industry, etc. need to be taken into consideration. The trade practices in

respect of the product should be thoroughly understood. Branches should use the reports

from ICRA/CRISIL & Capitaline available on Stardesk.

Technical appraisal

Technical appraisal of the project needs to be carried out for industrial activity1 proposals

beyond the cut-off limits prescribed from time to time. Such appraisal may be carried out

in-house by Technical Officers working in Technical Appraisal Department/ Technical

Appraisal Cells or officers having technical expertise for the same or by an outside

agency as determined by the appropriate authority. Where technical appraisal is carried

out by All India Financial Institutions, PSU Banks/other leading banks having expertise

in the area, their report may be accepted for appraisal purposes.

Financial appraisal

Analysis of financial parameters/ratios should be done. Aspects like

i. Balance sheet strength

ii. Growth in TNW, sales, PAT etc

iii. Borrower’s ability to service the principal and interest, meet the cash flow

requirement in respect of payments under LC opened, absorb additional

burden due to escalation of raw material cost etc

iv. Position of receivables/inventory etc should be looked into.

The following parameters ratios should be computed:

i. TNW with reconciliation of change in TNW ii. Current Ratio iii. Total outside liabilities/equity (DER) iv. Profit before interest, depreciation, taxes, appropriation (PBIDTA/EBIDTA) v. Profit After Tax/Net sales vi. Inventory + receivables/Sales ratio vii. DSCR if the borrower enjoys any term loan with any bank/FI even if no

TL is being considered by our bank. viii. Capital Employed ix. PAT/Capital employed x. Investments xi. Segmental Revenue if applicable

CHECK POINTS FOR DUE DILIGENCE/ASSESSMENT IN CREDIT

PROPOSAL

1. Articles of Incorporation - A corporate registration is the cornerstone and basis

for legitimacy, as it requires the business to rely upon its corporate name, image

and reputation.

2. Status Reports - This is useful to show that the company continues to exist and

operate as a legal entity, and has not been dissolved and/or reincorporated under

another name. Most companies that actively engage in business with serious

clients will have one that is relatively recent. Whenever new proposals are put up

for approval, status reports of the company / group needs to be obtained from

their existing bankers. Obtaining status reports is an essential step in due diligence

process, in all advance accounts.

3. Market enquiries - This serves as an important tool. Verification of the

antecedents of the borrower through discrete market enquiries could amply reveal

inherent deficiencies. Cross verification with our existing customers in the line

and other players in the line, would serve as first hand information.

4. Licenses / Certifications - Ask for a copy of licenses, permits, registrations or

certifications if they are directly related to and required for the specific work the

company must perform. If copies are not available, request the number and

issuing authority of each document.

5. Web Site Addresses - All Companies have their websites. Companies that say

they do not have a website or do not need one have to be treated with caution.

Good companies always make efforts to allow clients or partners to keep in touch

with them, receive notice of changes of office address, e-mail addresses or phone

numbers, reminders of services offered or updates on new services.

6. Resume of Managers or Key Employees - Ask for resume (also called

"professional bio") of managers / key employees of the company. This will give

you some additional leads and information to verify the company's ability to

perform the work promised and general capabilities.

7. Corporate Brochure or Company Overview - Every company should have a

professional and well-developed presentation of their business concept or

services. This evidences the level of preparation of the company, and

demonstrates whether they have sufficiently developed their capabilities. Project

Reports / Information Memoranda, are not to be taken for face value. They need

to be critically examined vis-à-vis other sources like similar businesses.

8. It should be ensured that too much dependence on consultant driven business, is

avoided by the Company. Even when consultants refer business, discussions

should be held with the promoters/CFOs.

9. ROC search – ROC search, as applicable, at the time of considering fresh

advances, needs to be done, to assess existing charge/s on company’s assets.

10. Each proposal should bear reference related to RBI/CIBIL/ECGC/ List of

Defaulters / willful Defaulter List, etc. As per existing guidelines, Branch / Zonal

Office must bring out this aspect in the proposal.

11. Pre-Sanction Inspection – Branches should note to conduct pre-sanction

inspections before submitting new proposals. Inspection reports should be

prepared strictly as per the format. Findings of the inspection should be brought

out in the proposal. It should invariably include the place of work of the entity in

addition to visiting the corporate office, meeting promoters & employees etc.

12. Critical information as envisaged in Credit policies / Circulars, are to be obtained

and scrutinized.

13. Scrutiny of statements of accounts with previous / existing bankers, to be done, to

ascertain their conduct. This is more so necessary while takeover of the facilities

is involved.

14. Risk Mitigation - Proper coverage of risk and mitigation in the proposal reflects

good understanding of the business. As per existing guidelines, Branch / Zonal

Office must bring out these aspects in the proposal.

15. Status of Litigation If the company is involved in any litigation/disputes/

arbitration, Zone / Branch should give details in the proposal.

16. Assessment of Limits Financial parameters like DER, Current Ratio for W/C &

DSCR, DER, FACR, BEP, IRR, sensitivity analysis for Term Loan are to be

properly captured in the proposals. Proposals should not be considered without

these parameters being adequately brought out.

17. Assessment about promoter/s ability to bring in the funds envisaged, to be

properly done.

18. Risk Rating - Risk Rating Exercise for Credit Rating & Pricing has to be done as

per different Risk Scoring Modules.

19. The security which is obtained by the Bank (either as principal or as collateral)

shall be verified as to its title clearance as well as value by independent Panel

Advocates/ Valuers and periodical Encumbrance Certificate shall be obtained. In

this regard, extant guidelines, is enumerated in Branch Circular from time to time

are to be meticulously observed.

Check points for Pre and Post Monitoring Norms:

PRE DISBURSEMENT:

i. Suitable monitoring of various acts by the customer/Branch officials/out-side agencies

should be done at the pre-disbursement stage. Depending upon the terms of sanction in

each case, the following actions/steps, wherever applicable, may be taken prior to

disbursement:-

ii. Obtention of satisfactory credit reports from existing lenders and other service

providers such as D&B, CIBIL etc. if stipulated. Branch staff, which is processing the

applications for credit requests of new customers, should personally call on the Bank/FI

with whom the incumbent is presently enjoying facilities and discreetly enquire about the

conduct and general aspects of the account. This is in addition to obtaining status reports.

The personal visit to the operating staff of that Bank/FI may reveal more about the

proposed borrower which may not have been incorporated in the report. Wherever it is

not desirable to obtain Status Report for the fear of putting our competitor on guard,

decision may be taken on the basis of scrutiny of proponent’s statement of account for the

last one year with the existing Banker and the fact that the Sanctioning Authority has

satisfied itself about the credit worthiness of the proponents on the strength of statement

of account for the last one year and that status report is not being obtained for the fear of

putting the existing banker on guard should be recorded in the proposal.

However, in case Branch desires not to obtain ‘Status Report’ from other

Bankers/Service providers prior to disbursement then specific ‘approval’ of the higher

authority viz GM NBG and/or GM Head Office should be obtained

In such cases the Branch should obtain status report subsequently and the staff should

visit the Bank/FI immediately after disbursement to discreetly enquire about the conduct

and general aspects of the account.

iii. Adhering to Head Office guidelines for Credit Rating exercise pertaining to entry

level for new accounts.

iv. Post-sanction inspection of the unit prior to disbursement. Needless to add, pre-

sanction inspection report cannot substitute the need of pre-disbursement inspection

vi. Issuance of sanction letter and acceptance of terms, conditions and stipulations of

sanctions by the borrowers.

vii. Execution of all relevant documents, including creation of collateral security /

mortgage etc. as per terms of sanction

ix. Furnishing of Letters of guarantee by guarantors.

x. Disbursement of amounts by other participating financial agencies / Banks / Financial

Institutions etc.

Clarity in regard to draw down of amounts such as first date of disbursal and last date of

disbursal, the stages in which the monies are required to be drawn, its acceptance and

evaluation at Branch level (If these are already included in the credit proposal, the same

must be adhered to).

xii. Vetting of documents

xiii. Credit Process Audit compliance

xiv. Post Sanction Pre Disbursement approval wherever branch level sanction

xv. Keeping the duly completed/signed check list on record along with other security

documents

DURING DISBURSEMENT:

Credit delivery in loan accounts is distinct from running accounts such as Cash Credit.

All disbursements whether in loan account or in running accounts, will be related to

actual / acceptable performance of the business unit and should never lose sight of basic

objective of safety of Bank's exposure in the credit assets. The disbursements should

commensurate with the progress of the project / business activity, also taking into account

the extent of margin brought in by the promoters up to the given point of time.

The sanction of the limit is not a commitment in isolation to extend funds to the borrower

under all circumstances. It is only a financial contract to make available funds for due

performance of various business objectives and goals set out in his proposal. Bank's

disbursements depend upon due performance /compliance of/with borrower's own

commitments. Therefore, the credit delivery has to be used as an effective monitoring

tool to ensure that there are only normal and acceptable credit risks.

The following aspects wherever applicable, may be considered for monitoring:

(a) LOAN ACCOUNTS :

i. Actual Implementation vis-a-vis Project schedule.

ii. Possibility of time or cost overrun.

iii. Adequacy of arrangements to meet cost overruns.

iv. Impact of time overrun on timely cash generations of the project.

v. Verification of end-use of funds with reference to verifiable records such as invoices,

account books, registers, records, inspection of the unit etc.

vi. Certificate from Company’s Statutory Auditors on the extent of cost incurred on the

project at any given point of time, implementation progress certificate from approved

architect/contractor etc., wherever applicable.

vii. Disbursements to be made, to the extent possible, directly to the suppliers / service

providers and the element of cash withdrawals to be kept minimum.

Status report on the suppliers of machinery as per the guidelines which ensures

genuineness of supplier/transaction must be obtained.

Even while making direct payments, whenever doubt arises about the genuine nature of

the transaction, due care is to be exercised.

(b) CASH CREDIT ACCOUNTS:

i. Compliance of sanction terms / stipulations (any exception requires approval of

appropriate authority)

ii. Verification of completion of the implementation of the project/business activity and

readiness to commence commercial production.

iii. Disbursements to be made, to the extent possible, directly to the suppliers/service

providers and the element of cash withdrawals to be kept minimum.

iv. Even while making direct payments, whenever doubt arises about the genuine nature

of the transaction, due care is to be exercised.

v. Stock inspection data regarding regular movement of goods, actual sales keeping pace

with projections, not having unacceptable quality rejections in sales, not accumulating

slow/ obsolete inventory, elongation of debtors beyond acceptable levels, change in credit

periods from suppliers etc.

vi. Meaningful on site/off site verification of Stock/Book Debt statements to ensure

adequacy of Drawing Power/Drawing Limit

POST DISBURSEMENT:

i. Monitoring of the actual performance of the borrowers on monthly basis by

calling for MSOD statements and comparing the same with the projected

performance figures appearing in the customer’s own CMA data submitted to

Bank, sanctioned proposal / QIS returns etc. Any substantial deviation will

have to be probed into, not waiting for submission of audited financials.

ii. Obtention of Stock/Book debts statements as per stipulation and scrutiny

thereof

iii. Periodical inspections by our staff (comprehensive guidelines issued vide

BC 98/16 dated 19.04.2004 and 102/96 dated 09.08.2008)

iv. Stock Audit by approved C.As as per extant policy. (Comprehensive

guidelines issued vide BC 98/61 dated 05.07.2004)

v. Timely obtention and analysis of Audited statements of Accounts.

vi. Timely review of account

vii. Conducting periodical consortium meet/ JLA meet and sharing the

information with member of consortium /JLA.

viii. Obtaining LIE report periodically and verifying the progress, wherever

applicable. Following it up & complying post disbursement conditions.

ix. Timely identification of accounts showing symptoms of strain and, wherever

considered fit, resort to prompt restructuring of the account, so that the

rehabilitation process is meaningful.

Monitoring of an account is not confined to any single office (Branches including Large

Corporate/Mid Corporate branches/Zonal Office /NBG office/Divisional Office/Head

Office) and concerted efforts will have to be made at all levels with whatever information

available at each level, to prevent any deterioration in asset quality. Under-lending or

delay in lending can be equally painful to the wellbeing/viability of the borrower’s unit

and this itself can lead to asset becoming non-performing.

CREDIT REPORT AND CREDIT RATING

The credit report is an important determinant of an individual's financial credibility. They

are used by lenders to judge a person's creditworthiness. They also help the person

concerned to narrow down on the financial problem areas.

Credit report is a document, which comprises detailed information about the credit

payment history of an applicant. It is mostly used by the lenders to determine the credit

worthiness of an applicant. The business credit reports provide information on the

background of a company. This assists one to take crucial business related decisions.

People can also assess the amount of business risk associated with a company and then

decide whether they would be comfortable in providing them with credit facilities. The

degree of interest that would be shown by investors in their company can also be gauged

from the business credit reports as they can get an idea of the conception of their

customers regarding themselves. Since these records are updated at regular intervals of

time they enable people to identify the risk levels associated with a business as well as its

future. These reports also allow businesses to get detailed information about the financial

status of business partners and suppliers.

What Is A Corporate Credit Rating?

Ratings can be assigned to short-term and long-term debt obligations as well as securities,

loans, preferred stock and insurance companies. Long-term credit ratings tend to be more

indicative of a country's investment surroundings and/or a company's ability to honor its

debt responsibilities. . The ratings therefore assess an entity's ability to pay debts.

There are various organizations that perform credit rating for various business

organizations.

Bank of India follows a finely defined Credit Rating Model for assessing the

creditworthiness of the applicant. The credit rating model of DHANLAKSHMI BANK

assesses various aspects of the projects and assigns scores against them thereby

determining the risk level involved with the project.

It is divided in five sections:

1. Rating of the borrower- Financial risk- Management risk

2. Market condition/ Demand situation3. Rating of the facility4. Business consideration5. Cash flow related parameters

1) Rating of the borrower: This part of credit rating model deals with assessing the

financial and managerial ability of the borrower. The financial ability of the firm is

derived by calculating ratios that determine the short term and long term financial

position of the firm

Short term ratios include Current Ratio, determines the liquidity position of the

company over a period of one year. The current ratio is an indication of a firm's market

liquidity and ability to meet creditor's demands. It is excess of current assets over current

liability. If current liabilities exceed current assets (the current ratio is below 1), then the

company may have problems meeting its short-term obligations. If the current ratio is too

high, then the company may not be efficiently using its current assets.

According to the guidelines given to DHANLAKSHMI BANK the ideal level is at 1.33:1

however the acceptable level is at 1.17:1.

However at times current ratio may not be a true indicator, the current ratio for road

projects is very high but this does not indicate that the company is not using its assets

well but the ratio is high because the activity involves more in dealing with current assets.

Hence it is important for the evaluator to understand the nature of the industry.

Long term ratio include Debt Equity Ratio is a financial ratio indicating the relative

proportion of equity and debt used to finance a company's assets. This ratio is also known

as Risk, Gearing or Leverage. A high debt equity ratio is not preferable by an investor as

the company already has acquired high amount of funds from market thereby reducing

the investor share over the securities available, increasing the risk.

It is also important for the lender bank to assess the firm’s debt paying capacity over a

period. Such capacity is derived by calculating ratio like Debt Service Coverage Ratio

minimum acceptable level is 1.50.

It is also necessary for the lender to determine the ability of the firm to achieve the

projected growth by evaluating the projected sales with actual. However such parameter

remains non applicable if the business is new.

Financial risk evaluation is only one of the parameter and not the only parameter for

determining the risk level. It is important to evaluate the Management Risk also while

evaluating the risk relating 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 from crisis

situation. In order 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 experienced personnel.

2) Market potential / Demand Situation

A Company does not operate in isolation there are various market forces that acts in

either favorable or unfavorable 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

1. Level of competition: Monopoly, Favorable, Unfavorable

2. Seasonality in demand: affected by short term seasonality, long term seasonality

or may not be affected by seasonality in demand.

3. Raw material availability

4. Location issues like proximity to market, inputs, infrastructure: Favorable,

neutral, unfavorable

5. Technology i.e. proven technology: Not to be changed in immediate future,

technology undergoes change, outdated technology.

6. Capacity utilization

3) Rating of the Facility:

The company can start functioning only after completing statutory obligations laid down

by the governing authority. Such statutory obligation involves obtaining licenses, permits

for ensuring smooth operations. Preparation and Submission of Financial Statements,

Stock statements in the standard format within the given time schedule.

4) Business Consideration:

The length of relationship with the bank enables the lender to assess the previous

performance of the account holder. A good track record acts in the favor of the applicant,

however an under-performance make the lender more vigilant.

The income value to the bank is also given due consideration.

Thus Credit Rating of the Business takes into consideration various aspects that have

direct or indirect effect on the performance of the business.

After evaluating the risk level involved the lender bank decides on lending interest rate.

In DHANLAKSHMI BANK they are categorized in 9 segments:

1. Lowest Risk CR-1

2. Low Risk CR-2

3. Medium Risk CR- 3

4. Moderate/ Satisfactory Risk CR- 4

5. Fair Risk CR- 5

6. High Risk CR- 6

7. Higher Risk CR- 7

8. Highest risk CR- 8

9. NPA CR- 9

In DHANLAKSHMI BANK, a business receiving Credit Rating above level 6 are not

considered good from point of investment and thus are avoided.