PRESENTATION ON RAISING FUNDS DOMESTIC AND GLOBAL SCENARIO
At
WIRC-ICAI
On
Saturday
04th February,2012
By
CA Pankaj Sanghavi, Director
Aarayaa Advisory Services Pvt .Ltd.
SYNOPSIS
Introduction
Process of Fund raising
Role of each of the players
Regulatory Environment
Instruments
Specialized Instruments
Cost structure
Risk assessment
Challenges faced by Corporates
Challenges faced by the SME
INTRODUCTION
Fund raising a peculiar activity can be associated with a country raising funds for its development projects or to Trusts raising donations.
Fund raising is a process where several stake owners play vital role apart from the actual investor and the investee.
Since this is a Banking Seminar we shall focus on Fund Raising through the banks .
PROCESS OF FUND RAISING
Identification of usage for productive purposes.
Appointment of appropriate Investment Bankers.
Feasibility study
Evaluation of various Instruments
Evaluation of regulatory framework
Evaluation of cost structure
Evaluation of Liquidity particularly for Foreign Currency
Approach the appropriate Lender
Appraisal by the Lender
Documentation
Credit Process Audit
Disbursement
Monitoring
IMPORTANT TERMS OF NEGOTIATIONS
Promoters Contribution and
Core promoters' Contribution
Security margin Primary & Collateral
Rates of Interest
Personal Guarantees of the Promoters
Processing and other Charges
ROLES OF EACH OF THE PLAYERS
The Parliament
Identification of priority sector like Agriculture
Writing off the Agriculture loans
The Government
Ministry of Finance frames the budget and highlights growth orientation of various sectors.
Interest subsidy is offered through Refinance i.e. Export/Agriculture/SME or through direct disbursement like in the state of Gujarat.
Capital subsidies
Deferment of Tax payments
Ministry of Company Affairs monitors Capital Structures and regulates borrowing powers of companies.
ROLE OF EACH OF THE PLAYERS(contd..)
Service Providers
Credit information agencies like CIBIL
Credit rating agencies like CIRISIL
Credit insurance and guarantee corporate agencies like ECGC
Assurance Providers like CA, CS, Lawyers, Valuers
Investment Bankers
Investment Advisors/Brokers
Asset Reconstruction Companies
Depository Participants
Trusteeship Companies
Asset Management Companies
Registrar and transfer agents
Public relations and advertising agencies
ROLES OF EACH OF THE PLAYERS(contd..)
Regulators
SEBI regulates fund raising activities from public
RBI regulates Banks and NBFC through regulations on aspects like
Risk Weightage for different sectors for capital adequacy
Priority sector identification
Liquidity management through CRR and OMO
Interest rate guidance through credit policies
PLR & Base rate Policies
Foreign currency availability
ECB norms
Asset quality guidance through NPA provisions
Export Refinance
ROLES OF EACH OF THE PLAYERS(contd..)
Media
Electronic Media like TV, Internet etc.
Print Media like Newspapers and Magazines.
Provide excellent channel of communications for all the otherplayers like lenders, borrower, regulator etc.
Creates awareness about investment decisions and related risks.
Creates platform for experts advice.
Creates a platform for comparison between various fund raisingoptions.
ROLE OF SOME GLOBAL PLAYERS(contd..)
Multilateral Investment Guarantee Agencies(MIGA)
It is a World Bank Group enterprise
Its basic role is to absorb the political risks of non criminal nature
Provides shelter for the Projects undertaken by Indian Companies in politically unstable countries
This shelter induces lenders to fund these projects
Aarti Steel Nigeria Ltd is one such Project funded by SBI has guarantee of USD 12.83 Million.
ROLE OF SOME GLOBAL PLAYERS(contd..)
The International Finance Corporation (IFC) is World Bank Group which provides loans, equity and technical assistance to stimulate private sector investment in developing countries.
Asian Development Bank ADB funds activities in various sectors or for specific themes through loans and grants, financed from ordinary capital resources as well as special and trust funds.
Asian Development Fund, the ADF offers loans at very low interest rates as well as grants to help reduce poverty in ADB's poorest borrowing countries
REGULATORY ENVIRONMENT
Government Guidelines like PPP Projects for Viability Gap
Funding
SEBI Act and Guidelines
RBI Guidelines
The Companies Act 1956
The Taxation Laws like Income Tax, Service Tax, Interest Tax
Each of the Players mentioned is regulated under one legal
frame work or the other.
INSTRUMENTS (DOMESTIC)
Equity Shares
Warrants
Preference Shares
Debentures and Bonds
Government Securities
Mutual Funds Units
Fixed Deposits - Banks
Company Fixed Deposits
Business Loans
Personal Loans
Patron/Membership Cards by societies
INSTRUMENTS (GLOBAL)
American Depository Receipts(ADR)
Global Depository Receipts(GDR)
Foreign Currency Convertible Bonds(FCCB)
Foreign Currency Term Loans
World Bank Project Finance
Development Bank Loans (Asian Development Bank)
REGULAR INSTRUMENTS
Secured Business Loans
Term Loans
Working Capital facilities
Term Loans for Project having larger gestation periods involve provision for convertibility in equity.
Corporate Loans for short term gap in net working capital margin.
Qualified Institutional Placement
Indian-listed company can raise capital from its domestic
markets without the need to submit any pre-issue filings tomarket regulators.
A measure to counter ADR/GDR
SPECIALIZED INSTRUMENTS
Securitization
o It Involves creation of mezzanine instrument to cover a collection of underlyingportfolio of loans for e.g.- A lender can be approached for placement of an instrumentrepresenting the entire portfolio of home loans granted by a Bank/NBFC to meet itsliquidity requirement at an agreed price. Better price can be negotiated by allowingcherry picking (i.e.:- carve out good and performing loans for securitization.
Direct Refinancing
o SIDBI and IDBI are the refinancing agencies for TUF(Technology UpgradationScheme) for Textile Sector
o NABARD (National Bank for Agriculture and Rural Development)o Export Finance is also refinanced by RBI.
Direct Lines of Credit
o The Export Import Bank of India operates several lines of credit for African countriesto boost Indian exports by providing coverage for political and credit risk.
PECULIARITIES OF EXPOSURE TO FOREIGN CURRENCY BOROWINGS
Foreign Currency is considered cheaper compared to Indian Rupee however the latest volatility has brought out several risk factors as follows:
Oscillating liquidity position resulting in non availability of foreign currency for even sanctioned and committed lending making INR borrowing compulsory even at a huge difference of over 7% for exporters with natural hedge.
Volatility in FX market reducing limits used in Foreign currency sanctioned with INR cap.
Non availability of PCFC requiring cost adjustments for exporters
Wait and watch policy of overseas customers for payments and orders creating overdues in FBP limits and lack orders resulting non availability of EPC.
Temptation to speculate
SPECIALIZED INSTRUMENTS (contd)
Buyers Credit
It is an import finance instrument whereby the usance period under the letter of creditis enhanced by roping in another banker for the elongated period.
Sellers Credit
It is extended by the EXIM Bank of the exporters country usually to boost export ofcapital goods to support project of longer gestation.
Packing Credit
It is extended exclusively to the exporters to procure and process raw material againstconfirmed order or letter of credit.
Foreign Bill Discounting
It is Exclusively extended to exporters to bridge the gap of credit given to foreignbuyer and the credit available from vendors.
SPECIALIZED INSTRUMENTS (contd)
Factoring
Specialized factoring agents provides bill purchase facilities based on credit insuranceobtained from the specialized credit insurance companies.
Forfeiting
Method of export trade financing, especially when dealing in capital goods (whichhave long payment periods) or with high risk countries.
In forfeiting, a bank advances cash to an exporter against invoices or promissorynotes guaranteed by the importer's bank.
The amount advanced is always 'without recourse' to the exporter, and is less than theinvoice or note amount as it is discounted by the bank. The discount rates depends on
the terms of the invoice/note and the level of the associated risk.
Letter of Credits
Letters of credit from a bank allows higher credit from the suppliers resulting inavailability of Working Capital at cheaper cost through the non fund based facilities
SPECIALIZED INSTRUMENTS (contd)
Advance Payment Bank Guarantees
Actual advance payment for import or local purchase can be replaced byadvance payment guarantees there by raising Working Capital at cheapercost through the non fund based facilities.
Channel Financing
It is cheaper option for Corporates to reduce interest cost of its suppliers byproviding assurance to the lenders who operates the same as bill discountingfacilities.
Acquisition Financing
A lender or an investor supporting the acquirer to acquire the company and/orits business and/or its assets.
SPECIALIZED INSTRUMENTS (contd)
Rent Discounting
A lender can discount rent receivable on a leased property to a credit worthy lessee.
Loan against shares
A lender provides loan against listed and liquid equity shares after leaving sufficientmargin for its distress sale value.
LEASE
CONCEPT OF LEASE FINANCING
Lease as a concept involves a contract whereby the ownership,financing and risk taking of any equipment or asset are separatedand shared by two or more parties.
The lessor may finance and lessee may accept the risk through theuse of it while a third party may own it.
Alternatively the lessor may finance and own it while the lesseeenjoys the use of it and bears the risk.
There are various combinations in which the above characteristicsare shared by the lessor and lessee.
TYPES OF LEASE AGREEMENTS
Lease agreements are basically of two types. They are (a) Financial lease and(b)Operating lease. The other variations in lease agreements are (c) Sale and leaseback (d) Leveraged leasing and (e) Direct leasing.
LEASE
FINANCIAL LEASE
Long-term, non-cancellable lease contracts are known as financialleases.
The essential point of financial lease agreement is that it contains acondition whereby the lessor agrees to transfer the title for the assetat the end of the lease period at a nominal cost.
The lease agreement is irrevocable. Practically all the risksincidental to the asset ownership and all the benefits arising therefrom are transferred to the lessee who bears the cost ofmaintenance, insurance and repairs.
Only title deeds remain with the lessor.
Financial lease is also known as capital lease. In India, financialleases are very popular with high-cost and high technologyequipment.
LEASE (CONTD..)
OPERATING LEASE
An operating lease stands in contrast to the financial lease in almostall aspects. This lease agreement gives to the lessee only a limitedright to use the asset. The lessor is responsible for the upkeep andmaintenance of the asset.
The lessee is not given any uplift to purchase the asset at the end ofthe lease period.
Normally the lease is for a short period and even otherwise isrevocable at a short notice.
Mines, Computers hardware, trucks and automobiles are foundsuitable for operating lease because the rate of obsolescence is veryhigh in this kind of assets.
LEASE (CONTD..)
SALE AND LEASE BACK
It is a sub-part of finance lease.
Under this, the owner of an asset sells the asset to a party (thebuyer), who in turn leases back the same asset to the owner inconsideration of lease rentals.
However, under this arrangement, the assets are notphysically exchanged but it all happens in records only.
SALE & LEASE BACK
Under this transaction, the seller assumes the role of a lessee and thebuyer assumes the role of a lessor. The seller gets the agreed selling priceand the buyer gets the lease rentals. It is possible to structure the sale atagreed value (below or above the fair market price) and to adjustdifference in the lease rentals. Thus the effect of profit/loss on sale ofassets can be deferred.
LEASE (CONTD..)
LEVERAGED LEASING
Under leveraged leasing arrangement, a third party is involved beside lessor and lessee.The lessor borrows a part of the purchase cost (say 80%) of the asset from the third partyi.e., lender and the asset so purchased is held as security against the loan.
The lender is paid off from the lease rentals directly by the lessee and the surplus aftermeeting the claims of the lender goes to the lessor.
The lessor, the owner of the asset is entitled to depreciation allowance associated withthe asset
LEASE (CONTD..)
DIRECT LEASING
Under direct leasing, a firm acquires the right to use an asset fromthe manufacturer directly.
The ownership of the asset leased out remains with the manufactureritself.
The major types of direct lessor include manufacturers, financecompanies, independent lease companies, special purpose leasingcompanies etc
HIRE PURCHASE
Hire purchase is a type of installment credit under which the hire purchaser,called the hirer, agrees to take the goods on hire at a stated rental, which isinclusive of the repayment of principal as well as interest, with an option topurchase.
Under this transaction, the hire purchaser acquires the property (goods)immediately on signing the hire purchase agreement but the ownership or titleof the same is transferred only when the last installment is paid.
The hire purchase system is regulated by the Hire Purchase Act 1972.
This Act defines a hire purchase as an agreement under which goods are leton hire and under which the hirer has an option to purchase them inaccordance with the terms of the agreement .
Hire purchase should be distinguished from installment sale wherein propertypasses to the purchaser with the payment of the first installment.
But in case of HP (ownership remains with the seller until the last installment ispaid) buyer gets ownership after paying the last installment. HP also differsfrom leasing.
DIFFERENCE BETWEEN LEASE FINANCINGAND HIRE PURCHASE
PERSONAL LOANS
HOME LOANS
CAR LOANS
LOANS AGAINST PROPERTY
LOANS AGAINST GOLD
LOANS AGAINST CONSUMER DURABLES
UNSECURED PERSONAL LOANS
LOANS AGAINST CREDIT CARDS
COST STRUCTURE
The cost of raising funds mainly depends on
the type of instrument
time for raising the same.
Credit worthiness of the borrower.
The cost encompass the following
One Time Cost
Preparation of project report or feasibility study
Merchant Bankers fees
Printers charges
Logistics cost
Fees of various service providers like Bankers, Registrar, PR agenciesand Assurance Providers
Brokerage and Commission
Stamp duty on security documents
Banks processing fees
Investment Bankers Indication fees
COST STRUCTURE (contd)
Recurring Cost
Interest
Commitment charges
LC opening charges
Bank guarantee commission
Hedging cost
Foreign Currency Remittance Costs
RISK ASSESSMENT AND MITIGATION
The cost of raising funds is directly related to the risks perceived by thelender or the investors.
Accordingly risk assessment and its mitigation can result in substantialsaving in cost of raising funds.
The following are the major risks which determine cost of funds
Country risk
Political risk
Regulatory risk
Industry risk
Performance risk
Credit risk
RISK ASSESSMENT AND MITIGATION (contd)
Country Risk
Country with stable democracy, rich resources, favorable demography and potentialgrowth is considered better investment avenue as compared to dictatorship, monarchyetc.
Political Risk
Political stability with clear mandate under democratic environment is consideredfavorable investment avenue as compared to unstable government without a clearmajority.
Regulatory Risk
Political will to bring about reforms in terms of repatriation benefits, avoidance ofdouble taxation, sectoral limits for higher foreign direct investment are consideredbetter regulatory frame work.
RISK ASSESSMENT AND MITIGATION (contd)
Industry Risk/Sector risk Each Industry has its own cycle of growth and recession. The sector passing growth
phase is less riskier compared to an industrial sector for e.g. Real estate and sharebroking business is considered riskier as compared to education and healthcaresector.
Performance Risk Availability of factors of production like materials, machine, men and management
(4Ms). Successful track record of growth in turnover, profitability, net worth for a longrun is a mitigating factor.
Credit Risk Businesses which have to be heavily dependant on customer demanding larger credit
period. Size of the customer and its credit worthiness for realization of unpaid bills is a credit
risk. Improved KYC norms, constant monitoring of credit limits and upto date credit
information are the mitigating factors for the credit risk further creditors can be passedon specialized credit insurance companies.
CHALLENGES FACED BY CORPORATES
The Corporate under following sectors are facing challenges
Aviation Industry
Multi Brand Retail Trade
Real estate & related Ancillaries like Ceramic Tiles, EPC Providers.
Share Broking Services
NBFC
Diamonds
Micro Finance
Import Dependent Industries for its Raw materials like
Crude, Precious Metals users
CHALLENGES FACED BY CORPORATES FCCB REDEMPTION
Large FCCB redemptions in 2012:
Between 2005 and 2010, Indian companies issued FCCBs of US$23bn of which
US$7.8bn (at redemption value) worth of FCCBs mature in 2012. With stock prices
depressed, a large majority of the issues would need to be redeemed, and refinancedby domestic expensive debt in most cases, creating refinancing risk as well asimpacting profitability.
Pledging of promoter holdings an added risk:
While in aggregate, promoter share pledges remain low and have not
increased in the recent quarter, they are concentrated in a few
sectors and represent non-business risk for stocks where promoter
shareholding is large (22 stocks out of BSE500 with more than 75%
promoter shareholding pledged as of Sept).
CHALLENGES FACED BY CORPORATES FCCB REDEMPTION
An FCCB is basically like this:
You give me dollars I give you bonds that have a coupon interest rate,which I dont pay you, it accumulates over the period.
At the end or anywhere in between you can convert some or all of yourbonds, with accrued interest, into equity shares at a predefinedconversion price.
If you dont convert, I pay you back the principal plus interest, in dollars.
Most offerings had conversion prices at a premium to the thenmarket price, assuming, as investors do, that stocks only go up in thelong term. Interest rates, or coupons, were at zero percent orextremely low figures of 1-2% .
The typical term of an FCCB was five to seven years.
CHALLENGES FACED BY CORPORATES FCCB REDEMPTION
India went gung-ho on FCCBs in the 2004-07 timeframe, whenstocks went nuts. This is now reaching redemption zone, and hurting.
More than 50,000 cr. worth FCCBs are nearing maturity soon, and ofthis the next two years will see between 35,000 and 40,000 cr. worthof bonds maturing.
Conversion prices are far above current market prices, so thecompanies have to pay investors back.
CHALLENGES FACED BY CORPORATES FCCB REDEMPTION
What can companies do?
Their choices are:
Borrow in dollars, through more FCCBs, to pay back current investors: That willprobably take a leap of faith because investors have been burnt badly. Conversionprices will be required to be much lower, meaning more dilution for existingshareholders. Coupon rates will also need to be higher.
Change the conversion price of the bonds to near market prices. Considering thatsome issues have conversion prices 90% below conversion prices, a drop to marketprice will mean 10x the dilution of the share. e.g. S Ltd has to pay $131 million orconvert at a price of 646 in one tranche the stock price is at Rs. 40 today. (Additionallylowering conversion prices may need RBI approval, or breach FDI limits)
Repay through cash or selling assets. ET says some can like JP Associates, FT,L&T or Moser Baer.
Raise cash through equity offers: Companies can use rights issues, an FPO or aprivate placement. Given the situation in the market, these options look bleak.
Default. This is the least preferred option but its what companies will have to do if they
cant do any of the above steps. If a default occurs, the lenders will take the company tocourt, and most likely require it to be wound up and assets sold to recover their money.Importantly, this will hurt all other lenders even domestic banks that have lent money as such an action will prompt them to have to restructure or write-off their loans as well.
CHALLENGES FACED BY CORPORATES FCCB REDEMPTION
The problem is compounded by
The Rupee Fall
When the FCCBs were taken, the rupee was at values of Rs. 40-44. Today, the rupee isat Rs. 50 to a dollar. That means to buy the same number of dollars and pay back,companies need to pay 20% more! This is apart from the coupon interest; and given thatif they try to pay back the FCCBs, they will end up flooding the market with buy orders,the rupee will fall even more.
This rupee fall hurts conversion as well. Consider an FCCB issue with the dollar at 44,and a conversion price of Rs. 440. That means one share = $10 worth. Today, even if thestock stays at Rs.440, it will be worth just $8.46 a loss of 15%. To break even, the stockneeds to be at least Rs. 520.
This hurts more when companies borrowed to deploy money in India if they used thefunds abroad, the return on those funds would also be in dollars so the impact is lesser.
CHALLENGES FACED BY CORPORATES FCCB REDEMPTION
CHALLEGES FACED BY SME SECTOR
It is observed that the NPA ratio in SME sector is normally lower than that of the Corporate Sector. Hence it is safer to lend to SME.
Most of the banks have identified SME as their growth driver and have created specialized branches.
However several challenges are faced by SME while raising funds.
CHALLEGES FACED BY SME SECTOR (contd..)
Lenders comfort is limited due to
Lack of delegation and team work
Lack of proper Accounting & Reporting Systems
Lack of Qualified staff
Large number related parties Transactions
Substantial orientation towards tax savings
Lower capital base
Lower level of financial discipline
Lack of succession planning
Risk of diversion of funds
Difficult to assess requirements due to lower level of information.
SME Sector faces severe challenges at each stage of its fund raising programme as follows:
Non availability of talented and professional team due to limited growth opportunities and lack of delegation.
Lack of time or inclination for knowledge about various financial parameters affecting credit rating
Lack of time or inclination for knowledge for evaluation of fund raising options.
Lack of proper planning resulting in panicked attempts and huge costs
Focus on short term gains at the cost of loosing huge long term benefits.
Averse to paper work
CHALLEGES FACED BY SME SECTOR (contd..)
CHALLENGES FACED BY SPECIFIC SECTORS
SCHOOLS & HOSPITALS
Perceived as Real Estate due to Land acquisition
Forced recovery is perceived to be difficult due to social angle.
Considered as non profit making activities
Norms of normal Term loans like promoters margin etc have to be fulfilled.
Issues on Collateral security availability.
Promoters are perceived to have Political background
PROJECTS PROMOTING SPORTS INFRASTRUCTURE
Perceived as Real Estate project
Viability Gap Funding only under PPP projects
No subsidies
Not covered under Infrastructure Projects for softer terms
CHALLENGES FACED BY SPECIFIC SECTORS
SOFTWARE FIRMS & MEDIA COMPANIES IN SME
Lower asset base
Lease finance on most of the assets
Enforceability of IPR or the contents by lenders
High credit risk of the customers
CHALLENGES FACED BY SPECIFIC SECTORS
FUND RAISERS ARE ALWAYS VIEWED WITH
GREATER RESPECT DUE TO THE CHALLENGES
OVERCOME BY THEM IN A TIMELY MANNER WITHIN COST CONSTRAINTS .
THANK YOU
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