Equipment Loan Structure and RAROC Pricing
A borrower requests a 2.5m-equivalent USD loan to import equipment with a five-year useful life. It asks for a five-year tenor with a 24-month principal moratorium and a bullet repayment, priced at 12% fixed. The bank's cost of funds is 8.5%, expected loss is 1.5% per annum, operating cost is 0.5%, and capital allocation is 12% of exposure. The borrower's DSCR is 1.8x under a three-year amortizing structure but only 1.25x under the requested five-year bullet, because cash flow is seasonal. Policy caps equipment loan tenor at four years, requires minimum DSCR of 1.4x, and targets a minimum RAROC of 18% after funding cost, expected loss, and operating cost. The equipment will be imported from an OEM; the borrower has no FX hedge and earns local currency. Security offered is the equipment only, plus a personal guarantee. A one-off arrangement fee of 1% is proposed.
1. Structure the loan (tenor, grace, repayment profile, security, covenants) to meet both policy and borrower cash flow.
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Structure. A 5-year bullet with 24-month grace does not fit policy or cash flow. Recommend a 4-year tenor (policy cap) with a 6-month grace and quarterly amortization thereafter. Size the loan so DSCR is at least 1.4x under a stress case, not 1.25x. Security: first-ranking charge over the equipment, assignment of insurance, personal guarantee, and a requirement to hedge at least 70% of the USD exposure or borrow in local currency. Covenants: DSCR >=1.4x, debt/equity <=2.0x, no additional debt without consent, equipment maintenance and insurance, cross-default. Add a cash sweep of 50% of excess cash flow. If the borrower cannot accept 4 years, decline rather than extend tenor to 5 years with a bullet.
2. Calculate RAROC at 12% pricing and recommend a pricing or fee adjustment if needed.
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RAROC at 12%. Interest income = 12% x 2.5m = 300k. Funding cost = 8.5% x 2.5m = 212.5k. Fee income = 1% x 2.5m = 25k. Net income before risk = 300 - 212.5 + 25 = 112.5k. Expected loss = 1.5% x 2.5m = 37.5k. Operating cost = 0.5% x 2.5m = 12.5k. Net risk-adjusted income = 62.5k. Capital = 12% x 2.5m = 300k. RAROC = 62.5/300 = 20.8%, above the 18% target. However, the buffer is only 2.8 percentage points and does not price FX risk. If the local currency depreciates 20%, the borrower's effective debt service rises and DSCR may fall below 1.4x. Recommend either 12.5% pricing or a 0.5% FX risk premium, plus mandatory hedging. If the borrower rejects, require 20% cash collateral or a guarantee from a stronger entity. Document the pricing exception if 12% is retained.