Term Loan Appraisal for an Auto Components Firm
Anand Auto Components, a partnership firm, seeks a ₹60 lakh term loan to buy a CNC machine and a ₹15 lakh cash credit limit. Its audited sales are ₹3.20 crore, net profit ₹12 lakh, and cash accruals ₹18 lakh. Existing term loan EMI is ₹3.6 lakh per year; the proposed loan EMI works out to ₹13.8 lakh per year. The firm's current account shows an average balance of ₹40,000, and its ₹20 lakh OD limit has been fully utilised for the last five months. The stock statement submitted is five months old. The partners' credit scores are 714 and 638. The factory land, offered as collateral, is valued at ₹50 lakh and already carries a first charge for an earlier loan of ₹18 lakh. The branch manager must place the proposal before the district-level committee next week.
1. Assess the proposal against the principles of lending and compute the DSCR. State whether the branch should recommend sanction.
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Principles of lending: safety, liquidity, purpose, profitability, security, and repayment capacity. The purpose is acceptable, but repayment capacity is weak:
- Annual cash accrual = ₹18 lakh.
- Existing EMI = ₹3.6 lakh; proposed EMI = ₹13.8 lakh; total = ₹17.4 lakh.
- DSCR = 18 / 17.4 = 1.03. A DSCR near 1 leaves no cushion; most banks look for at least 1.5–2.0 for a term loan.
- The OD is fully utilised, average current account balance is only ₹40,000, and the stock statement is five months old. These show liquidity stress and weak monitoring.
- Collateral of ₹50 lakh already has a first charge for ₹18 lakh; the bank would get only a second charge, so security cover is inadequate.
- One partner's score of 638 is below the usual comfort level.
Recommendation: do not recommend the proposal as structured. It fails the safety and repayment-capacity tests. The branch may ask for a reduced loan, longer tenor, fresh stock statement, clearing of OD irregularity, additional collateral, and a credible repayment plan before resubmitting.
2. If the branch wants to salvage the proposal, what conditions or restructuring would you suggest?
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- Reduce the term loan to a level where DSCR is at least 1.5; for example, cap the total EMI near ₹8–9 lakh after including the existing EMI.
- Extend the tenor to 7–8 years and provide a moratorium linked to machine installation.
- Bring in additional margin and a personal guarantee of both partners.
- Clear the OD utilisation and submit monthly stock statements; route sales through the account.
- Obtain a first charge on unencumbered property or additional collateral; do not rely on a second charge.
- Stipulate installation and insurance of the CNC machine, and a quarterly monitoring covenant.
- Address the low-scoring partner through a credit report explanation or additional security.
The branch should sanction in stages, with disbursement after equity contribution and machine invoice verification.
3. If the term loan later becomes overdue, explain SMA classification and the bank's reporting obligations.
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For a term loan, repayment is due monthly or quarterly. If the overdue amount remains unpaid:
- SMA-0: overdue 1–30 days.
- SMA-1: 31–60 days.
- SMA-2: 61–90 days.
- NPA: overdue more than 90 days.
The classification is based on the oldest overdue instalment, not the whole account. The bank must report SMA accounts to the CRILC as per RBI norms and maintain a board-approved recovery policy. It should issue notices, verify the machine and stock, and consider restructuring only within regulatory norms. If the account slips to NPA, provisioning and income recognition stop. The branch should not hide the overdue by granting a fresh loan or quietly rolling over the instalment.