What is Post-shipment Credit?

Post-shipment Credit means any loan or advance granted or any other credit provided by a bank to an exporter of goods / services from India from the date of extending credit after shipment of goods / rendering of services to the date of realisation of export proceeds as per the period of realization prescribed by Foreign Exchange Dept. (FED) of RBI, and includes any loan or advance granted to an exporter, in consideration of, or on the security of any duty drawback allowed by the Government from time to time. As per the current instructions of FED, the period prescribed for realisation of export proceeds is 365 days from the date of shipment. With effect from May 05, 2012, banks have been given freedom to decide rate of interest to be charged by them on Post-shipment Credit.

Post-shipment advance can mainly take the form of: (A) Export bills purchased/discounted/negotiated (B) Advances against bills for collection (C) Advances against duty drawback receivable from Government.

Post-shipment credit is to be liquidated by the proceeds of export bills received from abroad in respect of goods exported / services rendered. Further, subject to mutual agreement between the exporter and the banker it can also be repaid / prepaid out of balances in Exchange Earners Foreign Currency Account (EEFC A/C) as also from proceeds of any other unfinanced (collection) bills. Such adjusted export bills should however continue to be followed up for realization of the export proceeds. In order to reduce the cost to exporters (i.e. interest cost on overdue export bills), exporters with overdue export bills may also extinguish their overdue post shipment rupee export credit from their rupee resources.

The Bold & Beautiful of Asset Lease Finance by Lease Rental Discounting

This is one of the bold innovative financing structures evolved in the field of lending. Urge of Lessors, Lessees, and Bankers to fall in love with it makes it really beautiful. Under an Asset Lease, there is a party who needs some asset(s) but does not want to shell out cash for purchasing the same. One of the reason may be that the balance sheet of the party is already heavily leveraged (i.e ratio of total outside liabilities to networth) and it does not want to further overstress the same. The other reason could be that the asset to be procured are expected to become obsolete after 2-3 years and the party may like to return these assets to the leasing agency and procure new assets (examples of such type of assets may be laptops, computers, servers etc. for office). In order to meet this requirement of the party, there are asset leasing agencies who supply the required assets on lease basis. Under the leasing arrangement, the assets are supplied for an agreed period (generally between 3 to 5 years) wherein the party agrees to pay monthly or quarterly rentals to the leasing agency. At the end of the lease period the party is provided option either to renew the contract for an extended period or return the assets to the leasing agency.

 

Now, the questions comes is that who funds the procurement cost for these equipments. Say for an example that the purchase cost of the equipments is USD 1100 and the party is willing to take these equipments for a one year lease and ready to pay USD 100 per month as rental. Therefore, if the leasing agency procures the equipment and puts on lease for a year it will get USD 1200 during the lease period of 12 months against the procurement cost of USD 1100 and difference of USD 100 will be the profit.  In order to earn this profit of USD 100, the lease agency will need to shell out USD 1100 from its own funds or other option is to take bank finance for a part of the procurement cost. Leasing agency would not like to entirely invest USD 1100 from its own coffers as it would need funds for expanding the business. Therefore, let’s say it decides to fund the procurement through bank loan.

Now the beautiful part of the transactions comes. The banker will discount the future expected monthly lease rentals (let’s assume nominal monthly discount rate of 20%) and arrives at value of USD 1080. So, the bank may provide USD 1050 and the leasing agency will shell out USD 50 (which will be treated as its contribution) for procurement of equipments worth USD 1100. The party to whom the equipments are rented is called Lessee, the leasing agency who procures the equipments for renting is called Lessor and the bank is called the Funder. The Lessor agrees to deposit the monthly rental into an escrow account with the banker so the banker is assured of directly getting the monthly instalment from the Lessee.  By the end of the lease period, the equipments become free from loan and can be put on lease again by the leasing agency. I would like readers to think about the risk factors involved in the transaction, and just to hint I would like to mention that there are many.

What is Pre-shipment/Packaging Credit?

The Government of India encourages commercial banks to finance the credit requirements of exporters. Pre-shipment and Post-shipment credit are two of the schemes under the same efforts of the Government.

Pre-shipment / Packing Credit (PC) means any loan or advance granted or any other credit provided by a bank to an exporter for financing the purchase, processing, manufacturing or packing of goods prior to shipment / working capital expenses towards rendering of services on the basis of letter of credit opened in his favour or in favour of some other person, by an overseas buyer or a confirmed and irrevocable order for the export of goods / services from India or any other evidence of an order for export from India having been placed on the exporter or some other person, unless lodgement of export orders or letter of credit with the bank has been waived. If pre-shipment advances are not adjusted by submission of export documents within 360 days from the date of advance, the advances will cease to qualify for subsidised interest rate offered by bank for export credit to the exporter. When PC is given by banks in Foreign Currency it is known as PCFC. With effect from May 05, 2012 banks have been given freedom to decide rate of interest to be charged by them on PC/PCFC.

The packing credit / pre-shipment credit granted to an exporter may be liquidated out of proceeds of bills drawn for the exported commodities on its purchase, discount etc., thereby converting pre-shipment credit into post-shipment credit. Further, subject to mutual agreement between the exporter and the banker it can also be repaid / prepaid out of balances in Exchange Earners Foreign Currency A/c (EEFC A/c) as also from rupee resources of the exporter to the extent exports have actually taken place. If not so liquidated/ repaid, banks are free to decide the rate of interest as prescribed by RBI.

It has been observed in many cases that the exporters have to procure raw material, manufacture the export product and keep the same ready for shipment, in anticipation of receipt of letters of credit / firm export orders from the overseas buyers. Having regard to difficulties being faced by the exporters in availing of adequate pre-shipment credit in such cases, banks have been authorised to extend Pre-shipment Credit ‘Running Account’ facility in respect of any commodity, without insisting on prior lodgement of letters of credit / firm export orders, depending on the bank’s judgement regarding the need to extend such a facility.

 

Banks may extend the ‘Running Account’ facility only to those exporters whose track record has been good as also to Export Oriented Units (EOUs)/ Units in Free Trade Zones / Export Processing Zones (EPZs) and Special Economic Zones (SEZs). In all cases where Pre-shipment Credit ‘Running Account’ facility has been extended, letters of credit / firm orders should be produced within a reasonable period of time to be decided by the banks. Banks should mark off individual export bills, as and when they are received for negotiation / collection, against the earliest outstanding pre-shipment credit on 'First In First Out' (FIFO) basis. Banks should ensure that export credit available in respect of individual pre-shipment credit does not go beyond the period of sanction or 360 days from the date of advance, whichever is earlier.

How is bank finance provided to Private Developers of Commercial Real Estate in India?

The Commercial Real Estate (CRE) bank finance in India is regulated by Reserve Bank India (RBI). The regulator considers this to be a sensitive sector for bank finance and closely monitors the same.  RBI’s latest release indicated about Rs. 1,30,363 crore (USD 24 billion) of gross bank credit being deployed to CRE sector as on February 22, 2013, against Rs. 1,17,961 crore (USD 21 billion) on February 23, 2012.

 

The core definition of CRE lending is considered as lending to income-producing real estate (such as, office buildings to let, retail space, multifamily residential buildings, industrial or warehouse space, and hotels etc.) where the prospects for repayment and recovery on the exposure depend primarily on the cash flows generated by the asset. The primary source of these cash flows would generally be lease or rental payments or the sale of the asset. The distinguishing characteristic of CRE versus other corporate exposures that are collateralised by real estate is the strong positive correlation between the prospects for repayment of the exposure and the prospects for recovery in the event of default, with both depending primarily (i.e. more than 50%) on the cash flows generated by a property.

RBI has issued various circulars for regulating the bank finance to CRE sector and key circulars are Master circular on Housing Finance, and Exposure Norms apart from various other notifications issued from time to time. The key guidelines on financing to private sector Real Estate developers are as under:

1. Banks are not permitted to extend fund based or non-fund based facilities to private builders for acquisition of land even as part of a housing project. (Note : This is a very crucial condition)

2. The period of credit for loans extended by banks to private builders may be decided by banks themselves based on their commercial judgment subject to usual safeguards and after obtaining such security, as banks may deem appropriate.

3. Such credit may be extended to builders of repute, employing professionally qualified personnel.

4. It should be ensured, through close monitoring, that no part of such funds is used for any speculation in land

5. Care should also be taken to see that prices charged from the ultimate beneficiaries do not include any speculative element that is, prices should be based only on the documented price of land, the actual cost of construction and a reasonable profit margin.

6. Banks may extend credit to private builders on commercial terms by way of loans linked to each specific project (Note : This is a very crucial condition)

7. Banks should ensure that the borrowers have obtained prior permission from government / local governments / other statutory authorities for the project, wherever required. In order to ensure that the loan approval process is not hampered on account of this, while the proposals could be sanctioned in the normal course, the disbursements should be made only after the borrower has obtained requisite clearances from the government authorities.

8.  While granting finance to specific housing /development projects the banks should stipulate the following terms and conditions:

-The builder / developer / company would disclose in the Pamphlets / Brochures etc., the name(s) of the bank(s) to which the property is mortgaged.

-The builder / developer / company would append the information relating to mortgage while publishing advertisement of a particular scheme in newspapers / magazines etc.

-The builder / developer / company would indicate in their pamphlets / brochures, that they would provide No Objection Certificate (NOC) / permission of the mortgagee bank for sale of flats / property, if required.

 

With these set of guidelines RBI ensures that bank finance is not channelized to private builders for acquisition of land and there is a tighter control by way of monitoring through project specific lending. These tighter controls have their genesis from the concerns that mild controls may lead to flow of bank finance for acquisition of land resulting in rising of land prices in India which consequently leads to rise of Housing prices and making the access to Housing out of reach of masses. The project specific lending ensures that monitoring of the deployment of bank funds  is possible and timely construction of the project is accomplished.

How a bank should take entry into a company by extending working capital finance?

Working Capital lending is more of an Art than Science. Unlike Term Loans which have a fixed tenor and repayment schedule, working capital fund based loans are considered to practically perennial. A new bank entering a company first time through working capital finance needs to have a cautious approach despite knowing the external credit rating of the borrower. This is important because external credit rating gives a transparent picture of the borrower but one needs to also remember that it is the lender who is taking a risk on the borrower not the rating company. After the Lehman and mortgage finance collapse in USA, the world has now practically learnt how much one should rely on credit ratings, at what point the reliance on credit rating needs to be stopped and self judgement based on own analysis and experience needs to be factored in because in case of default, it is the lender who is going to be financially affected. Therefore, it is of utmost importance for a banker to really understand the DNA of the borrower. This does not happen overnight by simply analyzing the financials of the borrower or by going through the credit rating report. We should accept that the financial statements are the Fine Art produced by the accounts.

The working capital entry needs to be guided by basic principle of put every step forward slowly and testing the ground. Interact more and more with the borrower’s teams, promoters, senior management and learn more and more about the ethics of the promoters, professionalism of the management, profit margins in the industry to develop your basic instinct about the borrower. These interactions gives a lot of insight about the borrower which can not be found in the financial statements or in credit rating reports. A learned working capital banker would like himself or his team to interact at some level of borrower’s teams at least once in day or two.

To start with, the working capital entry into a company might be only through non fund based limits or through sales bill discounting/purchased of good clients of the borrower.

Based on all these learning over a time period, bank can add or reduce or change the composition of fund based and non fund based limits sanctioned to the borrower. Depending on the collaterals and their real value, slowly and over the years bank can strengthen its security and move forward for enhancement in exposure.

Should RBI allow for Restructuring of Advances?

The Loans and Advances given by banks to its borrowers are considered as Assets of the banks. Banks expect that Principal and Interest on these Advances will be repaid as per the repayment terms. However, there is always an element of risk of non repayment or default by borrowers. In anticipation of default by borrowers, banks have to keep on setting aside a certain percentage of these Advances from their profits for tolerating the losses/anticipated future losses. This practice of setting aside profits for meeting losses is called Provisioning. Provisioning is done based on expected losses as well as on specific Assets (based on occurrence of default). Indian banks make the following types of loan loss provisions at present:

-General provisions for Standard assets (Provisioning range from 0.25% to 1%),

-Specific provisions for NPAs (Provisioning range from 15% to 100%),

-Floating provisions,

-Provisions against the diminution in the fair value of a restructured asset.   

Therefore, profitability of the banks is affected on account of Provisioning when an account starts defaulting and becomes non performing. The existing regulatory set up in India provides banks to reduce this impact by way of Restructuring of the Advances. Under Restructuring, banks review the viability of a borrower/project based on revised assumptions, consider reducing interest rates, change/increase the tenor for repayment etc. in order to achieve viability of the borrower/project which leads to ensure that the borrower/project will have capacity to repay the Advance. The Reserve Bank of India (RBI) has set norms for Restructuring of Advances.  When Restructuring is done in compliance with the guidelines set by RBI, an Advance is not considered as non performing and banks are given benefits of not providing Provisioning as required for non performing Advances. This helps to banks in reducing impact of Provisioning on their current profits as well to borrowers since banks consider judiciously and TIMELY in considering their request for Restructuring of Advance. As a prudent measure, RBI norms stipulate special Provisioning of higher level for Restructured Advances as compared to general Standard assets. It was at 2% and then increased to 2.75% of the Restructured Advance. Recently, RBI has issued new guidelines related to Restructuring of Advances and Provision. As per these new guidelines, the benefit of not considering a Restructured Advance as non performing will not be available from April 01, 2015. Further, the special Provisioning of 2.75% has been increased to 5% for all the new Restructuring of Advances which may be done before April 01, 2015. For the existing Restructured Advances also the rate has been increased from 2.75% to 5% in phase manner to be achieved by FY 2015-16. From banking perspective this may be a conservative step, however, it has to be also seen from the economic view. These new rules will not encourage banks to support (by way of restructuring) borrowers as there will not be self interest attached. The borrower’s viability will not be reworked/supported by banks and situation may lead to winding up of the borrowing entities/projects. Such a scenario also increase legal disputes, affect manufacturing capacities, cause job losses, affected associated small vendors/SMEs depending on the borrowing entity etc.

Many of the borrowers where it is possible to revive them through a suitable restructuring plan may not get the opportunity of getting support from their banks.  A Borrower may have genuine need for Restructuring under certain circumstances viz. a general downturn in the economy or in any particular sector, which result in the deterioration in the financial health of borrowers. It may also be warranted in case of emergence of legal or other issues that cause delays, particularly in cases of project implementation. External developments, such as global factors may also result in widespread impact on the financial health of borrowers and may necessitate use of restructuring as a tool to help the borrower tide over difficult circumstances.

However it is also a fact that some unscrupulous borrowers with unviable companies/projects try to get the advantage of Restructuring on the slightest sign of slowing down of the economy or any particular sector of the economy leading to RBI’s concerns of excessive Restructuring of Advances and prompting it for tighter norms for Restructuring.