Published on February 14, 2014
RAISING FUNDS : DOMESTIC & GLOBAL SCENARIO
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(CONTS..) 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 other players like lenders, borrower, regulator etc. Creates awareness about investment decisions and related risks. Creates platform for expert’s advice. Creates a platform for comparison between various fund raising options.
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.
SPECIALIZED INSTRUMENTS Securitization It Involves creation of mezzanine instrument to cover a collection of underlying portfolio of loans for e.g.- A lender can be approached for placement of an instrument representing the entire portfolio of home loans granted by a Bank/NBFC to meet its liquidity requirement at an agreed price. Better price can be negotiated by allowing cherry picking (i.e.:- carve out good and performing loans for securitization. Direct Refinancing SDBI and IDBI are the refinancing agencies for TUF(Technology Upgradation Scheme) for Textile Sector NABARD (National Bank for Agriculture and Rural Development) Export Finance is also refinanced by RBI. Direct Lines of Credit The Export Import Bank of India operates several lines of credit for African countries to 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…) Buyer’s Credit It is an import finance instrument whereby the usance period under the letter of credit is enhanced by roping in another banker for the elongated period. Seller’s Credit It is extended by the EXIM Bank of the exporters country usually to boost export of capital goods to support project of longer gestation. Packing Credit It is extended exclusively to the exporters to procure and process raw material against confirmed order or letter of credit. Foreign Bill Discounting It is Exclusively extended to exporters to bridge the gap of credit given to foreign buyer and the credit available from vendors.
SPECIALIZED INSTRUMENTS (contd…) Factoring Specialized factoring agents provides bill purchase facilities based on credit insurance obtained from the specialized credit insurance companies. Forfeiting Method of export trade financing, especially when dealing in capital goods (which have long payment periods) or with high risk countries. In forfeiting, a bank advances cash to an exporter against invoices or promissory notes guaranteed by the importer's bank. The amount advanced is always 'without recourse' to the exporter, and is less than the invoice 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 in availability 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 by advance payment guarantees there by raising Working Capital at cheaper cost through the non fund based facilities. Channel Financing It is cheaper option for Corporates to reduce interest cost of its suppliers by providing assurance to the lenders who operates the same as bill discounting facilities. Acquisition Financing A lender or an investor supporting the acquirer to acquire the company and/or its 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 sufficient margin 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 separated and shared by two or more parties. The lessor may finance and lessee may accept the risk through the use of it while a third party may own it. Alternatively the lessor may finance and own it while the lessee enjoys the use of it and bears the risk. There are various combinations in which the above characteristics are 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 lease back (d) Leveraged leasing and (e) Direct leasing.
LEASE FINANCIAL LEASE Long-term, non-cancellable lease contracts are known as financial leases. The essential point of financial lease agreement is that it contains a condition whereby the lessor agrees to transfer the title for the asset at the end of the lease period at a nominal cost. The lease agreement is irrevocable. Practically all the risks incidental to the asset ownership and all the benefits arising there from are transferred to the lessee who bears the cost of maintenance, insurance and repairs. Only title deeds remain with the lessor. Financial lease is also known as ‘capital lease’. In India, financial leases are very popular with high-cost and high technology equipment.
LEASE(CONTD..) OPERATING LEASE An operating lease stands in contrast to the financial lease in almost all aspects. This lease agreement gives to the lessee only a limited right to use the asset. The lessor is responsible for the upkeep and maintenance of the asset. The lessee is not given any uplift to purchase the asset at the end of the lease period. Normally the lease is for a short period and even otherwise is revocable at a short notice. Mines, Computers hardware, trucks and automobiles are found suitable for operating lease because the rate of obsolescence is very high 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 (the buyer), who in turn leases back the same asset to the owner in consideration of lease rentals. However, under this arrangement, the assets are not physically exchanged but it all happens in records only.
SALE & LEASE BACK Under this transaction, the seller assumes the role of a lessee and the buyer assumes the role of a lessor. The seller gets the agreed selling price and the buyer gets the lease rentals. It is possible to structure the sale at agreed value (below or above the fair market price) and to adjust difference in the lease rentals. Thus the effect of profit/loss on sale of assets 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 party i.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 after meeting the claims of the lender goes to the lessor. The lessor, the owner of the asset is entitled to depreciation allowance associated with the asset
LEASE (CONTD..) DIRECT LEASING Under direct leasing, a firm acquires the right to use an asset from the manufacturer directly. The ownership of the asset leased out remains with the manufacturer itself. The major types of direct lessor include manufacturers, finance companies, independent lease companies, special purpose leasing companies 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 is inclusive of the repayment of principal as well as interest, with an option to purchase. Under this transaction, the hire purchaser acquires the property (goods) immediately on signing the hire purchase agreement but the ownership or title of 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 let on hire and under which the hirer has an option to purchase them in accordance with the terms of the agreement . Hire purchase should be distinguished from installment sale wherein property passes to the purchaser with the payment of the first installment. But in case of HP (ownership remains with the seller until the last installment is paid) buyer gets ownership after paying the last installment. HP also differs from leasing.
DIFFERENCE BETWEEN LEASE FINANCING AND 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 agencies and 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 the lender or the investors. Accordingly risk assessment and its mitigation can result in substantial saving 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 potential growth is considered better investment avenue as compared to dictatorship, monarchy etc. Political Risk Political stability with clear mandate under democratic environment is considered favorable investment avenue as compared to unstable government without a clear majority. Regulatory Risk Political will to bring about reforms in terms of repatriation benefits, avoidance of double taxation, sectoral limits for higher foreign direct investment are considered better 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 share broking business is considered riskier as compared to education and healthcare sector. 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 long run 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 passed on 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 refinanced by domestic ‘expensive’ debt in most cases, creating refinancing risk as well as impacting 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 don’t pay you, it accumulates over the period. •At the end – or anywhere in between – you can convert some or all of your bonds, with accrued interest, into equity shares at a predefined “conversion” price. • If you don’t convert, I pay you back the principal plus interest, in dollars. Most offerings had conversion prices at a “premium” to the then market price, assuming, as investors do, that stocks only go up in the long term. Interest rates, or “coupons”, were at zero percent or extremely 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, when stocks went nuts. This is now reaching redemption zone, and hurting. More than 50,000 cr. worth FCCBs are nearing maturity soon, and of this the next two years will see between 35,000 and 40,000 cr. worth of bonds maturing. Conversion prices are far above current market prices, so the companies 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 will probably take a leap of faith because investors have been burnt badly. Conversion prices will be required to be much lower, meaning more dilution for existing shareholders. Coupon rates will also need to be higher. Change the conversion price of the bonds to near market prices. Considering that some issues have conversion prices 90% below conversion prices, a drop to market price will mean 10x the dilution of the share. e.g. S Ltd has to pay $131 million or convert at a price of 646 in one tranche the stock price is at Rs. 40 today. (Additionally lowering conversion prices may need RBI approval, or breach FDI limits)
CHALLENGES FACED BY CORPORATES FCCB REDEMPTION 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 a private placement. Given the situation in the market, these options look bleak. Default. This is the least preferred option but it’s what companies will have to do if they can’t do any of the above steps. If a default occurs, the lenders will take the company to court, 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 is at 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 that if 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 the stock stays at Rs.440, it will be worth just $8.46 – a loss of 15%. To break even, the stock needs to be at least Rs. 520. This hurts more when companies borrowed to deploy money in India – if they used the funds abroad, the return on those funds would also be in dollars so the impact is lesser.
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.
CHALLEGES FACED BY SME SECTOR(contd..) 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
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
CHALLENGES FACED BY SPECIFIC SECTORS 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
FUND RAISERS ARE ALWAYS VIEWED WITH GREATER RESPECT DUE TO THE CHALLENGES OVERCOME BY THEM IN A TIMELY MANNER.
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