5 Reasons Why Structured Finance is better

Guidance in time can save your Lakhs!

Let’s say, one day you have got a huge order and your company needs a loan to execute that order.

What will you look in any loan, while applying?

Which bank will give me, at what rate, what amount, how will I repay?

Sounds simple enough? Right?

Maybe not. A perfect bank loan should be well structured to best serve your company. A structured loan can save a lot of time, money, energy and a possible, trouble in the future.

Any prudent banker will look at two basic thing in any loan – Risk (in case, the money doesn’t come back and how to mitigate that) and Repayment capacity (how to ensure that by proper loan structuring).

To put it simply, a loan structuring is the format of any loan which can fulfill the borrower requirement as well as ensuring that the lender gets his money back and on time, every time. Now if we can get little theoretical here, it’s a perception of risk by a lender of a probable default in the future. And Perception can be very subjective for everyone.

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    Any Loan structuring typically involves several components namely:

    Purpose, security, amount, pricing and at what terms. Once the product is created keeping these in mind, we can say it’s a win-win for the lender as well as borrower.

    1. Purpose – It defines or defeats any loan product

    For example, if you are looking for a home loan, then it will have longer tenure, lower rate, a different method of calculation; whereas if you apply for a personal loan it will have shorter tenure and high rate of interest. Hence the rate, tenure, security, etc. everything is depended on what is the purpose of any facility. A borrower’s requirements are said to be fulfilled only when his/her intended purpose is accomplished. It could be anything right from a commitment to pay a vendor or extend credit to few large corporate clients, to paying off salaries/wages, pay rent, pay advance to vendors; buy new or repair existing equipment, acquire another company, set up new factory to launch a new product or penetrate a new market.

    Better you define your purpose, better it will serve your requirement. For different borrowers, in different circumstances, in different industries, the loan that enables the borrower to accomplish any of the above purposes may require different structuring. Any improperly structured loan may prove to be restraining, rather than empowering the borrower’s intend of its purpose.

    1. Security

    For many businesses, short term facilities like Letter of Credit, Cash Credit facility makes more sense as they are short term in nature and can be secured by way of receivables. But if the loan is for purchase of any Asset like Machinery, office or buying a company itself, bankers will take projections into account to arrive at the future cash flows. Thus, depending on the type of transaction, its cash flow security is established making it either working capital or term loan. A longer-term loan will look more for net profit while revolving finance will be more of short term.

    Both require a different set of security. And this security is required by a lender to secure themselves in the event of default. Now, the question is how much security is sufficient to mitigate the risk associated completely depends on the structuring and risk appetite of the lender. The balance of cash flows and security collateral is important for any lender. Once that happens, it will be a win-win situation for the borrower as well as for the lender.

    Type of security or collateral also plays a vital role. A Real estate is hard collateral, which comes with a huge valuation, but for the smaller transaction, liquid security like FD or Equity shares should go with the purpose. Type of loan or line of credit is important depending on if it’s a working capital requirement or a CAPEX requirement. Therefore, a lot depends on purpose which can define the tenor of loan and thus type of security. It’s a call which a lender has to take to arrive at the final conclusion.

    1. Amount

    The amount of any funding transaction is derived from its sole purpose. Once the purpose is defined, then the lender has to ensure that the amount is adequate enough to fulfill the purpose in its entirety. Otherwise, it raises the risk of jeopardizing of the entire transaction and probability of the stress in repayment. I am sure, neither lender nor borrower would want to get into it.

    As important as lending less than the requirement could create distress in serving the purpose for the borrower, lending more can also create an issue of cash flow in future and hence, the lender should ensure that the borrower has appropriate or will have sufficient cash flow to service a loan for the sanctioned amount.

    1. Pricing

    The biggest bait or prize for a borrower to go for structured finance is to reduce their cost of capital. A structured deal can be priced in ways which can be lighter on cash flows and beneficial for the borrower. Pricing may include some onboarding cost incurred by lenders called Processing fees, advisory fees for the consultant, bank’s interest rates or charges.  A good external rating also helps to get a lower rate for a borrower. So, the cost of external rating should be amortized with the loan set-up cost and it will have a direct impact on the transaction. A good lender will always have an internal risk rating and with effective risk recognition and mitigation effectively performed, the lender can price the loan to provide an acceptable yield and a benefit to the borrower.

    1. Terms of Lending

    Once any loan is sanctioned, it has its own terms and conditional to fulfill as stipulated by risk team of the bank. Generally, these terms are standard and mutually acceptable across the industry. However, some conditions are very specific to the transaction and need a closer look and detailed discussion. These covenants are most of the times are the outcome of the credit risk meeting with the borrower or the observations. A number of conditions and its criticality may vary in every case. But, it is generally lender biased to protect their interest. At the same time, one has to look if it is not excessive binding on the borrower’s, that the normal course of business is not disturbed.

    I am sure by now we all must have concluded that the benefits of structured loan outnumber the unstructured one.

    Do let us know to understand if your company is enjoying a perfect structured transaction, Please feel free to call for an appointment and we will be happy to help you.

    Do let us know to understand if your company is enjoying a perfect structured transaction, Please feel free to call for an appointment and we will be happy to help you.

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