Term Loan

A term loan is a type of loan where a fixed amount of money is borrowed from a financial
institution for a specified period, typically these loans are granted for more than 1 year and are
meant for purchase of capital assets for the establishment of new units and for expansion or
diversification of existing units. Terms loans are quite distinct from commercial loans as they are
project oriented loans provided for investment purposes. Banks usually grant such loans
together with specialised financing institutions. Term loans are essentially based on a different
theory that is anticipated income theory. Term loans can be 3 types based on their tenure.

Short-term Loans: These loans have a tenure of typically less than one year. They are often
used for working capital needs or to cover short-term expenses.

Medium-term Loans: With a tenure usually ranging from one to five years, medium-term loans
are commonly used for financing equipment purchases, expansion projects, or other medium-
term investments.

Long-term Loans: Long-term loans have tenures exceeding five years and can extend up to
several decades. They are often used for large-scale investments such as real estate
purchases, infrastructure projects, or business acquisitions.

Features of Term Loans

Purpose: In order to establish new industrial companies and to renovate, modernise, replace,
expand, or diversify existing units, medium- and long-term loans are necessary. These loans
are used to build factory buildings, buy land for factories, buy new equipment and machinery,
etc. Term loans are also given out to cover a portion of the ongoing working capital
requirements.

Project-oriented Approach: Term lending companies use a project-based methodology. The

fundamental idea behind a term loan is that the borrower's ability to repay the loan is
determined more by the project's expected income flow than by the sale of his assets. As a
result, the lending institutions use a thorough appraisal process. To determine the earning
potential and repayment capability of the borrowing units, they carefully assess the project's
viability and profitability. They go into detail about the thorough appraisal process they use.

Period of Loan: Term loans are repayable in instalments over a period of time. Repayment
must be made in accordance with a timetable that spans eight to ten years, requiring the
borrower to exercise financial restraint. Loans are typically repaid in half-yearly instalments, with
payments beginning two or three years after the loan is approved.

Security: Term loans are generally secured by–

● First Legal Mortgage of Fixed Assets: This involves pledging the fixed assets of the
industrial unit, both existing and those to be acquired in the future, as collateral for the
term loan.
● First Charge by Hypothecation of Movable Assets: This type of security entails
pledging movable assets of the company, such as inventory, equipment, and
receivables, as collateral for the term loan. However, this charge is subordinate to any
prior charges created in favour of the company's bankers for securing finance for
working capital requirements.
● Equitable Mortgage and Second Charge on Immovable Property: In certain cases,
lenders may accept an equitable mortgage and a second charge on immovable property
as additional security for the term loan. An equitable mortgage involves creating a
charge on immovable property without transferring the title to the lender. This provides
the lender with an additional layer of security in case the primary security (e.g., fixed or
movable assets) is insufficient to crar the loan amount in case of default.

Rate of Interest: The actual rate of interest charged by banks depends upon the perceived risk
and the creditworthiness of borrowers.

Advantages of Term Loan

Term loans stand as a pillar of financial support for businesses, offering a range of advantages
that can redefine growth and stability. Some of the advantages of term loans are:

Financial Flexibility and Stability: Term loans introduce a sense of stability and predictability
to your financial obligations. With a fixed repayment structure, you can precisely determine your
monthly payments, streamlining budgeting and cash flow management. This foresight extends
to long-term planning, allowing you to harmonise business strategies with financial
commitments. This dual sense of stability collectively fosters business growth and equilibrium.

Lower Interest Rates: Term loans offer the advantage of cost-effective borrowing, particularly
for loans backed by collateral. Collateralized loans, where you provide assets as security, often
result in more favorable interest terms due to perceived lower risk for lenders. Furthermore,
fixed interest rates serve as a safeguard against market rate volatility, simplifying financial
projections and eliminating uncertainty about future borrowing costs.
Access to Larger Capital: Term loans serve as a gateway to substantial capital, rendering
them ideal for ambitious undertakings. Whether your focus is expansion, embarking on
significant ventures, or making substantial asset investments, term loans equip you with the
financial means to seize opportunities that might otherwise remain elusive. This capacity to
access larger capital positions your business to thrive on a more expansive scale.

Diversified Use: A core strength of term loans lies in their adaptability. Unlike financing options
with imposed usage limitations, term loans empower you to allocate funds as per your specific
business needs. Whether addressing challenges, pursuing avenues for growth, or enhancing
operational capabilities, term loans deliver the financial versatility necessary to navigate
dynamic market conditions.

It’s essential to recognize the potential challenges that can accompany these financing options.
Here’s a closer look at these disadvantages, shedding light on the considerations that
businesses should be mindful of:

Rigidity in Repayment: The structured nature of term loan repayments, while aiding in financial
planning, can also introduce rigidity. This fixed repayment schedule might become a challenge if
unexpected financial fluctuations occur, as adapting repayment schedules accordingly might not
be feasible. Furthermore, the consistency of fixed monthly payments can strain cash flow,
particularly during periods of financial tightness. This rigidity necessitates careful budgeting to
ensure consistent meeting of financial obligations.

Collateral Requirement: Term loans often require collateral, which can present potential
disadvantages. While collateralization can secure lower interest rates, the risk lies in the
possibility of asset seizure in case of loan default. Pledging valuable assets as collateral can
also impact your business’s asset portfolio, potentially limiting its usability for other financial
opportunities.

C. Prepayment Penalties: Term loans might come with prepayment penalties if you choose to
pay off the loan ahead of schedule. While intended to ensure lenders earn expected interest,
these penalties can complicate early loan repayment. Weighing potential cost savings on
interest against prepayment penalties becomes a crucial factor when considering paying off the
loan before its term.
Long-Term Commitment: Opting for a term loan commits your business to a long-term
financial arrangement. While this might suit certain needs, it can potentially impact business
flexibility. Tied-up cash flow and financial capacity might hinder your ability to swiftly respond to
unforeseen opportunities or challenges. Moreover, committing to a long-term loan might not
align with potential shifts in your business’s strategic direction.

Hard to Get Loan: Obtaining a term loan is not always easy for a new business, since new
businesses may not have sufficient financial statements to provide banks with confidence about
the organisation's finances.

In essence, while term loans offer various advantages, understanding these potential
disadvantages is equally vital. This comprehensive perspective empowers businesses to make
informed financial decisions that align with their unique circumstances and aspirations.

The loan classification and provisioning guidelines are set by the Bangladesh Bank, the central
bank of Bangladesh. Here is an overview of the key points related to term loans:

Loan Classification Categories:

Loans and advances are grouped into four main categories for classification purposes.
● Continuous Loan: Transactions can be made within certain limits.
● Demand Loan: Repayment is due upon demand by the bank.
● Fixed Term Loan: Repayment occurs in instalments over a fixed period.
● Short-term Agricultural & Micro-Credit: Specific loans for agriculture and micro-credit.

Objective Criteria for Loan Classification:

Loans are classified based on their repayment status and overdue periods. Here are the criteria:
● Past Due/Overdue: Any continuous loan not repaid/renewed within the fixed expiry date
or after the bank’s demand becomes past due from the following day.
● Sub-standard (SS): Loans remaining past due for 3 to 9 months fall into this category.
● Doubtful (DF): Loans remaining past due for 9 to 12 months fall into this category.
● Bad/Loss (B/L): Loans remaining past due for 12 months or more are classified as
bad/loss.
● Defaulted Loan Reporting: Loans are treated as defaulted as per the Banking
Companies Act, 1991, and reported accordingly.

Loan Rescheduling Rules:

● Any classified loan can be rescheduled up to three times.
● A fourth-time rescheduling provision is available for defaulted loans.
● Fixed-term loans with balances less than Tk 1 billion can be rescheduled for up to six
years with a grace period.

Foreign Currency Short-Term Borrowings: Admissible in convertible foreign currencies for up

to six years from the inception of manufacturing/service activities. Borrowing companies may
pay interest at a maximum rate of 3.0% per annum. Prior approval by Bangladesh Bank is not
required for receipt or repayment of such loans.

Appraisal Procedure

Term loans are essentially based on a different theory that is anticipated income theory and hint
the method of Appraisal of term loan proposals is quite different and exhaustive. A term loan is
expected to be repaid not by liquidating the assets acquired but out of the increased earnings of
the borrowing units resulting from new units or higher level of utilisation of existing units. The
landing institution has therefore , to assure itself that the borrowing concern shall be able to
earn the expected profits in future years out of which the term loan is to be repaid in an agreed
manner. This requires detailed procedure for the appraisal of a term loan. The following are the
steps in the process of long-term lending:
1. Submission of detailed application form by the borrower.
2. Appraisal of the loan proposal.
3. Setting out the appropriate terms and conditions.
4. Follow-up and supervision.

Application Form

The process begins with the borrower submitting a comprehensive application form to the
lending institution. This form typically includes the following information:
1. Particulars of promoters.
2. Particulars of the industrial concern
3. Particulars of the project.
4. Cost of the project.
5. Means of financing.
6. Marketing and selling arrangements.
7. Profitability and cash flow.
8. Economic consideration.
9. Government consent.
The application is to be accompanied with the following statements:
1. Estimates of cost of production.
2. Estimates of working results.
3. Estimates of production and sales.
4. Cash flow statement.
5. Estimates of the cost of the projects.
6. Pro forma balance sheet.

Loan Appraisal

There are four broad aspects of appraisal of a term loan proposal, namely, technical feasibility,
economic feasibility, financial feasibility and managerial competence.
Technical Feasibility: A project must be technically feasible. To ensure this,various
requirements of the actual production process are to be assessed. The term lending in
institution pays special attention to the following aspect:
● The feasibility of the technical process selected and its suitability.
● The location of the project, particularly in relation to the sources and availability of raw
materials, water, power, fuel, transport, labour etc.
● Specification of plant and equipment.
● Plant layout
● Facilities for the disposal of effluents and also of the by-products.
● The construction schedule.

Economic and Social Aspects: It is necessary to examine that the project not only finds a
useful place in the economy of the country but is satisfactory from the point of view of the
marketability of its products and the price at which these are to be sold within the country or
abroad. The term lending institution also analyses the economic impact of the project which
includes assessing its contribution to employment, income generation, the capacity to create a
climate for industrialisation in a relatively underdeveloped or backward area and overall
economic development. It also considers social factors such as environmental impact,
community benefits, and social responsibility.

Managerial Competence: The management set-up of the borrowing concern is examined to

ensure that it has a competent and broad-based board of directors comprising persons of
integrity and adequate business experience. Evaluating the borrower’s management team.

Financial Appraisal: The financial appraisal is the most important part of the appraisal of a
term loan proposal. The financial Appraisal deal with the following issues:

● Profitability: The term Lending institutions assesses the borrower's ability to generate
profits from its operations. Lenders evaluate factors such as the borrower's historical and
projected financial performance, including revenue growth, profit margins, and return on
investment. A profitable borrower is more likely to generate sufficient cash flow to repay
the loan and interest.

● Liquidity: The term lending institution also assesses the borrower's ability to meet its
short-term financial obligations. Lenders assess liquidity by examining the borrower's
current assets (e.g., cash, accounts receivable) compared to its current liabilities (e.g.,
short-term debt, accounts payable). A higher liquidity ratio indicates a stronger ability to
cover short-term obligations, including loan payments.

● Solvency: Solvency evaluates the borrower's long-term financial health and ability to
meet its long-term obligations. Lenders analyse solvency ratios, such as debt-to-equity
ratio and total debt ratio, to assess the proportion of debt to equity and the borrower's
 capacity to absorb losses. A borrower with healthy solvency ratios is better positioned to
withstand economic downturns and fulfil long-term loan commitments.

● Collateral: Collateral refers to assets pledged by the borrower to secure the loan.
Lenders assess the value, type, and quality of collateral to mitigate the risk of default.
Common types of collateral include real estate, equipment, inventory, and accounts
receivable. Collateral provides lenders with a source of repayment in case the borrower
fails to meet its loan obligations.

● Debt-Service Coverage Ratio (DSCR):DSCR measures the borrower's ability to cover

its debt obligations with its operating income. It is calculated by dividing the borrower's
annual operating income by its annual debt service (principal and interest payments). A
DSCR of 1 or higher indicates that the borrower's operating income is sufficient to cover
its debt obligations. Lenders typically require a minimum DSCR to ensure loan
repayment capacity.

● Creditworthiness: Creditworthiness assesses the borrower's overall financial credibility

and ability to repay the loan. Lenders evaluate creditworthiness based on factors such
as the borrower's credit history, financial statements, industry experience, and
management team. A borrower with a strong creditworthiness profile is considered less
risky and may qualify for lower interest rates and better loan terms.

● Risk Assessment: Risk assessment involves identifying and evaluating the potential
risks associated with lending to a particular borrower or financing a specific project.
Lenders consider factors such as industry risk, market conditions, regulatory
compliance, borrower-specific risks, and external factors (e.g., geopolitical events,
economic conditions). Effective risk assessment helps lenders make informed lending
decisions, price loans appropriately, and implement risk mitigation strategies.

Follow-up and Supervision

After granting loan to borrower the term lending

institutions monitor how the proceeds of the loan is being used. A term lending institution can
supervise the end use of a loan in 2 ways. These are:

On-Site Supervision:

● Preparation and Planning: Before conducting on-site visits, the lender typically
develops a plan outlining the objectives, scope, and schedule of the visit. This includes
identifying key areas to inspect and documents to review.

● Site Visit: Lenders visit the borrower's premises or project site to physically inspect
operations, assets, and progress. During the visit, they may meet with management, tour
facilities, observe production processes, and assess the quality of assets.
 ● Document Review: Lenders review relevant documents on-site, such as financial
records, project plans, contracts, permits, and progress reports. This helps verify the
accuracy of information provided and ensures compliance with loan terms.

● Interviews and Discussions: Lenders engage in discussions with management and

key personnel to gain insights into project status, challenges, and future plans. This may
include discussing operational issues, market conditions, and risk management
strategies.

● Observations and Assessments: Lenders observe the borrower's operations,

infrastructure, and management practices to assess performance, adherence to loan
covenants, and overall risk profile. They also identify any potential red flags or areas for
improvement.

● Reporting and Follow-Up: After the on-site visit, lenders prepare a detailed report
summarising their findings, observations, and recommendations. They may follow up
with the borrower to address any concerns, provide feedback, or request additional
information as needed.

Off-Site Supervision:

● Data Collection: Lenders collect and analyse financial and operational data provided by
the borrower on a regular basis. This includes financial statements, cash flow
projections, budgets, progress reports, and compliance certificates.

● Financial Analysis: Lenders conduct financial analysis to assess the borrower's

financial performance, liquidity, solvency, profitability, and compliance with loan
covenants. They monitor key financial ratios and trends to identify any deviations or
warning signs.

● Risk Monitoring: Lenders monitor various risks, including credit risk, market risk,
operational risk, and regulatory risk, through ongoing analysis and surveillance. They
stay informed about industry developments, market conditions, and macroeconomic
factors that may impact the borrower's business or repayment capacity.

● Communication and Reporting: Lenders maintain regular communication with the

borrower to discuss performance, address concerns, and provide guidance. They may
request additional information or clarification on specific issues. Lenders also prepare
periodic reports summarising the borrower's financial and operational status, risk profile,
and compliance with loan terms.

● Escalation and Intervention: If issues or challenges arise during off-site supervision,

lenders may escalate the matter to senior management or initiate corrective actions.
 This may involve renegotiating loan terms, implementing risk mitigation measures, or
restructuring the loan arrangement to mitigate potential losses.

Overall, a combination of on-site and off-site supervision enables lenders to effectively monitor
borrower activities, mitigate risks, and safeguard their interests throughout the term loan
lifecycle.