Due Diligence for Participation LoansBanker Resource
April 23, 2014 — 2,631 views
Lenders such as banks and financial institutions loan money on a regular basis to individuals, companies and even the government. These loans are required for various purposes. Banks use this money for their own growth and development, to set aside an amount for credit risks and bad debts, while using the principal amount along with the interest to give out more loans.
Due diligence or complying with the necessary legal requirements and documentation while issuing syndicated or participated commercial loans, is of prime importance. Due diligence basically involves three important practices, credit analysis, collateral security and loan documentation. A bank has to make sure that it properly complies with the necessary due diligence requirements and obtain required approvals.
Every bank or lending institution must check the credit rating given to the borrower company by a registered credit rating agency, such as CRISIL or Fitch India. Credit rating is the study and analysis of the firm’s financial position and its ability to repay the loan. Based on previous year’s annual returns, reports and balance sheets, the credit rating agency will study the company’s financial performance and stability in earnings, and assign a rating between 1 to 5. 1 being the lowest and 5 being the highest along with a credit rating report. The bank must also perform a credit analysis before granting a loan.
Every syndicated loan must be secured in the event of non-repayment of the borrowed amount by the debtor. The security is called collateral and is usually immoveable property. The bank can sell or exercise rights over the collateral security if the borrower delays or fails to repay the loan.
Mandate Letter - It contains details of whether the lender will use his best efforts to arrange for the money or if he agrees to underwrite the entire amount borrowed. The mandate letter will also include an agreement to underwrite, names and details of the lenders, commitment amounts and other provisions, borrower’s obligations and lender’s conditions, costs and indemnity clauses.
Term Sheet - It is attached to the mandate letter and contains the terms and conditions of the lending, parties involved and explanations of important commercial loan terminology.
Information Memorandum and Syndicated Loan Agreement – These are the most important documents to complete the due diligence process. They set out detailed descriptions of the borrower and lender and the loan facilities.