Commercial Credit Analysis: Sources of Repayment

The main concern that a banker has when facilities are extended is on the repayment of the monies advanced. This is the question that he will invariably zero in on and it would be prudent for the prospective borrower to advise him upfront on how he intends to repay the facility.

In ideal circumstances there should be more than one source of repayment so that should there be, for some reason, a delay or a problem, the repayment commitment can still be honored. Bankers too, if presented with a well structured plan/ plans of repayment would be more willing to listen and even advance facilities.

  1. Primary Source: The primary source of repayment should be directly related to the kind of loan given i.e. for facilities extended (overdraft) for working capital or to finance trade the repayment should be from the proceeds of the goods sold. If a bridge loan prior to the final allotment of a public issue has been given, the repayment should be from the monies received after the allotment is made. On the other hand if the bridge loan is given prior to the sale of an asset, the proceeds from the sale of the asset should be used to extinguish the loan.
  2. Secondary Source: Even though there may be a real and quantifiable first source of repayment, there is always a possibility that on account of occurrences beyond the borrower’s control, the loan cannot be repaid from the primary source. A classic example is what is presently happening in India on account of the liquidity crunch and the demand downswing. A well known company purchased 41 windmills at a cost of around Rs. 1 crore each and was confident of selling them quickly. Due to a credit squeeze the windmills were unsold and the company could not repay the borrowings from the proceeds of the sale. The company in order to meet its credit commitments sold some property it owned. This was its secondary source of repayment. When companies take working capital finance in the form of overdrafts they normally hypothecate debtors and stock. If repayments are not made, the secondary source of repayment can be seized and sold and the proceeds can be used to liquidate the loan.
  3. Tertiary Source: The tertiary source is further security for a loan. This is in the form of additional collateral that may be unconnected with the business. A director could pledge the shares that he owns in certain blue chip companies as additional security. Alternatively the principal shareholders could give their personal guarantees or a well wisher could give his guarantee. The comfort that a Bank would derive is that should the primary and secondary source of repayment fail, they will have recourse to yet another source of repayment. It is assurances such as these that help the Banker in supporting and recommending a request for a credit facility.


Another method of repaying a loan is by refinancing – procuring a second loan out of which the existing loan is repaid. This may be either by:

  1. Taking another loan.
  2. Accepting fixed deposits. This is not particularly easy presently owing to the credit/ liquidity crunch and the fact that several good companies have defaulted on the payment of principal and/or interest.
  3. Issuing debentures. Debentures are an acknowledgment of debt and this is a very popular form of raising funds to repay existing loans. The convenience of a debenture is that it is usually repayable only after a minimum of three years. It gives the borrower some time to arrange his finances.

The banker will seek to ensure that the charge is properly registered so that should the need arise, the banker can take possession of the asset. There are two kinds of charges – specific and floating. A specific charge is a charge on a specific asset. A floating charge, on the other hand, is a charge on all the assets both present and future of the company. A specific charge has a prior charge however and a banker would always prefer a specific charge.

There are times when the asset to be charged is already hypothecated. In such instances the bank can only get a second charge for the facility given. This means that the banker’s rights are subordinate to the entity that holds the first charge. In other occasions where there are a number of lending banks as in a consortium, the borrower would be able to give the bank only a “pari passu” charge. In this instance the bank’s rights are on the same footing as the other lending banks.

No banker will issue facilities unless it knows and checks the sources of repayment because he is in the business of lending, and not in the business of giving away.


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