Term loan

A term loan is a common debt-base financial arrangement where a borrower receives a lump sum of money from a financial institution and agrees to repay the loan over a specified period, known as the loan term.
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  • Loan-based Financing

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Concessional loan
Syndicated loans

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Water Environment Improvement Project, Viet Nam

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Description

A term loan is a common debt-based financial arrangement where a borrower receives a lump sum of money from a financial institution, such as a bank, and agrees to repay the loan over a specified period, known as the loan term. Unlike revolving credit facilities, term loans have a fixed repayment schedule, typically comprising of monthly instalments, making them a structured form of debt. Term loans serve as a variety of purpose, including funding capital expenditures, expansion projects, equipment purchases, or meeting long-term working capital needs. These loans may have fixed or variable interest rates, and the repayment period can be short- or long-term, depending on the nature of the loan and the purpose for which it is obtained.

Term loans can be secured, where assets are pledge as collateral, or unsecured, relying solely on the borrower’s creditworthiness. Terms and condition of term loans are typically outlined in a formal agreement, including details such as interest rates, repayment schedules, associated fees, and prepayment options.

Enabling Conditions and Key Considerations

  • Creditworthiness of the city. A city’s credit rating significantly shapes the terms and conditions it can secure in a term loan. Cities boasting strong creditworthiness often qualify for more favourable interest rates and repayment terms. The assessment of a city’s creditworthiness depends on its financial statements, including income statements, balance sheet statements, and cash flow statements. In assessing the city’s financial health, banks will seek indicators such as stable revenue stream, manageable debt levels, and positive cash flows.
  • Ability to repay the loan. A pivotal factor in a bank’s decision to grant a term loan hinges on the city or project’s capacity to repay the loan’s principal and interest. This typically entails a thorough examination of the city or project revenue stream, budget allocations, and financial management practices by the bank. A strong repayment capacity instils confidence in the bank, assuring them of the city’s ability to fulfil its debt obligations.
  • Ability to enforce loan terms. Banks require assurance that the city will adhere to all legal and regulatory requirements in securing a term loan. This assurance spans from understanding the city’s authority to borrow and raise debt, verifying the legality of the intended use of funds, and ensuring the bank’s ability to enforce repayment terms. A stable regulatory environment provides a foundation for the successful execution and enforcement of term loans.

Potential Challenges

  • Cities might face challenges securing favourable rates. Cities with lower credit rating or a history of financial instability may face challenges in securing favourable terms for a term loan. Limited creditworthiness can result in higher interest rates, stringent repayment conditions, or even difficulties in obtaining the loan. Improving the city’s creditworthiness through sound financial management practices becomes crucial in overcoming this challenge.
  • Concerns around project viability could hinder loans. If the term loan is intended to finance a specific project, concerns about the viability and success of the project can hinder the loan approval. Lenders may scrutinise the project’s business plan, intended use of funds, the city’s ability to execute the project successfully, and even the potential economic, environmental, or social impact of the project. Clear communication and a detailed project plan can help address this issue.
  • Macroeconomic conditions could impact lending rates significantly. Uncertain economic conditions, stemming from factors beyond a city’s control – such as political instability, recessions, pandemics, etc. – can pose a challenge for cities seeking term loans. Lenders may exercise increased caution during periods of economic uncertainty. This would have significant impact on loan approvals and interest rates.

Potential Benefits

  • Repayment arrangements are structured and predictable. Term loans offer a structure and predictable repayment schedule, providing cities with clarity and stability in their financial planning and management. Unlike loans of credit or revolving funds, term loans have fixed internet rates and predetermined repayment periods, reducing the uncertainty associated with fluctuating interest rates. The predictable repayment schedule also allows for better budgeting and allocation of resources over the loan term.
  • Non-complex and straightforward financing option. Unlike more complex financial arrangements like municipal bonds, or on-bill financing schemes that may require more sophisticated capital market participation, term loans offer simplicity and accessibility to cities. Cities can navigate the loan acquisition process with relative ease, allowing cities to secure financing without the need for elaborate financial structures or an in-depth understanding of capital markets, making them a practical and straightforward financing option to raising capital for crucial development projects.

Sources/Additional Information

Case Study

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