Financial appraisal of project a case study of maritime comercial joint stock bank head office,graduation thesis

INTRODUCTION

R ATIONALE

The banking system serves as the backbone of the economy, channeling capital for investment projects from both government and corporate sectors However, recent financial crises have significantly impacted global financial systems, including Vietnam's banking sector, leading to decreased investment rates and reduced revenue from credit activities In this challenging economic environment, banks must carefully assess high-risk investment projects while focusing on loan activities Effective project appraisal is crucial, as it helps banks mitigate risks associated with market volatility and fluctuating exchange rates A thorough appraisal process not only enhances investment effectiveness but also minimizes default risks and eliminates unproductive ventures.

The diagram below illustrated the full procedure for the Appraisal stage of the whole process

The financial aspect of project loan appraisal is a critical component that must be thoroughly analyzed, as it directly influences the bank's ability to assess a customer's capacity to repay the loan and its interest This step is essential among various factors, including legal, socio-economic, technical, and risk management considerations Focusing on the financial dimension ensures a comprehensive evaluation, ultimately guiding lending decisions.

Chart 1: Full Procedure for the Appraisal Stage of the whole process

Supervisor: Dr Phạm Quốc Khánh Student: Nguyễn Khoa Diệu Ngọc- ATCAK11

This article aims to explore the project appraisal process at Maritime Bank, applying theoretical foundations to real-world scenarios The objective is to enhance both the scale and depth of this process, ultimately contributing to its improvement.

For all of that reasons, I choose the topic of: “Financial Appraisal of Project”.

R ESEARCH OBJECTIVE

The purpose of this document is to complete the written part of my bachelor’s project in English for Banking and Finance

This thesis aims to enhance project loan appraisal processes at Maritime Commercial Joint Stock Bank by leveraging theoretical principles of project appraisal and examining current practices within Vietnam's commercial banking sector.

R ESEARCH METHODOLOGY

The thesis is research based on information collection, statistical analysis, synthetic, and comparable methods.

S COPE OF RESEARCH

The thesis focuses on the process of project loan appraisal in Maritime Bank Commercial Joint Stock Company.

T ASKS

In order to reach the objective of the thesis, the responsibility in each part:

Part 1: Research the theoretical foundation of commercial banks and project loan appraisal process

Part 2: Make clear the situation of project loan appraisal process in Vietnam Commercial Banks

Part 3: Research one typical study case: “FTN Vietnam Co., Ltd in Maritime Bank- Appraisal & Loan Approval Report- dated 06/09/2010”

Part 4: Evaluate the quality of project loan appraisal, through which suggests some recommendations to improve its quality.

C ONTENT OF THE THESIS

Besides the introduction and conclusion, the thesis includes 4 parts as follow:

Part 1: Commercial banks and project appraisal

Part 2: Project’s financial appraisal by Vietnam Commercial Banks

COMMERCIAL BANK AND PROJECT APPRAISAL

LENDING ACTIVITY AND COMMERCIAL BANKS

Banks play a crucial role in the economy as key financial institutions They are categorized into various types based on overall economic development and the specific evolution of the financial system Notably, commercial banks represent the largest share in terms of asset size, market share, and the number of institutions.

Under Law No 47/2010/QH12, enacted on June 16, 2010, commercial banks are defined as financial institutions authorized to perform a full range of banking operations and engage in various profit-oriented business activities as stipulated by this legislation.

Banking operations means the trading in and regular provision of one or some of the following services: capital mobilization, credit extension, and via- account payment a Capital mobilization

Capital mobilization is crucial for commercial banks as it generates funding resources essential for their operations Traditionally reliant on customer deposits, banks now benefit from a diversified range of capital sources due to technological advancements and economic development These sources include equity, payment deposits, and borrowing from other financial institutions and capital markets, enhancing the overall capacity for credit extension.

The primary function of commercial banks is to offer credit to businesses, institutions, and individuals, making it their most crucial activity Credit serves as a significant asset for banks, generating substantial revenue through interest on loans, while also posing considerable risks Additionally, credit can be categorized based on various criteria.

− According to timeline, credit is divided into short- term, medium- term, and long- term loan

− According to collateral, people classify credit as: loan with and without collateral

− According to the level of risk, credit includes loans with high, medium, and low safe

These classifications indicate the diversification and specialization in providing credit of banks c Other activities

In today's evolving economy, commercial banks have transformed into multifunctional institutions, expanding their operations into various sectors such as payment services, guarantees, leasing, and foreign currency trading Their primary functions—capital mobilization and credit extension—are complemented by a focus on enhancing these low-risk services, which serve as a buffer against the risks associated with lending However, the lower risk associated with these activities results in reduced returns, typically accounting for only 30% of total revenue, leading banking managers to prioritize lending activities.

1.2 Lending activity of commercial banks

Lending activity is a type of credit extension, which means that banks grant an amount to customer with the commitment of principal and interest repayment in a specified time

According to the Decision 1627/2001/QD- NHNN, there are eight types of loans as follows:

Single loan Short term or long term

Credit line loan Short term

Syndicated loan Short term or long term

Installment loan Long term for consumers

Standby credit loan Short term

Credit card loan Short term

1.3 Project loan in commercial banks

Customers looking to purchase or construct fixed assets for a specific project can secure loans from banks A key requirement from banks is that borrowers must present a project plan that outlines their objectives, investment strategy, and implementation process Project analysis and appraisal serve as critical factors for banks when deciding on loan approvals and assessing the corporation's repayment capacity.

Project appraisal encompasses various critical components, including market research, human resources, technology, and financial analysis, with the latter being the most vital To assess a project's financial efficiency, several methods such as Net Present Value (NPV), Internal Rate of Return (IRR), and payback period are utilized In addition to selecting the appropriate evaluation criteria, banks prioritize the timing and potential sources for debt repayment Consequently, when assessing existing borrowers without new projects or legal entities, banks conduct a comprehensive analysis of the borrowers' financial status alongside the project details.

PROJECT APPRAISAL

Investment project appraisal involves a comprehensive and objective evaluation of all facets of a proposed investment This critical process influences the project's feasibility, effectiveness, and potential for repaying the investment funds, ultimately guiding decision-making regarding project financing.

Aspects of project appraisal include:

 Technical aspect Non- financial aspects

2.2 The role of project appraisal in lending activity of commercial banks

Project appraisal serves two primary purposes: it assesses the financial aspects to determine the project's capacity for principal and interest repayment, and it evaluates non-financial factors to analyze the project's feasibility and associated risks.

This serves as a foundational protection plan prior to project implementation, playing a crucial role in project selection by eliminating risky and unfeasible options Additionally, it identifies potential risks and outlines strategies for their prevention.

The preparation and evaluation of an investment project enable financial institutions to make informed and precise lending decisions, thereby reducing the risks associated with their financial activities.

PRINCIPLES AND BEST PRACTICES OF PROJECT’S FINANCIAL

Appraisers are obligated to adhere to national and international laws governing credit activities They must avoid using the bank's reputation and resources for personal gain and should conduct themselves with integrity, competence, diligence, respect, and ethical standards in all credit-related dealings.

Secondly, the principle of suitable loan making according to each bank’s strategy of development and business in each period

Commercial banks must uphold the principle of equality and customer orientation in their credit provision, ensuring no discrimination based on economic background or business ownership types, except in cases of government-appointed credit All customer transactions should be managed by a dedicated segment of the credit department to ensure consistent service.

Commercial banks must enhance personal accountability by increasing transparency and the quality of credit activities It is essential that every individual involved in decision-making takes full responsibility for their choices.

And finally, the principle of practicing ethics and encouraging others to practice:

All appraisers have the responsibility of practicing and encouraging others to practice in a professional and ethical manner that will reflect credit on themselves and the profession

3.2 Best practices of project’s financial appraisal

Attractive investment projects for both equity owners and debt-holders are characterized by positive Net Present Value (NPV) of incremental net cash flows relative to total capital This indicates that the expected cash flows will enhance the overall value of the investment.

When a stable company proposes a project that fails to provide private investors with an adequate return, financial analysis plays a crucial role in determining the minimum incentive required to encourage investment This analysis assesses the necessary support to elevate the project's net present value (NPV) from negative to zero Consequently, financial analysis is essential for calculating the budgetary support needed for public sector projects and identifying the government assistance or partnerships necessary for private sector investments.

In financial analysis, there are two key perspectives on financial flows: free cash flows to total investment and the interests of debt and equity holders Debt holders focus on whether free cash flows provide a sufficient margin of safety for debt repayment, while equity holders, or project sponsors, are concerned with the residual cash flows available after debt repayment, which must be adequate to recover their capital investment This latter perspective is essential for private sector projects and public initiatives relying on user charges or public-private partnerships to cover costs.

In non-self-financing projects that generate minimal or no user fees, the financial sustainability relies heavily on predicting future public sector revenue availability The following table aids in enhancing the project analysis for both self-financing and non-self-financing initiatives.

Nonself- financing Investment Project Source of payment of operational expenses and financing costs

Sales revenue has to cover all costs

Exogenous finances such as government tax revenues have to cover any balance of operational expenses and financing costs

Key forecasts to assure project finances

Market demand and sales revenues

Typical projects 1 Private sector projects

Public sector projects (with no or low user charges) such as public infrastructure or social services

1 Is investment financially attractive to equity holders?

2 Are the free cash flows from the total investment sufficient to cover the debt repayment at an acceptable level of default risk

1 Can adequate debt and revenue financing be raised to cover capital investment expenditures?

2 Will sufficient revenues be available over the future years to cover operational costs and debt repayments?

Derivation of economic benefits of project

Economic benefits are found directly from private market demand

Separate analysis required of the net benefits derived by users of public project — for example, farmers gains from irrigation or rural roads

Table 2: Key characteristics of financial analysis of self- financing and nonself- financing projects

When evaluating the financial attractiveness of an investment opportunity, several key criteria should be considered, including net present value (NPV), internal rate of return (IRR), payback period, and profitability index Each of these metrics has its own strengths and weaknesses, which are essential for making informed investment decisions.

Because individuals consider waiting to be a cost, it is necessary to compensate them for forgoing their consumption today and instead lending their funds to a bank or a borrower

Expressing values as future or present values effectively captures the time dimension of a project's net cash flows Analysts must account for the compounding of cash flows when calculating future values Conversely, to compare these future values with present values, it is essential to apply discounting, which serves as the inverse of compounding.

NPV is the algebraic sum of the present values of the expected incremental positive and negative net cash flows over a project’s anticipated lifetime

The formula for computing the NPV of expected incremental net cash flows over n time periods with annual discounting is:

Where: is incremental net cash flow r is discount rate (which equal to the cost of capital)

The NPV criterion can be stated in the form of a set of decision rules

Decision Rule 1: Do not accept any project unless it generates a positive NPV when discounted by a discount rate equal to the opportunity cost of funds

To maximize net worth, select the project or project scenario with the highest Net Present Value (NPV) If faced with a budget constraint, prioritize a combination of projects that collectively yield the greatest NPV within the fixed budget.

When choosing between mutually exclusive projects without budget constraints, investors aiming to maximize their net worth should opt for the project that offers the highest Net Present Value (NPV).

IRR is the discount rate that set the NPV = 0

The IRR criterion can be stated in the form of a set of decision rules

When evaluating projects, adhere to Decision Rule 1: only accept projects with an Internal Rate of Return (IRR) that exceeds the opportunity cost of capital (r) If the IRR is greater than the opportunity cost, proceed with the project; if not, it should be rejected.

Decision Rule 2: When a choice must be made between two or more mutually exclusive projects, then investors should select the project with the higher, or highest IRR

Problems with the IRR criterion:

 The IRR may not exist

 The IRR may not be unique There could be multiple IRRs

 IRR generally favors projects with shorter life

 IRR is independent of the timing of a project, whereas the NPV is sensitive to timing

The profitability index (PI) is the present value of a project’s future cash flows divided by the initial cash outlay:

Decision Rule 1: Do not accept any project unless its PI is greater than one Accept project if PI > 1; otherwise, reject

Decision Rule 2: When a choice must be made between two or more mutually exclusive projects, then investors should select the project with the higher, or highest

PROJECT’S FINANCIAL APPRAISAL BY VIETNAM COMMERCIAL

VIETNAM COMMERCIAL BANKS AND PROJECT FINANCE

1.1 Current financial situation affect project finance

In the first quarter of 2012, as of March 30, total deposit accounts rose by 1.56%, and total M2 payment methods increased by 1.22%, marking the slowest growth rates in recent years, while credit growth for the economy declined by 2.13% This period highlighted a reversal trend in the interbank market, where despite high system liquidity, credit availability for the economy diminished The situation indicates a frozen capital market, with funds trapped in banks and not reaching the economy Additionally, due to low demand and high borrowing rates, factories limited their need for debt resources.

A negative credit growth rate will adversely impact the quality of banking services, leading to a contraction in the production sector This decline is likely to increase the ratio of bad debts and affect system liquidity in the upcoming period of 2012.

The banking system in Vietnam has been officially categorized into two groups: healthy and unhealthy, following the implementation of decision 01/CT-NHNN The State Bank of Vietnam (SBV) has set target credit growth rates for each bank to stimulate the restructuring process and to caution those in groups 3 and 4 Additionally, the SBV has indicated that nine more banks will be required to undergo mergers and acquisitions.

Weak banks aren't the only ones facing challenges; the banking system as a whole grapples with poor-quality financial assets Larger banks temporarily maintain liquidity by absorbing deposits from smaller institutions and experiencing reduced credit demand However, as the transfer of deposits slows and the ratio of bad debts rises, even financially stable commercial banks may find themselves facing liquidity issues again.

In order to solve thoroughly the problem of the system, the quality of project appraisal needs to be improved

A financial appraisal is a crucial process for evaluating the financial feasibility of a proposed project It measures the project's ability to generate sufficient revenue to cover its financial obligations, utilizing the Net Present Value (NPV) of its cash flows This assessment considers all revenues and expenditures associated with the project.

 the sensitivity of financial projections to key project risks

 the adequacy of the estimated investment cost, and

 the financial impact of alternative projects

Projects may involve asset construction, purchase, lease or sale and may be financed in a wide variety of ways through grants, borrowings, revenues, supplier finance or a combination of these mechanisms

1.3 Conditions to implement a project’s financial appraisal

 The necessity of information in appraising project finance

"Information serves as the foundation of knowledge, particularly in project appraisal, where it is essential for conducting effective financial analysis Without accurate and reliable information, appraisers are unable to make informed decisions."

Appraisers should gather various information sources for each client, as each source provides a unique perspective on the business's narrative, collectively contributing to a comprehensive understanding of the overall story.

Main source of information for Project’s Financial Appraisal:

In financial appraisal of project, there are two main types of information needed to be considered before implementing appraisal, namely: business financial information and project’s information

Banks must evaluate the financial health of businesses seeking loans or services to make informed decisions A critical step in this process is reviewing the financial statements of each company, which provide insights into its financial strength, profitability, and future prospects.

When a bank sponsors project finance, it effectively makes an indirect investment in the project, highlighting the importance of detailed project information Key aspects of this information include the project's objectives, implementation process, payment schedule, and potential risks, all of which are crucial for assessing the project's feasibility and profitability.

To effectively conduct a financial appraisal of a project, it is essential to utilize an appraisal method that equips analysts to decide which projects to accept or reject While there is no universally superior technique for estimating project value, certain methods outperform others, and some are particularly inadequate.

Project appraisal techniques can be categorized into two main types: undiscounted and discounted methods Undiscounted techniques, such as payback period, value added, capital-output ratio, proceeds per unit of outlay, and average annual proceeds per unit of outlay, focus on straightforward financial assessments In contrast, discounted techniques account for the time value of money and include methods like Net Present Value (NPV), Internal Rate of Return (IRR), Profitability Index (PI), and discounted payback period, providing a more comprehensive evaluation of a project's financial viability.

Defining which methodology to be applied has to be decided before implementing financial appraisal so that appraisers have an orientation to select and analyze information.

2.3.6 Define the balance sheet of the ability of paying off the loan

CASE STUDIES

1 CASE STUDY I: FTN VIETNAM CO., LTD IN MARITIME BANK- APPRAISAL & LOAN APPROVAL REPORT- DATED 06/09/2010

1.1 General information of FTN Vietnam Co., Ltd

Enterprise name: FTN Việt Nam Limited Partnership (Nines Limited

CIC Code( new ): 7400001533 CIC Code( old ) : 650001569

Head Office: G2-CN, Road D1, Industrial Area Mỹ Phước, Bến Cát,

Business license: 462023000045 Date of issue: 19/12/2006 Business line: Clothing

Chairman of board of director:

Table 6: General information of FTN Vietnam Co., Ltd

1.2 Financial appraisal of the project

The project focuses on investing in the company's second factory located in My Phuoc 1 Industrial Park, Ben Cat, Binh Duong, with the approval of the Company Member Committee.

Currently, Company has signed the construction Bidding Contract and acknowledge about the price of the machines and equipment for the construction

1.2.2 Appraise financial condition of the project investor

 Credit balance for latest 1 year

Chart 3: Credit balance of customer (May 2009- May 2010)

 Relationship with other credit institutions in the past

Ord Institution Credit institution code

Table 7: Relationship with other credit institutions in the past

Customer does not have any credit balance with other institutions

 The history of substandard debt for the latest 3 years

Customer does not any substandard debt for the latest 3 years

1.2.3 Appraise investment capital of the project and the feasibility of capital structure

The factory is designed to produce 150,000 products monthly, totaling around 1.8 million products annually It boasts high-quality equipment and machines, with 80-100% of them sourced from Japan, featuring renowned brands like Juki, Yamato, and Sun Star.

Total anticipated investment capital is 2,000,000 USD, in which construction made up 50%; equipments and facilities account for 50% total investment

 Evaluation of the Project progression

The estimated time for Project construction and utilization: Construction from 3/2010 to 8/2010; Project utilization: 15 years

Currently, Company has financing approximately 35% the value of project construction and according to plan, the factory will be finished construction and installment of equipments/facilities  reasonable

Electricity and water supply and installment

4 Working capital needs 50% Total revenue

Loan from other institution 0% W/C needs

Table 8: Investment Capital of the project Comments: Total invesment is calculated quite detailed and precisely

 Feasibility of capital sources and capital structure

Equity source is expected to increase from the profit of the Parent company or advanced capital payment from the Parent Company  however, there is no clear confirmation

1.2.4 Appraise expected revenue and costs of the project

The activation of the second factory will significantly enhance the overall capacity of the plant, enabling it to meet the growing demands of customers Furthermore, FTN Parent Company has secured contracts with WALMART, which could lead to substantial purchasing agreements if FTN can ensure timely supply Products will be transferred to FTN Parent Company in Korea for distribution, ensuring a reliable consumption capacity for the produced items.

Refer to the Appendix for Full Revenue/ Break-even point Plan in 15 years

Costs are classified as followed:

Sales costs Other variable costs

- Interest expenses for fixed costs

Interests Expenses for Working capital

Table 9: Types of costs of the project

1.2.5 Appraise annual cash flow of the project

Appraise annual cash flow of the project:

Table 10: Appraise annual cash flow of the project

1.2.6 Appraise and analyze indicators evaluating the financial efficiency of the project

Project is calculated to borrow in 5 years, grace period 1 year, payback time 5years with the following results:

 Evaluation on the efficiency of the project :

Comment: The project has adequate financial capacity (NPV>0, IRR> WACC)

The project's feasibility is significantly influenced by the buying and selling dynamics of the company and its parent, FTN Parent Company, as well as the overall business capacity and growth potential of the parent organization.

Sources of debts payment (both principal and interest) and expected Debts Payment Schedules:

In its first year, the project's operating capacity achieved 60% of the designed capacity, marking a 15% increase in the second year, followed by a consistent 10% growth in subsequent years compared to the second year.

Conducting sensitivity analysis for single changes in price of the products and changes in both prices and material costs as follow:

Table 13: Sensitivity analysis- change in price

Change in price and material cost:

Table 14: Sensitivity analysis- change in price and material cost

DISCUSSION/ RECOMMENDATION

1 EVALUATION OF THE QUALITY OF PROJECT LOAN APPRAISAL

Investment project credit in Vietnam has faced significant challenges, particularly following the financial recession of late 2008 In response, commercial banks in Vietnam have heightened their focus on the appraisal process for project loans before granting approval While this increased scrutiny can facilitate revenue growth and business expansion, it also raises the risk of potential bad debts if the appraisal process is not conducted meticulously.

In fact, Vietnam commercial banks have reached some finite achievements in project loans as follow:

- Continuously expand the project portfolio, especially for the customers whose projects are considerably safe; restricted with risky and inefficient project

- Strategically expand for project in key economic sectors, products with stable demand; prudent with project with fluctuations in prices and demand

Project loans from commercial banks play a crucial role in supporting enterprises and the economy by providing essential funding These loans effectively address capital shortages for new investments or business expansions, ensuring that businesses can seize valuable investment opportunities without delay.

- The appraisal and lending process is strictly in accordance with strict regulations, which organize, coordinate and manage flexibly within departments and committees

- Ensure of the specialization, transparency and clear separation between Customers Department, Project Appraisal and Lending Approval

Project appraisal has been implemented with risk assessment, but it lacks thoroughness and depth While there are methods available for assessing risks, many are outdated and unable to evaluate the impacts of multiple changing factors effectively Although various models and generalized methods exist, such as scenario analysis and probability methods, they have not been widely applied in practice.

In revenue-cost appraisal, utilizing fixed costs and prices for the entire economic life of a project is often impractical due to the significant instability of the economy, particularly in the context of current economic integration.

Finally, collateral to secured project loan is still low Regulations and procedures on collateral are not really strict, collateral value does not really match with the real assets value

To ensure rational lending decisions, reliable information is essential However, appraisers at Vietnamese commercial banks often face challenges due to limited quantitative and qualitative data.

Appraisers should thoroughly research project details and ownership information from reliable online sources and mass media It is crucial to carefully evaluate and select this information before utilizing it; however, many appraisers tend to use it hastily This can result in ill-informed lending decisions, potentially leading to significant repercussions.

The current capability to assess industry sectors is inadequate, significantly impacting the appraisal process and decision-making This deficiency particularly hinders the analysis of new products and eco-tourism projects over the medium and long term Consequently, promising new projects are often overlooked in favor of more familiar ventures, which carry greater risks.

1.3 Suggested for causes of existing limitations

1.3.1 Causes from commercial banks a Lending policy has not yet completed

Despite most commercial banks having sound policies that align with legal standards and the business environment, they face challenges in Appraisal and Customer Services, particularly due to insufficient information gathering within the customer services department.

In addition, project profile is not specific for each type of business, business fields in a specific area

Currently, the information source is mainly provided from the customers However, this source is sometimes insufficient, inaccurate, and depends a lot on the customers

Additionally, banks gather data from their internal sources and the Credit Information Centre of the State Bank of Vietnam (CIC-SBV) This internal data includes details like customer revenue and credit balances for those with existing or past relationships with the bank or other financial institutions However, it is important to note that the information provided by CIC-SBV can often be inadequate, outdated, and of poor quality, affecting the overall appraisal process.

In certain sectors, the limited number of appraisers leads to high job intensity, restricting their ability to conduct thorough assessments of projects Consequently, appraisers can only evaluate material indicators and methods relevant to the project, leaving many aspects unexamined Additionally, many appraisers are young and inexperienced, lacking essential social connections and a solid understanding of economic principles Furthermore, the absence of foundational training and development programs hampers the enhancement of staff skills.

Despite efforts by various banks to prioritize employee well-being, many reward systems remain ineffective in fully harnessing employees' capabilities and potential Additionally, inadequate facilities and equipment hinder productivity and overall job satisfaction.

The "Modernizing Banks and Payment System Project" by the World Bank is currently focused solely on the accounting, inspection of lending, and retail sectors, with no specialized software available for the appraisal field As a result, most appraisers continue to rely on Excel, leading to inefficiencies in both productivity and timeliness.

Customers face two primary challenges: a lack of experience and capacity in project construction and appraisal, and insufficient credibility and transparency in the information provided to appraisers.

The credibility of the project owners and transparency of the information can affect a lot the project appraisal, which in turn, affects the efficiency of the project

1.3.3 Other causes a Policies are not completed

The intersection of the legal frameworks in investment banking and finance, coupled with lax government oversight, poses significant challenges for banks in conducting project appraisals, often resulting in adverse outcomes Additionally, the frequent issuance and modification of regulatory documents disrupt project assessments, leading to potential inaccuracies in project predictions Furthermore, inadequate collaboration among banks exacerbates these issues.

Recent market conditions have intensified competition among banks in mobilizing and utilizing funds Consequently, collaboration and information sharing between banks and the State Bank of Vietnam (SBV) regarding banking operations, particularly in project loan appraisal, are notably restricted This limitation adversely affects the quality of the information gathered, highlighting the significance of macroeconomic factors within the business environment.

CONCLUSION

Base on the broad view from Part II: “Commercial Bank and Project Appraisal”, project finance in Vietnam is evaluated in part III by comparison and statistic method

To adapt to the evolving economic landscape, commercial banks must develop strategic policies This article highlights practices implemented by Vietnam Commercial Banks, focusing on the appraisal process exemplified by the Appraisal & Loan Approval Report from FTN Vietnam Co., Ltd at Maritime Bank, dated 06/09/2010 The analysis evaluates achievements and limitations, as discussed in part IV, identifying causes for these limitations in appraisal practices Additionally, the article proposes four key solution groups aimed at enhancing the accuracy and reliability of project appraisals within Vietnam's Commercial Banks.

The financial appraisal process of projects is complex and influenced by various subjective and objective factors, necessitating strict management of project lending by the State Bank of Vietnam to help commercial banks avoid high-risk investments Enhancing the credit database is also crucial for providing better information to these banks The quality of project financial performance evaluations relies on the professional qualifications and ethical standards of appraisers, as well as factors such as evaluation processes, technology, information management, and the regulatory and economic environments Therefore, improving the financial appraisal quality requires collaboration among various branches and ministries, along with thorough and comprehensive research to develop effective solutions.

Due to constraints in time, data, and analytical methods, this thesis has not thoroughly assessed the overall influence of various factors on the appraisal process, nor has it provided an in-depth analysis of their interrelationships With future development, the author hopes to explore this topic more comprehensively to offer broader recommendations for financial appraisal.

Full Procedure for the Appraisal Stage of the whole process

This article aims to explore the project appraisal process at Maritime Bank, leveraging theoretical foundations to enhance both the scope and depth of this process.

For all of that reasons, I choose the topic of: “Financial Appraisal of Project”

The purpose of this document is to complete the written part of my bachelor’s project in English for Banking and Finance

This thesis aims to enhance project loan appraisal practices at Maritime Commercial Joint Stock Bank by proposing solutions grounded in the theoretical framework of project appraisal and the current practices observed in Vietnam's commercial banking sector.

The thesis is research based on information collection, statistical analysis, synthetic, and comparable methods

The thesis focuses on the process of project loan appraisal in Maritime Bank Commercial Joint Stock Company

In order to reach the objective of the thesis, the responsibility in each part:

Part 1: Research the theoretical foundation of commercial banks and project loan appraisal process

Part 2: Make clear the situation of project loan appraisal process in Vietnam Commercial Banks

Part 3: Research one typical study case: “FTN Vietnam Co., Ltd in Maritime Bank- Appraisal & Loan Approval Report- dated 06/09/2010”

Part 4: Evaluate the quality of project loan appraisal, through which suggests some recommendations to improve its quality

Besides the introduction and conclusion, the thesis includes 4 parts as follow:

Part 1: Commercial banks and project appraisal

Part 2: Project’s financial appraisal by Vietnam Commercial Banks

II COMMERCIAL BANK AND PROJECT APPRAISAL

1 LENDING ACTIVITY AND COMMERCIAL BANKS

Banks play a crucial role in the economy as essential financial institutions They can be categorized into various types based on the overall economic development and the evolution of the financial system Notably, commercial banks dominate in terms of asset size, market share, and the number of institutions within the banking sector.

Under the law no 47/2010/QH12, dated June 16, 2010, commercial banks are defined as financial institutions authorized to perform a wide range of banking operations and other business activities for profit.

Banking operations means the trading in and regular provision of one or some of the following services: capital mobilization, credit extension, and via- account payment a Capital mobilization

Capital mobilization is crucial for commercial banks as it generates funding resources essential for their operations Traditionally, banks relied primarily on customer deposits for capital mobilization However, advancements in technology and economic development have led to a diversification of funding sources, including equity, payment deposits, borrowing from other financial institutions, and capital market borrowing This evolution enhances the banks' ability to extend credit effectively.

Commercial banks prioritize providing credit to businesses, institutions, and individuals, as it represents a key asset that generates significant revenue through interest rates However, this activity also entails considerable risk for most banks Credit can be categorized based on various criteria.

− According to timeline, credit is divided into short- term, medium- term, and long- term loan

− According to collateral, people classify credit as: loan with and without collateral

− According to the level of risk, credit includes loans with high, medium, and low safe

These classifications indicate the diversification and specialization in providing credit of banks c Other activities

In today's evolving economy, commercial banks have transformed into multi-functional institutions, expanding their operations into various sectors such as payment services, guarantees, leasing, and foreign currency trading Their primary functions of capital mobilization and credit extension drive a focus on enhancing these lower-risk services, which serve as a buffer against the risks associated with lending activities However, the low-risk nature of these services results in modest returns, typically accounting for only 30% of total revenue, prompting banking managers to prioritize lending activities for greater profitability.

1.2 Lending activity of commercial banks

Lending activity is a type of credit extension, which means that banks grant an amount to customer with the commitment of principal and interest repayment in a specified time

According to the Decision 1627/2001/QD- NHNN, there are eight types of loans as follows:

Single loan Short term or long term

Credit line loan Short term

Syndicated loan Short term or long term

Installment loan Long term for consumers

Standby credit loan Short term

Credit card loan Short term

1.3 Project loan in commercial banks

Customers seeking to purchase or construct fixed assets for specific projects can secure loans from banks A key requirement is that borrowers must present a comprehensive project plan that outlines their objectives, investment strategy, and implementation process Project analysis and appraisal serve as critical factors for banks in determining loan approvals and assessing the corporation's repayment capacity.

Project appraisal encompasses various elements, including market research, human resources, technology, and financial analysis, with financial analysis being the most critical Key methods for assessing a project's financial efficiency include Net Present Value (NPV), Internal Rate of Return (IRR), and payback period When selecting evaluation criteria, banks emphasize the timeline and potential sources for debt repayment Consequently, in scenarios involving existing entities without new projects, banks conduct a thorough analysis of the borrower's financial status alongside the project's viability.

Investment project appraisal involves a comprehensive and unbiased evaluation of all facets of an investment initiative This critical process influences the project's feasibility, effectiveness, and capacity to repay the invested funds, enabling informed decisions regarding project financing.

Aspects of project appraisal include:

 Technical aspect Non- financial aspects

2.2 The role of project appraisal in lending activity of commercial banks

Project appraisal serves two primary purposes: first, it assesses the financial aspects to determine the project's ability to repay principal and interest; second, it evaluates non-financial factors to analyze the project's feasibility and associated risks.

This process serves as a crucial foundation and protection strategy prior to project implementation Its primary functions include evaluating project viability, discarding high-risk and unfeasible initiatives, and identifying potential risks along with effective prevention methods.

The preparation and evaluation of an investment project enable financial institutions to make informed and precise decisions regarding lending or sponsoring, thereby reducing risks associated with their financial operations.

3 PRINCIPLES AND BEST PRACTICES OF PROJECT’S FINANCIAL

Appraisers are obligated to adhere to national and international laws governing credit activities They must maintain integrity and professionalism, avoiding any misuse of the bank's reputation and resources for personal gain Upholding ethical standards, appraisers should conduct their duties with competence, diligence, and respect.

Secondly, the principle of suitable loan making according to each bank’s strategy of development and business in each period

Commercial banks must uphold the principle of equality and customer orientation in their credit services, ensuring that all customers are treated fairly, regardless of their economic background or business ownership structure, except in cases where government directives apply Each customer's transactions will be managed by a dedicated team within the credit department, promoting a personalized and equitable approach to banking.

Project’s financial appraisal process

 Step 1: Define the model of investment project

Extension Project (aiming at improving production capacity (2)

Deep Investment Project (aiming at production rationalization) (3)

Project’s input and output factors are separated clearly

 It is easy to define project’s efficiency

There are 2 methods to evaluate project’s efficiency:

1- Outputs are additional production capacity, inputs are benefits, semi- finished products used from current project, and new inputs for additional production capacity

2- All operation of project’s investor (part of current project and extension project is similar to independent projects)

Outputs are saved costs or additional revenue from deep investment, increasing product quality And inputs are essential costs to reach the output target

The difference of outputs/ inputs between before and after investing

Table 3: The model of investment project

 Step 2: Assumptions used in calculation process

To accurately calculate annual fixed asset depreciation and expenses related to fixed asset overhauls, it is essential to define the time frame and method of depreciation for each asset type The straight-line depreciation method is commonly employed in project appraisals, providing a consistent approach to assessing asset value over time.

Define interest rate, weighted average cost of capital (WACC), schedule of principal and loan interest payoff

Capacity increasing: compare with designed capacity, outputs products, outputs distribution, and expected annual revenue

Selling price of goods and/or services and expected revenue

Define consumption levels of materials, management costs, cost price per unit, general cost, commission cost, and administration cost, etc

Base on current accounting standards, regulations on financial management, current tax regulations to define the proportion of responsibility of project’s investor on the budget

 Step 3: Establish tables, charts, and analyze financial ratio

In general, banks need to collect at least following documents:

− The demand for project’s annual working capital

− The schedule of principal and loan interest repayment

Finally, through the process of analyzing some financial indicators, appraiser can give out some conclusions about the project’s risk tolerance and loan repayment ability

Indicators of profitability ratios: NPV,

Indicators of loan repayment ability: payback period, net annual cash flows, cash on hand, etc

Making sensitivity analysis to evaluate profitability ratio, loan repayment ability Making scenario analysis

 Loan repayment ability and project’s financial risks:

 Annual efficiency and the whole project’s cycle efficiency, capital recovery ability

 Investor’s ability of obeying financial obligations by project’s income

2.3 Content of financial appraisal of project loan in Vietnam commercial banks

2.3.1 Appraise financial condition of the project’s investor

Before appraising a project loan, banks must evaluate the financial condition of the project investor, as it is a crucial factor in assessing the project's financial safety This evaluation encompasses various aspects, including the borrower's overall financial health, creditworthiness, debt repayment capacity, and operational efficiency of the business.

The financial appraisal conducted by project investors serves as a crucial tool in the evaluation process, providing banks with a comprehensive overview of the corporate's situation and future prospects A clear and transparent financial condition enhances the corporate's creditworthiness, making it more appealing to banks Additionally, banks view a solid financial foundation as a supportive resource, offering security in the event of project failure or insufficient cash inflows to meet debt obligations.

For an effective financial appraisal, it is crucial to gather objective and accurate information Bankers should source data not only from investors but also from mass media, financial institutions, and corporations connected to the investor to ensure comprehensive analysis.

2.3.2 Appraise investment capital of a project

Appraising investment capital is a crucial aspect of project evaluation, as banks not only assess the total investment capital required for a project but also conduct a thorough analysis of the capital structure, evaluate the sufficiency of funds, and determine the investment capital needs based on project implementation.

 Appraise total investment capital of a project

Carelessly appraised projects often face capital imbalances during implementation, negatively impacting their ability to repay debts and diminishing overall project efficiency.

Theoretically, total investment of a project is the value of money and necessary assets used in establishing and implementing the project

Total investment capital= Fixed capital + Working capital + Reserve capital

When appraising investment capital, bankers must assess the suitability of the project's total investment while considering factors that may lead to increased costs, such as inflation, unexpected inventory accumulation, and fluctuations in exchange rates.

 Appraise the structure of capital of a project

A project is often sponsored from following sources:

 Equity: in order to define equity of project’s investor, banks have to analyze financial status, as well as operating status of investor’s corporate at least for latest 2 years

 Capital from state budget: is one of the safest sources and often provided for state owned company whose outputs have strategy influence on the economy

 Debt from other commercial banks

 Debt from overseas: this source often occurs in large project, technology exchange with foreign country

After collecting data on the project's capital structure, the appraiser must thoroughly verify the legal foundation of these funding sources For instance, if the project is financed by the state budget, it should include agreements from legal departments within a written contract Each funding source must be backed by certificates from the relevant legal authorities.

On the base of defined total investment capital, through considering the size of capital structure, banks may define the deficit capital and the lending amount for the project

In the case of syndicated loan, the factor of capital sources has to be agreed by all banks involved

 Define the need of investment capital according to project implementation

Appraisers assess the progress of project implementation and the capital requirements at each stage The suitability of meeting these capital needs is often initially addressed through equity financing.

Defining implementing progress and the need for capital may be the foundation for disbursement progress, debt’s interest rate calculation and payoff the debt prediction

2.3.3 Appraise expected benefits and costs of the project

 Benefits and costs of a project

The financial benefits of a project encompass the revenues generated from the sale of goods or services, while the financial costs refer to the actual expenditures incurred by the implementing agency Revenue expectations from sales represent the project's benefits, whereas costs include capital expenses for land, equipment, and facilities, as well as ongoing operational costs for labor, raw materials, fuel, and utilities.

The financial costs and benefits of the project are evaluated based on market prices, which reflect the actual prices in the local economy These prices encompass all relevant taxes, tariffs, mark-ups, and commissions, ensuring a comprehensive assessment of the inputs and outputs utilized in the project.

 Real price or nominal price?

In economics, nominal price is defined as the value of a good or service expressed in currency for a specific year or period In contrast, real price accounts for inflation and adjusts the nominal value to reflect changes in purchasing power over time.

Understanding whether the input and output projections from the proposing firm or agency are expressed in nominal (current) or real (constant) prices is crucial This distinction is essential for conducting an analysis based on a consistent pricing framework, ensuring that the final net value of the project is accurately represented in real terms.

In project cash flow analysis, real prices are preferred over nominal prices, as they eliminate the need to account for the anticipated inflation rate throughout the project's duration This approach is suitable when both input and output prices in the local currency are expected to rise at a similar rate over the project's lifespan.

In certain scenarios, using real prices may be inappropriate, particularly when analysts are preparing project financial plans In such cases, it's essential to estimate expenditures in nominal terms to ensure that the planned financing can adequately cover all project costs Additionally, when investments are privately operated and subject to company income tax, financial analysis must be conducted in both nominal and real terms due to the impact of inflation on interest payments, depreciation allowances, and stock holding costs Furthermore, if input prices are anticipated to increase at varying rates throughout the project's duration, this complexity necessitates careful consideration in financial assessments.

Supervisor: Dr Phạm Quốc Khánh Student: Nguyễn Khoa Diệu Ngọc- ATCAK11 and vary from year to year, it will usually be simpler to include all prices in current terms

 Internal transport and handling costs treatment

Credit balance of customer (May 2009- May 2010)

 Relationship with other credit institutions in the past

Ord Institution Credit institution code

Table 7: Relationship with other credit institutions in the past

Customer does not have any credit balance with other institutions

 The history of substandard debt for the latest 3 years

Customer does not any substandard debt for the latest 3 years

1.2.3 Appraise investment capital of the project and the feasibility of capital structure

The factory has a designed capacity of producing 150,000 products per month, totaling around 1,800,000 products annually All equipment and machines are of high quality, with 80-100% sourced from Japan, featuring renowned brands such as Juki, Yamato, and Sun Star.

Total anticipated investment capital is 2,000,000 USD, in which construction made up 50%; equipments and facilities account for 50% total investment

 Evaluation of the Project progression

The estimated time for Project construction and utilization: Construction from 3/2010 to 8/2010; Project utilization: 15 years

Currently, Company has financing approximately 35% the value of project construction and according to plan, the factory will be finished construction and installment of equipments/facilities  reasonable

Electricity and water supply and installment

4 Working capital needs 50% Total revenue

Loan from other institution 0% W/C needs

Table 8: Investment Capital of the project Comments: Total invesment is calculated quite detailed and precisely

 Feasibility of capital sources and capital structure

Equity source is expected to increase from the profit of the Parent company or advanced capital payment from the Parent Company  however, there is no clear confirmation

1.2.4 Appraise expected revenue and costs of the project

The activation of the second factory will significantly enhance the overall capacity of the plant, enabling it to meet the growing demands of customers Furthermore, FTN Parent Company has secured contracts with WALMART, which could lead to substantial purchasing agreements if FTN can ensure timely supply Products will be transferred to FTN Parent Company in Korea for distribution to its customers, thereby ensuring a strong consumption capacity for the produced goods.

Refer to the Appendix for Full Revenue/ Break-even point Plan in 15 years

Costs are classified as followed:

Sales costs Other variable costs

- Interest expenses for fixed costs

Interests Expenses for Working capital

Table 9: Types of costs of the project

1.2.5 Appraise annual cash flow of the project

Appraise annual cash flow of the project:

Table 10: Appraise annual cash flow of the project

1.2.6 Appraise and analyze indicators evaluating the financial efficiency of the project

Project is calculated to borrow in 5 years, grace period 1 year, payback time 5years with the following results:

 Evaluation on the efficiency of the project :

Comment: The project has adequate financial capacity (NPV>0, IRR> WACC)

The project's feasibility is significantly influenced by the buying and selling activities of the company and its parent, FTN Parent Company, as well as the overall business capacity and development of the parent company.

Sources of debts payment (both principal and interest) and expected Debts Payment Schedules:

In its first year of operation, the project achieved 60% of its designed capacity, marking a 15% increase in the second year, followed by a consistent growth of 10% each subsequent year compared to the second year.

Conducting sensitivity analysis for single changes in price of the products and changes in both prices and material costs as follow:

Table 13: Sensitivity analysis- change in price

Change in price and material cost:

Table 14: Sensitivity analysis- change in price and material cost

1 EVALUATION OF THE QUALITY OF PROJECT LOAN APPRAISAL

Investment project credit in Vietnam has faced significant challenges, particularly following the financial recession of late 2008 In response, commercial banks in Vietnam have intensified their appraisal processes for project loans before granting approval While this approach has facilitated revenue growth and business expansion, it also raises the risk of potential bad debts if the appraisal process is not conducted meticulously.

In fact, Vietnam commercial banks have reached some finite achievements in project loans as follow:

- Continuously expand the project portfolio, especially for the customers whose projects are considerably safe; restricted with risky and inefficient project

- Strategically expand for project in key economic sectors, products with stable demand; prudent with project with fluctuations in prices and demand

Project loans from commercial banks play a crucial role in providing enterprises and the economy with essential funding They effectively address the capital shortages faced by businesses seeking new investments or expansion, ensuring that companies do not miss valuable investment opportunities.

- The appraisal and lending process is strictly in accordance with strict regulations, which organize, coordinate and manage flexibly within departments and committees

- Ensure of the specialization, transparency and clear separation between Customers Department, Project Appraisal and Lending Approval

Despite the implementation of project appraisal with risk assessment, it remains insufficiently thorough Existing risk assessment methods are often outdated and fail to account for multiple changing factors and their impacts While various models and generalized methods like scenario analysis and probability methods exist, they have yet to be effectively applied in practice.

In revenue-cost appraisal, it is common to use fixed costs and prices for the entire economic lifespan of a project However, this approach is unrealistic due to the significant instability in the economy, particularly in the context of current economic integration.

Finally, collateral to secured project loan is still low Regulations and procedures on collateral are not really strict, collateral value does not really match with the real assets value

To ensure rational lending decisions, reliable information is essential However, appraisers at commercial banks in Vietnam often face significant limitations in both quantitative and qualitative data.

Appraisers should conduct thorough research on project details and owners through reliable online sources and media It is crucial to critically evaluate this information before utilizing it, as hasty decisions can result in irrational lending practices and potentially severe repercussions.

The current ability to assess industry sectors is inadequate, significantly impacting the appraisal process and decision-making This limitation often hinders the analysis of new products and eco-tourism projects in both the medium and long term Consequently, promising new projects may be overlooked in favor of more familiar ventures, which carry higher risks.

1.3 Suggested for causes of existing limitations

1.3.1 Causes from commercial banks a Lending policy has not yet completed

Despite most commercial banks having appropriate policies that align with legal standards and the business environment, they face challenges in Appraisal and Customer Services, particularly due to insufficient information gathering in the customer services department.

In addition, project profile is not specific for each type of business, business fields in a specific area

Currently, the information source is mainly provided from the customers However, this source is sometimes insufficient, inaccurate, and depends a lot on the customers

Banks gather data from their internal sources alongside information from the Credit Information Centre of the State Bank of Vietnam (CIC-SBV) This internal data includes customer revenue and credit balances for individuals with existing or past relationships with the bank or other credit institutions However, the information provided by CIC-SBV can often be inadequate, outdated, and of poor quality, leading to challenges in timely and accurate appraisals.

In certain sectors, the limited number of appraisers results in high job intensity, restricting their ability to conduct comprehensive assessments of projects Many appraisers are young and lack experience, social connections, and a solid understanding of economic principles Furthermore, the absence of foundational training and development programs hinders the enhancement of their skills.

Many banks have attempted to prioritize employee well-being; however, their reward systems often fail to effectively enhance employee performance and potential Additionally, inadequate facilities and equipment further hinder productivity and growth.

Tiêu đề	Financial Appraisal of Project: A Case Study of Maritime Commercial Joint Stock Bank Head Office
Tác giả	Nguyễn Khoa Diệu Ngọc
Người hướng dẫn	Dr. Phạm Quốc Khánh, M.A. Bùi Lê Minh
Trường học	State Bank of Vietnam Banking Academy
Chuyên ngành	Foreign Language
Thể loại	Graduation Thesis
Năm xuất bản	2012
Thành phố	Hanoi

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