Case 079Asset-backed, project and real-asset lendingCore
A contractor buys 50 excavators with 90% loans repaid in equal instalments over five years, and the machines lose 30% of their value in year one. Is the loan ever bigger than the collateral, and when?
1The situation
Rudrani Earthmovers, a mining contractor, buys 50 excavators at Rs 1.2 crore each, Rs 60 crore in all. A bank lends 90%, Rs 54 crore, secured on the machines, repaid in 20 equal quarterly principal instalments of Rs 2.7 crore over five years, plus interest.
Used excavators lose about 30% of their value in the first year and 15% a year after that. Assume the fall is spread evenly through each year. If the bank ever has to repossess, a quick sale fetches about 80% of the machines' market value.
2Your task
Is the loan ever larger than the value of the machines, when, and by how much? What would you change in the structure?
Quick check
At the end of year one, which is bigger: the loan or the machines' value?
Worked solution
Try it on paper, then open one step at a time.
30-second answerThe answer to give first
Yes: around the end of year one the loan, Rs 43.2 crore, exceeds the machines' value of Rs 42.0 crore, an LTV of 102.9%. In year one the machines lose Rs 18 crore while repayments cut the loan by only Rs 10.8 crore. From year two the slower 15% decline lets repayment catch up. At a forced-sale value of 80%, the bank is short of cover from day one until the middle of year three, so the 10% down payment is too thin.
Step 1What race is the lender watching?
Two numbers fall at once: the loan, by a fixed Rs 2.7 crore a quarter, and the machines' value, fast at first and then slowly. In equipment finance the risk is not the final year but the first, when depreciation is steepest and the loan has barely been repaid. It is the same trap as a new car bought with a small down payment: drive it off the lot and it is worth less than the loan for a year or two.
Step 2When exactly is the loan underwater, and by how much?
Step through the quarters. After three quarters the cushion is Rs 0.6 crore; after four it is minus Rs 1.2 crore; after five it is still slightly negative, minus Rs 7.5 lakh; after six it is back to Rs 1.05 crore. The loan is underwater for roughly the turn of year one into year two, by at most Rs 1.2 crore, and the cushion rebuilds steadily after that. By year three the machines are worth Rs 30.3 crore against a loan of Rs 21.6 crore.
| End of year | Loan, Rs crore | Machine value | Cushion | Loan to value |
|---|---|---|---|---|
| 0 | 54.0 | 60.0 | +6.0 | 90.0% |
| 1 | 43.2 | 42.0 | -1.2 | 102.9% |
| 2 | 32.4 | 35.7 | +3.3 | 90.8% |
| 3 | 21.6 | 30.3 | +8.7 | 71.2% |
| 4 | 10.8 | 25.8 | +15.0 | 41.9% |
| 5 | 0.0 | 21.9 | +21.9 | 0% |
Step 3Why is the real exposure worse than the chart suggests?
Market value is what a willing buyer pays in no hurry. A bank repossessing 50 machines from a failed contractor sells fast, often into a weak market, because contractors tend to fail when mining activity is slow. At a forced-sale value of 80%, Rudrani's machines cover less than the loan from day one: Rs 48 crore against Rs 54 crore, and the shortfall lasts until quarter 10. That is the number a credit committee should look at.
Step 4What would you change in the structure?
Match the repayment to the depreciation rather than to the calendar. Either lend no more than about 70% of cost, Rs 42 crore, which is the most that stays inside forced-sale value in every quarter on this schedule, or front-load principal so that more is repaid in year one when value falls fastest. The tightest quarter is the end of year one, which sets that limit. A lender could also take a charge over the contracts the machines work on, so cash flow as well as metal backs the loan. The limitation: the 30% and 15% rates are averages, and resale values for heavy equipment swing with the mining and construction cycle.
Where candidates lose it
The common error is checking cover only on day one, seeing 60 against 54, and calling the loan safe. The risk sits a year later, when the steep first-year depreciation has run ahead of equal instalments.
The second is using market value for collateral. A lender realises forced-sale value, and on that basis the 10% down payment never covers the gap in year one.
What the interviewer asks next
- What repayment profile would keep the loan below 90% of forced-sale value every quarter?
- Would you prefer a lease to a loan here, and who bears the residual value risk in each?
- How does a mining slowdown hit both the borrower's cash flow and your collateral at the same time?
Company names and figures are illustrative.