Credit appraisal for projects in the field of Petroleum in Vietnam Joint stock commercial bank for Industry and Trade - Hanoi branch

When integrating into regional as well as global economies, every company should improve its competitiveness by all means in order to secure a firm position on the market. In the banking sector – an important sector in the economy – this becomes even more important. There are many criteria to evaluate a bank’s success, of which credit quality is an extremely important criterion. In a market economy, it is any bank’s opportunity as well as challenge. This is especially true when credit is the main activity of Vietnamese banks as a whole. While competing, enterprises in various areas should support one another for co-development. Banks and major industries such petroleum has close and long lasting relationship. Whereas petroleum industry need huge amount of capital, banks have funds that need investing. However, when making decisions on investment, a bank must make sure its investment is profitable. Based on knowledge gained from the Master course as well as personal working experience; being a bank manager in charge of the department specializing in lending to corporate customers, including big petroleum companies, the author has completed the research on “Credit appraisal for projects in the field of Petroleum in Vietnam Joint stock commercial bank for Industry and Trade - Hanoi branch”. By applying theoretical knowledge and practical data, the author has generalized and analyzed the main aspects of investment projects, project content appraisal, appraisal process, profit assessment criteria of investment projects in general and projects concerning petroleum field in particular. From a master degree researcher’s viewpoint, basing on practical work on credit appraisal for projects in the field of petroleum, demonstrated by one of Vietinbank’s specific lending projects in petroleum field: the loan for acquiring 50% equity of Block No 67 Oil Mine in Peru, in this thesis, the author has assessed results as well as limitations of project appraisal process of VietinBank in general and the Hanoi Branch's in particular. The author has also recommended some solutions so the bank can improve the credit appraisal cycle for projects in the field of petroleum. When completed the Master course, the author has bridged the gaps in theory and applied the findings to the work, obtaining an overall picture of reality and improving himself. As an experienced person working in financial field, the author has always been interested in the field’s complicated and interesting nature. It is expected that the author will be more successful in personal career thanks to the obtainment of comprehensive theoretical and practical foundation from the course.

JEAN MOULIN LYON 3 UNIVERSITY VIETNAM UNIVERSITY OF COMMERCE

MASTERs OF FINANCE AND CONTROL

THESIS

Credit appraisal for projects in the field of Petroleum in Vietnam Joint stock commercial bank

for Industry and Trade - Hanoi branch

Prepare by: NGUYEN Quang Duy Supervised by: Prof ABADIE Laurence

Hanoi – August 2013

Furthermore, my special thanks go to Mr Vu Manh Chien, who is in charge of the Programfor Vietnamese master students, for his suggestion of ideas and introduction of thesis topics to us Hehas also given to all of us great support throughout the entire course so that we could have bestcondition to study

I would also like to express my sincere gratitude to our International and National Teachersand Professors who have willingly shared and given us their precious and immense knowledge andexperiences during the course Thanks to their teaching we became higher developed in personalcapacity to more successfully fulfil our career

My great thanks go to the leaders of VietinBank – Hanoi Branch for allowing me time toparticipate in the master course as well as providing with valuable data for my thesis

Last but not least, I would like to give my special thanks to my friends and my family fortheir support that enabled me to complete this work

Chapter 2 ACTUAL SITUATION OF CREDIT APPRAISAL FOR

PROJECTS IN THE FIELD OF PETROLEUM IN VIETINBANK

24

2.1 Some general information about Vietnam Joint stock commercial bank

for Industry and Trade – Hanoi branch

24

2.2 The status of the evaluation quality of the investment project of the

petroleum sector in Vietinbank and Hanoi branch

27

Chapter 3 ACTUAL SITUATION OF CREDIT APPRAISAL FOR

PROJECTS IN THE FIELD OF PETROLEUM IN VIETINBANK AND HANOI BRANCH WITH SPECIFIC EXAMPLE

3.10 Project’s risks assessment and mitigation 42

3.11 Tentative benefits of Vietinbank Hanoi Branch in case the loan is

approved

45

Chapter 4 EVALUATION QUALITY OF CREDIT APPRAISAL FOR

PROJECTS IN THE FIELD OF PETROLEUM AND OFFER SOLUTION TO IMPROVE THE QUALITY AS WELL AS LIMITATIONS OF THE EVALUATION OF THE RISKS

I INTRODUCTION

Vietnam is, in many ways, a developing country Its economy in general and banking sector

in particular, are growing fast In such a developing economy as Vietnam’s, financial activities arefacing lots of difficulties caused by both objective and subjective factors

In countries with developed financial activities, banks’ turnover comes from diverse sources

In Vietnam, however, this comes mainly from credit activities Credit project appraisal process is,therefore, extremely important to banks It is considered a decisive element in identifying bankingsystem’s risks

Previously, loans granted to giant state corporations (eg to Petrolimex) were always regarded

as safe and risk-free ones However, in recent years a lot of those corporations have confrontednumerous difficulties caused by economic recession, resulting in huge losses for banks Plenty ofstate giants have expanded their business into areas in which they have no experience, leading tolosses As a result, the government must assist them This makes it more difficult for the bankingsystem to do business, especially in appraising credit projects

Well-appraised projects are those that help banks not only be able to duly and adequatelycollect the money they have lent but also to sift and classify projects so as to minimize the wastage

of public funds, contributing to socio-economic stability and sustainable growth but also to theimplementation of government macroeconomic policies, including those on optimizing nationaleconomy’s structure, creating jobs for labors, improving people’s life quality, enhancing nationaleconomic relations, expanding international economy, and speeding up industrialization andmodernization process

The current heavier investment in inefficient projects in general field, especially of largepetroleum groups, is a threat to economic growth and commercial banks This is the reason whyappraising investment projects in this field should be strictly carried out in order to guarantee theefficiency of both banks and their customers

Appraising an investment project, under the investor’s provisions, means to assess theinvestor’s ability, technology, market and financial status, of which financial assessment is the mostvital factor in lending decisions

Credit appraisal for projects in Vietnam Joint stock commercial bank for Industry and Trade(VietinBank), especially Hanoi Branch’s, has always received attention in recent years so as to meetthe demand for huge capital of investment projects in various economic sectors, including gas andpetro one

The above mentioned arguments made the author choose the topic on “Credit appraisal forprojects in the field of Petroleum in Vietnam Joint stock commercial bank for Industry and Trade -Hanoi branch” for this thesis

In the structure of returns of Commercial banks in Vietnam, return from credit plays the mostimportant role Thus, commercial banks in Vietnam, Vietinbank included, always put creditevaluation top so we can be sure that we make the best investments in effective and low-riskprojects.

It is reported that, almost 30% of Vietnam GDP is made by Petroleum That’s the reason whyVietinbank has been concentrated on creating credit for this field

In the credit process, credit analysis is the most important step It determines the quality ofcredit entities A qualified credit product usually minimizes the default risk and the risk of bad debtexpense Yet, a highly conservative credit analysis will eventually prevent the flow of lending Thus,the balance between quality and flexibility in credit analysis has a great impact on the business

Big institutions as PVN are always one of the potential clients with the tremendous sponsorsfrom the government However, these institutions recently have ineffectively used their capitals(such as misuse of investment, ineffective capital management) It leads to high records of bad debtexpenses Some had enormous consequences to the economy as a whole, and particularly thebanking system, such as Vinashin, Vinalines Thus, credit analysis is becoming more and moreimportant, and difficult

My research purpose is clarifing the theory of credit appraisal on investment and financialprojects; Applying and bringing up the actual market problems on credit appraisal for appraisalactivities Besides, I research one credit situation of Vietinbank HN Branch for customers in the field

of Petroleum and find the way to improve the quality as well as limitations of the evaluation of therisks based on the facts

The Research Subjects is a project in the field of Petroleum in Vietnam Joint stockcommercial bank for Industry and Trade - Hanoi branch One of Vietinbank’s specific lendingprojects in petroleum field is: the loan for acquiring 50% equity of Block No 67 Oil Mine in Peru

My Methodologies are applying these theories of investment and management risk, thesestatistical methods, comparison of data, synthesis Systemizing diagrams based on real data in thefield of Petroleum, particularly based on the banking data and reports to assess the appraisal process.Besides, analyzing critical points for specific projects due to personal experiences of expertise

II DEVELOPMENT

CHAPTER I: THE BASICS OF CREDIT APPRAISAL FOR COMMERCIAL BANK

APPRAISAL OF COMMERCIAL BANK

a Concept

Investment activities are conducted multistage with diversified economic characteristics,normally in the form of one or more investment projects Some projects have a huge capitalrequirement, on a certain time, in a long-time framework, and complex project management andoperation As a result, a seriously active preparation process should be conducted, and investmentshould be viewed as separated projects to be achievement-oriented Investment projects could beconsidered in various manners:

Investment projects, in form of documents, are a method to present operating activities andcosts in a detailed and systematical way to achieve certain desired results and future goals

For businesses in general, investment projects combine related activities, which are planned

to achieve defined objectives in a given time-frame using certain resources

On the management perspective, investment projects are a management tool, monitoring theuse of capital, materials and labor to create the financial as well as economic - social results in along-time framework

On the planning perspective, Investment projects are a useful tool to plan in detailed abusiness that can lead to economic-social developments and be the prerequisite for future investmentdecisions and funding activities

For commercial banks, an investment project is a funded project on the basis of creditappraisal of commercial bank In other words, it is the amount of money that commercial banks loan

to businesses or investors on the agreed terms to implement a particular investment project of theinvestor

b Investment project requirement

An investment project that is compelling and attractive to participants must ensure thefollowing basic requirements:

- The project must be scientifically sound This is the most important element of investmentprojects It ensures the success of the project development and implementation It is shown on thefollowing criteria:

o Data and information transparency accuracy of the project must be guaranteed That

is the data and information must come from originated sources

o Project elements should not be considered separately but in an interrelationship as awhole Therefore, the project planning process must be implemented logically andcoherently

o Measurements calculation must be simple and accurate

- Projects must fulfill the due diligence process It must be licensed by the competentauthorities before implementation

- The project must be realistic, meaning that it has the ability to deploy its applications inpractice

- The project must be considered under the consensus of benefit among related parties toensure its consistency

- The last criterion is predictability Projects must be based on estimations of production, costs,prices, revenues, profit, etc Thus, the aggregate amount is estimated In practice, there is never asituation where the estimates are exactly correct In some cases, outcomes are much different fromproject estimations

c Project classification

Investment projects are classified according to many different criteria depending onmanagement objectives, organization, investment plans

- Based on the operating characteristics, investment projects are classified into:

o Investment projects in manufacturing, services that are easily to payback

o Infrastructure, social and cultural investment projects

o Regional economic development investment projects

- Based on the collaterals of the loan, investment projects are classified into two sub

categories:

o Investment projects without collaterals: projects that do not require the use of assets

as collateral but based fully on financial situation, management capacity, faith on thecustomer relationship and the effectiveness of the project itself

o Investment projects with collaterals: projects that require assets, mortgage or the use

of third party guarantee as collaterals for the loan

- Based on the project’s time frame, investment projects are classified into:

o Short-term projects: projects that have a borrowing period shorter than 12 months,and the use of the loan are mainly to maintain current assets or short-term liquidity need ofthe customer

o Medium, long-term projects: projects that have a borrowing period longer than 12months These projects use the loan to obtain noncurrent assets such as plant, properties,equipment replacement, infrastructure, etc.

- Based on the Government decree 112/2006/ND-CP on management of investment projects on construction, investment projects are classified into 4 sub categories: national-level

projects that are passed by the National Assembly on the policy, and three other A-, B-, C-levelinvestment projects to effectively governance and actively manage the project implementationprocess

Besides, there are various classification methods depending on the project nature andimportance

d Characteristics of commercial bank’s project lending

Project lending satisfies the medium, long term financial need of customers to enhanceproductivity through expansion investment, replacement investment, etc The costs of these kinds ofinvestment include plans, properties, installment, machines, equipment; or the incremental of currentassets to serve the project

Project lending satisfies the total financial requirement for a project (current and noncurrentassets investment for the project), creates a financial leverage, ease the shortage of long-term fund

Project lending assures the customer ownership over their assets over the lending periodcompared to financial lease

Lending process is based on the financial effectiveness of the project measured by theproject’s net present value (NPV) and the project’s internal rate of return (IRR)

Project lending process is implemented according to the current stage of the project

Project lending must be considered under the aggregate relation of the project elements toensure the total timeline of the project, guarantee the payback period

Project lending contents include the value of equipment, goods, machines, and other costs forcustomers to implement a business project and expanding their projects, taking out the interest cost

of the banking loan in the period when projects are under construction and noncurrent assets are notready for the medium-and-long-term noncurrent-asset projects that the interest are based on thevalue of that noncurrent asset

e Process of commercial bank’s project lending

The project lending process of commercial banks is often implemented in three stages: projectappraisal, lending period, and collection period

Project appraisal:

Investors create a project, considering all the project’s funding resources to make the bestfunding decision Investors who have the funding need send their documents to commercial banks,including legal documents, documents of financial situation of the investor, project documents, andother related documents After receiving all the necessary documents from customers, thecommercial bank will implement the project appraisal process, including the necessity of theinvestment, project goals, technical issues, economic-social issues, and financial issues to considerthe feasibility of the project After the appraisal process, the commercial bank will reconsider theinvestment project based on its own measurements to make the final decision If the project is notfeasible, the commercial bank will document its customer; clearly define its reason for rejection.Other than that, the commercial bank will accept the customer’s document and begin the lendingcontract.

Lending implementation:

After the success of the project appraisal, the commercial bank will announce the loan andcreate credit contracts, and other related contracts After completing legal procedures of the lendingprocess, the commercial bank must ensure that the loan is ready according to the project’s stagesagreed in the contract In this process, the commercial bank must monitor the project implementation

to timely recognize and solve any problems

Loan repayment:

After the loan is delivered in full and the grace period, the commercial bank will announce itsrepayment schedule to its customer In the agreed period according to the loan contract, thecommercial bank will collect its principals, interests, and any agreed fee when they due According

to the bank’s announcement, the investor will repay the principals, interests, and fee Parties mustdiscuss and timely find a solution if there is any difference from the agreed contract

Among the three stages above, the project appraisal, especially the project financial appraisal isthe most important stage that will be the core of the investment process

a Concepts

Project appraisal is a process of objectively, scientifically and thoroughly analyzing alleconomic and technical contents of the project, in the context of natural, economical, and socialenvironment that leads to the final lending decision

The project appraisal satisfies different goals due to the party that consider the project:

For the investor, separately implementing the appraisal project while creating the projectbring a more objective point of view of the project, realize the pros and cons of the project andresolve them.

For the government authorities in the investment and construction fields, the appraisal goal is

to assess the suitability of the project to the industrial, local and national development in fouraspects: target, scope, plan and effectiveness

For financial and banking institutions, the purpose of project appraisal is to draw accurateconclusions about the feasibility, economic efficiency, solvency and potential risks of the project tomake the lending decision Based on the available information and project appraisal experiences,financial and banking institutions can actively advice investors to adjust and improve the missingcontents of the project, enhancing the project efficiency Besides, project appraisal is the basis todecide the loan amount, the lending period, the appropriate collecting level, ensuring theeffectiveness of the project, as well as the repayment timeline

However, projects are often viewed from the investor’s perspective regardless of thoroughlyconsideration Thus, the appraisal process must be separately and objectively implemented to ensureits economic and social benefit Project appraisal is considered the criticized process of the projectplanning process

b Content

To ensure the reliability and persuasiveness of the project, credit appraisal must beconsidered thoroughly The process must competently and exactly address the issues raised in eachproject Some core contents include:

- Legality of the project:

Legality of the project is an important element for the project to be smoothly implemented andoperated The object of the project should not be included in the government blacklist of illegalgoods and services Legal documents that should be considered when conducting the projectappraisal process include establishment document, investment license, design approval, otherdocuments relating to the project such as geological result, environment impact assessment,exploitation license, etc

- Project’s necessity and goal:

The project’s necessity and goal must be the first issue to consider for a project This is themost important consideration of a project appraisal When considering the project’s necessity andgoal, these issues must be addressed:

o Does the project goal suitable with and meet the industry, local, and nationalobjective?

o Is the necessity of the business development meet the increasing demand of the openmarket economy? How will the project benefit the investor and the economy if it isconducted?

o Assessment of the supply-demand relationship and future prediction; address theproject’s ability to participate in the market and potential development

- Technical Appraisal of the investment project:

The project technology is an important factor to consider when planning the project This isthe prerequisite for the economic-financial analysis of investment projects There is no possible way

to conduct the economic-financial analysis without technical and technological data; although therelationship seems to be the other way around Projects that are technically impossible should beeliminated to reduce potential damages in the future implementation and operation

The technical appraisal of a project includes:

o Location appraisal: this is one of the important aspects of the appraisal Factors that should

be considered are: the project location should be closed to input sources or its main market;convenient transportation, suitable delivery costs; available infrastructure, such as road, port,electricity, etc to reduce investment costs Premises must be suitable with the current capacityand potential development in the future

o Scale appraisal: analyzing current and potential demand for the project’s product; capacity ofthe product in the comparison with market acceptability, the ability to meet capital demand, theavailability of raw materials, machinery, and equipment, as well as the project managementability

o Technology and equipment appraisal: this is the determinant factor to the product quality.Equipment is the key factor of fixed assets that directly influence the product quality and theproduction process Thus, the project must clearly address the criteria for technology, machinery,equipment, measurement of technology transfer, etc

o Input appraisal: This is the determinant factor to the project efficiency Thus, the aggregatelevel for core inputs such as energy, electricity, water, etc should be carefully estimated in acompetently analysis

o Scale and Capacity appraisal: the suitable design and arrangement of the property to thechosen technology should be considered thoroughly to ensure the efficiency of the productionprocess On the basis of the technical requirement and capacity level, capital requirement foreach item of the project will be rechecked

o Design appraisal: the project must meet the technical requirement, sustainability, theapplication of construction criteria and standards, etc

- Economic and social impact of the project

The first target of an investment project to any investor is profit Thus, project’s profitability

is the benchmark for the attraction of the project However, in fact, the project’s profitability andfinancial safety does not guarantee its economic, social and environment benefit The economical

element of the project is the social benefit that the project could create That means this aspectshould be considered for every project.

Economic appraisal will review the project’s economic and social goal The project’seconomic goal is the direct benefit of the investor The project’s social goal is the social benefit ofthe project Economic and social appraisal, to the commercial bank, is one of the factors thatdetermine the lending decision If the project show no economic and social benefit, it will be veryhard for the investor to get the investment license and the bank loan

- Market impact of the project

Market appraisal helps the investor determine the most potential product for his project, andthe main market for that product To the bank, market appraisal helps determine the product’s ability

to consume, and the appropriate of the product strategy, pricing strategy, product distributionstrategy Some core contents include:

o Product and service appraisal: the project’s product, the market demand for that product, aswell as the supply level and capacity, etc must be competently analyzed

o Product positioning and customers’ taste: this helps build the product’s orientation anddistribution channel to enhance the project efficiency

o Analysis of the potential market competition and competitive advantages of the product:clearly define the product competitiveness in its market What is the current product on themarket, how does it go compared with the project’s product? Thus leads to a conclusion of theproduct’s competitive advantages in comparison with other existing products

- Project’s financial appraisal

Financial analysis for a project is the process of comprehensively and thoroughly organizing, andanalyzing every aspects of the project, such as: legality, feasibility, effectiveness, and solvency of theproject, to come up with suitable decisions

The commercial bank financial appraisal is the process in which the bank comprehensively andthoroughly organizes, and analyzes every aspects of the project to make correct lending decisions

The purpose of the financial appraisal is to objectively evaluate the financial feasibility of theproject, choosing good projects and simultaneously eliminating high-risk projects that are ineffectiveand lack of the ability to repay In addition, the project financial appraisal also assesses the project’slevel of risk for expertise to advise their client of possible solutions to ensure effective operation ofthe project and minimize the risk for the loan On the basis of the evaluation results and the level ofrisk, expertise can make decisions on the loan amount, term, interest rate, debt collection plan andloan security measures

Financial appraisal includes many interdependent factors Some of the most important factorsare the following: (research and provide some of the content and method so financial appraisals used

by Vietnamese commercial banks)

o The appraisal of aggregate investment, investment structure and capital schedule:

The aggregate investment contains all the costs (initial production cost included) of theproject and is the highest amount of cost that is agreed in the investment contract It is the value ofall the necessary assets for the project installment and operation; and is the needed capital for theproject

The appraisal of aggregate investment is very important It will reduce the possibility ofcapital fluctuation in the project’s implementation process that can leads to capital imbalance, badlyinfluencing the project’s effectiveness and solvency The basis to appraisal of aggregate investmentdepends on the project scale, modernity of equipment, and the financing form According to currentregulations, aggregate investment includes fixed capital, current capital, and capital reserve

The appraisal of aggregate investment is not only simple calculations but also the assessment

of the reliability of provided data to recheck the required capital on the bank’s viewpoint

After estimating the aggregate investment, equity investment, and other sources of fund, aswell as the financial health of the firm, the bank will address the real capital need for the project:

Loan = Aggregate investment – Equity investment – others

The reappraisal of the bank will ensure the lending process to be exact, suitable, and timely,reducing the possibility of capital imbalance that can lead to capital shortage, misstating the project’sfinancial effectiveness, or inefficient use of capital The aggregate investment must be consideredduring each stage of the project To the bank, it is the base to address suitable capital progress, thusactively manage its capital Besides, the bank is also able to monitor and analyze its invested capital

The sources of fund for a project include equity investment, bank loan, and other sources.Thus, when doing the capital structure appraisal for a project, the commercial bank must analyze thereality, availability and feasibility of each of these sources For the equity capital, the bank needs toaddress the ability to use current capital or equity-invested assets, their liquidity and market value todetermine the equity amount of the project For the other sources of fund, the bank needs to considereach loan contract, or third-party agreement for the project

It is very important to consider the feasibility of each source of fund for the project becausethis has a large impact on the solvency of the project

Capital shortage, capital imbalance or time lag could make a financial-sound project veryrisky and harm its solvency Thus, the bank should closely monitor and analyze the projectimplementation and capital needs for each stage to ensure the project’s timeline This is also the base

to build the lending and collecting schedule

Beside the initial capital, the project requires annual current incremental to ensure itsoperation Thus, an efficient project could be ineffective if the annual required current incremental isinappropriately estimated.

o Cash flow appraisal:

Project cash flow is the difference between the cash inflow and outflow of the project

Net project cash flow = cash inflow – cash out flow

Cash inflow contains operating revenues, cash inflow from financing, gain from fixed assetssale, and cash recollect from current incremental

Cash outflow contains investment costs, annual operating costs, and implementing cost.Most of the firms borrow money to do their businesses Thus the project cash flow is theoperating cash flow The cash flow is calculated as:

Operating cash flow = (After tax net profit) + Depreciation + Interest – Initial cash outlay

Normally, project cash flow is negative in the early years of the project when the cashoutlays are delivered but the profit from product and service revenue is still not enough After aperiod of time, when the product has been popular to customers, cash inflow will exceed cashoutflow and the net cash flow will be positive Thus, the project cash flow has the tendency to rise inthe following years of the project

Financial appraisal, theoretically speaking, is easy to conduct; but, as the matter of fact, it isnot simple The project revenue in the following years depends on many factors such as economicgrowth, price level, customers’ taste, rival competition Estimation errors from actual cash flows willlead to mistakes in financial analysis, and a wrong investment decision as the result Therefore, toenhance the quality of the financial appraisal for investment projects, appraiser should not onlycalculate financial measurements but also analyze market, technical factors which influence theproject’s cash flow

o Discount rate appraisal:

Discount rate is the required rate of return that investors require for the project It is also used

to discount the project’s cash flows in calculating present value If the project is funded usingmultiple sources of fund, the discount rate is the weighted average cost of capital (WACC):

W rack = 



m t

ft

0

x r at

Ft: weight of the capital source t in the total investment.

R: cost of the capital t.

M: number of sources of fund.

o Project financial measurement appraisal:

It is important to consider many aspects before making an investment decision There aremany criteria to determine the economic benefit of a project Normally, these followingmeasurements will be used to assess a project’s financial effectiveness:

 Net present value (NPV):

The project’s net present value is the difference between the present value of the cash flowsfrom the project and the present value of the investment, and is calculated as:

)1(

)(





BT: project income in year t

Ct: project costs in year t (financing, operating costs, and corporate tax)

N: life of the project

R: discount rate

The project is accepted when the project’s NPV ≥ 0, the total project’s income exceeds thetotal project’s costs after discounting back to present The higher the project’s NPV, the morefinancial attractive the project is

The project is rejected when the NPV < 0, the total project’s income cannot cover its costs

In the case of NPV ≥ 0, projects should be independent, which means they serve differenttasks, and the choice of a project does not affect the others; then they should all be accepted In thecase of mutually exclusive, the project with the highest NPV will be accepted

The net present value shows the increase in value of the investment, regarding the time value

of money It gives a better look at the investment; make the investment decision align with the profitmaximization goal of the firm However, the net present value cannot tell the profitability of theproject and the relationship between the project’s profit and costs

NPV reflects the net profit of the project, which has already been discounted back to present,during its life For the bank, the consideration is the ability to timely collect the interest and principal

of the loan, not the gross cash flow during the project’s life Thus, NPV is only the first step toanalyze the project effectiveness, not a determinant factor to the lending decision Many small NPVprojects are still accepted because the investor has the ability to repay his loan

 The internal rate of return (IRR):

The internal rate of return is the discount rate that makes the present value of future profitfrom the project equal the present value of its costs Thus, the internal rate of return is also adiscount rate that will make the net present value of the project equals zero

Normally, the internal rate of return is calculated using the linear interpolation method ortrial and error These methods currently are unpopular due to their complexity, time consummation,and lack of accuracy Calculating the IRR by excel spreadsheet reduce the calculating time anderrors

This measurement reflects the rate of return that the project can obtain Thus, it can be used

to analyze the project by comparing with the discount rate or the interest rate of the bank If theIRR< the cost of capital, the project is rejected If the IRR = the cost of capital, the investor canchoose to accept or reject the project based on the current situation If the IRR> the cost of capital, inthe case of independent projects, all of them can be accepted If the projects are mutually exclusive,the IRR cannot be used directly to rank projects because the project with higher IRR is notnecessarily the more effective one

This measurement shows the project’s profit in comparison with the cost of capital, therelationship between the funding methods and the efficiency of the capital used of the project Thismethod also informs us the highest cost of capital that the project can bare Yet, the IRR methoddoes not mention the project size and use an unreal assumption of the reinvestment rate thusinvestors can easily leave out highly profitable projects low profitability rate.

 Profit index (PI):

The profit index shows the income from each dollar invested, thus, the project is acceptedonly if its PI ≥ 1 It is a profitability benchmark that takes into account the time value of money PI iscalculated as the present value of all the incomes from the project divided by the present value of theinvested capital This ratio is as follow:

PI =

K

OC B

t t t

r K r

OC B

11

PV B : present value of the incomes including yearly income of the project during its life.

PV OC : present value of the costs

B T : project income in year t

Co: operating costs.

The PI reflects the relationship between the project incomes and the project invested capital.The bank can use this measurement with projects that are different in size to rank projects’profitability However, the PI does not reflect the gross profit of each project; thus, it can lead tomisleading conclusions It means that the PI should be used together with other measurements tohave a better overall conclusion.

 The payback period (Top):

The payback period is the period required for the project to create cash inflows that equal tothe project invested capital It is the time to payback the initial outlay by the yearly income anddepreciation If the yearly income and depreciation is stable, the payback period is calculated as:

T =

D P

Top is very important for the bank to determine the repayment period This is an essentialelement to consider beside the investment period; and it must be suitable with the project’s cashflow Projects with smaller Top will be preferred because the reinvestment process comes quicker.Another thing is that smaller Top will reduce the risk of business failure, especially in the time ofhigh competition In fact, banks often set the repayment period equal to the payback period to ensurecustomers’ ability to repay the loan, and also reduce the risk that customers use their capital toreinvest if the repayment period is longer than the payback period

 Return on investment:

Return on investment is the relationship between the yearly average profits of the projectduring the life of the project and the initial investment

The yearly average profit of the project during its life is the arithmetic average of the profitsfrom the beginning until the end of the project.

Among projects, the project with higher return on investment is the better one Thismeasurement is simple but does not take into account the difference in the time to recognize thefuture profit of each project

 Benefit – cost ratio (BCR):

The benefit-cost ratio is the ratio between the benefit and the cost of a project These datacould be at the present value or future value Normally, the CBR is calculated as:

r Bt

1

1

)1(1

)1(

1

=

) (

) (

C PV

B PV

B T : project’s income in year t

C t : project’s cost in year t

R: discount rate

PV (B): present value of the project’s incomes

PV(C): present value of the project’s costs

The project is accepted if B\C ≥ 1 It means the total income of the project exceeds its totalcost, and the project is likely to be profitable

The B\C is used as a benchmark to rank independent projects In the case of mutuallyexclusive projects, we cannot use the B\C

o Risk appraisal:

Risk is uncertainty; it is the difference between the expected value and the actual value Theproject’s risk can be seen as the difference between the actual profit and the expected profit Thereare always potential risks and they can largely affect the project effectiveness

The average life of a project is from 10 to 50 years Projects are created and analyzed based

on their operations and future profits In the market economy, data are always changing, especiallyfuture data Thus, risk cannot be eliminated In the above analysis, factors such as revenue or costsonly take one value The uncertainty and risk of a project exist when at any point of time during theproject life; there is more than one potential outcome Therefore, we need to consider all theoutcomes that might happen to come up with solutions to prevent and mitigate risk, ensure the

project’s recoverability and profitability Especially for the bank, as the lender, undesired outcomescan have negative impacts on the project’s solvency and lead to investment loss Thus, risk analysis

is very essential in the project appraisal process The assessment of risk is also very importantinformation for making investment decision

To assess the risk of a project, commercial banks often use these methods:

The sensitivity analysis shows us which factors should be closely monitored and regularlychecked to prevent and mitigate potential risks to the project However this method still has somelimits, such as does not take into account the possibility of outcomes, the relationship betweenvariables and the change in their values in constant percentage is not always linked to the variability

of the observed effective variable

 Scenario analysis

Although sensitivity analysis is very popular, it contains many limits as presented above.Thus, scenario analysis is also used in project risk appraisal This method combines the possibility ofrisk variables and the impact of those variables onto the project This analysis requires a collection

of good and bad outcomes to compare with the basic values However, this method still has somelimits such as cannot identify all the possible combinations of the variables and only analyze someconcrete events, in fact there are numerous possible combinations among variables

 Monte Carlo analysis

This method accounts for the possibility and correlation and recognizes potential impacts of

an event onto the project It can also account for any delay or other events that can influence theproject The most important thing is that it helps evaluate the present value of the project, distributethe possibility of outcomes and failures By ranking events due to their impacts on the project resultand their possibilities, the Monte Carlo analysis helps the financial analyst enhance their projectappraisal and identify potential risks of the project Nowadays, with the technology progress in thebooking system, Monte Carlo analysis is very useful in the form of spreadsheets, become a favoritetool of many modern banks on the world

1.2 Quality of credit appraisal of commercial banks:

1.2.1 Quality of credit appraisal in general

In general, the evaluation of a project is considered to be good if it achieves the Bank’sevaluation objectives as well as satisfies businesses’ demands

The goal of credit appraisal of commercial banks is to get an exact and objective conclusionabout the feasibility of the project, making a base for the lending decision, preventing potential risksfor the bank; and also not leaving out profitable projects that can benefit the bank Project appraisal,especially financial appraisal is considered effective when the result helps the bank make suitablelending decision, lending amount, lending period, and interest rate, etc In contrast, the appraisalquality is bad if the result leads to wrong decisions such as investing in ineffective projects, loss,hard to collect principal, or rejecting profitable projects that harms the bank profitability, losingrelationship with firms, and damaging the bank reputation

Firms, otherwise, evaluate the quality of project appraisal by time and the utilities that theycan get Time should be long enough for the bank to give accurate appraisal result but short enoughfor the firm to catch their investment opportunities The simple and comfortable appraisal proceduresthat do not disturb the firm are also a criterion The utilities that the appraisal process can bring tofirms are advices such as whether to invest or not, what the suitable investment scale is, etc Thebank’s advices to firms will be useful because of its expertise and experience in the financial field Itcan help firms prevent and mitigate potential risks as well as catch the best investment opportunities

We can generally understand from the analysis above that “the quality of credit appraisalshows the accuracy, objectivity, rationality, and flexibility level in evaluating the investmentproject”

1.2.2 Factors that influences the quality of credit appraisal

Quality of projects appraisal is influenced by both subjective and objective factors, whichneed researching and evaluating their influences in order to improve the quality of projects appraisal

Subjective factors

These are the internal factors of the Bank, the influence of these factors on the quality ofproject appraisal is decisive because the bank will do its project appraisal and its results directlyaffect the lending decisions

o Appraisal operation

The appraisal is operated under multiple processes and the coordination of many peoplefrom different departments Therefore, to achieve high efficiency, strict management, and division ofresponsibilities to each department colliding with ability and qualification, and close monitoringneed to be ensured

o Appraisal staff

Investment project appraisal is actually a comprehensive assessment of economic, social,financial aspects of the project to estimate the efficiency after being brought to life Therefore, theresult is mostly affected by the people who appraise it, based on two aspects:

 Personal qualification: The project appraisal in general and of the financial aspect inparticular requires a careful all over consideration One-sided conclusions from an unqualifiedappraiser could lead to wrong decisions in lending operations of the Bank

 Morality: is always the primary concern of the bank’s leaders Bad attitude can distortinformation, falsify results in the evaluation process or mislead the initial results which all lead tothe wrong decision in lending activity of the Bank

o Material and technical basis

Along with the increasing development of powerful technology, investment projects aregetting more complex and the risks involved in investment activities are harder to predict Thus up-to-date technical facilities are a must For example, the analysis of simulated situations cannot beperformed manually; it requires the assistance of computers with statistical mathematical software

o Appraisal costs

The appraisal of commercial banks require additional costs to clarify items such asevaluation of technology applied to the project, the actual investment of the project, etc which areusually beyond the understanding of the bank It has negative impacts on the project quality andmisidentifies customers’ funding need Therefore, the rising of evaluation cost will help the bank bemore accurate in determining the capital requirements of customers with the expertise it has

The objective factors

o Quality of the investment project

Generally the appraisal relies on the project conducted by companies In other words, the firstsource of information used in the appraisal about technical, environmental, financial aspects isprovided by the companies in their carrying out projects The bank conducts the appraisal based onthe reliability and objectivity of the information as well as the ability to set up a project of thecustomer If the projects are of high qualities with clear investment opportunities and a reliable basis,the bank can conclude easily with high effectiveness The complex project requires extensive andnewly updated knowledge of appraisers to assess comprehensively through all aspects Thus themore complex they are, the less accurate the conclusions might be

o Investors’ elements:

The investor is a huge factor that directly affects the quality of project evaluation generally andfinancial evaluation of the project particularly in two aspects: the honesty and the project executivemanagement level

In many cases, the success or failure of the project is not due to market or technical factors butthe capacity of the enterprise management and execution An unclear organizational structure orunclear assignment of responsibilities will obviously affect the distribution of human resources,labor cost and project management Furthermore, incurred costs will make the financial performanceless effective and push the business into difficulties of repaying the bank.

The investor’s honesty deeply affects projects’ quality; and has direct impacts on the projectappraisal process Besides, failing to report the financial situation of the firm also makes it difficultfor the bank to appraise the project

o Market elements and the economic-social impact:

Market is always an important factor that affects a project’s measurements Market variations ofthe project’s inputs and outputs can easily cause estimations errors For example, an unexpectedincrease in input prices can turn a profitable project into a bad-looking one and extremely hurt itssolvency Positive changes in the economy will directly affect the project schedule, and operation Apossible project can easily be changed into impossible one in a dynamic economy

o Government’s regulations and policies:

Changes in the government’s policies and regulations have direct impacts on projects If theappraiser cannot predict exactly these changes, he might incorrectly conclude about the projectfinancial effectiveness, leading to bad lending decisions for the bank

CHAPTER 2: ACTUAL SITUATION OF CREDIT APPRAISAL FOR PROJECTS IN THE

FIELD OF PETROLEUM IN VIETINBANK

2.1 Some general information about Vietnam Joint stock commercial bank for Industry and Trade - Hanoi branch

2.1.1 Introduction about Vietnam Joint stock commercial bank for Industry and Trade

-Hanoi branch

a General introduction about Vietnam Joint stock commercial bank for Industry and Trade

Vietnam Joint stock Commercial bank for Industry and Tradewas established in 1988 is one

of the 5 largest commercial banks in Vietnam On 15/04/2008 Industrial and Commercial Bank ofVietnam are branded from Income Bank to the new brand as Vietinbank (named after the EnglishIndustrialand Trade Bank of Vietnam, known asVietinbank)

Up to the present time, Industrial and Commercial Bank ofVietnam has grown into a network

of 01 exchange, 149 branches and over 900 transaction offices/savings in most provinces, cities,shopping centers, commercial and industrial zones, export processing zones in the country

b General introduction about Hanoi branch

Formerly Exchange I, HN branch is the first branch and the largest of Vietinbank In recentyears, Hanoi branch has invested in many large projects, insectors, key areas of the economy such asthe Vinasat project sponsored by Vietinbank, the network-expansion project of the Vietnam Post andTelecommunications Group (VNPT), the grid development projects of the Vietnam Electricity(EVN)

In 2012, the business operations of the branch is always growing, exceeding the assignedtargets The branch was the especially outstanding unit in Vietinbank’s whole system

2.1.2 Business operating results of Vietinbank and Hanoi branch

a Business operating results of Vietinbank

In the recent years, the world economy is becoming more and more unstable, particularlywhen the banking and financial crisis in the U.S spread to other countries in the world Vietnameconomy’s growth rate remains modest However, Vietinbank still manages to remain its stable andsustainable growth Credit operation of the bank is enhanced in terms of quality and is diversified tobest response to the clients’ demands

In addition to traditional lending activities, Vietinbank increase operations in bothinternational and national interbank market to improve the efficiency of capital, contributing toprofit’s growth

In order to better understand the operation of VietinBank in the past few years, we canexamine each service:

Borrowing activities:

Currently, capital from individuals and house holds is accounting for 40 percent of the bankcapital and is a stable proportion of the bank’s capital structure Year after year, there is a quicklyincrease in the sources of capital of Vietinbank (table 1)

Graph 1 Vietinbank’s sources of capital

Unit: billion USD

0 5 10 15 20 25

Year 2009 Year 2010 Year 2011 Year 2012

(Source: Vietinbank annual financial report 2009-2012)

Lending activities:

Lending activities is the core of Vietinbank’s operation from its first days In recent years,the bank’s loans-over-total-assets has reduced largely due to various reasons but mostly because ofchanges in the bank’s strategies from direct lending business to financial services and modernbanking services Some of the services include: foreign currencies exchange, trade sponsor,guaranty, etc

From 2008 to present, a decrease in loans to public sector and loans without collaterals, and

an increase in loans to private sector and loans with collaterals This capital flow is certainly suitablewith changes in the economy structure A high portion of loans with collaterals guarantee the bank’slending activities

Graph 2 Vietinbank’s lending activities

Unit: billion USD

0 10 20

8.15 12.16 14.67 16.66 Year 2009 Year 2010 Year 2011 Year 2012

(Source: Vietinbank annual financial report 2009-2012)

To 31/12/2012, the branch’s total capital reached the level of 1.13 billion USD, increase 0.03billion compared to 2011 (+2%) Lending and invested capital (to 31/12/2012) reached 2.1 billionUSD, including 1.8 billion of lending capital, an increase of 0.8 billion compared to 2011 (+73%)

Hanoi Branch improving accountability in the evaluation and assessment of credit risk.Therefore, almost of the credit projects are safe, there is a little bad debts incurred The branch’scredit transactions have been examined by many inspections from international audit, internal auditand state bank through the year And they all concluded that the branch Hanoi has complied withcurrent credit & evaluation procedures

Table 1 Business results of Vietinbank - Hanoi Branch

Number of employees people 360 407 412

Number os transaction offices 14 14 16

2.2 The status of the evaluation quality of the investment project of the petroleum sector in Vietinbank and Hanoi branch

2.2.1 The characteristics of the oil and gas sector project evaluation

a The general characteristics of credit project in oil Industry

Oils, gas, and related products are essential for the economy as a whole The demand for oilincreases in line with the growth of the economy According to predictions of 16-17% demandgrowth rate in the 2009 - 2020 period, supply of oil must increase fastly in 5 years, and there is arequirement for heavy investment in the petroleum industry According to special necessity for theeconomy, projects in the petroleum industry have their unique characteristics:

Oils and gas is an irreplaceable product in modern economy Thus, projects in this field areoften sponsored by the government with many mechanisms of priority such as borrowing guaranteesfrom the finance department; government’s borrowing assignment for commercial banks with lowinterest rate and long repayment period

b General characteristics of the evaluation of loans for projects of petroleum industry.

During the process of management and exploitation of oil and gas, there are many issues thatneed to be researched, analysed and evaluated Efficient exploitation of power projects brings aboutbenefit to the investors and to the whole society Therefore, evaluation of investment project of oilindustry plays an essential role in national-level development investment During the evaluationprocess, many problems need to be paid attention to:

- Project’s total cost during its economic life, including initial investment outlay, annualoperating costs, replacement costs during the project’s life

- Petroleum projects often require large investments Thus, the analysis of investor and sources

of capital must be carefully considered to ensure the timeliness and appropriateness of the project’scapital level Appraisers also need to update related information, changes in nonrecurringunexpected items, changes in input prices, natural resource taxes, etc These are factors that increaseprojects costs; reduce product prices, and project’s profitability

- Petroleum projects require advanced technologies Oil reserves evaluation is an exploitationprocess that needs expertise and professional equipment It is out of the appraisers’ knowledge, andrequires external advisors

- The quality of project constructor must also be carefully considered to prevent anyunnecessary delays

- Petroleum project often have special geographic positions, such as: South China seacontinental shelf, where are the place of disagreement between China and Southeast Asia countries,the Siberia, the tropical forests in Latin America, etc And, the use of expensive equipment and thelow possibility in exploring of 30% makes it more costly and less effective for project if theireconomic life is long

- Due to the lack of technology, Vietnam still have no petrochemical technology, projects’product is often crude oil, largely affected by the world oil prices, which is dominated by the OPEC.Thus, the accuracy of projects’ cash flow prediction during their life is still low, leading todifficulties in assessing their effectiveness and deciding their lending period.

- Most petroleum projects use the USD as the functional currency, while the USD interest rate

is very high because the currency balance of domestic commercial banks is still limited due todeficits in balance of payment for years Thus, cost of fund for petroleum projects is often pushed

up, reducing projects’ efficiency

2.2.2 The status of loans to investment projects of petroleum industry in Vietinbank and Hanoi branch

Vietnam faces a rising demand for investment in petroleum field due to an increase in oildemand In recent years, oil demand was always higher than predicted Petroleum project’scapital demand:

According to strategic national energy security 2006-2025, to ensure the energy demand,capital needed for petroleum projects is very high, 2 billion USD/year for the exploration andexploitation of the whole industry The analysis shows that capital demand for the industryexceeds its internal sources of fund Thus, one of the main sources of fund for its projects is thecommercial banking system

Banking balance of the petroleum industry at Vietinbank (31/12/2012): At the time, total loan

of the industry is 21,767 billion VND, accounting for 5% of the Vietinbank’s total loan It includes99.87% qualified loans Loans in the second group are very low (0.13%) Currently, loans forexploration and exploitation account for 78% total loans, the rest are loans for Dung QuatRefinery,Camaufertilizer company, and auxiliary fields in the industry

Table 2: Vietinbank credit for petroleum industry

Unit: million USD

No

Customer