History of Bank Instruments
Bank Guarantees are traditionally used in trade finance, however some financial institutions raise funds via bank instruments to facilitate project finance. After WWII Governments, investment banks and other large institutions used bank instruments to generate revenue to fund projects that would help rebuild cities and it's infrastructure.
On the main, bank instruments aim to provide assurance that payment can be made should there be a default therefore if a client has funds in a bank, the bank will guarantee money is in the account to cover costs.. There are two types of "letter of credit. One which a commitment on the supplier side (DLC) and one on the buyer/beneficiary side (SBLC).
Documentary Letter of Credit
Documentary letter of credit is dependent on the performance by the supplier. They are mainly used for commodity and industrial use as performance bonds.
Standby Letter Of Credit
A Standby Letter Of Credit (SBLC) is a type of letter of credit. “Standby” simply means that the letter of credit is activated upon default if a buyer does not fulfil their contractual agreement in other words, its a "payment of last resort". SBLC's are issued as a guarantee of payment by a bank on behalf of their client.
SBLC's can also be used as a way to fund projects. They can be used to enhance your ability to apply for a line of credit which is backed by collateral when a bank requires additional comfort when you ask them to fund your project. Very often when a bank asks for an SBLC to back a line of credit, do be aware that often it has to be a purchased instrument and not a leased one.
How Funding Projects via conventional funding can be achieved?Conventional funding can be done through the help of institutional funders. These funders tend to be hedge funds, Ultra high net worths, or any organisation that have deep pockets. Once they've assessed and accepted a project, bonds will d and credit lines can be called upon therefore they have the liquidity/cash to move ahead with said project. There are pros and cons of conventional project funding done through institutional funders. This method of funding can take some time due to:
1) Onerous due diligence procedures
2) The 'cost of doing business' with such funders would either be debt financing at a rate of interest determined by the funder and/or equity share which needs to be ceded to the funder which could include
3) Someone from the fund dictating what the money can/cannot be used for
4) If debt funding is the solution, the money would need to be paid back in full plus interest leading to companies having to carry a heavy debt burden which will of course eat into the overall profits
5) Most funders would require that the project sponsor has some 'skin in the game' upwards of 5% or more of overall funding amount required.
From start to finish, most funders would take anything from 3 to 9 months to assess the project, go to their credit committee, have meetings upon meetings and finally, negotiate rates before the first drawdown begins.
On that basis, it would be an ideal solution to get an SBLC which not only puts you in a FAR better off position. Once all monies have been drawn down, you would also maintain full control and ownership of your project.
Funding A Project With An SBLCProcedures are not always the same. Legitimate Providers can be very hard to find as this industry is fraught with fraudsters. Saying that, common procedures you can more or less expect are as follows:
Apply for and sign the Deed of Agreement (DOA) contract. If you are accepted as a client the contract will be countersigned after the provider has conducted due diligence. You would be required to submit along with your DOA a copy of your passport/id as well as a certificate of incorporation. Once the DOA is countersigned and sent back, you will then receive the provider’s corporate refund undertaking along with the invoice for the SWIFT and bank arrangement fees (providing that the provider charges the lessee to cover these fees.
As soon as your payment reaches the provider’s designated account, he will block his cash funds or assets for your transaction and applies for delivery of the SWIFT MT799 followed by a MT760 to your bank. The provider will block his cash or assets for your transaction, once you have paid for the arrangements. You will pay for the actual leasing fees only after receipt and verification of the SWIFT MT760 through your own bank.
How Long Are SBLC's Valid?
There is a validity period/timeline SBLC's can be used. Leased SBLC's are generally issued for 1 year and 1 day (With the option of Rolls and Extension but not always. This is at the discretion of the provider.) A project can be funded by leasing a bank instrument or by purchasing one. (A purchased SBLC means that you have full ownership of collateral). Please note that monetising a leased SBLC is very difficult indeed. Very few monetisers will monetise leased instruments.
Monetising An SBLC
Purchasing an SBLC is a lot more expensive than leasing an instrument. However, if you purchase the instrument, you are the legal owner of the collateral thus can provide to the bank the collateral they require to issue a credit line to fund a project. You can then consider having the bank instrument monetised which in turn the monetised. Some monetisers will offer monetised funds on a ‘non-recourse’ basis. Again this is at the discretion of the monetiser.
Very often people will say “you cannot monetise a leased instrument” – which more often than not is true. One cannot take a leased instrument and go to a monetiser and expect them to monetise it. The provider does not know to the monetiser and vice versa. However IF the negotiations have been done BEFORE the instrument has been issued and the monetiser AGREES to monetise the leased instrument. This is what we call a 'closed ended' program whereby the instrument does not leave the system so to speak. Not all monetisers would agree to this however some will.
As well be mindful of the fact that an instrument issued for commercial trade vs an instrument issued for project funding will have different wording. In order to monetise a leased instrument, the wording would have to include that the SBLC is assignable, transferable, divisible, callable and cash backed. That or similar wording would need to be included. Our job is to get party 'a' (provider) to agree terms and conditions with party 'b' (monetiser.)
Banking FeesThere are associated fees involved when taking out a bank instrument. Fees such as lease, purchase and Swift fees. Very often the terms and conditions on the DOA would require that the borrower/lessee pays the Swift fee and not the other way round (provider pays for the Swift fee.)
As well there could be a bank arrangement fee. Both Swift and bank arrangement fees would normally be placed directly with the provider and paid into an account as nominated by the provider after executed contracts and before the SWIFT MT799/760 is sent to the receiving bank..
Funding A Project Example using an SBLC via a closed ended programBelow are numbers for indicative purposes only to demonstrate how a program like this would work?
Target amount $300m USD
In order to do this you would need to lease an SBLC for $240m USD
Lease fee is 9% of face value so in this case $21.6m USD
Anticipated LTV would be 70% so $240m would become $168m USD
From the $168m the $21.6m lease fee would need to be paid thus leaving $146.4m USD for trading purposes
$146.4m will trade at 10% per week = $14.64m USD
Deduct 20% (trader's fee) from $14.64m = $11.744m USD (net) generated per week
$11.744m x 40 week trading cycle = $469.76m USD in total
$469.76m minus the $168m (anticipated LTV amount) used for trading = $301.76m
Loan To ValueA LTV of 70% has been used just to be safe when in reality it could be more towards 75% or 80% LTV depending on the rating of the issuing bank. So to get the whole process started an instrument for $240m USD would need to be issued. When using a 'closed ended' program, there is potential to have the lease fee paid for by the monetiser so that the only fee payable by the project is the Swift fees. However this process takes some careful negotiation between the provider and the monetiser.
Why Go Through Prestige?We make sure that the SBLC work within a closed end transaction. This means we have organised a Provider >Monetiser>Trader so your bank instrument doesn't leave the system. This fluid route is secure and processes run smooth and efficiently and puts less risk on the Beneficiary.
For more information please visit Prestige Capital Partners website.