Standby Letters of Credit
We see numerous requests for Standby Letters of Credit (SBLCs). All too often a client reaches out to us with this deal or a variation: they have been approved for finance for some project, sometimes into the millions, and the funding company has said: “We’ll release the cash for your project. All you have to do is provide us with an SBLC in an equivalent amount.”
Think about this for a moment. The “funder” is saying they’ll finance it as long as someone ELSE takes the actual risk of the deal. In such cases, the funder may have the cash, but they want another party to take the hit if things go south. That takes us back to the basic rules of many deals: there has to be someone with cash who has assessed the deal and its risks, and finds the risks manageable. That’s true both in trade finance and in project finance. We do not handle leased SBLCs or BGs of any sort, as it is hard to see how a leased instrument can be monetized. A leased instrument requires return of the instrument which puts the monetizer in the position of making an unsecured loan.
There is a place for credit-enhancement instruments but it depends on the underlying situation. Here’s where a credit enhancement SBLC might work to the client’s advantage:
applicant and beneficiary have a prior relationship and a financial instrument has to be on file even though both parties have structured the deal to their satisfaction;
as a short-term place holder for a real estate transaction in some jurisdictions;
as a way of marginally increasing the asset side of a balance sheet.
Credit enhancement SBLC’s are generally not practical for commodity transactions. In such cases, it’s best to see if the deal can be financed properly.