Letters of credit

A letter of credit is a financial instrument used to secure payment to a specified party on production of specified documents that evidence the shipment of goods. Letters of credit are typically required by overseas suppliers in an attempt to mitigate some of the risks associated with trading on open account terms. Although they can also be used in trade within one company in some circumstances. The letter of credit also gives some element of reassurance to the buyer that they will not be payment for product that has not been shipped or does not meet the terms of their order.

The letter of credit is issued by a bank and will typically name the business that will be the beneficiary (typically the supplier), specify the documents that are required to be presented (see below), specify the sum to be paid and the expiry date of the letter of credit (often abbreviated to an LC).

The documents required by the LC are normally those required to evidence shipment of the goods and the quality and quantity of the product that has been shipped. Letters of credit are not only relevant to sea transportation, they can be equally be used for air and road transported goods.

Typically the LC may call for documents that evidence the packing of the goods, known as a packing list. Multiple copies of documents may be required by the LC. Invoices are also typically required. The buyer may call for some form of inspection certification. This may be by an independent inspectorate such as a government department or it may be by the buyers overseas agent. The former may be required for the importation of the product e.g. compliance with safety standards and the latter can be required to give the buyer more assurance that the product is fit for purpose and of merchantable quality.

Next the LC is likely to call for documentation that evidences the shipment of the product. For sea freight this may be bills of lading. A bill of lading is a document issued by a shipping company evidencing the receipt of goods (normally in containers) onto a specified ship for onward transfer to a specified destination. For air freight, an airway bill is typically required, providing similar evidence of loading onto a plane. In the case of transport by road, documents evidencing road transportation will be requested.

The letter of credit could make request for other documents in addition to the above. The LC will confirm that on presentation of these documents to a bank, the specified sum will be paid.
Despite the added security of trading by letter of credit there are still some risks to the supplier if funds are not available from the issuing bank to clear the LC. Therefore, in some cases the seller may ask for the letter of credit to be confirmed by a local bank. In confirming a letter of credit, the local bank undertakes to pay the LC and takes on the financial risk.

Letters of credit can therefore be useful to the buyer and the seller but the buyer will need to either provide funds to their bank or have a facility in order to open a letter of credit to their supplier. This can create an issue for the buyer. This can be addressed in a number of ways. Firstly, if the buyers credit standing is good they may quality for a revolving facility which can be used to open letters of credit to their suppliers. If the buyers credit history is not so strong they may be able to use a factoring facility, combined with a trade finance facility to secure the transaction. In the case of factoring, the factoring company will factor the ultimate debts to the buyers debtors and the funds released from these sales invoices are used to liquidate the liability incurred from the letter of credit.

Similar to a letter of credit is a documentary collection. With this form of payment, a local bank will be instructed to pay the buyer of production of specified documents in much the same way as a letter of credit. However, the sellers security is reduced as the exact requirements are not set out and agreed in a financial instrument as is the case with a letter of credit.

Letters of credit, documentary collections, trade finance and factoring are complicated areas, especially when concerned with imports and exports. However, our advisers will be more than happy to assist you by finding you organizations that can open letter of credit for you and if necessary provide the trade finance and factoring facilities to support the opening of letters of credit to your suppliers. The cost of letter of credit, trade finance facilities depends very much upon your requirements and circumstances.

Trade Finance - Funding Imports and Exports

Trade finance assists in funding imports, exports and international trade .

One of the most difficult challenges in any business is managing success – it’s all very well securing that large order, but if you can’t fund the supply, especially if you’re buying or selling overseas, it can be a nightmare.

We understand that on one hand you may need to advance a supplier funds up-front, while on the other hand your customer will want to pay on credit terms.

We can structure international trade finance for importers where we fund the entire trade cycle as long as they have a confirmed order from a reputable customer. This is typically mixed with an invoice finance facility to provide a seamless finance facility that can allow you to take on large orders with confidence..

Trade cycle finance will allow you to trade with peace of mind and, at the same time, take the risk out of any concerns about customer credit-worthiness.

If you are exporting you may wish to consider an export invoice finance facility.

Private Project Financing

Since the banks have left many Project Financing options hanging, there are other options that have come available to companies looking for larger ticket financing.

There are finance groups out there that are interested in your venture and offer Project Financing. In general the sweet spot is $25 million and over, but if you have projects that are $5 million and over, there are sources.

Where does the money come from? Generally Private Corporations that manage hedge funds and the like that have found an opportunity that has been left by the banks since many banks are not funding these types of deals anymore.

The fees and rates to get private money like this will typically range from 6% to 9% interest, which is comparable to what the banks were charging when they were doing Project Financing.

What do they fund? In reality, any type of project that makes sense. Real Estate Developments, Alternative Fuel Projects, Acquisitions, Import/Export anything like this.

Requirements. In order to apply for Project Funding you need to have a well crafted Executive Summary to start. You need to demonstrate that you have the capability to see the project through. The Executive Summary must be both your resume as well as the analysis of the project to show how you will do it, step by step and also an exit strategy to show if things do not work out, how the lender funds will be secured.

If you have everything done ahead of time and all your information is complete then you can expect to close in as little as 45 days. After you have accepted the terms of the financing then the file goes to an exhaustive underwriting process to make sure everything is set up properly and the risks are minimized.

What do we mean by a vested interest? The Project Financing lenders must make sure that if things get difficult in the project, you are not going to walk away from it. This is done by you, the applicant having a significant financial interest in the project.

Vested interest in the project may come in the form of funds being held in escrow, down payment, equity, hold other valuables as collateral, this varies project by project.

If your venture is on hold, speak to a Commercial Finance Broker that is set up for Project Financing so you can get back on track.

Banking Instruments For Project Funding

Arriving at successful project financing is not an easily achieved task in today's banking environment. Companies have gone away from traditional institutional financing in search of other more reliable channels of funds. This is where the advent of using bank instruments as a direct source of creating capital for project finance has opened up.

While it is true that a financial instrument is used for credit enhancement such as in the complicated structured financing employing collateralized debt; bank instruments can be used in a much more simplified fashion to unleash the power of bank credit lines needed to complete project finance.

Most any bank instrument with cash backed value can be monetized to provide the necessary collateral and security a bank lender needs when making a loan. So long as the underlying assets of the instrument is indeed cash or cash equivalent, and the cash asset and the bank issuing the instrument is rated high enough to achieve comfort, many different types of financial instruments can be used for financing.

It is important to stay away from financial assets that are given value by complicated credit valuations with multiple tiers of debt securitization such as mortgage-backed securities, collateralized debt obligations, and securities and bonds backed by corporate debt and other over-valued assets outside of cash backed assets or cash equivalent assets. These types of instruments used in complex investment derivatives helped plunged the financial world into disarray over the last decade, a mess which will take another decade at least to recover from.

Cash backed assets, such as those in the form of bank guarantees, letters of credit, standby letters, certificates of deposit, cash collateral accounts, and other more easy to understand financial assets make financing simple and straight forward. When these types of instruments are used as primary or secondary collateral in connection with a viable project, bankers have an easier time making loans for project financing.

However, if you are not a tycoon big name client with multiple lines of credit and long-standing financial history with top-tier banks most companies and individuals can forget making an attempt to acquire loans of the great magnitude needed for major developments and projects. This is where financial partners with credible financial services companies become important to companies on Main Street.

While the ability to issue top-tier bank instruments as collateral for financing is a crucial piece of the financing process, this does not preclude the importance of ensuring you have solid relationships with lending institutions that can ensure the safekeeping and ultimate return of the bank instrument. This means one must be able to provide a solid bank undertaking, which strengthens the trust and confidence of the investors and asset holders involved to know the lending process will not put the instrument and their cash assets in jeopardy should a default occur.

If you feel you have everything it takes to get financing, but only lack the right cash-backed security and guarantees necessary, seek a competent financial services company to help complete the cycle with you.