Credit Enhancement is a strategy to improve the credit risk profile of a business. Usually, the aim is to obtain better terms for a loan or to repay debt. Credit Enhancement is used to reduce the risks of a lender or investor in structured financial products.
Credit Enhancement usually reduces the default risk of the company’s debt and thus can make it eligible for lower interest rates or to enable a transaction in the first place.
A company that engages in Credit Enhancement is providing assurance to the lender for re-payment of a debt by providing additional collateral, an insurance guarantee, or arranging a third-party guarantee.
DOCUMENTARY LETTER OF CREDIT
A Documentary Letter of Credit or Letter of Credit is a payment medium widely used in International trade to secure a guarantee from a Bank or a Financial Institution to an exporter.
These are best used when the reliability of the parties in an international purchase transaction cannot be easily or readily determined. The issuer in this case, assumes the liability of the importer for the payment.
A Documentary Letter of Credit (DLC) is a promise of payment provided by a buyer/importer to a seller/exporter that is guaranteed by a particular bank. Once a DLC document is presented by the seller/exporter to the issuing bank, the bank is obliged to remit full payment to the seller.
A Documentary Letter of Credit assures the exporter that payment for the exact value of the DLC will be honored and credited to them so long as they make a compliant presentation of documents. The seller/exporter may be required to fulfill certain conditions listed in the Documentary Letter of Credit, such as providing proof of shipment of the goods sold to the buyer, before collecting payment from the bank.
An LC is a financial document provided by a third-party (with no direct interest in the transaction), mostly a bank or a financial institution, that guarantees the payment of funds for goods and services to the seller once the seller submits the required documents.
A letter of credit has three important elements – the beneficiary/seller who is the recipient of the LC, the buyer/applicant who buys the goods or services and the issuing bank that issues the LC on the buyer’s request. At times, there is an involvement of another bank as an advising bank that advises the beneficiary.
BENEFITS OF DLC TO THE BUYER
- Works as a credit certificate for buyer
- Elimination of risk of losing money
- Timely Shipments
- More Favorable Payment Terms
- Safely expand business internationally
BENEFITS OF DLC TO THE SELLER
- Reducing the production risk, if the buyer cancels or changes his order
- Mitigates the risk of dealing with an unknown importer in a foreign nation.
- possibility of payment before handing the goods over to the buyer
- seller is free of credit risk
TYPES OF DLC
- LC AT SIGHT
LC At Sight is a letter of credit (LC) that is payable once is presented to the issuing bank along with all the necessary documents. This type of LC provides the fastest mode of payment to the exporter/seller, when selling to their overseas importers/buyers.
A letter of credit that demands payment on the submission of the required documents. The bank reviews the documents and pays the beneficiary if the documents meet the conditions of the letter.
An organisation offering an At Sight Letter of Credit commits itself to paying the agreed amount of funds provided that all of the provisions of the Letter of Credit are met.
For example, a business owner may present a bill of exchange to a lender along with an Sight Letter of Credit and walk away with the necessary funds right away. An At Sight Letter of Credit is therefore considered more on-demand than other types of letters of credit.
- USANCE LETTER OF CREDIT DEFFERRED LC
An Usance Letter of Credit is a letter of credit that is payable at a specific time and after the presentation of certain necessary documents listed in the letter of credit.
Unlike an At Sight letter of Credit, where the issuing bank pays the beneficiary of the letter of credit immediately after the issuing bank has had the required documents in the letter of credit presented to them, with an Usance Letter of Credit, the issuing Bank will defer the payment until the end of an agreed upon terms and once required documents are presented to the issuing bank
An Usance Letter of Credit ensures payment after a certain period, The bank may review the documents early but the payment to the beneficiary is made after the agreed-to time passes. It is also known as Deferred Letter of Credit.
- STANDBY LETTER OF CREDIT [SBLC]
A Standby Letter of Credit (SBLC) is a guarantee of payment issued by an issuing bank on behalf of a client that is used as a “last resort payment” should the client fail to fulfill a contractual commitment with a third party.
Standby Letters of Credit (SBLC) are issued as a sign of good faith in business deals and are used as proof of a client’s credit capability and repayment abilities.
The bank issuing the SBLC will perform a brief underwriting procedure to ensure the credit worthiness of the party applying for the Standby Letter of Credit, before issuing the SBLC to its beneficiary.
READY WILLING & ABLE [RWA] LETTER
A Ready Willing and Able Letter (RWA) is a document issued by a bank or financial institution for their clients. It demonstrates the intent and capability of the clients to enter into a financial business transaction both legally and financially.
After being issued, the Ready Willing and Able Letter (RWA) is sent to the beneficiary via MT799 SWIFT message.
PROOF OF FUND LETTER
A Proof of Funds Letter (POF) is a document that assists the seller in knowing that the buyer has cash funds available. It shows that these funds are not only legitimate but also obtainable.
A Proof of Funds Letter (POF) is often required at the beginning of negotiations between parties who haven’t worked together in the past.
The POF not only shows that the buyer has cash in the bank but also can help show the seller how serious the buyer is in doing a deal.
After issued, the Proof of Funds (POF) Letter is sent to the beneficiary via MT799 SWIFT message.
BANK COMFORT LETTER
A Bank Comfort Letter (BCL) or as it is sometimes referred to, a Bank Confirmation Letter is a letter from a bank or financial institution confirming the intent and capability of the clients to enter into a financial business transaction both legally and financially.
The Bank Comfort Letter officially vouches for the fact that the borrower (an individual, company or organization) is eligible to borrow a specified amount of funds for a specified purpose.
When it comes to Letters of Credit, at the request of an applicant, the issuing bank may send a Pre-Advice Letter of issuance and/or amendment of the particular letter of credit.
A pre-advice is usually marked with a reference such as “full details to follow”.
Unless otherwise stated, the Pre-Advice Letter irrevocably commits the issuing bank to issue/amend the letter of credit as stated in the said Pre-Advice Letter.
A Bank Guarantee (BG) is very similar to a Letter Of Credit (LC) as they both are used for many types of business transactions (financial or performance based).
The real difference between the two is that a Letter Of Credit (LC) ensures that a business transaction goes as planned, whereas a Bank Guarantee (BG) reduces losses if a business transaction doesn’t go as planned.
A Bank Guarantee (BG) guarantees a certain sum to the beneficiary if the opposing party doesn’t fulfil its specific obligations under their agreed upon contract.
Bank Guarantees (BG) ensure both sides in a contractual agreement from credit risk. A construction company and its steel beam supplier may enter into a contractual agreement to build a new complex.
Both sides might have to issue Bank Guarantees (BG) in order to prove their credit-worthiness to each other.
In a case that the steel beam supplier fails to deliver steel beams to the job site per their agreed contractual agreement, the construction company would notify the issuing bank of the breach of terms agreed up in the Bank Guarantee (BG) and the bank would then pay the construction company the amount agreed upon in the Bank Guarantee (BG).
TYPES OF BANK GUARANTEE
- Bid Bond Guarantee:
Is issued as part of the bidding process between a contractor and the project owner, in order to guarantee that the winning bidder will undertake the contract under the term sand conditions that they bid.
- Performance Bond Guarantee:
A surety bond usually issued by a bank to guarantee the satisfactory completion of a project by a contractor. Also known as a contract bond.
- Advance Payment Guarantee:
Is utilized whenever a contract includes advance payment to be made to the seller. It guarantees that this advance payment will be returned to the buyer if the seller happens to not fulfil its obligation to the seller.
- Warranty Bond Guarantee:
A type of security bond that states that the contractor has a history of trustworthiness. It also protects the client should the work completed be subpar or unethical in any way.
- Payment Guarantee:
A financial commitment that requires a debtor to make a repayment due to terms outlined in the debt agreement.
- Rental Guarantee:
A type of insurance used to protect landlords against loss of rent.
- Letter of Indemnity:
A letter that guarantees certain contractual provisions will be met or financial reparations will be made. Guarantees that losses will not be suffered if the contractual provisions aren’t met.
- Confirmed Payment Order Guarantee:
A guarantee of payment on a certain due date on top of the letter of credit issuing bank’s own commitment to pay the supplier.
What is SWIFT MT 799
When dealing with Bank Guarantees (Demand Guarantees) and Letters of Credit (Documentary Letters of Credit), you may often hear someone discuss the use of SWIFT MT799.
The MT799 is a type of SWIFT message that banks use to securely communicate uthenticated free format messages with other banks. It is important to understand that the MT799 is not used for transferring funds or a promise to do so.
SWIFT MT799 messages are mostly used for showing proof of funds or proof of deposits.
Since the MT799 is free format, banks can easily send many various types of messages to other banks before funds, a guarantee, or letter of credit is sent via SWIFT. …
Types of MT799 Messages
Banks have many uses for the MT799 message including:
How Can I Get A SWIFT MT-799 Message Issued?
Only a bank that has SWIFT capabilities can issue a MT799. You can try to use your personal bank, or you can use RESTORIUM to provide you the service from our network of 50+ banks.
Banks normally will not issue a MT799 without some type of collateral.
If you don’t have the collateral at hand, you can utilize the services of RESTORIUM as we can provide you a MT799 without the use of your own collateral.
What Information Do I Need To Provide In Order To Send A MT799?
Here is the most common information needed to send a MT799:
- Applicant’s name and contact information
- Instrument amount
- Advising bank’s information
- Beneficiary’s name and contact information
- Validity of instrument
- Copy of contract / pro forma invoice
- Letter of Credit number
- Letter of Credit amount
- Letter of Credit draft
- Latest shipment date
What Is Project Finance?
Project finance is the funding (financing) of long-term infrastructure, industrial projects, and public services using a non-recourse or limited recourse financial structure. The debt and equity used to finance the project are paid back from the cash flow generated by the project.
Project financing is a loan structure that relies primarily on the project’s cash flow for repayment, with the project’s assets, rights, and interests held as secondary collateral. Project finance is especially attractive to the private sector because companies can fund major projects off-balance sheet.
When defaulting on a loan, recourse financing gives lenders full claim to shareholders’ assets or cash flow. In contrast, project financing provides the project company as a limited-liability SPV. The lenders’ recourse is thus limited primarily or entirely to the project’s assets, including completion and performance guarantees and bonds, in case the project company defaults.
A key issue in non-recourse financing is whether circumstances may arise in which the lenders have recourse to some or all of the shareholders’ assets. A deliberate breach on the part of the shareholders may give the lender recourse to assets.
Applicable law may restrict the extent to which shareholder liability may be limited. For example, liability for personal injury or death is typically not subject to elimination. Non-recourse debt is characterized by high capital expenditures, long loan periods and uncertain revenue streams. Underwriting these loans requires financial modeling skills and a sound knowledge of the underlying technical domain.
To preempt deficiency balances, loan-to-value (LTV) ratios are usually limited to 60% in non-recourse loans. Lenders impose higher credit standards on borrowers to minimize the chance of default. Non-recourse loans, on account of their greater risk, carry higher interest rates than recourse loans.
Recourse Versus Non-Recourse Loans
If two people are looking to purchase large assets, such as a home, and one receives a recourse loan and the other a non-recourse loan, the actions the financial institution can take against each borrower are different.
In both cases, the homes may be used as collateral, meaning they can be seized should either borrower default. To recoup costs when the borrowers default, the financial institutions can attempt to sell the homes and use the sale price to pay down the associated debt. If the properties sell for less than the amount owed, the financial institution can pursue only the debtor with the recourse loan. The debtor with the non-recourse loan cannot be pursued for any additional payment beyond the seizure of the asset.
Let’s Meet Your Investment Banking and Project Development Needs in Ireland
Talk to Restorium Capital about your Investment Banking and Project Development needs in Ireland and the rest of Europe. Kindly call +353 1 687 5778 or email firstname.lastname@example.org. Our working hours are 9am – 5pm, Mondays through Friday.