Can someone comment on the general cost structure for a Letter of Credit provided by borrower to lender in lieu of recourse guaranty?
Assuming LOC for $25M and required for the full term of loan (36 months). Is there an origination fee and then form of interest payment due to the provider of the LOC until it is removed?
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Based on the highest ranked content on WSO, here are some insights regarding the cost structure for a Letter of Credit (LOC) provided by a borrower to a lender in lieu of a personal guaranty:
Origination Fee:
Interest Payment (LOC Fee):
Term of the Loan:
Additional Costs:
In summary, for a $25M LOC required for 36 months, you can expect: - An origination fee potentially in the range of 50-150 bps. - An annual fee of 1-2% of the LOC amount, translating to $250,000 to $500,000 per year. - Total cost over 36 months could range from $750,000 to $1,500,000, plus any additional administrative fees.
If you need more specific details or have further questions, it might be helpful to consult directly with a financial institution or a professional experienced in LOC arrangements.
Sources: Origination Fees on +$100MM Loans, Rational behind a lender choosing a loan term
My second hand experience has been an annual fee of 1% of the amount. If the institution issuing the LOC is a consumer bank, they also tend to have some deposit/escrow requirements. My general experience has been that it’s almost always too prohibitive given cost and deposit requirements, but I haven’t dealt with an LOC of that size.
Have seen deposit requirements be anywhere from 30-100%. Never makes sense in my experience
How the heck would 100% deposit make sense to borrower? Isn't the goal to minimize cash outlay?
It is about recapitalization. Deposits don't necessarily mean cash in every situation. You can collateralize other assets.
So for example, construction lender requiring 20% recourse or a $20MM LOC on a $100M construction loan for a hotel.
Should developer complete the project, but be unable to repay the full $100MM, then construction lender can look to issuer of LOC to pay up to $20MM to make them whole.
Issuer of LOC now looks to developer's deposits/collateral pledge to make them whole, or as close to whole as possible. If deposits/collateral only allow for $15MM, then LOC issuer is out the remaining $5MM.
Is that the gist?
Yes but mostly no in practice. No lender wants a letter of credit especially with hotel or office.
In theory, yes. In practice, the mechanics are a little different but you end up at the same place.... but this is only part 1. The second part is that the borrower then has an unpaid debt to the bank which the bank then demands. In lieu of payment, they'll typically structure it into a new note with terms and other collateral.
But the lender doesn't care at that point, they've been paid. That is a borrower/sponsor issue.
If it gets to that point, that's true. But this is why others are commenting that most lenders don't want or won't accept an L/C in lieu of guaranty. While it is in theory a perfectly fungible substitute for a guaranty (actually preferable to a guaranty since it is more liquid if structured correctly); it still creates counterparty risk. If the L/C is multi-year to cover the term of the loan and the applicant doesn't pay the L/C fees, then it gets terminated and the lender is left exposed unless they make payment which creates additional exposure which has no recourse to anyone since the L/C was in lieu of the guaranty itself. With a guaranty, you just tack that extra exposure on and rely on legal remedies to recoup that in the event of default.
LOCs are irrevocable through the termination date. Similar to insurance, they have 30 termination notices if they are for example 2years with (3) 1 year extensions. If a lender receives a termination notice or notice or non-extension, they simply cash the LOC, put funds into a reserve and hold until it is replaced.
The question of why you have an LOC is more important in the question of LOC vs Guaranty.
LOCs by nature cap the exposure, where as guarantees are typically written as open ended.
Guaranties also need to be litigated before you can collect. LOCs I just show up to the bank per the instructions in the LOC and get a wire transfer instantly.
Yes, that is a great point. Presumably for that reason, I think I can count on one hand the number of multi-year L/Cs I saw (excepting bond purchase agreement type L/Cs for muni bonds but even those were somewhat rare if only for market reasons [at least right after the GFC, can't speak to the before time]).
I'm reaching way into memory here, but I recall there actually being a big fubar on a deal I worked on briefly with an L/C that supported a big public/private development whereby a private investor developed a major project and the local municipality provided lots of public investment and heavy tax incentives and they secured some portion of their bond repayment with an L/C triggered if the TIF baseline assumptions weren't met (or something like that). It was extremely aggressive. After the GFC, this project completely failed to meet all its targets and we didn't want to renew the L/C but we knew if we provided notice the muni or bond trustee would call the L/C so there was a lot of brain power spent figuring out a way to try and get out of that exposure without having to fund it since the borrower's had absolutely no cash flow to service the additional funded debt in a way that would have let us keep it on accrual. I don't recall what ended up happening. Crazy times, that was.
The story with WeWorks LOCs is that GS demanded they be fully capitalized with cash prior to their BK. Something close to 1bn that Softbank had to put up. Usually they aren't collateralized to 100% unless you are a huge credit risk.
I’ve never understood the mechanics of Bank A actually getting the money from Bank B that issued the L/C. It’s not like they can just draw on it, the guarantor has to affirmatively do that and why would they without a fight.
The L/C in such circumstances will allow the beneficiary the right to present a request for draw and the issuing bank is obliged to honor it without question. The issuing bank is not even obligated to verify the veracity or correctness of the underlying circumstances. You simply walk in and say "I am [beneficiary]. Under L/C #12345 please give me $X." And the issuer cuts you a check and then makes a very interesting phone call to the applicant.
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