Credit Enhancement in business is usually sought when a bank or a seller is not fully satisfied with a client’s financial background or collateral capacity.
Banks provide Credit Enhancement Support but only for well established companies with a solid financial background. It is important for banks to build up a long-term stable business relationship and to have customers of substance and good standing. To get a bank’s support you and must be qualified. Banks follow certain protocols to evaluate an application. Banks look for the borrower’s Capacity, Collateral, Capital, Character and general Conditions. These are the basics of credit analysis to evaluate the application for the loan or to provide a client with a financial service. The better your financial business background, the better will be the terms that you can get. But this also works the other way around. In extreme situations of a poor financial and business background, you hardly can expect any kind of support from a bank. As always: “In the real world of banking, those clients who actually would not need the support of a bank can expect to be served easily and on favourable terms.”
Your Bank: Can you get an instrument from your bank?
If you have ever asked your own bank to issue a Letter of Credit, then you will know that banks are inclined to issue financial instruments for companies who have sufficient cash, investments, and financial assets in the bank to cover any eventual financial risks. If you are not in such a fortunate financial situation, it is not only a question of terms to arrange an instrument and a question of price, but it becomes an issue if an instrument is arranged for you in the first place. Only if you are holding sufficient cash in your bank, they will provide you with such a service. If you don’t, you probably will have to deposit 100% or more in cash to get the same service a financially well-situated bank customer can access (almost) for free.
Supportive Banks can get you Credit Enhancement.
If a bank client is not cash rich, does not have significant financial assets on account or on safekeeping in a bank, then no bank will ever provide Credit Enhancement, issue, or send an instrument for a client, and definitely not for free, or wait until a client pays from future generated business. A bank never engages into risks that are not covered by existing wealth parked with them. They will never engage into a transaction and provide any financial service hoping to get paid in the future. It is a completely different story if a client is cash rich or holds significant assets in a bank.
Credit Enhancement may be available, but hardly on your terms.
In business, Credit Enhancement is a service usually required by companies who would not receive Credit Enhancement from their own bank. It is based on special professional financial structures that must be arranged followed by the emission of relevant financial instruments.
Considerations regarding a financial instrument and the principal amount that is involved.
No one will ever lend a valid financial instrument to a third party for a small fee if the borrower is not qualified, can evidence an established business, or is able to account for an eventual financial risk that may be created based on the Credit Enhancement instrument. If you have tried your own bank, and got rejected, on what basis do you expect the service from an alternative providing entity? Just think of what happens in case you default on your commitments, and the instrument backing up your transaction or the loan that you take out is being called by your lender? You have learned this already, no bank will take the risk on a transaction for a customer, unless the bank is covered by hard cash, bankable assets or investments deposited in the bank.
If you do not get the service from your own bank, you may create a significant credit risk if somebody issues a Standby Letter of Credit, a Bank Guarantee, any kind of a Documentary Letter of Credit or a Proof of Funds to your benefit. It simply becomes a very risky business for any third party as you can’t cover such liabilities effectively in a bankable way. If you would be able to do so, you would not need the service as your own bank would provide it to you. On lending collateral instruments to clients, there is also a country risk that will have to be taken into consideration. The biggest financial institutions on the planet like Euler Hermes regularly evaluate country risks, a credit insurance company that offers a wide range of bonding, guarantees and collections services for the management of business-to-business trade receivables. They evaluate and rate country risk level from AA to D while AA is the lowest risk level and D is the highest. See the section “Country and Industry Risk Assessment” for more details on that important subject.
Fees and financial commitment.
All banks charge fees to reserve, to emit, and to transmit a bank Instrument on behalf of a client. No bank will do that for free or wait until a client is willing pay. No bank provides any kind of a service unless the client has already sufficient cash in the bank to cover the costs and an eventual risk.
In Credit Enhancement there are basically two types of transactions. One is about borrowing and lending of valid and verifiable financial collateral. This type of transaction (Euro 10 million and up) is based on genuine fully cash backed, assignable and divisible bank instruments issued by major world banks. This transaction generally is secured by a clear understanding of terms agreed between the issuing and the receiving bank and is secured through a conditional commitment provided by an acceptable receiving bank before the instrument is emitted and sent.
The second type of Credit Enhancement transaction is based on “contract and verbiage-controlled instruments” issued by “willing” private banks.
This type of transaction can be available for transactions starting at Euro 250,000. Flexibility comes with the willingness of a bank to engage into an enhancement transaction and avail the required to achieve Credit Enhancement at the client’s own bank, a third party, or a seller. This comes however with a delivery protocol that requires that the agreed upon fees are deposited in cash with the provider before the instrument is emitted and sent.
The procedure to get Credit Enhancement structured usually starts with the appointment of a professional manager empowered through a mandate and the placement of a retainer.
Here are some other Credit Enhancement tools. Basically these are financial instruments which may come in these formats and are usually advised on a bank-to-bank basis, like L/C and DLC – Letter of Credit and Documentary Letter of Credit, SBLC – Standby Letters of Credit, BG – Bank Guarantee, Bid or Tender Bond, RWA – Ready, Willing, Able confirmation, POF Proof of Funds and BCL Bank Comfort Letter, BF– Blocked Funds, CD –Certificate of Deposit, Pre-Advice via bank to bank SWIFT
Chances to materialize a transaction can be very high if the borrower’s company is of substance. If you would like to discuss this further, please use the reply form, or call 00353860325153. This number also works on Whatsapp, Signal, Telegram and WeChat.
Banks must have a balance between the assets they hold or have in custody and the credit lines to customers. This relationship has become increasingly stringent over the past decade. The collapse of Silicon Valley Bank raises again fears of new financial crisis. Despite authorities' efforts to limit the impact of bank's failure, investors fear a spillover. Banks have many illiquid assets that do not allow them the necessary manoeuvrability to open lines of credit. For this reason, banks are looking for liquid collateral that can counterbalance the relationship between assets/loans, allowing banks the ability to operate within central bank regulations.
NOTE: The content of this report is part of an abstract of the 577-page book we make available to our contracted clients providing guideline to successfully structure project finance with the help of third-party collateral and Prime Bank Guarantees. It is widely read by private sector investors and lenders who intend to make project finance deals.