We're considering have our bank issue a LOC for a new lease where we don't want to pay the large security deposit. All of the guidance I find is related to the bank/guarantor but I cannot locate anything about our side. I think there would be no balance sheet impact, we would account for the fees as they're incurred (over time) and we would include this in a footnote disclosure. Can anyone confirm this or point me to the guidance? Thanks!
How do you account for Standby Letters of Credit?
Answers
To clarify, the bank will not be paying anything immediately, they are only guaranteeing payment should we default.
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We have letters of credit for 3 leases, as they just reduce the amount of the working capital line that we have access to, we don't put anything in the GL, except a footnote note disclosure for financials. We account for our draw on the line as typical-- current liability on the balance sheet.
Anonymous, you might want to check out this free resource here at Proformative.
I have 3 concerns/questions :
1. Not sure about the validity (appropriateness?) of a Letter of Credit as a guarantee for your purpose. A Letter of Credit (or Standby Letter of Credit) is typically issued for trade transactions where one party submits documents/delivers and the other accepts..then the bank pays. Do you mean Line of Credit?
2. You are right about the LOC (both Line and Letter ;and used/unused) being just a footnote/disclosure on the financials with the used portion in your Current Liabilities.
3. If you default, your credit rating takes a hit and may affect your ability to drawdown on a Line of Credit. If I were the bank, I would reevaluate your account knowing that you already defaulted. Do you have documentation/agreement with the bank specifically stating this?
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Emerson, standby l/c's are often used where a bank is guaranteeing another party's financial performance. The trade-related l/c's (usually international) are not standby's. The bank issuing either does so based on the credit-worthiness of the customer they are guaranteeing. If the bank extends a line of credit to the customer, either with "use up" part of the line.
But I don't see any need to show this stand-by on the customer's financial statements or footnotes.
I have used a Standby Letter of Credit many times in lieu of providing a landlord with a sizable cash deposit which could be tied up for years. I have done it two ways:
1. Certificate of Deposit as collateral for Bank's issuance of the LOC. In this case, the "Cash" is shown as "Restricted Cash" on the face of the Balance Sheet. The Footnotes describe why its restricted, e.g. to serve as collateral for a LOC issued to the landlord by Bank.
2. Use of a portion of a Line of Credit, which in most cases have specific carve outs for LOC issuances. In this case only Footnote disclosure is required, e.g. $XXX,XXX of the Line of Credit has been used to secure the issuance of a LOC by Bank. As such, the amount available under the line is $X,XXX,XXX.
This is a very common practice and pretty standard.
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Dear Anon CFO,
I have identical scenario to yours. For 1. where the CD is collateralizing the security deposit and presented as Restricted Cash, are you able to share the SoCF treatment? I have it in financing activities currently and just want to confirm.
I have used LOC in lieu of "cash" for a Lease as well. I use Mr Anonymous (
The interest earned and the fees paid for the LOC don't quite net out, but that is an OPEX charge.
As a Corporate Real Estate Services provider, I can say that Letters of Credit are very common for security in lieu of cash deposits. Many lanldords prefer these to cash deposits. From what we've seen with various CFOs its almost toss up in terms of the two, depending on the size of the deposit.
Thank you all for the comments; they are extremely helpful!
We sometimes use LOC in lieu of performance bonds on large boat building projects. As to any balance sheet effect.... you want to show the funds supporting the LOC as restricted cash. Depending on the term of the LOC it may no longer be listed as a current asset.
Our NY landlord required six months rent in cash in the form of a LOC. It is invested in a CD earning .2%, while the bank charges fees of 2.0% of the value of the LOC every year!
Is a Standby LOC different? Is there a form of LOC that is just a bank guarantee that would not require us to deposit funds to cover it?
Stephen the only way that I know of to do what you are asking is this. If you have a line of credit with the bank you can ask the bank to "carve out" a portion of your available line of credit to support the LOC. Depending on your relationship with the bank you will probably still pay a fee but you will not have to earmark any of your current funds (or deposit additional funds) to support the LOC nor will you have to pay any interest unless the bank is called upon to honor the LOC.
From an
We specialized in Bank Guarantee {BG}, Standby Letter of Credit {SBLC}, Medium Term Notes {MTN}, Confirmable Bank Draft {CBD} as well as other financial instruments issued from AAA Rated bank such as HSBC Bank Hong Kong, HSBC Bank London, Deutsche Bank AG Frankfurt, Barclays Bank , Standard Chartered Bank and others on lease at the lowest available rates depending on the face value of the instrument needed.
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