FINANCING FOREIGN SALES

The Export Usance Letter of Credit

An exporter in the United States can offer terms to an overseas buyer through

the usance (time) letter of credit mechanism. An export letter of credit may call

for the beneficiarys drafts to be drawn at a certain number of days after sight

or after the bill of lading date. Typically, the drafts are drawn on the exporters

bank. Once the buyers bank has accepted the documents under the letter of

credit as a conforming drawing, the accepted draft becomes a bankers

acceptance.

The advantages of the usance (time) letter of credit are:

The exporter can give the foreign buyer the option of financing its trade

cycle at the bankers acceptance rate in the United States.

For buyers in developing countries, the bankers acceptance rate is usually

a much better rate than they can access in their own country.

The exporters credit risk is the U.S. bank or foreign bank on which the draft

is drawn as an irrevocable undertaking to pay the exporter at maturity.

In many cases, the exporter can finance the foreign sale at a better rate

under the usance letter of credit than under its own bank line of credit based

on Prime.

The exporter can extend financing terms without using its own line of credit.

For example, a Mexican company, Alfa Industries, opens a $500,000 time

letter of credit with its bank, MexiBank, in favor of the beneficiary in the United

States, Beta Corp. The time letter of credit calls for the draft to be drawn on

Bank of America at 90 days after the bill of lading date. Since the draft is

drawn on Bank of America, they are taking the credit risk of MexiBank. Thus, it

is important for the exporter to check with Bank of America before the letter of

credit is issued to determine if Bank of America has sufficient availability

under its credit limit to MexiBank to accept this transaction. (An alternative to

having the draft drawn on Bank of America is to have the draft drawn on

Mexibank. The exporter thus upgrades the credit risk from that of his buyer to

that of the buyers bank. But, Bank of America no longer has credit exposure

to MexiBank under this alternative and payment will not be coming from Bank

of America.)

The goods are shipped on April 14. Alfa Industries presents the documents

required by the letter of credit to Bank of America on April 20, accompanied

by a 90-day draft maturing on July 13. Bank of America examines the

documents; finds two discrepancies, and sends the documents to

MexiBank in Mexico by courier. On April 24 MexiBank notifies Bank of America

by an authenticated SWIFT transmission that the buyer has waived the

discrepancies, enabling MexiBank to give Alfa Industries the title documents

and obligating MexiBank to pay Bank of America on July 13. This discrepancy

waiver in turn enables Bank of America to stamp the draft drawn on it as

accepted, thereby creating a bankers acceptance.

Once the bankers acceptance has been created, the exporter has two

choices:

1) Wait until July 13 to get the $500,000, knowing that its credit risk is now

that of Bank of America. If this option is picked, Beta Corp. will be charged a

per annum commission of 1.5% ($833.33) representing Bank of America’s

price for accepting the Mexican bank’s risk for 80 days.

2) On April 24, discount the draft with Bank of America at the bankers

acceptance discount rate of 6.4% plus the commission of 1.5%. In this

example, Beta Corp. would be discounting the bankers acceptance for the

time period of 80 days left until maturity at a rate of 7.9% based on a year of

360 days, giving a total discount of $8,777.76. Beta Corp. will receive the net

proceeds of $491,222.24.

A significant advantage to Beta Corp. is that it can finance this foreign

receivable at a cheaper rate than under its bank line of credit, priced at one

percent over Prime (9.5%). In this example, Beta Corp. is saving 2% and does

not have to utilize its own bank line to finance the export sale.

The Mexican buyer could not receive such advantageous pricing from

MexiBank based on its credit rating. If it were financing this transaction with

MexiBank under its Peso denominated line of credit, it would be paying 16% to

18%. However, Alfa Corp. does have the commission costs of opening the

letter of credit as well as the 25% cash margin requirement required by

MexiBank for credit and foreign exchange reasons.

Bankers Acceptance Discount Rates

These rates vary with the amount and tenor; the larger the amount and the

smaller the number of days, the less the rate will be. Bankers acceptance

rates are quoted in the third section of the Wall Street Journal under Money

Rates for periods of 30, 60, 90 and 180 days. These quoted rates are for

million dollar transactions and represent the best rates. Since the bankers

acceptance discount rate is approximately equal to the banks cost of funds;

the all-in discount rate includes the commission, which covers the credit risk

and operational overhead assumed by the U.S. bank. The U.S. bank can, in

turn, re-discount or sell these bankers’ acceptances to investors in the money

markets, thereby providing a liquid source of funding for the bank.

Bankers Acceptance Rules

The rules for bankers acceptances are established by the Federal Reserve