You want a Letter of Credit, Really? Part 3

As we continue this series on Letters of Credit, certainly an arcane and boring subject for most of us, bear in mind that today the U.S. Commerce announced that U.S. exports in 2013 set a new record for a fourth straight year.  International Trade in U.S. Goods and Services data released today by the U.S. Department of Commerce show that U.S. exports reached $2.3 trillion in 2013, up nearly $700 billion since 2009.  Export sectors reached all-time highs across the board in 2013, including key industries such as automotive, industrial supplies, consumer goods, capital goods, and petroleum. Imports of goods decreased for the first time since 2009.

While many companies trading overseas do so via related parties, or have been doing so for years, many do take risks when selling globally.

For those companies that have not considered Letters of Credit when trading, there are several reasons why you would want to think this through and consider the all-in-transaction cost:

  •  Preshipment Finance – Having a Letter of credit puts your sellers in a better position to do preshipment finance to procure materials and pay labor.  There are just not that many solutions aroundp preshipment finance today, as it is deemed too risky by financiers (Purchase orders can be canceled, amended, suppliers can breach contracts, or worse, fail.)
  • Credit management costs - When selling, exporters need to manage country risk, establish buyers’ credit lines, and manage the drawdown process – all of this can be an expensive process.  Every sale made to customers must have some credit line and payment term associated with it.  By having an L/C, this eliminates those costs as the seller is taking bank risk, not buyer risk.
  • Additional Insurance costs - Sellers typically don’t need insurance on a letter of credit.  Sure, they could confirm it based on the issuing bank’s standing and country risk, and that information is very accessible.  But open account?  Have you ever tried to secure receivable insurance as a middle market seller – few insurers will look at it from a transactional basis. They want a premium based on some holistic package, typically selling you a BMW when all you need is a Volkswagen.
  • Outsource processing to Banks - From my discussions with Treasurers, there continues to be a lack of awareness around their risk exposure and the necessary controls required to be in compliance with regulatory requirements like Know Your Customer, OFAC, valuation issues, goods classification, etc. when dealing with not only overseas suppliers, but the myriad of agents that are involved in the process.

So yes, the Letter of Credit is ugly, document and credit intensive, and for many, worthwhile to stay away from. But do not totally discount it before you look at the all-in-costs of trading.  It could be a worthwhile bet in this risky world we live in today.

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