A letter of credit is when a bank writes a promise to make a payment to a vendor, or beneficiary, if the customer, or holder, fails to do so themselves. International bulk commodity transactions are the most common place to see these letters being utilized. Whether it is simply because buyers and sellers do not know each other well, or certain laws make their transaction difficult, letters of credit ensure that a sale can go through even if the seller is concerned about the buyer’s ability to pay. A standby letter of credit is specifically when the bank will only pay the beneficiary if the holder cannot. Both parties to a standby letter hope they never have to utilize it, but investing in these letters of credit could be beneficial for you.
Until recently, private placement brokers hardly ever mentioned these letters or even comprehended their application. Today, however, they are all over the place. Having said that, it is not all that common to use them for leasing or investing opportunities. However, these letters are incredibly flexible, giving them nearly limitless versatility. Before you decide that investing in them is right for you, consider the circumstances that must arise for you to make a profit with your investment.
Because these letters are only submitted to the bank for payment if the holder defaults in their payment to the beneficiary, this is the only situation in which investing in them can be beneficial to a third-party investor. Consider that the credit can be sold to a third party, but it has no value until the date that payment from the holder is due. If the date passes and the holder defaults, the investment can be worthwhile. Otherwise, if the holder comes through with the payment, the credit issued to the investor is now completely worthless.
Plus, in order for this scenario to even take place, the letter must specifically state that it is transferable, which is required for an investor to even become involved in the transaction in the first place. Therefore, if you are interested in investing in them, you must make sure it is designated as transferable by the bank who issued it and you must keep close tabs on the holder and whether or not they come through with their payment.