The word Leased in the term Leased Bank Guarantee is in fact a misnomer, the correct technical term is Collateral Transfer. Financial historians suggest that Leased is derived from a commercial leasing contract that has similarities to a Leased Bank Guarantee contract. However, Leased, in the context of Leased Bank Guarantee (or Leased Standby Letter of Credit), is rooted in todays’ financial jargon and is here to stay.
To lease a Bank Guarantee two parties, enter into a contract – a Collateral Transfer Agreement. One party (the Provider) and owner of the asset, will transfer the Bank Guarantee to another party (the Beneficiary) for a limited period of time – usually one year. The ownership of the asset then reverts to the provider on expiry of the Bank Guarantee. The Beneficiary will pay the Provider a “Contract Fee” in payment for the use of their asset. On receipt of the Bank Guarantee, the Beneficiary is free to approach their bank and apply for a line of credit or bank loan, (alluded to as Credit Guarantee Facilities), utilising the Bank Guarantee as security. The Beneficiary must ensure all loans and credit lines are repaid before the expiry of the Bank Guarantee.
Provider – A direct group of sophisticated investors that lease Bank Guarantees, often companies such as Hedge Funds, Sovereign Wealth Funds, Private Equity Funds and Larger Family Offices. They are not geographically centred but spread out through various global financial centres.
The Providers all have one thing in common – massive balance sheets. This allows them to lend part of their asset base for leasing Bank Guarantees or technically Collateral Transfer transactions. Inevitably, part of their portfolio will be underperforming, and other assets such as medium and long-term notes do not generate big returns. The Providers can utilise these assets as security for providing Bank Guarantees for Collateral Transfer transactions that will accordingly generate a better return on investment.
The Bank Guarantee utilised for this purpose is a Demand Bank Guarantee and it is governed by ICC Uniform Rules for Demand Guarantees (URDG 760).
More information surrounding this can be found under Monetising, ‘Credit Lining a Bank Guarantee’.
The cost to a company for entering into a Collateral Transfer Agreement or leasing a Bank Guarantee will depend on the portfolio of the Provider and the subsequent strength of The Issuing Bank. It’s worth noting, a Bank Guarantee does not carry a rating. On average, the company or Beneficiary can expect to pay a fee of 6% of face value on a Bank Guarantee, (Collateral Transfer Fee), with an expiry date of one year.
The Collateral Transfer fee is not the only cost the company beneficiary will have to bear. If the Bank Guarantee is for monetisation purposes, they will have to take into account the interest rate that will be charged by the lender.
Further charges such as legal costs for contracts, due diligence and arrangement fees will also be incurred by the beneficiary company. Collateral Transfer Agreements are not cheap, and a company can expect to pay, if utilising Euros or Pounds Sterling, a cost in the region 12 – 13% to lease a Bank Guarantee in year one. If the company wishes to rollover a Bank Guarantee into the second year, then the cost will be the Providers’ collateral fee and the loan interest.
Even though Bank Guarantees come over as costly, their purpose is to provide access to loans, capital injections and credit lines to companies who are being denied access to these credit facilities by traditional financiers.