Synthetic Letter of Credit

Kerry Fabor's Profile

Letter Of Credit

Are synthetic letters of credit widely used?   What are the negatives for a beneficiary who accepts one as collateral?  If I understand correctly, the cost to the borrower is a facility fee plus the interest generated from the funds supporting the LC placed in escrow. 

Thanks for any information you can provide.


Member's Profile

Kerry, in a technical sense, since funds borrowed via a synthetic letter of credit are available immediately, they're usually considered a more "liquid" source of funds to the borrower than a standard letter of credit. The proceeds are therefore considered more secure, as there is no counterparty risk which could result in the funds becoming unavailable.
However, in practice (in my experience, at least), I don't really see any difference between a synthetic letter of credit and an irrevocable LOC -- except -- when my bank, due to my company's liquidity, requires me to post a deposit or CD or other "anchor" to ensure we can meet the LOCs obligations.

As to the cost, it is certainly a facility fee, but additionally because the interest generated is seen as an opportunity cost to the lender, it is typically added to the borrower's cost base.