Collateral Transfer

A Definition

Collateral Transfer is a highly interesting product. It allows companies starved of credit facilities by their own banks to access these facilities without too much fuss or bother. Sadly, some companies have not heard of this credit facility as it has been incorrectly referred to as Leased Bank Guarantees.

Collateral Transfer is actually the technical name for leased bank guarantees. Experts from the financial world suggest the term leased has been plagiarised from a commercial leasing contract. Their opinions are founded on the close similarities between a commercial leasing contract and a leased bank guarantee contract.

Companies looking to lease a bank guarantee or a standby letter of credit will sign a Collateral Transfer Agreement with a provider. The company leasing the bank guarantee is now referenced as the Beneficiary.

The agreement in effect allow the beneficiary to rent or lease a bank guarantee usually for a period of one year. The provider will receive a fee from the beneficiary for the use of the bank guarantee. This fee is referred to as the Collateral Transfer Fee.

Once the agreement has been signed by both parties the provider will instruct their bank to issue a bank guarantee. The bank guarantee will be in favour of the beneficiary.

The providers bank will then SWIFT transmit the bank guarantee to the beneficiary’s bank for credit to the beneficiary’s account.

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Is Collateral Transfer Expensive?

Beneficiaries of bank guarantees initially complain that the cost of collateral transfer is expensive. But when confronted with the possibility of bankruptcy most agree it is cheap at the price. Other companies who are start-ups often feel collateral transfer is value for money.

There are three sets of costs beneficiaries must contemplate. The first is the collateral transfer fee. As already advised this cost is averaging out at 6% of the face value of the bank guarantee. This cost can sometimes be much higher.

The fee is directly linked to the credit rating of the issuing bank. If the beneficiary desires the issuing bank to be of high investment grade, they can pay 16% to 20% or more. The lower the rating the lower the collateral transfer fee.

The second cost is the cost of borrowing for one year. This will be set on 12-month Euribor or 12-month sterling Libor rates plus whatever premium the lender adds on. If the bank guarantee is rolled over into a second year the rate may be different. This is because interest rates are subject to market pressures.

The third set of costs are basically administrative costs. The beneficiary must look to pay arrangement fees, booking fees, due diligence and legal fees. However, these fees only apply in the first year. Any second years costs will be the collateral transfer fee and one year’s cost of borrowing.