The financing is over; the bonds have been issued. Letter of credit documents and the official statement or offering circular have been placed high upon a shelf, where they gather dust as construction gets under way or renovations move forward.

But don’t let that dust get too thick: Organizations that issue bonds using a bank letter of credit as enhancement must be conscious of their renewal deadline.  While the underwriter and trustee should be good resources for staying on track, borrowers themselves must remain aware of their deadlines in order to take advantage of the best financial opportunities and avoid costly repercussions, which can include loss of benefits such as low, tax-exempt rates.

Letters of credit typically are issued in three-year or five-year increments. They must be renewed or replaced as they expire for the term of the bonds or notes. Letters of credit can be renegotiated by the borrower at any time, but few borrowers consider this option unless they are approaching a deadline. When properly planned for, the renewal deadline can be a catalyst for borrowers to renegotiate enhancement terms, or even shop around for a new bank to issue a letter of credit with better pricing or terms.

Missed deadlines, however, can severely damage an organization’s finances. Under normal circumstances, the bond trustee draws monthly interest and principal payments to pay investors from the letter of credit account at the issuing bank, and the borrower repays those withdrawals at the same time. But if a trustee notices a deadline is approaching and the borrower will not have a valid letter of credit the next month, the trustee is obligated to draw down the entire letter of credit account to pay off bond investors.  The borrower is left owing money to the bank – often at a high rate of prime plus 2 or 3 points. Any low-interest benefits of the bonds or notes are lost because the bonds or notes have been paid off and replaced by a traditional bank loan.

The choice to renew, replace or negotiate for better rates on a letter of credit must be considered at least six months ahead of the renewal or termination deadline to meet remarketing and other requirements and to effectively consider changes in the organization’s finances, the markets in general, and the issuing bank.

The Implications of Change

When considering strategies in anticipation of a letter of credit deadline, consider

1) Changes to the organization’s financial condition and plans for the future;
2) Changes to the issuing bank

Organizations issuing bonds or notes often are in the midst of construction projects that can decrease operating margins for the short term. Several years later, when the letter of credit is set to expire, financial ratios may have considerably improved, and perhaps market share has increased. These improvements can help organizations negotiate better enhancement rates and different, and hopefully improved, covenants.

Facilities also should consider any near-term capital projects. Letters of credit offer a significant advantage in flexibility over other borrowing options; borrowers who are working on a several-phase project can consider terminating a letter of credit prior to the deadline and rolling it into a financial structure that incorporates the new project. This can save issuance costs and simplify financial obligations.

Borrowers also should consider factors beyond their control, namely, any changes in the situation at the bank. Has a merger changed the industries to which the bank prefers to lend, and could it phase out certain organizations and refuse to renew a letter of credit? Has the bank’s credit rating dropped? Has it improved?

Staying Put, or Moving On?

Borrowers need not remain with the same letter of credit issuer, though renewing existing letters of credit carries fewer complications and fees than re-bidding an enhancement to other providers. Replacing the enhancement with a new provider, however, may be the right choice. Borrowers will be obligated to pay some legal fees, and possibly pay costs associated with a survey or title insurance. Often there is no cost to renew or extend an existing letter of credit. Extensions or renewals should always be for a minimum of one year to create time efficiencies.

Borrowers who have executed a swap to exchange a floating rate for a fixed rate in combination with a letter of credit will have additional considerations, which will be outlined in a future installment of The Capital Issue.

Keeping the Shelves Dust-Free

Borrowers should keep their Reimbursement Agreement and Trust Indenture handy for renewal and replacement timing. Any new leaders must be made aware of these deadlines upon joining the organization. Finally, stay in touch with remarketing agents or underwriters so all parties are on the same page. Organizations anticipating and preparing for deadlines will not be left in the dust when opportunities for financial improvement arise.

Print this article