A Letter of Credit is a letter from a bank guaranteeing that a buyer's payment to a seller will be received on time and for the correct amount. In the event that the buyer is unable to make payment on the purchase, the bank will be required to cover the full or remaining amount of the purchase. The purpose of this article is to better understand how to price a Letter of Credit in PrecisionLender.
In This Article
Pricing a Letter of Credit
Select the Letter of Credit product to begin pricing a New Opportunity. Confirm the Payment Type field is set to Letter of Credit. Similar to pricing other loan products, you'll enter the Commitment, Maturity, Fees, Origination and Servicing Channels, and Risk Rating.
If you do not see Letter of Credit as an available product, please contact the PrecisionLender administrator at your bank. We recommend that organizations configure a separate product for Letters of Credit to account for the product’s unique capital allocation and usage given default (UGD).
Next, select the correct Letter of Credit Type. The Letter of Credit Type determines the Regulatory Usage which is used to calculate the Regulatory Risk Weighted Assets, and plays an important role in the profitability equation.
There are four available Letter of Credit Types in PrecisionLender. You may see one or all of these Types depending on how your administrator has configured this product.
- Commercial - Self Liquidating
For more information on the Letter of Credit Types, see Setting Up a Letter of Credit.
Understanding the Financial Statements
Letters of Credit are unique because they are not associated with an outstanding balance. Let’s take a closer look at the Financial Statements using the original Opportunity inputs in the image above.
Although there is not an outstanding balance to generate interest income, Origination Fees and Origination Expenses are both line items in the Interest Income category on the Financial Statement. In this example, Raw Interest Income is $0, and the $10,000 in Origination Fees and $3,000 in Origination Expenses nets to $7,000 in Interest Income.
Interest Expense may also have a value based on the regional settings for unfunded liquidity.
Next, we can see the $1,500 annual Servicing Expense (indicated by the Servicing Channel field on the Opportunity) rolls through the Non-Interest Expense line item.
After taxes, the total annual Net Income in this example is $4,246.
- Setting Up a Letter of Credit
- Understanding Financial Statements for Opportunities with Multiple Loans