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By Ira Weissman

Bankers' acceptance (B/A) financing in the last decade has increased more than tenfold, to a large extent reflecting the expansion of U.S. dollar-denominated trade transactions. This has brought about change in the practices of banks that create B/As, the operation of the secondary market, and Federal Reserve regulations governing B/As.

Most global transactions begin with the issuance of a letter of credit (L/C). The following paragraphs focus on the relationship between L/Cs and B/As and this technique of working capital financing from the buyer's point of view.

Letters of Credit

A standard, negotiable, irrevocable, import L/C, by definition, is a written undertaking issued by a bank, acting at the request--and on instructions--of its customer, the applicant for the credit, account party, or buyer, in which the bank obligates itself to make payment to the beneficiary (seller of goods or services) up to an amount stated in the L/C, within a prescribed time frame, and upon presentation of appropriate documents (e.g., commercial invoice, bill of lading, inspection certificate, visa documentation) by the beneficiary that conform to terms and conditions set by the buyer, expressed in the L/C.

In issuing an L/C, the buyer's bank substitutes its credit standing for that of the buyer. The seller is then assured of receiving payment when it presents documents that comply with the terms and conditions of the L/C, independent of the ability or willingness of the buyer to pay. For a more extensive discussion of L/Cs, see "Letters of Credit--Doing Business in a Global Market" in the January 1996 issue of The CPA Journal.

For the purpose of illustrating the use of L/Cs and B/As in the following paragraphs, examples are structured around Domestic Inc. (Domestic), a U.S. purchaser of manufactured goods and Foreign Mfg. (Foreign), an overseas manufacturer. The banks servicing the two parties are Buyer Bank (Domestic's bank), and Seller Bank (Foreign's bank).

Sight Basis L/C Without B/A Financing

Domestic purchases trousers for $10,000 from Foreign. If an L/C is issued by Buyer Bank, at the request of Domestic, on a sight basis (to be paid for immediately upon presentation of the appropriate documents), Buyer Bank pays the seller, Foreign, usually at the point of shipment. For example, using a sight basis L/C without B/A financing, upon proper passage of title, Buyer Bank would charge Domestic's account for $10,000 and remit these funds to Seller Bank for the account of Foreign.

Time Basis L/C Without B/A Financing

If the L/C is issued on a time basis, e.g., 60 days, then Buyer Bank does not charge Domestic's account until the end of the 60-day period, when the funds are forwarded to Seller Bank for the account of Foreign. Under this scenario, Foreign, in effect, finances the transaction for 60 days, usually not an acceptable option to sellers, even with a time basis L/C as collateral. Domestic will then look to another source of funding the transaction, probably B/A financing.

Bankers' Acceptances

A B/A is a time draft (also known as a bill of exchange) drawn on and accepted by a bank, which obligates itself to pay the holder of the draft the face amount of the draft at maturity. The draft becomes a B/A when the bank accepts it by officially signing, dating, and stamping "accepted" on its face. If the accepting bank, the primary obligor, fails to meet its payment obligation, the holder of the note--assuming the bank has sold the B/A in the open market--has recourse back to the drawer of the draft, the secondary obligor. The secondary obligor has the unconditional responsibility to pay the acceptance if the primary obligor dishonors it. This characteristic makes the B/A--referred to as a two-name paper--a safe investment instrument, usually with lower rates than might be available in a direct borrowing.

Foreign manufacturers generally prefer to do business using sight basis L/Cs. Because most international transactions are shipped via ocean, sight basis L/Cs result in payments for merchandise being received by the seller before the shipments are received by the buyer. B/A financing becomes a logical consequence to a sight basis L/C transaction. When negotiating L/Cs, buyers finance the transactions using B/As for any or all of the

l. Insufficient working capital to pay off the L/C.

2. Time basis L/Cs are usually not acceptable from a foreign supplier's point of view.

3. B/A financing usually offers lower interest rates than conventional financing.

B/As are issued with due dates not to exceed 180 days (Federal Reserve requirement) from the shipment date of the merchandise. This provides buyers ample time to receive, warehouse, ship, and collect the proceeds from sales to third party customers, also enabling them to accumulate the funds necessary to pay the B/A at its maturity date.

When a bank creates a B/A it secures the obligation by taking a security interest in the purchased inventory by either having the buyer sign a trust receipt for each purchase under the original L/C or by creating a UCC filing, establishing a public record of a specific security interest.

Restrictions. Because B/A financing involves the use of bank credit, the Federal Reserve System, as part of its regulatory function, establishes limitations on the types of transactions to be financed by such instruments.

Depending upon whether or not they meet certain requirements, B/As are classified as either eligible or ineligible for discount at the Federal Reserve. For example, if the collateral is made up of perishable goods, therefore not a good candidate for a security interest, the B/A would be ineligible for discount. If a B/A is eligible for discount, it is exempt from reserve requirements which, if imposed, raise the effective cost of the acceptance.

Pricing B/As. To obtain funds using a B/A, the B/A must be discounted. The amount a beneficiary receives is the face amount less an amount called the all-in-rate, which is comprised of the market discount rate plus the bank's acceptance commission.

Assume that Domestic elects to finance a $10,000 sight L/C by issuing a 180-day draft which is accepted by Buyer Bank. Buyer Bank discounts the 180-day B/A and charges Domestic an effective rate of 10.52% per annum consisting of a market discount rate for funds borrowed of 10% and the B/A commission rate of .52%. In this case, when the B/A is issued, Buyer Bank discounts the financing fees and credits Domestic's account for $9,474. Buyer Bank then remits $10,000 to Seller Bank for the account of Foreign Mfg. and charges Domestic's account the full amount, creating an up-front $526 discount. At the maturity date of the B/A, 180 days from issue date, Buyer Bank charges Domestic Inc.'s account for $10,000.

Sight Basis L/C Using B/A Financing

For its $10,000 purchase from Foreign, Domestic issues a sight L/C to Foreign, which it finances using a B/A. Upon proper compliance with the terms of the sight L/C, Domestic prepares a draft note and submits it to Buyer Bank. Buyer Bank stamps the draft "accepted" and the B/A is created. Buyer Bank immediately transfers the full amount to Seller Bank for Foreign's account, and charges Domestic's account for the $10,000. It then credits Domestic for the discounted amount of the B/A, $9,474, creating a net up-front charge of $526 for discount and commission. When the B/A matures, Buyer Bank charges Domestic's account for $10,000. If Domestic had elected to finance this transaction under more conventional banking procedures the borrowing rate would probably have exceeded the effective rate of the B/A, which Buyer Bank will probably sell in the open market.

Time Basis L/C Using B/A Financing

Buyer Bank, at the request of Domestic, issues a $10,000, 60 day, time L/C to Foreign. Sixty days after the goods are shipped and title has passed, Buyer Bank accepts a draft note from Domestic and a B/A for up to 180 days (a statutory limitation) from when the original shipment date is created. Again, Buyer Bank probably sells the B/A in the open market. At the maturity date of the time L/C, Buyer Bank remits the $10,000 to Seller Bank for the account of Foreign and charges Domestic's account accordingly. At the same time, Buyer Bank credits Domestic's account (The B/A doesn't take effect until the L/C matures, which is after the 60th day. This will only allow the B/A to be in existence for 120 days.) for the proceeds under the B/A less all discount and commission charges, or $9,655. At the B/A maturity date, Buyer Bank charges Domestic's account for $10,000. In this case, if Foreign is in need of immediate funds it arranges to have the original time basis L/C discounted by Seller Bank for the 60- day period.

Benefits are available to both Domestic and Foreign; it permits the seller to get paid immediately, assuming Foreign elects to discount the transaction with Seller Bank upon presentation of documents conforming to the terms and conditions under the original time basis L/C, and it does not require Domestic to pay until the B/A matures.

B/A Financing: Advantages & Disadvantages


* Permits seller of goods to offer buyer extended payment terms while allowing for immediate funding.

* Foreign users access the U.S. dollar market at lower rates than might be available in their own countries.

* Rates are often lower than rates tied to prime.

* Cash flow, i.e., when goods underlying the B/A are sold, the proceeds are used to repay B/A.


* Financing can only be extended for a maximum of six months for B/A to be considered eligible.

* Federal Reserve regulations restrict this type of financing, e.g., underlying shipments must correspond to the tenor (terms of agreement) of the B/A.

Clearly, the bankers' acceptance can be an attractive financing alternative for merchandise acquired through the letter-of-credit vehicle. Although the B/A is frequently misunderstood, it is a relatively uncomplicated instrument when the basic mechanics are clearly presented. In summation, it is apparent that the use of bankers' acceptances has been instrumental in alleviating the financing constraints often associated with global market activity. *

Ira Weissman, CPA, is a management consultant (currently associated with Lawrence Stevens), an adjunct professor at Baruch College of the City University of New York and Rutgers University, and an instructor at Fox-Gearty CPA Review programs.


Michael Goldstein, CPA
The CPA Journal


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