Moody's Investors Service has said that the bonds enhanced by standby letters of credit (L/Cs) meet the standards for credit substitution.

The bonds which have become increasingly popular in Asia, notably with offshore subsidiaries of Chinese companies, have raised concerns in some quarters (DC World News, 17 March 2014).

Standards met

"To date, the standby L/C-backed bonds rated by Moody's meet the standards for credit substitution, whereby the credit quality of the rated bond is equivalent to that of the supporting bank," according to Joe Wong, a Moody's Assistant Vice President and Analyst.

"Standby L/C transactions have varying structural mechanisms which require careful analysis to ensure investors can benefit from the support provided by issuing banks," he added at the launch of a new report from the ratings agency entitled, "FAQs on Asian Bonds Backed by Standby Letters of Credit: An Update".

Limited legal uncertainty

While conceding that the legal certainty of these issuances have yet to be tested in court, the report says that legal opinions received by Moody's indicate that an issuing bank's obligations under a standby L/C are legal, valid, binding and enforceable.

The report says the L/C enhanced bonds have two key advantages: protecting offshore investors and allowing issuers to reduce borrowing costs.

In this context, Moody's says that legal uncertainty in standby L/C transactions is limited.

Report scope

The report addresses several questions concerning L/C enhanced bonds, including why they are becoming so popular, the general characteristics of the issuers and how these structures compare with other credit enhancement arrangements.

It also looks at the risk profile of a transaction backed by a standby L/C and how this differs from one backed by trade finance L/C.

Moody's subscribers can access the report at http://www.moodys.com/viewresearchdoc.aspx?docid=PBS_SF372014.

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