Bonds with Standby Letters of Credit Meet Standards for Credit Substitution

Bonds issued with standby letters of credit are legal, valid, binding and enforceable, thus meet the standards for credit substitution, says Moody's Investors Service.

"To date, the SBLC-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," says Joe Wong, a Moody's Assistant Vice President and Analyst.

Wong explains that SBLC transactions have varying structural mechanisms which require careful analysis to ensure investors can benefit from the support provided by issuing banks.

The report notes that bonds issued with SBLC from banks are becoming increasingly common in Asia, particularly with the offshore subsidiaries of Chinese companies.

SBLC structures have two advantages; they protect offshore investors and allow borrowers to reduce borrowing costs.

In this context, legal uncertainty in SBLC transactions is limited. For example, while Asian SBLC transactions have yet to be tested in a court, the legal opinions received by Moody's indicate that an issuing bank's obligations under an SBLC are legal, valid, binding and enforceable. The report further notes that a bank's obligations under SBLC transactions rank pari passu with its other senior unsecured obligations.

Given the fact that Chinese companies offshore are increasingly issuing bonds backed by SBLC, Moody's -- after obtaining legal opinions -- determined that the obligations of issuing banks under an SBLC and decisions by courts abroad regarding SBLC-backed transactions are enforceable against banks in China.

While the legal opinions are subject to the usual caveats, such as that enforcement is subject to the relevant civil procedural requirements, these caveats relate to general legal principles, rather than being particular to SBLC-backed transactions, says the report.

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