A bankers’ acceptance (“BA”) is essentially a negotiable financial instrument used to raise short term funds in the money market. It is a common form of short term borrowing at a fixed rate in Canadian credit facilities.
How A BA Works
A BA consists of a draft containing a promise to pay a sum certain at a specified date drawn by a borrower and stamped or accepted by a bank. By accepting the draft, the bank assumes the primary obligation to pay the principal face amount of the BA at maturity.
The BA is rendered negotiable through an effective endorsement by the borrower, enabling the BA to be sold at a discount by the borrower (a) to a lender under a credit facility being provided to the borrower or (b) if the borrower has sufficient distribution capability (and usually only investment grade issuers have such capability), directly to a purchaser in the secondary market. In either case, the lender or purchaser may further negotiate the BA or hold it until maturity. If the purchaser holds the BA to maturity, it is entitled to present the BA to the accepting bank for payment of the principal face amount of the BA. In this manner, the borrower may use the superior credit rating of the accepting bank to lower the borrower’s cost of borrowing.
BAs usually have a term of 30 to 180 days. For trading convenience, BAs are also drawn in convenient amounts, usually in integral multiples of hundreds of thousands of dollars. BAs are usually denominated in Canadian dollars but also may be denominated in US dollars.
The cost to the borrower is a function of the discount applied to the BA and an accepting fee charged by the bank. At the time of acceptance, the bank charges an acceptance fee based upon the face amount and the term of the BA. The fee charged in respect of any particular instrument will reflect the bank’s assessment of the drawer’s credit-worthiness. The discount reflects the purchaser’s assessment of the risk of the transaction (as measured in relation to the bank’s credit-worthiness) and the amount charged by the purchaser for the use of its funds until the date of maturity. BA funding is usually 50-75 basis points cheaper than floating prime rate funding.
Common BA Terms
In practice, banks assume an active role in the trading of BAs. It is common for loan agreements to provide that the bank, after accepting a BA, may sell the BA.
At the date of maturity, the holder of the BA calls upon the accepting bank to honour its obligation, the accepting bank pays the holder and then looks to the borrower for reimbursement. Typically, the loan agreement provides the borrower with the option of either “rolling the BAs” (i.e. issuing new BAs and reimbursing the accepting bank for the matured BAs with the proceeds of such new issuance) or using some other method of availment under the facility to reimburse the bank, such as borrowing through a Canadian prime rate advance.