A letter of credit sublimit is a capped portion of a revolving credit facility set aside for issuing letters of credit rather than drawing cash. If your revolver totals $10 million and the sublimit is $2 million, you can have up to $2 million in outstanding letters of credit at any time, and every dollar tied up in those instruments reduces the cash you can borrow from the same facility. The sublimit lives inside the total commitment, never on top of it.1U.S. Securities and Exchange Commission. Revolving Credit Facility Agreement
How the Sublimit Sits Inside the Revolver
A revolving credit facility gives a business a maximum borrowing amount it can draw, repay, and draw again over the life of the agreement. Credit agreements define the letter of credit sublimit as the lesser of a fixed dollar cap or the total revolving commitment, and they make clear the sublimit is part of, not in addition to, that commitment.1U.S. Securities and Exchange Commission. Revolving Credit Facility Agreement Total revolving loans plus all letter of credit obligations plus any other outstanding amounts under the facility cannot exceed the revolving committed amount. If the total ever crosses that line or the sublimit itself, the excess is immediately due and payable.2U.S. Securities and Exchange Commission. WLMS 10-K Annual Report
So the sublimit does two things at once. It sets the ceiling on how much letter of credit exposure the bank will carry for you, and it consumes availability under the larger facility on a dollar-for-dollar basis.
What the Sublimit Covers
Most sublimits cover commercial letters of credit and standby letters of credit. A commercial letter of credit is a payment instrument in a trade transaction: the seller ships goods, presents the required documents to the bank, and the bank pays. It is designed to be drawn on as part of the normal deal.
Standby letters of credit work the opposite way. They sit in the background as a guarantee and only get drawn if something goes wrong. A financial standby backs a monetary obligation such as a loan or lease payment; the beneficiary draws on it if the borrower defaults. A performance standby backs a nonfinancial commitment like completing a construction project, and the beneficiary draws only if the applicant fails to perform.
From the sublimit’s perspective, the type does not matter. A $500,000 commercial letter of credit and a $500,000 standby letter of credit each reduce your sublimit and your total facility availability by the same $500,000.
Calculating What You Have Left
Two limits run in parallel, and whichever binds first is the one that controls. Suppose you have a $10 million revolving commitment and a $3 million letter of credit sublimit. You have drawn $4 million in cash loans and have $1.5 million in outstanding letters of credit.
- Remaining sublimit capacity: $3 million minus $1.5 million equals $1.5 million available for new letters of credit.
- Remaining total availability: $10 million minus $4 million in cash loans minus $1.5 million in letter of credit obligations equals $4.5 million.
- Maximum new letter of credit: the lesser of the two, so $1.5 million.
- Maximum additional cash draw: $4.5 million, but only if you issue no new letters of credit.
Businesses that lean heavily on letters of credit, like construction firms posting performance bonds or importers financing shipments, often hit the sublimit before they exhaust the overall facility. When that happens, the options are negotiating a higher sublimit, letting existing letters of credit expire, or posting cash collateral outside the facility.
Fees You’ll Pay
Letters of credit generate fees separate from interest on cash borrowings. The primary charge is a letter of credit fee, typically an annual percentage of the instrument’s face value. Most fall in the range of 0.75% to 1.5% per year. Standby letters of credit for higher-risk borrowers can run above that; investment-grade borrowers with strong banking relationships negotiate lower.
On top of the letter of credit fee, many agreements charge a fronting fee to the issuing bank. One SEC filing shows a fronting fee of 0.25% per year, paid quarterly, on top of any other customary issuer fees.2U.S. Securities and Exchange Commission. WLMS 10-K Annual Report Fronting fees compensate the bank that actually issues the instrument when a syndicate of lenders shares the risk behind it.
The unused portion of the overall facility usually carries a commitment fee, typically 0.25% to 0.50%. Whether outstanding letters of credit count as “used” for this fee depends on the agreement. Some treat letter of credit exposure the same as a cash draw and reduce the base on which the commitment fee is charged. Others do not. On a large facility that difference is real money, so read the definition carefully before signing.
What Happens When a Letter of Credit Is Drawn
While a letter of credit sits undrawn, it is contingent exposure, not funded debt. The moment a beneficiary presents complying documents and the bank pays, that changes. You owe the bank the money, and the obligation to reimburse is typically immediate and unconditional, secured by the same collateral that backs the facility.
In most revolving agreements, a draw automatically converts into a funded loan under the facility. The exposure moves from the unfunded column to the funded column on the bank’s books. Total facility usage stays the same because the letter of credit was already counted against your availability, but you now owe interest on a loan balance rather than just letter of credit fees. The rate is usually the same rate that applies to revolving cash borrowings.
If reimbursement cannot be immediate and the draw cannot be converted into a revolving loan, because doing so would breach a covenant or exceed the facility limit, the agreement typically treats the shortfall as a default. Defaults tend to cascade. A default on one provision gives the lender the right to accelerate the entire facility, demanding repayment of everything at once. A single draw that goes sideways can put the whole borrowing relationship at risk.
One structural feature worth understanding: the issuing bank pays against documents, not against the underlying deal. Under Article 5 of the Uniform Commercial Code, if the documents presented appear to comply with the letter of credit’s terms, the bank must pay. If they do not appear to comply, the bank must refuse.3Cornell Law Institute. UCC Article 5-111 – Remedies The bank does not investigate whether the beneficiary actually performed or whether the goods were defective. If a contractor performs badly but presents facially compliant documents on a standby, the bank pays and your remedy is against the contractor, not the bank. Fraud defenses are narrow and hard to establish.
Evergreen Clauses and Expiration Risk
Many standby letters of credit include an evergreen clause that automatically renews the instrument for successive one-year periods unless the issuing bank sends a non-renewal notice before a specified deadline. This suits ongoing obligations like lease guarantees or regulatory requirements without a fixed end date. Non-renewal notice periods commonly run 30 to 90 days before the current expiration date.
Credit agreements typically require that any evergreen letter of credit let the bank decline renewal at least once every twelve months, and that final expiration cannot extend beyond the maturity date of the facility itself. If the facility matures before an evergreen letter of credit’s next renewal, the borrower usually must post cash collateral equal to the face value or arrange for termination.
Language matters. Recent court decisions have scrutinized whether evergreen clauses actually provide for successive renewals or only a single one-time extension, depending on the wording. If a letter of credit is supposed to roll forward indefinitely, the clause should explicitly say “successive” renewals rather than phrasing that could be read to allow only one additional term.
Sizing and Negotiating the Sublimit
The sublimit is negotiated as part of the overall credit facility, and getting it right at closing saves trouble later. Too small, and you run out of letter of credit capacity, forcing an amendment (which takes time and often costs a fee) or requiring cash collateral for obligations the facility should have covered. Too large, and you pay commitment fees on capacity you never use.
Inventory every obligation that requires or could require a letter of credit: lease deposits, performance bonds, import transactions, insurance requirements, utility deposits, contractual guarantees. Add a buffer for growth and unexpected requirements. The bank will want to see the seasonal pattern too, because many businesses have letter of credit needs that peak at certain times of year.
Ask whether the sublimit can be raised without amending the entire agreement. Some facilities include an accordion feature that allows the borrower to increase the total commitment and the sublimit up to a preagreed maximum, subject to lender approval. Others lock the sublimit at closing and require a formal amendment for any change. The flexibility negotiated upfront determines how quickly you can respond when a new contract calls for a letter of credit that does not fit within your existing capacity.
Covenant Traps and Common Mistakes
Letter of credit activity does not live in isolation from the rest of the credit agreement. The master agreement imposes financial covenants such as minimum net worth or maximum leverage ratios, plus affirmative covenants requiring insurance, financial reporting, and event notices. Issuing a letter of credit that inadvertently pushes total facility usage past a covenant threshold creates a default even if the sublimit itself still has room.
The most common mistake is failing to count letter of credit exposure when checking covenant compliance. A company with $6 million in cash loans and $2 million in outstanding letters of credit under an $8 million facility is fully drawn even though it has borrowed only $6 million in cash. If a financial covenant tests total funded debt, whether letter of credit obligations count depends on the definition. Most agreements include them in total exposure, but treatment varies.
The other frequent mistake is letting a letter of credit expire without confirming the underlying obligation has been satisfied. If a lease requires a standby for the entire term and the letter of credit lapses early, the landlord can declare a default under the lease. A non-evergreen letter of credit does not renew on its own, and the borrower may not realize the instrument has expired until the beneficiary complains. Tracking expiration dates across multiple outstanding instruments is an administrative task that deserves closer attention than most companies give it.