LCI and LCA: what they are and how do they work

If you are interested in or already investing in the financial market, you may have already heard about Real Estate and Agribusiness Letters of Credit (LCI and LCA), but do you know what they are and the main characteristics of Letters of Credit?

In this guide, we will explain everything to you:

What are LCIs and LCAs;
How do LCI and LCA yields work;
How the LCI and LCA costs and taxation work;
How the LCI and LCA liquidity terms work;
What are the risks involved in LCI and LCA;
CDB or LCI and LCA, how to know which is paying off;
What are the main advantages and disadvantages of this type of investment?

What are LCIs and LCAs

LCI and LCA are bonds issued by banks to raise money. The big difference is that this money raised has a certain destination. In the case of LCI, this destination is the real estate market, and that’s where its name comes from Real Estate Credit Letter. The LCA, on the other hand, has agribusiness as its funding destination, hence its name: Letter of Credit for Agribusiness.

Therefore, we can summarize that in LCIs, the funds raised by the issuing bank go towards financing activities in the real estate sector — while in LCAs, the funds go towards financing activities in the agribusiness sector.

Both are fixed-income securities where, in exchange for the investment, the issuer offers an annual rate of return that is defined at the time of purchase of the security.

But you might be wondering, “what is the difference between LCI and LCA?”

For the investor, there is no significant difference between investing in an LCI or LCA unless the investor has a direct interest in investing his money in the real estate or agribusiness sector.

So, deciding between an LCI or LCA can involve both aspects related to return on investment and personal aspects. Normally, the choice is made based on the term of the application, the initial contribution, and mainly the yield rate.

How LCI and LCA yields work

Generally, the yield of LCI and LCA is either fixed or post-fixed.

PREFIXED: The rate of return is fixed, and at the time of purchase, you already know exactly how much your money will yield until the maturity date. For example, an LCI or LCA with an interest rate of 8% pa makes your money grow by 8% a year until its maturity date, no matter what happens.

POST-FIXED: The rate of return is linked to an index, such as the CDI or IPCA, for example, and the issuer pays a percentage of that index or the index + a return. An example would be an LCI with a yield of 95% of the CDI pa or an LCI that pays 4.5% pa + the IPCA variation.

How LCI and LCA costs and taxation work

This is one of the biggest advantages of investing in LCI or LCA: they are free of fees and taxes. That’s right, the investor will have no cost investing in this type of paper, and the net income will be equal to the gross at the end of the period.

And why this happens?

The Federal Government understands that the real estate sector and agribusiness are very important for the development of the country’s economy. Thus, through tax exemption (Income Tax and IOF) for individual investment in LCI and LCA, it is encouraging investors to lend resources to these two important sectors.

How the LCI and LCA liquidity terms work

Unlike CDBs, LCIs, and LCAs, in general, cannot be redeemed at any time. Generally, they have a minimum grace period of 90 days, and after that period they

usually have restrictions on early redemption — such as, for example, allowing early redemption only of the main investment — without any return or even paying a lower return than agreed.

In some cases, the LCI or LCA may not allow for early redemption under any conditions, thus either having to be carried to maturity or sold to another interested investor, which may also sacrifice profitability.

Therefore, it is very important that when investing in LCA or LCI, the investor is aware of the redemption period and only makes the investment that is in accordance with his objectives and needs.

What are the risks involved in LCI and LCA?

LCI and LCA are considered low-risk and conservative investments. However, like all financial investments, they contain important risks that investors need to understand.

One of the risks, as we have already mentioned, is liquidity risk. The liquidity of LCIs and LCAs is usually lower than that of other conservative investments such as CDB, savings, and fixed-income funds.

Another existing risk is the credit risk, which despite being low, cannot be ignored.

When investing in this type of security, the investor is exposed to the risk of the issuing bank, as well as in savings and CBD; that is, the investor runs the risk of the issuing institution going bankrupt.

However, just like CDB and savings, LCIs and LCAs are also guaranteed by the FGC (Credit Guarantee Fund), a private non-profit entity whose objective is to help maintain the health of the National Financial System. If the issuer of the LCI or LCA goes bankrupt, the FGC guarantees individual investors reimbursement of up to 250,000 reais, including the main investment and the return due.

It is worth noting that the limit of 250 thousand reais is per CPF and financial institution and not per application. So let’s assume an investor has more than that amount in LCI, LCA, CDB, and savings at the same institution. In this case, he will only be entitled to reimbursement up to a limit of 250,000 — above that amount; the investor is, in fact, completely exposed to the risk of the institution, with no right to guarantees.

It should also be noted that the FGC has a global coverage limit of 1 million reais per CPF, adding up all guaranteed investments in all financial institutions.

CDB or LCI and LCA, how to know which one is paying off

Usually, when we see investment offers from banks and brokerages, CDB rates are usually better than LCI and LCA, but we have to remember that the second type is free of fees and taxes.

So how do I know which one is performing better?

Let’s look at the table below to understand the yield differences.

investment term	Equivalent LCI/LCA rate
Up to 180 days	CBD Yield x (1-0.0225)
From 181 to 360 days	CBD Yield x (1-0.2)
From 361 to 720 days	CBD Yield x (1-0.175)
Over 720 days	CBD Yield x (1-0.15)

The equivalent rate is the investment difference excluding income tax.

What pays off more: an LCI with 90% of the DI or a CDB at 100% of the DI for an investment with a term of 360 days?

Equivalent LCI/LCA rate = CDB yield x (1-0.20) Equivalent rate = 100 x (0.80) = 80%

Therefore, this means that any LCI/LCA yield above 80% of the DI is worth the investment when compared to a CDB of 100% for the same term.

In general, the LCA usually has a minimum contribution and a longer investment period than the LCI, so it is important that the investment is aligned with the investor’s objectives and the investment time.

What are the main advantages and disadvantages of this type of investment?

Advantages

Security: High level of security, as they are guaranteed by the FGC.
Profitability: Good profitability, normally in line with the fixed income benchmark, the CDI.
Diversification: Usually used with portfolio diversification. As they finance important sectors of the economy, it is possible to have good profitability and also help in the development of sectors.
Tax exemption: The biggest advantage of this type of application is the tax-free investment.

Disadvantages

Grace period: They usually have a grace period of 90 days, a period in which the money cannot be used.
Low liquidity: In addition to the grace period, these assets have low liquidity, and this means that it is best to hold them until the maturity date to avoid loss of income.

Conclusion

Now that you understand how LCI and LCA work, get to work to find the best investments. However, before making any investment, it is important to consider the risks involved. Knowing your investor profile and being clear about your financial goals is essential before choosing assets to trade in the financial market.

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