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Surety Bonds Explained

If you are in the civil contracting, construction, earthmoving or any other industry that requires you to provide a performance or other form of guarantee, then a Surety Bond may be the product for you.

What is a Surety Bond?

A Surety Bond is a bond/guarantee that can be provided in lieu of cash or bank guarantee as security that a business will meet its obligations under a contract.

So rather than having cash or property tied up as supporting security for the traditional bank guarantee, surety bonds are unsecured. Not only does this free up security, but it allows the facility to grow with the business. This also provides the business with confidence when tendering for larger projects and increasing work.

What is the difference between Surety Bonds and Bank Guarantees?

Both are unconditional and on demand guarantees, issued by an S&P (Standard & Poor’s) rated financial institution. The difference is that in the case of a Surety, the financial institution is an insurer not a bank.

Why use Surety Bonds?

Unlike a bank, surety providers do not require security over assets or cash collateral. This allows the contractor to free up funds, reduce debt and tender for additional contracts. Surety Bonds can also represent a cheaper alternative to Bank Guarantees with no line fees as overheads.

What are the key considerations for a suitable facility?

  • Facility size and rate
  • Issue fees
  • Renewal fees
  • Acceptability
  • Access to bank fronting

What are the key considerations from an insurer’s perspective?

  • Balance sheet size (i.e. generally looking for a minimum net equity position of $2M +)
  • Minimum turnover of $20M + and rising
  • Past history of guarantees issued (e.g. have there been any claims in the past)
  • Frequency and value of guarantees

What are Bank Fronted Guarantees?

In rare instances, a Principal/Beneficiary may require a Bank Guarantee in lieu of a Surety Bond and in these situations, the Surety can arrange for the issue of a Bank Guarantee under an arrangement they have with a major bank.

Whilst there is some additional cost in arranging a guarantee through the Surety, the main benefit to the client is that they provide no security to support the guarantee as this is provided by the Surety.

Surety Bonds Case Study of an Engineering Client 

Facts

  • Ledge was recently engaged to review a company’s existing banking arrangements.
  • The client ran an engineering business and hence were involved in many construction projects where cash retentions and bank guarantees were required.

Ledge Approach

  • Ledge had a meeting with the client to gather all information and completed initial assessment based on their requirements – delving deep into their business, history, structure, financial position etc.
  • As part of this process, Ledge commenced the review by focusing on their Bank Guarantee side of things.
  • The client had a $12M Bank Guarantee facility secured dollar for dollar by their bank.

Solution

  • Ledge was able to undertake a comprehensive finance submission that resulted in us securing a Surety Bond limit of $18M (without property or cash security) and retained a small $2M Bank Guarantee limit.
  • Thereby giving the client a $20M combined facility and released $12M cash back to the client.
  • While pricing was slightly higher in the surety bonds, security / cash was released back to the client. This facility also has the ability to increase in limit, in line with the clients growing requirements, as the business expands over time.

To learn more, contact your Ledge Finance Executive directly or contact our offices here.


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