I recently had several situations where a client put up a letter of credit for an obligation that could have used a surety bond instead. A letter of credit is issued by and is the obligation of a bank. Many clients have a relationship with a bank, but not with a surety company.
Banks have specific regulations they must adhere to and cannot look at the actual obligation that the letter of credit is securing. The underwriting process is very standard and only reviews the financials alone. Often they require cash collateral or some deposit or draw down on a loan or line of credit. Many revolving credit facilities have provisions specifically for letters of credit.
A surety bond can take into account the merit of the obligation. The surety can review what the obligation is and factor this into the underwriting. A knowledgeable surety underwriter can quantify the risk, not just from a financial aspect, but also from a client’s ability to complete the job, perform, and do what they need to do so that there will not be a claim on the bond.
This allows for more flexibility with the terms offered for the bond, the amount charged and the amount of collateral the surety requires. In most of these situations, I’ve seen where a surety can waive or significantly reduce the amount of cash collateral behind the bond to secure the obligation. The standard practice for most clients is to reach out to their bank and have their bank issue a letter of credit. I had two matters. One was for a permit for a state license to operate a business on public land. The client previously had to put up cash collateral to get a letter of credit. In the case of the bond, they didn’t have to put up any cash collateral, only provide indemnification and an annual bond premium.
Another matter I had recently was a client who put up a letter of credit for an obligation to New York City. The bank charged them a fee and tied up collateral. They required them to deposit cash for the letter of credit. The actual cost of capital was over 10%, whereas when we replaced it with a surety bond, the client still elected to put up cash collateral, but we charged a smaller annual premium than the cost of the letter of credit. The surety was able to pay more interest on the collateral deposit than the bank was able to. It changed the cost of capital by over 5%. If the client was paying 10% percent previously, then the cost of capital was only 5%. Using a surety bond instead of a letter of credit can lead to substantial cost-savings and a happy client.
Letters of credit are costly, tie up capital, and take a lot of time. The surety bond is quicker, cleaner, generally costs less, and less collateral is needed. So, if you have a matter where you put up a letter of credit instead of putting up a surety bond, call and let’s discuss the situation and see what we can do.
Call me to discuss any matter for which you want to replace a letter of credit with a surety bond.
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