Bank Fronted Surety Bonds

Bank Fronted Surety Bonds are becoming a popular tool to provide financial guarantees. Learn more about what these bonds are and how they can be a useful tool for businesses. 

What is a Bank Fronted Surety Bond?

A Bank Fronted Surety Bond is a letter of credit provided by a lender on behalf of a surety bond company and Principal. Unlike typical surety bonds, these guarantees incorporate a 4th party, which is the lender. Bank fronted surety bonds may also be called Surety Backed Letters of Credit, or Surety Fronted Letters of Credit. 

How Do Bank Fronted Surety Bonds Work?

A Principal approaches their surety bond company for a financial guarantee. If the Principal is qualified, the surety bond company obtains a letter of credit for the Principal, from a lender. The letter of credit is in the Principal’s name and to a party of their choosing. The surety bond company pledges their financial strength to the lender in order to obtain the letter of credit.

 

This chart shows the 4 parties to Bank Fronted Surety Bonds and how they work.

 

Why Use a Bank Fronted Surety Bond?

Bank Fronted Surety Bonds have several advantages. Some of these include Cost, Preserving Credit Lines, and Not Affecting Credit Ratios.

Cost

First, they may be cheaper than Principal could secure through their own lending relationship. Corporate Surety Bond companies are required to have significant financial strength and liquid assets. Therefore, they may be able to secure better interest rates and terms than a company could on their own. 

Preserves Credit Lines

Under normal circumstances, letters of credit reduce a company’s borrowing ability. Because these letters can be drawn on demand, lenders view them as if they are already drawn. Conversely, a Bank Fronted Letter of Credit does not reduce a company’s borrowing ability. Surety is generally considered a type of unsecured credit and the guarantee is issued by the surety bond company’s lender instead of the Principal’s. Therefore, the Principal can use their borrowing ability for other purposes. 

Does Not Affect Credit Ratios

Companies often have to comply with certain credit ratios for lenders, shareholders and other purposes. A normal letter of credit will affect the company’s financial ratios by showing additional debt. Bank Fronted Surety Bonds will not affect a company in this way. Companies may be able to provide significant financial guarantees without affecting their balance sheets. 

Common Uses for Bank Fronted Surety Bonds

Different surety bond companies have different appetites for issuing Bank Fronted Surety Bonds. Common uses for these bonds include International Obligations, Self-Insurance Obligations, and many other situations where large letters of credit are required. 

International Obligations

Many countries around the world require companies to provide letters of credit to guarantee certain obligations. These can vary between supplying products, guaranteeing real estate obligations, or paying labor. Unlike the United States, surety bonds are not an acceptable tool for guaranteeing these obligations in many countries. Even international surety bonds can be difficult because surety law is not well established in many countries. The answer could be Bank Fronted Surety Bonds.

Self-Insurance

Many large and safe companies choose to self insurance some or all of their risk. However, most states make these companies provide a financial guarantee showing that they can pay these obligations. Self-insured Workers Compensation Surety Bonds do exist but surety bonds to cover other liabilities do not. Bank Fronted Surety Bonds are being used to cover the letter of credit requirements for many other types of self-insurance programs. 

Other Letters of Credit

Almost any obligation that requires a letter of credit can use a Bank Fronted Surety Bond. Companies in Real Estate, Manufacturing, Distribution and other industries are beginning to use these bonds. 

What Do Bank Fronted Surety Bonds Cost?

The cost of Bank Fronted Surety Bonds depends on a few factors including, strength of the Principal, The Surety Bond Company and the Lender supplying the obligation. Generally, most Principals will pay between 0.7% and 1%. Both the lender and the surety bond company will have a fee for this product. However, these guarantees are generally very competitive with normal letters of credit and these parties will compete to win the business for good Principals. 

 

This box shows the cost of Bank Fronted Surety Bonds.

 

Claims Against Bank Fronted Surety Bonds

Bank Fronted Surety Bonds are a fairly new product compared to other surety bonds. The industry has yet to see a lot of claim activity against these guarantees. However, it is safe to assume that a claim would result in a total loss. Generally, when a claim is made against a letter of credit, the beneficiary will demand the full amount of the letter of credit. Once this happens, the lender will ask to be reimbursed from the Surety Bond Company. The Surety Bond Company will then seek to be reimbursed from the Principal under the Indemnity Agreement

Summary

Bank Fronted Surety Bonds will likely continue to become more popular as interest rates increase. These guarantees can be a great way to meet financial obligations without using a company’s available credit lines. 

 

Vice President at Axcess Surety
Vice President of Axcess Surety. Surety Bond and financial expert dedicated to helping contractors, businesses and individuals understand and obtain surety bond credit.
Josh Carson, AFSB
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