Material shortages, price escalations, and rising interest rates continue to put pressure on profits. One way Manufacturers may be able to free up cash and save money is by replacing Irrevocable Letters of Credit (ILOCs) with surety bonds.
Manufacturers are often required to put up financial security for certain contractual guarantees. These guarantees can be required by key suppliers and other parties to ensure payment from the manufacturer. Usually, the Manufacturer can choose between cash, an ILOC, or a surety bond to meet the financial requirement.
For the past 15 years, ILOCs have been the instrument of choice for most manufacturing companies. Low interest rates have made these ILOCs inexpensive and easy to obtain. However, interest rates are rising, and The Federal Reserve is signaling more increases are coming to combat high inflation. As such, this may be the time for Manufacturers to reevaluate their options.
ILOCs rates are usually tied to an underlying rate such as the Federal Funds Rate, New York Prime Rate, Secured Overnight Financing Rate (SOFR), or London Interbank Offered Rate (LIBOR). The Federal Funds Rate has increased from 0.08% in January of 2022 to 4.83% currently. In that same period, the New York Prime has increased from 3.25% to 8.00%. SOFR has increased from 0.05 to 4.81% and LIBOR from 0.106% to 4.87% in the same time period. This volatility creates more uncertainty and cost escalation for Manufacturers relying on ILOCs. These costs are also unlikely to decrease in the coming year.
Another potential downside to ILOCs is that they can tie up a Manufacturer’s borrowing ability. Usually, lenders directly reduce a Manufacturer’s available credit in other areas such as their Operating Line of Credit or even the ability to finance capital improvement projects. In the worst of circumstances, some lenders require cash or marketable securities as collateral for an ILOC. This hurts a Manufacturer’s liquidity for operations and growth opportunities.
Alternatively, Surety Bonds may become a more attractive option to Manufacturing Companies. Surety Bond costs are not tied to interest rates and have been very stable. The surety bond market also remains very “soft”, meaning bond companies are aggressively competing for business and often reducing rates to pick up new business. In fact, the best manufacturing companies may pay as little as 0.2% for surety bonds. This market favors Manufacturers and may create significant cost savings by switching financial obligations from ILOCs to surety bonds.
An additional benefit of surety bonds is that they are generally not collateralized unless a claim occurs. This means a Manufacturer’s cash and other resources are not tied up and can be used for operating cash flow or growth.
Manufactuing companies can learn about other differences between surety bonds and ILOCs here.
Nobody can know what the future will hold for Manufacturing. However, rapid price escalation of labor and materials, and a potential economic downturn, means Manufacturing Companies need to look for additional profit opportunities. Replacing ILOCs with surety bonds should create significant savings in this market and those savings will only increase as interest rates continue to rise.
Axcess Surety is the premier provider of surety bonds nationally. We work individuals and businesses across the country to provide the best surety bond programs at the best price.
