Surety Backed Letters for Credit can be a useful way for businesses to provide a financial obligation. Learn the many benefits of this product and what it takes to qualify for one.
A Surety Backed Letter of Credit (SBLC) is an irrevocable financial guarantee issued by a financial institution with the financial backing of a surety bond company. Surety backed letters of credit may also be called Bank Fronted Surety Bonds. For the beneficiary of the SBLC, the instrument looks the same as an Irrevocable Letter of Credit. However, instead of underwriting the borrower individually, the financial institution is relying on the financial strength of the surety bond company. The fronting bank gives the surety bond company a counter credit, or predetermined amount of approval to issue these surety backed letters of credit. The surety is then responsible for underwriting and approving the borrower.
Let’s say a borrower is required to provide a letter of credit to a beneficiary. Instead of going to the borrower’s bank for a letter of credit, the borrower approached a surety bond for a surety backed letter of credit. The surety bond company will collect financial statements, information on the company, obligation details, and other underwriting information. If approved, the surety bond company will send the borrower (referred to as the principal) an indemnity agreement to sign. Once signed, the surety company will request a letter of credit in the borrower’s name to the beneficiary from the fronting bank. The bank will then issue the letter. The borrower’s relationship remains with the surety bond company, while the fronting bank’s relationship also remains with the surety bond company.
Surety Backed Letters of Credit created many advantages over standard bank issued letters of credit. These include:
It is common for banks and other financial institutions to want collateral in order to issue large letters of credit. Generally, surety backed letters of credit do not require collateral. These obligations have the backing of large, regulated and financially sound surety bond companies. This enables the borrower to obtain better terms than they often can on their own. Freeing up collateral if one of the number one reasons we see requests for surety backed letters of credit.
Surety Backed Letters of Credit are usually issued by large international banks. Because the surety bond company is ultimately the fronting bank’s customer, the borrower does not have to switch their banking relationship. In many cases, a surety backed letter of credit can free up the borrower’s credit with their existing lender. Instead of using their credit for the required letter of credit, they are free to use their bank credit in other ways.
Surety backed letters of credit may not have to be shown as a liability on a company’s balance sheet, although you should always check with your CPA. Like many surety bonds, these obligations are often shown in the notes, and reflect a contingent liability. Conversely, letters of credit are often shown as a liability on the company’s balance sheet. Using a surety backed letter of credit can be a major benefit by improving the company’s financial reporting position and credit ratios.
There are some disadvantages of surety backed letters of credit including:
Although surety backed letters of credit are a great product, they are considered high risk by surety bond companies. They are straight financial guarantees and default usually results in a forfeiture of the entire amount of the guarantee. Therefore, only a small number of bond companies are currently interested in writing surety backed letters of credit.
In addition to having a small amount of surety bond companies wanting to write surety backed letters of credit, the ones that do, often have a very small appetite. For example, many bond companies operating in this space want to focus on insurance related guarantees such as replacing letters of credit on high deductible and self insured insurance programs. While useful, those bond companies have a limited appetite for other types of financial guarantees.
Most surety backed letters of credit are fronted by very large international banks. These banks have different rules and requirements for reporting than U.S. banks and therefore have more of an appetite for the product. These banks are all highly rated, however, and most also have U.S. offices. While this is not a negative, the beneficiary must be willing to accept a guarantee from one of these banks. In my personal experience, I’ve never had an issue with a beneficiary accepting a guarantee from one of these institutions. They are some of the largest banks in the world.
Surety backed letters of credit are considered high risk. Therefore, most bond companies will want very strong balance sheets with high liquidity requirements in order to qualify for these products. Although public and private companies can qualify, most companies want to see a company that would be considered a BB- credit or better.
Surety backed letters of credit have costs similar to bank letters of credit. Generally, very strong companies can get a cost as low as 1.3% of the guarantee amount. However, these costs could go as high as 4%. Most of the private companies we issue these obligations to pay about 2.5% of the guarantee amount each year. This includes the cost to both the surety bond company and the fronting bank.
Almost any industry can use a surety backed letter of credit. If an Irrevocable Letter of Credit is required, a surety backed letter of credit can usually be substituted. The Oil and Gas industry, Manufacturing, Solar industry, Telecommunications industry and many others commonly need surety backed letters of credit.
Surety Backed Letters of Credit can be an excellent way for companies to free up collateral, reduce costs and improve their financial reporting. While everyone will not qualify, Axcess Surety has the best markets and expertise to help many companies with these guarantees. Contact us today.
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.
