Financial Guarantees, Sureties And Collateral

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The Three Parties To A Surety Bond Arrangement - Douglas E. Castle

 

FINANCIAL GUARANTEES, SURETIES AND COLLATERAL By: Douglas E. Castle

Obligees in a business relationship (such as contractors, subcontractors and sometimes mere payers) are frequently called upon by obligors (the parties for whom they are rendering a service, even if that service is merely making payment) to enhance or further bolster the likelihood that they will perform by bringing in either a third-party guarantee or by assigning the rights to some supplemental collateral (assets which can be liquidated in the unfortunate event that the contractor, payer or other obligor is unable to either perform or pay in full on a timely basis.

In a difficult economy, small- to medium-sized businesses are being called upon to provide these assurances by those parties hiring them or financing them. The tools or arrangements that are utilized to fulfill that need for additional “comfort” are financial guarantees (issued by financially strong third parties), surety bonds and supplemental collateral, which latter may be in the form of a lien on real estate, a hypothecation of marketable securities or any other assets which are not related to or involved in the subject transaction. These are, candidly, easier to obtain for smaller transactions (and newer or smaller companies) than are surety bonds or financial guarantees.

A very select and limited group of companies provide any of these hedges against an obligor’s failure, but any one of these “enhancements” could be the difference between obtaining business or being left out.

Following is a brief treatise on financial guarantees and surety bonds:

Definition: A non-cancellable indemnity bond, backed by an insurance company, which guarantees that principal and interest will be paid in compliance with the underlying contractual agreement or promissory note. Financial guarantee bonds are used by debt issuers as a way of attracting investors. The guarantee provides said investors with an additional level of security that the investment will be repaid/obligation will be fulfilled in the event that the securities issuer is unable to do so. The bond may benefit the principal by enhancing the principal’s creditworthiness thereby lowering the cost of financing. The guarantee “wraps” the security/promissory note with the insurer’s indemnity. Because the bond represents an UNCONDITIONAL GUARANTEE of compliance/repayment, a preferred interest rate is often offered.

There are three types of ‘financial guarantee bonds’. The first category is small “finite” financial guarantee. These are essentially performance bonds with a payment guarantee

element. They may look like license/permit bonds on their face. The bonds often have a small penalty (denomination) and are underwritten like standard surety bonds, with extra emphasis on the principal’s (applicant’s) liquidity and the insurer’s ability to recover any loss paid. Examples are lease bonds and energy broker obligations. The second category is bonding of structured finance, and the third public finance.

Bond denominations within these latter two categories can be enormous. As a result of severe losses in the financial guarantee sphere New York State passed the ‘ Appleton Law’ and quickly other insurance regulators’ policies regarding financial guarantee followed suit with administrative regulations restricting financial guarantee to only MONOLINE insurers. In the U.S. market, there are very few participants. AMBAC, Assured Guarantee, CIFG, Financial Guarantee Insurance Company, Radian, RAM Reinsurance, and Syncora Guarantee carry the majority of this market. These companies specialize in the selection of financial guarantee risks and the ongoing surveillance of their principals.

With some exceptions, financial guarantee insurers DO NOT PARTICIPATE IN PRIVATE, COMMERCIAL TRANSACTIONS. If you are engaging in a person-to- person or business-to-business contract and you seek to enhance your position with a financial guarantee, you WILL NOT OBTAIN A FINANCIAL GUARANTEE INSTRUMENT THROUGH STANDARD FINANCIAL GUARANTEE MARKETS.

Your only alternative is to approach a captive or specialty insurer based outside of the regulatory jurisdiction of the United States where carriers are not hampered by mono- line restrictions. Additionally, the few markets that will entertain private financial guarantee severely limit their exposure on each risk selected.

Financial guarantees for non-government issued securities, or asset-backed securities with very little worth DO NOT EXIST! If you are seeking a guarantee in the hundreds of millions of dollars, I recommend that you do not waste your time. You will not find one. Further, private financial guarantees are written with FULL COLLATERAL SECURITY. Financial guarantee insurers are not interested in promises of indemnity based on the speculation that your transaction, that your proposed project, will be successful, or on the ongoing profitability of your operation.

Financial guarantee bonds are considered to be a much higher risk than standard surety and fidelity products, therefore my due diligence must include a review of the proposed contract, the solvency and identity of the indemnitors, and the collateral that you wish to deposit to support the bond. Premiums are generally fifteen percent (15%) on face value per annum for those bonds up to one million, and ten percent (10%) on face value for those bonds in excess of one million dollars. Collateral security in the form of cash, letters of credit, or highly rated debt instruments (i.e., U.S. Treasury issues, notes, bills, warrants, and highly stable, publicly traded stock or bond issues) will be credited at one hundred percent (100%) of current market value. Unacceptable forms of collateral are REAL PROPERTY (although real estate might be considered by the obligee or lender to supplement or supplant a bond or other guaratnee in certain transactions) and ‘BLOCKED FUNDS LETTERS’.

And now a brief word about surety or financial guarantee bond “Ratings.”

When I receive requests for information about, or regarding the procurement of financial guarantee bonds, I am invariably asked about the carrier’s “rating.” To my knowledge, there are only three financial guarantee insurers with an A.M. Best rating which operate in the United States. Two of those entities are absolutely unwilling to write bonds for private contracts, one will consider them. The former two will only issue financial guarantee bonds to municipalities that collateralize the obligation with bonds or other instruments issued by that municipality, leaving only the third as a “rated” carrier from whom I receive authority.

Given the severe restrictions of financial guarantee to mono-line insurers, carriers that wish to engage in financial guarantee business in addition to other insurance lines are often forced to move to a domicile without those restrictions. Bermuda, Seychelles, the British Virgin Islands, and the Dominican Republic are currently the choice destinations for offshore captives.

There is no ‘automatic’ rating system for non-U.S. admitted carriers. In order to obtain an A.M. Best rating an insurer must ordinarily have certain ‘seasoning’ minimums during which time they are under market surveillance. The carrier’s financial statements and books must be open to the rating agency. These requirements cause problems for offshore captives.

First, by entry (admission) into the U.S. market, a carrier subjects itself to U.S. taxes, precisely one of the reasons for which insurers DO NOT enter. Second, not all insurers wish to share their financial statements with a market surveillance group. So, although I may be able to pair a principal with an A.M. Best rated carrier, you will have a great deal of difficulty identifying any other “rated” entity that will write these undertakings. Unrated carriers WILL provide audited financial statements demonstrating their solvency, and their current certificate(s) of authority.

I hope that my information is helpful in understanding this type of instrument. Please keep in mind that this market has few participants. They do not and will not deviate from the full collateral rule.

Call To Action: Understanding that neither I nor my management consulting companies provide or are licensed brokers for these types of guarantees or bonds (although we do frequently engage in arranging to provide for supplemental or substitute collateral [i.e., in the form of bank deposits, treasury securities, publicly-traded stock and real estate] with which to bring transactions into indirect or derivative compliance with the “full collateral” or “full coverage” rule, or to eliminate the need for surety or financial guarantee bonds entirely), please contact us at http://bit.ly/CASTLEDIRECT, and we’d be delighted to discuss your needs and your best choices for solutions. We pride ourselves on being creative – as we must when working hand-in-hand with small- to medium-sized client companies in this difficult economic climate.

Douglas E. Castle

NOTE: THE INFORMATION CONTAINED IN THIS ARTICLE SHOULD NOT BE CONSTRUED BY THE READER AS BEING LEGAL, FINANCIAL, TAX, ACCOUNTING, ECONOMIC OR INVESTMENT ADVICE. NO OFFERING OF SECURITIES OR OTHER INVESTMENT INTERESTS OF ANY TYPE IN ANY ENTITY IS MADE HEREBY, NOR IS A SOLICITATION FOR THE PURCHASE OF SECURITIES OR OTHER INVESTMENT INTERESTS OF ANY TYPE IN ANY ENTITY MADE HEREBY. THIS ARTICLE IS INTENDED FOR GENERAL INFORMATIONAL PURPOSES ONLY AND REPRESENTS THE VIEW OF THE AUTHOR ONLY.

THIS ARTICLE IS COPYRIGHT 2014 BY DOUGLAS E. CASTLE, WITH ALL RIGHTS RESERVED. ANY REPRODUCTION, TRANSMITTAL OR DISTRIBUTION OF THIS ARTICLE, EITHER IN WHOLE OR PART, IS UNAUTHORIZED AND MAY BE UNLAWFUL, UNLESS FULL ATTRIBUTION IS GIVEN TO THE AUTHOR AND ALL IMAGES AND LINKS IN THE ARTICLE REMAIN INCLUDED AND “LIVE.”

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This site is the Management Consultants' and Chief Reconstruction Officers' best all-industry guide to analyzing, diagnosing, devising a strategy, creating either an Action Plan or an Emergence Plan and overseeing and monitoring the successful implementation of either in order to ensure the client organization's optimal, sustainable profitability. These plans are always made scalable to accommodate the size and needs of the client, whether it is fast-growing young company with an aggressive and ambitious agenda, or whether it is an older, larger, well-established business which is experiencing problems or which is at a crucial decision making point in its evolution as an entity, and which requires sound advice (and often implementation oversight and assertive "hands-on" assistance in the form of a powerful third-party representative agent or a an expert in the art of negotiation as its appointed "point person") regarding its next steps. In the alternative, Douglas E. Castle is expert at helping fast-track, rapidly emerging companies to growth through acquisitions, mergers, licensing, branding and both domestic and international strategic joint ventures to access better, more efficient supply chain sourcing and to open up wider global markets to dramatically increase the scope of possible new revenue opportunities.


Established Companies As StartUp Incubators.

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Established Businesses As Incubators For Startups - Mutually Advantageous - Douglas E. Castle - DouglasECastleBlog

 

Established companies with existing infrastructure, whether doing extraordinarily well or due for a restructuring or a turnaround, generally have some additional capacity, knowledge, personnel and perhaps some available cash sufficient to incubate and assist in accelerating the growth of a start up or seedling enterprise, if properly inspired and advised of the incentives, i.e., possible rewards, which can make the symbiosis powerfully rewarding for both parties. In many cases, established companies may make the best startup incubators of all.

In the illustration above, a large, established company is merely investing some of its extra capacity (and perhaps some significant expertise and mentoring) in the seedling which it has fully absorbed. While the benefits to the seedling are obvious, the benefits to the established host may not be. In summary, these may include: equity or profit-sharing; a new revenue stream, an influx of unbridled, undampened creativity; a possible product line from the guest or license relating to the same; a hedge against the very real risk of displacement of their market position due to disruptions in technology, consumerism and other variables.

In Example A, the incubatee is embedded within the very body (womb) or the incubator. This gives the incubating entity more control, but a greater scope of responsibility. In Example B, the incubatee is further removed as more of a joint venturer with the incubating entity, sharing in only some of the obligations and rewards. This gives the incubatee significantly more independence and control.

One of the reasons for the failure of established business to remain profitable can be (aside from mismanagement, poor product profitability analysis, high culturally-embedded fixed costs, supply-chain problems, and the like) the growing or radical technological obsolescence of a service or product [think of the printing industry]. Part of a defense against being squeezed out of your traditional market is to expand and diversify the demographics of your market/s and your offerings.

It is my strong belief that these alliances, and their potential reciprocal benefits might work well for both the CrowdFunding and venture realm, and for the established but less-than-vigilant established business who would otherwise be in need or a radical restructuring or a turnaround.

To carry this analysis one step further, think of the the jobs saved and new jobs created by uniting the established (but suffering from a paucity of creativity and market vigilance) with the up-and-coming visionaries who will create disruptions and sea changes.

Established companies acting as start up incubators might be a culturally-enriching means of stimulating our difficult economy. Young start ups might have some tremendous advantages over new market entrants who were sustained through the impetus of crowdfunding, and their respective “real world” incubators might just get an overdue infusion of flexibility and creativity at only a nominal expense.

Thank you for reading me, and for sharing my articles with your colleagues, connections and contacts across your broad new band of social media.

Douglas E. Castle


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QUOTATIONS - Immortal Wisdom - WORDS - The Building Blocks Of Language - Linked Image - By Douglas E Castle














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NOTICE









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View DOUGLAS E. CASTLE's profile on LinkedIn
Share this page
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Contact Douglas E. Castle Follow Me on Pinterest
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This site is proudly affiliated with Global Edge International Consulting Associates, Inc. ["GEI”]
Free Subscription to The GEI Business Daily!
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Respond To Douglas E Castle
http://bit.ly/CASTLEDIRECT

Perspective Is Wisdom - Large
D.E.Castle's Daily Business Advisory Wrap-Up.
Skim It. But DON'T MISS It.
This site is the Management Consultants' and Chief Reconstruction Officers' best all-industry guide to analyzing, diagnosing, devising a strategy, creating either an Action Plan or an Emergence Plan and overseeing and monitoring the successful implementation of either in order to ensure the client organization's optimal, sustainable profitability. These plans are always made scalable to accommodate the size and needs of the client, whether it is fast-growing young company with an aggressive and ambitious agenda, or whether it is an older, larger, well-established business which is experiencing problems or which is at a crucial decision making point in its evolution as an entity, and which requires sound advice (and often implementation oversight and assertive "hands-on" assistance in the form of a powerful third-party representative agent or a an expert in the art of negotiation as its appointed "point person") regarding its next steps. In the alternative, Douglas E. Castle is expert at helping fast-track, rapidly emerging companies to growth through acquisitions, mergers, licensing, branding and both domestic and international strategic joint ventures to access better, more efficient supply chain sourcing and to open up wider global markets to dramatically increase the scope of possible new revenue opportunities.