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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http://DouglasECastleConsultancy.com

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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.


If Detroit Were My Turnaround Client

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IF DETROIT WERE MY TURNAROUND CLIENT

If only Detroit were one of my Turnaround Business Clients (sigh), either the bankruptcy might have been avoided, or its method of conducting its “Municipal Business” might have been radically changed some time ago.  There should have been much more oversight, checks and balances in all aspects of management, and operation, financial and forensic audits by a competent independent third party firm on a short notice basis. But then, the sad aspect of the public sector is that is by no means as accountable, or as interested in its investors (the taxpayers), as would be a simple medium-sized company.

When you combine poor accounting (and a lack of individual accountability), a lack of variance analysis, a lack of integrity in leadership, the absence of a formalized budgetary review process, the informality of fiduciary authority and a plethora of useless contracts for services and purchases that were not of benefit to the client [in a business they either call that “Other People’s Money” (OPM), which doesn’t really have to be accounted for directly if there’s enough of it (and who is keeping count as the nectar pours through the sieve? And more importantly, who knows what the total available capital for expenses and expenditures actually is?), or, in the worst case breach of fiduciary duty, fraud and embezzlement.

Goodness, if taxpayers realized that they were really shareholders, with the right to demand an accounting, a reconciliation, and an explanation of any ‘treasury leakage’ either through negligence or through political favors paid for at the expense of the populace. — DEC at 1Turnaround.

What follows is my curating and rather extensive and opinionated commentary regarding an article which I found in my inbox from Scoop.It!, a wonderful source of excellent articles and opportunities to really get a grand view of the topics which interest me, and are of crucial importance to my clients.

       

Editorial: What Detroit’s crisis can teach others Avoiding bankruptcy requires confronting crises early, focusing on taxpayers and making realistic promises

                                                                   From [original article source]                                                                                               www.thesilentmajorityus.com                                                                                       –

Detroit News: Detroit’s fall into bankruptcy is being pitched as a cautionary tale for governments at every level. And while there are extraordinary circumstances unique to the Motor City, there are…

Douglas E. Castle’s insight, as Curator:       

I am in full accord with the writer’s point of view as it concerns Detroit, specifically, and as it concerns all businesses and organizations which have fiduciary responsibilities. Sadly. election politics as well as organizational office politics tend to bring out some unsupported or unsupportable promises which ultimately will become perceived as lies. In any business or organizational structure (For-Profit and Not-For-Profit) you cannot make empty promises, as they will cost you all of your negotiating power (based largely in credibility), and possibly your career when the truth comes out.

Let’s assume that we are following a sensible business protocol, and that we are responsible to the Board, our colleagues, our employees, our customers (or constituents), our creditors and our investors. A methodical approach must be undertaken — it is sad that these politically-oriented individuals don’t examine the financial position and projections of the governments or businesses which they are trying to get the opportunity to lead prior to embarking on their campaigns.

A general rule to start with is that you cannot ever make a promise which is unconditional, especially if it is dependent upon the promises of others (grants, investments, lots of new business revenues, a technological breakthrough and the like). Make fewer promises of good and plenty, and more commitments to fixing problems at their source to ensure safety, stability and success.

Aside: Not to ridicule anyone at the federal government level, but you can’t make inferences to “getting out of debt by increasing borrowing,’ or balancing the budget and helping businesses by increasing taxes on the poorer and middle classes and reducing services to them as well!

Never make a commitment that you do not intend to keep, and that you do not have a plan (a method) to keep. Exaggerate costs and the length of estimated completion or delivery time frames – it makes it easier to be a hero.

In terms of examining, monitoring, course-correcting and maintaining or improving the  enterprise (whether it is government or non-government, For-Profit or Not-For-Profit), the protocols are universal.

Of course, in the case of all-too-many governmental subdivisions and entities, there is tremendous complexity, inadequate supervision, and labyrinthine accounting, authorization and record keeping. There’s too much capital, and too many persons with access to it, without proper oversight. A large number of seemingly trivial expenses and expenditures can eventually accumulate into a cavernous loss. This waste (being kind with my choice of terminology) is taxpayer money — in private enterprise, the shareholders would be taking the company’s management to court for this type of abuse. They would be speaking of breach of trust, breach of fiduciary duty, diversion of funds, fraud and possibly embezzlement.

I believe that Detroit is the first host organism to fall victim to an epidemic , and that municipal bankruptcies will be hooping up like crocuses in early springtime. And we’ll get closer to the truth about the extent of the federal deficit and the value of the U.S. dollar, fresh off of the press. That’s a scenario for The Global Futurist Blog to paint.

But then, I’ve gotten off of my focus. Let’s return to a standard fiduciary management protocol where each individual in the chain of command or hierarchy structure is responsible — truly responsible — at every level:

1) If a responsible individual sees or suspects a problem, it must be reported immediately to the appropriate persons of supervisory authority;

2) That person of supervisory authority should follow through with vigilance and persistence to see to it that the problem is solved before it wastes any more money and before it worsens;

3) The problem must be expediently fixed, and noted as such – after all, every minute of loss is a drain on profitability and solvency;

4) If there are too many systemic problems, and the organization’s current financials as well as its proformas (always have worst-case, realistic-case forecasts handy; they should be created frequently as assumptions and conditions change; they are a powerful management tool, and an early warning system) are not looking good, senior management must gather the right experts, both from inside of the organization and from senior management’s “A” list of outside professionals, and;

5) Re-examine the organization’s entire business model in terms of S.W.O.T. analysis, critical path dependencies analysis, and possible displacement (or antiquated assumptions) analysis. Look to prune your sunk costs and nonproductive recurring costs;

Note: From this point forward in my discussion, I’ll address this issue as if the business (even if it is the business of running a municipality) were yours, and that you were the executive ultimately in charge.

6) Reconstruct the organization’s business model with the help of the assembled expert committee, create a realistic, turnaround reconstruction plan, promulgate it to all of the involved and affected individuals, as well as to all other parties doing business or trade with the organization. Let them know of the changes, what the time frames really are, what sacrifices or compromises they will have to make lest the team effort fail (Note: If you’re a charismatic, credible, strongly committed leader, you will convince every individual, from the board room down to the janitorial staff that they are each, and all, partners in the the success of the business, and that necessary sacrifices may have to made to bring stability and better results for the benefit of all). Take a serious tone, especially when asking for sacrifices and compromises. Make everyone feel like a stakeholder and an employee or an agent of help;

7) Work the new plan to the letter, diligently, faithfully and without deviation. Report to all of your “partners” frequently as results come in and new forecasts are made. Your diligence, conscientiousness and candor in terms of reporting frequency and transparency will be appreciated and might make potentially hostile parties feel more like allies in a group project and a united effort. That latter is the effect for which you should strive – it justifies the sacrifices and compromises…and to make it even more potent, be certain that the C-Suite occupants, senior executives and the directors make visible meaningful sacrifices as well. You don’t want to look like a “too-big-to-fail” company that the U.S. government just bailed out [grin];

8) Demonstrate by variance analysis (projected versus actual results) how you are actually achieving the goals set forth in your turnaround business plan, and how you have converted waste and losses to a positive, potentially distributable fund balance;

9) From that positive pool of hard-won cash, reward all of the parties who have cooperated in the effort (at a sensible level,and not just to the senior most executives and directors, but to all of the participants, sacrificers and compromisers who have made it possible. Everyone enjoys a participatory celebration of success and a feeling of having participated in a victory…everyone! The object:

Demonstrate in distributable dollars and cents that the tough cuts have paid off in terms of solvency, stability and a positive cash flow. A great leader (as opposed to a basically attired career politician) rallies his forces for a job successfully done, reminds them that their efforts need to continue, and also reviews the victorious results of the variance analysis — show them how inflows have increased and how outflows have decreased. Make them all feel like stakeholders.

10) Promise to continue on course, and to remain vigilant and practical, as well as honest and tough. Continue to restructure and turnaround the business periodically with a “no sacred cows” and a zero-based budgeting approach. These techniques and tools work.

Douglas E. Castle  http://DouglasECastleBlog.com

Contact The Curator  https://getglobaledge.wufoo.com/forms/k7s0a7/

View DOUGLAS E. CASTLE’s profile on LinkedIn at   http://www.LinkedIn.com/in/douglascastle  ;

Follow @DECastleAdvisor on Twitter http://twitter.com/DECastleAdvisor
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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.