The Elusive Financial Guarantee Bond

Most lenders today are looking for collateral that is safer than land, which makes sense: look at the number of properties that are close to or are under bank ownership. Collateral today almost has to be cash or “cash backed”. There are all kind of instruments that qualify as excellent collateral: stand by letters of credit, Bank guarantee’s, and financial guarantees: often called “insurance wraps” Many people think that they can obtain an insurance wrap, and have the insurance wrap take care of the lender’s demand for more collateral. However, finding a real insurance wrap provider is challenging in today’s environment. I sought one out, and got a lot of information from Carlyle, just such a provider.

If you were to request a financial guarantee, you would have to provide information to support the request. After all, the guarantee provider is going to, for a fee, assume the liability should a client default. Here is what Carlyle shared regarding items that are required: “Financial guarantee bonds are generally 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 collateral that you wish to deposit to support the bond, your current audited financial statement, and the financial statements of all indemnitors in involved in your project”.

Were the insurance provider willing to move forward with issuing the guarantee, as you can imagine, there is a fee associated with that guarantee. Carlyle shared this: “premiums are generally fifteen percent (15%) on face value per annum for those bonds under five million, and ten percent (10%) on face value for those bonds in excess of five million dollars. Collateral security in the form of cash or cash equivalent (i.e., U.S. Treasury issues, notes, bills, warrants, and highly stable, publicly traded stock or bond issues) will be credited at eighty percent of current market value. Collateral in the form of real property will be credited at fifty percent of current market value. Letters of credit are acceptable at even value with the bond”

When I asked Carlyle why it was so hard to find a financial guarantee for a project, he shared a very key piece of information: “With regards to ratings, to my knowledge there are only two financial guarantee insurers in the United States. NEITHER of those entities is willing to write bonds for private contracts. They will only issued financial guarantee bonds to municipalities that collateralize the obligation with bonds or other instruments issued by that municipality as collateral”. The aforementioned statement goes a long way towards explaining why insurance wraps are so challenging to obtain.

So where would one go to find an insurance wrap? Once again, Carlyle was extremely helpful. However, there was a cautionary piece of information included with the assistance: “The Appleton Law (NY), other state statutes, and many insurance commissioner promulgated codes severely restrict financial guarantee to mono-line insurers. This posture forces carriers that wish to engage in financial guarantee business in addition to other insurance, 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 a minimum of three years ‘seasoning’, during which time they are under AMB’s market surveillance. The carrier’s financial statements and books must be open to AMB. These two 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, you will have a great deal of difficulty identifying an insurer that will do these that possesses a ‘rating’.”

I am not an expert in insurance wraps, but what I have seen is explained by what Carlyle shared. There are two entities that issue financial guarantee bonds in the US, but it appears that the issuers are limited to municipalities only. As a result, people looking for the insurance are being forced off shore to obtain the insurance. The challenge is that those entities issuing off shore, for competitive and rational reason, are not able to provide the transparency most lenders want to see in order to make sure that the guarantee is sufficiently “capitalized”. After all, if you are the lender, you want to make sure that the guarantor has the ability to perform in the event a borrower with a guarantee defaults. The lack of transparency makes it very difficult to match the lender’s need for “safety and security” with the needs of the borrower looking to provide the same.

I tend to write long posts, and this post is certainly no exception. However, the hope is that the information proves useful. Carlyle also provides other bonds, and his response and professionalism were very apparent. Please contact us at Commercialfundingsolution@gmail.com if you need further information: we would be happy to introduce you to Carlyle