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

Credit Enhancement Program

In today's lending world only the best projects and best clients are able to get financing, and many projects and clients just aren't strong enough to induce a lender to risk their assets. There is a solution: a credit enhancement. In effect, the enhancement provides an additional level of collateral in order to induce the lender to make the loan. Below is a description of how the program works, and contact if you need access to this resource to help get your project funded:

The product is primarily utilized as a "credit enhancement" type product. There are two principal types of uses for the product:

1) to serve as a "balance sheet enhancement" for certain types of entities that have regulatory capital minimum requirements...in particular insurance companies, banks, and investment banks

2) to be paired with a lending institution whereby the lender accepts the Treasury derivative securities (TDS) as primary collateral for making a loan, and the TDS group takes the collateral from the company that would normally go to the lender

The minimum loan size for both transaction types is $10 million, and large transactions are preferred. Opportunities in the hundreds of millions are a good fit, they can technically go into the billions but good quality projects at that level needing these types of capabilities are rare. The minimum loan period is 12 months, they much prefer lengths of 5 years or longer. The typical cost of the TDS is around 7.5% per year, and they are not interested in revolving credit type situations where balances are drawn and paid down on a regular ongoing basis.

Life insurance companies are an ideal fit for the first transaction type as their models are very statistically predictable. As a general rule the insurance companies would get a loan of the TDS which can go on their balance sheets as "capital" vs. debt, and thus be able to write additional premiums pursuant to regulatory requirements and limitations. The TDS firm takes a pledge of controlling interest stock or other types of assets as collateral. It is much less costly than raising equity and much easier in an environment such as this, and the program works perfectly where the insurance company bank does not need cash.

With the second transaction type, the TDS must be paired with a lender. The lender takes the TDS as primary collateral, leaving the borrowing company's stock and tangible assets as collateral for the TDS. We would generally expect to lenders to lend against the TDS at a rate of 4-6% per annum, making the all in cost in most cases 12-13%, not counting our fees.

The TDS has as an underlying instrument a U.S. Treasury bond, typically of a minimum size of $3 billion. Every Treasury bond carries a unique CUSIP identifying number, and the bond is then "carved" into smaller segments which carry their own unique CUSIP number for tracking...and to ensure that there is no possibility of fraudulent duplication of the value of the underlying asset. The maturities of the underlying bonds vary, so references are always in terms of market value...not face value. As a general rule, we would expect lenders to lend to at least 90% and potentially 95% against the market value...which is a direct function of the length to maturity. There are no "interest coupons" accompanying the TDS product.

Only high quality, low risk projects will qualify as the group managing this portfolio of Treasury bonds has no interest in earning even higher yields by pursuing riskier opportunities. Examples of acceptable projects would be sound infrastructure projects, energy projects (but not "wildcat" type oil drilling and mining, etc.), high quality real estate projects (land, existing bldgs., and construction). There is particular interest in casinos (including tribal casinos in the U.S.). U.S. and foreign "stable" countries are the geographic area of interest.