The Advantages of Using a Bond vs. a Letter of Credit

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Subdivision Bonds

Consider a bond as an alternative to a letter of credit

3 most common performance guarantees

ILOC (Bank Instrument): Often ILOCs are fully cash collateralized. Municipalities usually draw down on ILOCs 30 days prior to the renewal date (unless the ILOC has already been renewed). If the municipality determines the site improvements have not been completed according to specifications, they can begin to draw down the necessary funds to complete the project. There is little to no recourse for the developer if the ILOC is drawn upon.
Cash: Similar to a letter of credit, the developer’s cash will be tied up until completion and acceptance of the project. If the municipality is not satisfied with the site improvements, they may use the cash to complete the project with little or no recourse for the developer.
Surety Bond: Surety bonds provide more protection for the developer without tying up their cash. Unlike an ILOC or cash, the municipality must file a bond claim before any payment is made for site improvements. The bond claim must be substantiated, a process that often involves both the surety and the developer.

There are two broad types of Letters of Credit (L/C).

Commercial L/C: Pays seller for goods purchased; both parties expect the letter to be drawn upon
Standby L/C: Supports financial or performance obligations; not expected to be drawn upon

The advantages of using a bond vs. a letter of credit.

Credit capacity: An L/C ties up the company’s credit capacity, reducing financial flexibility. Surety bonds are not credited against a company’s bank line.
Covenants: Banks may place restrictive covenants in return for extending a line of credit or may require extensive financial reporting. Surety companies offer more flexibility.
Security: Banks can take a security interest in the client’s assets, which is required to be filed publicly (UCC filings). A surety is generally an unsecured creditor with no filing required.
Default defenses: A bank L/C is a demand instrument that may be drawn down at any time, giving the company no defenses. A surety bond requests proof of a company’s default from the obligee to protect the principal from the obligee taking possession of the bond proceeds without merit.
Claim handling: Bonding companies have a professional, dedicated claims staff available to handle disputes and to assist in the claim resolution process. Banks do not.
Rates: L/C rates can be volatile and may include a commitment, utilization, and/or issuance fees, in addition to a stated rate. Surety rates tend to be stable and are directly tied to the credit quality and the types of obligations bonded.

For more information on subdivision bonds, please contact us today!

Ken Peeples
Sr. Vice President | East Surety Practice Lead
919-215-9779
KPeeples@McGriff.com

Adam Pfanmiller
Vice President
919-744-1642
apfanmiller@McGriff.com

David Liggett
Surety Consultant
919-917-4744
David.K.Liggett@McGriff.com

McGriff.com

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