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Surety bonds are a widely accepted form of financial assurance used extensively within the construction and services sectors to ensure contractor performance.
Other than the issuer, surety bonds are identical to bank guarantees: They are unconditional, on-demand, and irrevocable. Businesses that have traditionally used bank guarantees have started to use surety bonds as a cost-effective alternative in meeting their financial assurance needs while diversifying their capital sources and releasing debt capacity within existing banking facilities.
Over the past 24 months, new and expanded uses for surety bonds have been developed, including committed facilities, securing workers’ compensation liabilities and mine-site rehabilitation. If required, surety facilities can also be paired with bank guarantees to meet specific business needs.
Marsh’s Surety Practice provides a complete solution for your guarantee needs, from arranging guarantee facilities and securing adequate capacity to providing advice on bond wordings and indemnity negotiation. We bring together the scale, scope, and intellectual capital of Marsh to deliver innovative solutions, domestically and globally.
Construction and Services
Companies operating in the construction and engineering sectors often need to provide their clients with guarantees to ensure contractual obligations are met. Typical uses of surety bonds include:
- Performance guarantees.
- Advance payment.
- Offsite material.
- Contract bids.
- Lease / rental.
- Maintenance.
- Petroleum.
- Retention release.
By using a surety facility, a company can reduce reliance on its banking facilities, preserving liquidity for other purposes such as working capital and investment.
Surety facilities are typically subordinated to senior lenders and can be committed or uncommitted.
Facility terms are a function of the credit strength and operational performance of the corporate. Facilities are typically for three to five years, and bond terms are usually up to five years and are typically competitively priced.
The surety markets are deep with aggregate capacity in excess of AUD2 billion (for a BBB-rated corporate).
Mining, Oil and Gas
Resource operators are required to provide financial assurance for various obligations, which are largely driven by regulatory requirements. The assurances are primarily in the form of bank guarantees, which directly impact banking lines and reduce available credit that could be used for other core funding activities.
Marsh has worked with government departments, resource operators and surety markets to develop rehabilitation surety bond capacity for the Australian resource sector. While some States accept surety bonds, others only accept bank guarantees. For the latter, Marsh has developed structures that satisfy the State’s demand for a bank guarantee while reducing corporates’ use of their bank guarantee facilities.
(Note that additional eligibility criteria apply for rehabilitation bonds.)
Rental Bonds
Rental bonds are an effective way of providing security for commercial property leases. Commercial landlords require lessees to provide security to ensure they comply with their obligations under the relevant lease. The value of the security varies and can range from one to six months in rental cost. Traditionally, this security has been provided by lessees in the form of either a bank guarantee or security deposit.
For most lessees Marsh can arrange a rental bond as an alternative form of security to satisfy the landlord’s security requirements.
Workers’ Compensation Guarantees
Organisations that operate under a self-insurer license (either State-based, on a limited basis, or via Comcare, Australia’s federal workers’ compensation scheme) or a retro paid-loss premium scheme, will typically require the establishment of security, usually in the form of a bank guarantee.
Until now, most surety markets have been unable to issue bonds in support of either self-insured or retro paid loss premium arrangements due to tight restrictions on eligibility. Marsh is uniquely positioned as a broker to arrange eligible security, which reduces utilisation of bank guarantees.
Australian Energy Market Operator (AEMO) Credit Support Solutions
Participants in the national electricity market are required by the AEMO to provide credit support in relation to the obligations to pay for electricity purchases in the spot market.
Traditionally, AEMO participants used bank guarantees to satisfy AEMO’s credit support requirements. Marsh has developed a solution using a combination of bank guarantees and surety bonds, which satisfies AEMO’s requirements and releases debt capacity under existing banking facilities.
Establishing a Surety Bond Facility
It usually takes between four to six weeks for a surety to process and establish a new surety facility. The surety will focus on the applicant’s financial strength, ability to undertake the contractual obligations, and the broader macroeconomic factors influencing the sector in which the applicant operates.
The process includes a review of the applicant’s audited historical financial statements in order to do a credit assessment. In our experience the minimum eligibility criteria to establish a surety facility is:
- Annual turnover of AUD50 million or more.
- Operations are profitable.
- Net tangible assets should be at least one-and-a-half times the bond facility, although this may be less for large organisations with annual turnovers of more than approximately AUD500 million.
In its due diligence, the surety will also review the applicant’s historical execution of similar projects and its pipeline of projects. Once the facility is established, the surety can issue bonds on behalf of contractors within 24 to 48 hours of an application being received.
Rehabilitation Bond Criteria
In addition to the above minimum criteria, businesses seeking a rehabilitation bond facility are subject to the following:
- Company must be investment grade (S&P BBB- or better).
- Mining / oil and gas projects must be low cost.
- Preference for companies operating diverse portfolios.