Jason Clout – The Australian Financial Review

Small and medium-sized enterprises are being urged to consider surety bonds as part of their financing arrangements.

The bonds provide security for a contract, without the use of a bank guarantee.

Guarantees affect a company’ s balance sheet and can be hard to obtain under current market conditions when the banks are looking very closely at their commitments.

Long-term broker of surety bonds, Stening Simpson, estimated the local market for the product was about $6 billion, compared to an estimated $24 billion for bank guarantees.

But despite good growth in the surety bond market, there were still many SME’ s that might not be aware of the facility, said Chief Executive of Stening Simpson, Peter Stening.

“ We believe surety bonds could account for 50 per cent of the total market as the implications of the banks covenant restrictions are realised,” Mr. Stening said.

He said bonds were used when a company had to provide security for a contract entered into with another party.

Numerous industries have to provide such security, including construction, engineering, manufacturing, consulting and high technology.

“ The bonds are a cost-effective method to mitigate risk of non-completion or delivery of a service, as spelled out in the contract,” Mr. Stening said.

“ Bonds are typically 5 to 10 per cent of the contract price.”

If a claim arises because the terms of a contract had not been met, the bond can provide compensation for the losses incurred or enable another contractor to complete the job.

“ Surety bonds have the backing of specialist underwriters and are a widely accepted form of contract security throughout the world,” he said.

Mr. Stening pointed out that in the United States surety bonds were the dominant form of security provision. Many Australian corporations used them and some had substantially increased their facility over time.

But he stressed it was a rigorous process to obtain a surety bond. A business’ finances, operations and management were assessed.

Should they succeed in the application, Mr. Stening said the surety bond facility could ease the strain on a company’ s balance sheet.

“ A benefit of surety bonds is that traditionally with bank guarantees a financial institution would require a company to either place funds on deposit with the bank or to effect a mortgage or fixed and floating charge over assets,” Mr. Stening said.

“ Surety bond underwriters do not typically require such security and assets remain unencumbered, while working capital is released to fund future contracts.”

Mr. Stening said the use of surety bonds also left a business’ banking arrangements in place as the bonds could operate with existing lines of credit.