What is a Collateral Bond?
A collateral bond is a bond where the surety does not provide the underlying bond without some sort of other collateral. The collateral is usually preferred to be liquid, such as an irrevocable letter of credit, but some sureties will also take other pieces of collateral, such as certain equipment or even real property.
A Collateral Bond is different when used in the context of a surety bond. In the financial world, a collateral bond is a short term debt security, which is used to provide collateral against a company's bond issuance. However, in the surety bond context, a collateral bond requires some piece of collateral to secure the underlying performance or payment bond.
Collateral Bond - What is it?
For many companies, they can qualify for a performance bond or payment bond without the need for any collateral. We work with our clients to try and get them bonds without collateral. The reason for this is pretty obvious. The more collateral that is required, the less is available for other purposes.
Where we typically see collateral used to secure a bond is in the performance bond situation where a company is not fully financially secure. In those situations, the company cannot qualify on its own for the bond. So, the surety company will require that the Obligor post some sort of collateral. What is preferred is liquid collateral, like a bank line of credit. However, other collateral can be used, such as real property, other property such as equipment. Obviously, equipment is not preferred as it can be sold, which would eliminate it from being used by the surety as a piece of collateral upon default.