What is a Performance Bond?
A performance bond is a type of surety bond that protects a foreign buyer against an exporter’s failure to perform as agreed—essentially insurance for the importer.
Performance bonds are often required by buyers to award international contracts, particularly when buyers and sellers do not have established relationships. The agreement protects buyers against economic damages and gives them assurance that they will be compensated when sellers fail to deliver as promised.
How do Performance Bonds Work?
The exporter must put up a performance bond, either through an issuing bank or insurance firm, to provide a foreign buyer the protection necessary to secure a project. The amount of coverage is generally a percentage of the export contract, depending on a variety of factors, including risk and industry standards. Typical coverage might range from five to 25 percent of the contract.
The bank or insurer will charge a price for issuance of the bond, depending on the terms of the deal and their perception of risk involved in guaranteeing the exporter’s performance. The institution issuing the bond on the exporter’s behalf also will require all or some percentage of the bond to be collateralized by cash or other assets.
If the exporter does not fulfill the agreed upon terms and conditions of the contract, the importer may call the bond for financial compensation. If the exporter abides by the agreement, the bond is retired.
What’s the Challenge for Exporters?
Exporters must put up assets to collateralize performance bonds and win foreign projects. In doing so, they are tying up assets that could otherwise be used to finance the fulfillment of the export contract itself. This creates serious working capital constraints for exporters and impedes their ability to take on new deals.
Additionally, banks are often unwilling to accept export-related assets as collateral because it may be difficult to collect inventory or accounts receivable outside U.S. jurisdiction. As such, exporters may be unable to use the future cash flows associated with the project to collateralize the bond.
How Can The Export-Import Bank (EXIM) Help Exporters Finance Performance Bonds?
EXIM’s Working Capital Loan Guarantees equip exporters to meet their foreign buyers’ desire for the protection of a performance bond. EXIM works directly with an exporter’s lender, guaranteeing a facility to secure a standby letter of credit that functions as a performance guarantee. This can be the difference between an exporter either making or missing out on a sale.
EXIM’s guarantee on the facility is essentially insurance for an exporter’s lender, backing 90 percent of the repayment risk and allowing export-related accounts receivable, inventory and even work-in-process to be pledged as collateral. Through EXIM’s program, standby letters of credit serving as performance guarantees need only be collateralized at 25 percent, empowering exporters to provide foreign buyers the assurance they require without tying up much needed cash in the process.