Third Party Credit Enhancement Agreement – What Is It and How Does It Work?

A third party credit enhancement agreement is a contract between a borrower, a lender, and a third party guarantor or insurer. The purpose of this agreement is to provide additional security to the lender by having a third party guarantee or insure the borrower`s repayment of the loan. This type of agreement is most commonly used in the context of municipal bonds.

Municipal bonds are debt securities issued by state and local governments to finance public projects such as schools, highways, and other infrastructure. These bonds are typically issued with lower interest rates than other types of debt securities because they are considered low risk. However, in order to ensure that investors are protected in the event of a default, many municipal bonds are issued with credit enhancement measures in place.

A third party credit enhancement agreement is one such measure. Typically, a bond issuer will enter into an agreement with a third party guarantor or insurer who will agree to repay the bond in the event that the issuer defaults on payments. This guarantees that investors will be repaid, even if the issuer is unable to fulfill its obligations. In exchange for this guarantee, the issuer will pay a fee to the guarantor or insurer.

There are several types of third party credit enhancement agreements, including letters of credit, insurance policies, and guarantees. Each type of agreement has its own benefits and drawbacks, and the choice of which type to use will depend on the specific needs of the borrower and lender.

One of the primary benefits of third party credit enhancement agreements is that they can help lower borrowing costs for the issuer. By providing additional security to the lender, the issuer can obtain a better interest rate on the bond, which will ultimately benefit the borrower by reducing the cost of borrowing.

Another benefit of third party credit enhancement agreements is that they can help issuers with lower credit ratings to access the bond market. Municipalities and other issuers with lower credit ratings may find it difficult to obtain financing through traditional channels, but a third party credit enhancement agreement can provide the added security that lenders need to be willing to lend to these issuers.

In conclusion, a third party credit enhancement agreement is an important tool for issuers looking to lower their borrowing costs and access the bond market. By providing additional security to lenders, these agreements can help borrowers with lower credit ratings to obtain financing and ultimately benefit the public by financing important public projects. If you are an issuer considering a third party credit enhancement agreement, be sure to work with an experienced financial advisor to determine which type of agreement is best for your specific needs.