What Is a Set Aside Letter and How Does It Support the Bonding Process?
A set-aside letter is a formal document issued by a lender (usually a bank or financial institution) to the surety through the developer. It confirms that a portion of the construction loan funds will be set aside for a specific subdivision project.
Unlike contractors whom the agency pays for public works, developers finance their own improvements through a construction loan. If a developer defaults on a project that required an improvement bond (also known as a subdivision bond), the surety company must step in and complete the improvements. A set-aside letter is a tool that is used to provide assurance to the surety company that the funds will be made available to the surety by the lender to pay for the improvements if the surety is required to complete them.
How the Surety and the Lender Benefit from a Set-Aside Letter
The set-aside letter benefits the surety. It ensures the surety has access to the remaining funds to complete the project, reducing the financial risk on their end, especially on large or phased developments. The lender, in turn, benefits by the surety completing the improvements which add value to the property that serves as the lender’s collateral.
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We want to know more about how we can help your construction company get the right contractor bond for your next project. Fill out the form and one of our local expert bonding agents will be in touch with you shortly.
Get a subdivision quote now
We want to know more about how we can help your construction company get the right contractor bond for your next project. Fill out the form and one of our local expert bonding agents will be in touch with you shortly.
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When Are Set Aside Letters Typically Required by Surety Companies?
Due to the protection it provides, the surety may require a set-aside letter for the following:
- Large or high-value subdivision developments
- Projects with phased construction or extended timelines
- When the developer’s financial strength or liquidity is below the surety’s preferred threshold
The developer must submit a set-aside letter from the lender to the surety after the construction loan is finalized but before the subdivision bond is issued. It can help the surety provide a bond approval when they might not have otherwise supported the bond because it helps offset the underwriting risk in cases where the developer lacks sufficient credit history, cash flow, or collateral.
Risks and Limitations of Relying on Set-Aside Letters
In some cases, the surety may not accept a set-aside letter. One of the primary risks to the surety is that the lender may not honor the set-aside letter. Despite the letter’s intent, it is not always a legally enforceable guarantee of access to funds. Some set-aside letters use vague language that may not obligate the lender to release the funds. The surety will most likely have its own required format and will only accept it from a list of approved banks. This is because if the bank goes out of business, it will leave the surety to pay for the improvements out of their pocket.
When obtaining a set-aside letter from the lender, make sure the surety reviews the specific terms and format of the letter before finalizing it.
Get a Free Bond Quote From a Trusted Surety Partner
At CSBA, we help you qualify, not just apply for the surety bonds you need. We understand the nuances of subdivision bonding, whether you’re a start-up developer or managing multi-phase projects.
Get a free bond quote from CSBA today and work with a trusted surety partner who knows how to get complex deals done in California.
Frequently Asked Questions About Set Aside Letters
The developer is typically responsible for requesting and obtaining the set-aside letter from their lender. The letter is then submitted to the surety company as part of the underwriting process.
No, a set-aside letter does not guarantee that a surety bond will be issued. It is one element of a broader underwriting package used to evaluate financial risk. The surety may still decline to issue a bond if other factors, like credit, project scope, or experience, don’t meet underwriting standards.
Get a subdivision bond quote now
We want to know more about how we can help your construction company get the right contractor bond for your next project.
