SBA Bond Guarantee Program Changes To Help Contractors Obtain Surety Backing?

As of July 25, 2007, the U.S. Small Business Administration (SBA) has changed their Surety Bond Guarantee Program. The goal of the SBA’s recent program changes are to help small contractors get surety bond guarantees. Will the changes make it easier for small contractors to get bonded? Is this just a political move by Senator Olympia J. Snowe (R-ME), the Bonded Contractordesigner of the changes? We originally started to cover the changes being made to the SBA in an article titled “Surety Bond Improvements Act of 2006“. In this article, we will review what changes are being made to the program and how they will likely effect the surety industry.

Change #1 – Flexible Rates
The SBA now allows “preferred” sureties to have flexible rates rather than be stuck using the states rate schedule, which is outdated by most standards. This should encourage more bonding companies to participate in the program.

Pros: Adding more surety carriers to the field will only make the program more accessible to all. It will also create more competition, which SHOULD benefit small contractors.

Cons: Allowing for more flexible rates really means allowing the sureties to increase their rates. Bonding companies clearly were not participating because they had too much to gain. This means the added competition will not lower pricing for small business owners, but may end up increasing them. However, in my honest opinion it is something that had to be done.

Change #2 – Reduced Surety Audits
The “preferred” sureties will have less audits and a 60-day time period to submit surety fees to the SBA.

Pros: Cutting down on red tape is good for the sureties and the SBA as it will increase efficiency of the program and egg on new bonding companies to consider the program.

Cons: None.

Change #3 – Upcoming Electronic Bond Application
Pros: The use of technology has revolutionized the surety industry as a whole, further implementation should further increase efficiency and participation by sureties and more importantly, agents.

Cons: The SBA website is not always the easiest to navigate. If the online application is not done correctly it potentially could create new problems rather than solving old ones.

The SBA’s changes will persuade more carriers to take a look at the SBA program, but will this really make it easier for small business to obtain surety guarantees? Personally, I don’t think the changes have gone far enough. The SBA needs to take a step back and take a look at the big picture…

SBA Surety Guarantee Program IssuesMost bonding companies require principals to obtain their bond through an appointed agency. As an agent, I can tell you we did not have problems placing clients in the SBA’s Surety Guarantee program due to lack of participating bonding companies. However, as an agency we choose to rarely work with the SBA. Why? They are an inefficient government agency that is extremely time consuming. It is unfortunate, as the program is a good idea, but it seems that the employees of the SBA’s Surety Program desperately need retraining. The changes made will not change the red tape and inefficient SBA employees that agents have to deal with. Therefore, our agency will not actively pursue writing SBA accounts. In fact, we only consider it for contractors that we have worked with for years that have fallen on hard times.

On the bright-side, the increased premium rates some of the “preferred” sureties will be charging will increase the commissions made for agents participating in the program. However, our agency still feels that our time can be better spent working strictly with the private sector.

Licensing Woes For New Mortgage Brokers?

Almost all states require mortgage brokers and bankers to post a surety bond with their state license. These mortgage broker and banker surety bonds have been one of the easiest bonds to procure in recent years. Unfortunately for mortgage brokers and lenders, it appears that all of that is about to change.

A little history…
Mortgage Broker BondingThe recent housing market boom brought about a boom in the mortgage industry. Many mortgage brokers and lenders decided to open their own shops. Most brokers and lenders quickly discovered a bond was required when applying for licensing from the states in which they chose to operate. Bonding companies backing mortgage brokers and lenders were liberally writing bonds for them due to the financial prosperity brought upon them from the large amount of home sales and refinanced loans. Both lenders and brokers had relatively low claim rates when compared to other bonded occupations. This allowed the surety market to offer more surety capacity and at a lower rate.

The change of tides…
The refinance market has long cooled and housing sales are desperately low in comparison to what fueled the mortgage industry no more than a year ago. The industry is now considered to be in a recession. Some of the largest mortgage lenders are currently declaring bankruptcy. Some analysts predict one-third of all mortgage brokers will be out of business by this time next year. Lenders and brokers alike are on hard times and the bonding companies know it.

A surety bond is a guarantee of performance; it is also a form of credit that the principal must repay to the surety in the event of a claim. Therefore, a bonding company is going to want to ensure the principal has the ability to repay the bonding company should a claim arise. Dwindling equity and liquidity within broker and lender business financial statements due to year end losses are making it so many within the mortgage industry do not qualify for the same amount of surety credit as they did in the past.

The surety bond industry reaction…
Mortgage Broker Industry RecessionAs stated above, many brokers and lenders no longer qualify for the aggregate amount of surety bonding they did at the peak of the boom, which is to be expected, as that is how surety underwriting works. However, some of the sureties that were once the most eager to bond brokers and lenders are changing their overall underwriting guidelines for these lines of business. As of recent, our agency has seen a drastic difference in underwriting methods for top carriers like The Hartford Financial Services Group, Inc. and Liberty Mutual Insurance Company. The Hartford in particular was previously known for writing mortgage brokers and lenders very freely at low rates. Now they are no longer willing to consider start-up mortgage broker businesses. A brokerage must be in business for a minimum of two years for them to consider writing a bond. These changes are significant, as limiting surety capacity will force those in the mortgage industry to be very careful about what states they choose to operate in, as they will likely not qualify for all the bond backing needed to operate legally. More importantly, if other carriers in the industry follow The Hartford’s path, start-up mortgage brokers would have to produce letters of credit rather than a bond; a much costlier alternative. This will allow for only start-ups with deep pockets to get licensed and bonded properly.

The silver lining…
There is no doubt, The Hartford is a big player in the surety industry, especially when it comes to mortgage brokers and lenders. The surety industry is relatively small and a large broker/banker guarantor like The Hartford will have impact when they drastically change their underwriting policies. However, like all industries the laws of capitalism apply to the world of suretyship. This means, if The Hartford no longer wants to bond start-ups, another surety will. Of coarse this means that demand may increase, which would in-turn result in higher rates, especially for those that were use to The Hartford’s low premiums.

For the time being brokers and lenders may be shocked that obtaining surety backing is not as easy as it once was. However, once their financial statements become healthier they will all see their aggregate bond limitations expand. Bonding companies guarantee the performance of the companies, so it is only natural that they panic a bit as the mortgage industry gets shaken up. In time, as the mortgage industry settles, the surety industry backing them well begin to back them more freely again.

Will The Mike Vick Case Further Hurt Dogs?

Regardless of what medium you chose to get your news, you have heard of the Michael Vick case. The alleged accusations are extreme and absolutely despicable. The media has bombarded the public with what could happen to Vick if found guilty, but how will the case effect dogs throughout the country? The most obvious answer would be the public awareness to such activities, which could have positive effects to prevent these types of gambling rings. Unfortunately, when one looks deeper, there may be further implications for man’s best friend.

Michael Vick CaseDog breeds listed as “dangerous” are becoming more difficult to insure every year. Many municipalities, including our agency’s home state of Pennsylvania also require a “violent” dog to be bonded. Some governments requiring a bond will put the animal to sleep if a bond can not be provided. I am not saying that these requirements should be revoked, as no one wants a potentially dangerous dog in their neighborhood. However, every dog bite case is not clearly black & white. Often times, an otherwise calm dog may be provoked into attacking out of self defense. Clearly a dog that is trained to fight can not live, as that can only cause trouble. My concern lies with the dogs that are not a danger to the public and may have been forced into a scenario by humans that made it act out.

The Michael Vick case has no doubt opened the eyes of many to ongoings of the underground dog-fighting world. Bonds guaranteeing a dog will not bite again are difficult to underwrite, as there isn’t detailed statistics on what is a good risk for a surety to take. The SFAA (Surety & Fidelity Association of America) does not accurately track this line of business as a whole, as it makes up a small portion of surety premium volume and is very far out of the realm of typical surety guarantees. Will the publicity Vick brought to the world of dog fighting make insurance and bond carriers more cautious when approving a policy? If so, it could mean additional dogs will be put to death due to lack of required insurance and bonding.

Tell us what you think about it on our forums at: Surety Bond Forums

How To Secure A Bond

In order to qualify for a bond, you must first prove that you are capable of performing the work and also completing the job. Once this is accomplished, you must now prove that you qualify for the bond. Your bond producer wants to know if you have the assets to pay for a claim should things go awry. A bonding company will write a bond if these two criteria are met. But how do you secure a bond?

Bonded ConstructionSureties may differ many ways when evaluating your assets and deciding them acceptable. Some may look for common stock that is traded in on the National Securities Exchange while others prefer certificates of deposits. All agree that the more you can liquidate your assets into cash, the better. Tangible assets that are easily converted are most acceptable. A good guideline is to follow which is acceptable to the government standards as well as which are unacceptable. Your surety can help you with this list. Common sense will tell you that your car, home, capitol equipment, or any asset that could fluctuate or depreciate over time is an unacceptable asset. Some bonding companies will even find real estate unacceptable as an asset so consult with them before making your list of assets. All your assets are favorable and establish your net worth. The assets that you use as collateral are the gems that underwriters seek. By accepting these assets, the surety “identifies” your assets as collateral.

A surety will write a bond if they are certain that they are not held liable for any claim that may occur; and that the liability is secured. In most cases, the liability is on the principal but sometimes the liability is shared with other indemnitors such as subcontractors. Once all parties agree that compensation shall be made for any damages or losses in form of a claim, which party is liable for the claim and adequate assets are identified to secure the claim; then a contract is written as an indemnity agreement. A surety may write one indemnity agreement for each bond or one general agreement for many bonds depending on the surety or the circumstances. Once signed by all parties, law binds it and all parties are obliged to adhere to the agreement. The principal promises to reimburse in full, any costs associated with the claim as well. This includes legal fees and other expenses incurred. In the event a claim is filed, the surety will pay for the claim and associated costs and the principal must reimburse the surety.

Surety BondingAs mentioned above, a general indemnity agreement may be for several bonds. This agreement covers a wide spectrum of costs that are considered relevant or not relevant to the claim such as sanctions or fines bestowed upon the surety. The surety has a right to call in the debt from the principal before the surety pays the claim. This common law right is called exoneration. When a surety becomes exonerated, the principal pays the cost of the claim and as a result, liability is removed from the surety. Some general indemnity agreements require principals to pay for claims as soon as they are made against the bond.

Upon notification of a forthcoming claim against a bond, the surety may produce a “reserve”? immediately. The funds are drawn from an account to satisfy the expected amount of the claim. The sum of funds deposited from the principal and surety together act as collateral for the surety to use if the issue arrives.

Surety’s Authority: If the job is in jeopardy of not completing the work, the surety may step in to avoid default on the contract. This gives the surety the right to use whatever means necessary to complete the work and expire the bond. Use of equipment or plant facility, decision-making and perhaps loans are included to insure that the performance is guaranteed. The surety is then reimbursed from the obligee, principal or both any expenses incurred. In some cases, the bonding company may out source the work altogether as another means of avoiding default. The assignment of contracts may be negotiated prior to bond issuance to the surety by the obligee and principal. This action gives the right to the surety for plant and equipment use, sub contractors and all other contractual rights to the surety. The surety is entitled to proceeds from the job along with any claims associated with the job.

Lowered Home Sales = Increased Subdivision Bond Claims?

The Dilemma
The housing boom is long gone, many say the housing market is in a recession. What does this mean for developers and the bonding companies that guaranteed their work? With Subdivisionhome sales plummeting many developers are in a bad spot, as they purchased the land when real estate was more costly. The developers have loans out on land that is no longer worth what they originally paid. Obviously, this eats into their bottom line. Worse off, the houses are also worth less and must be reduced to sell in the current market. However, the developers can only reduce the price of the homes so far until they are losing money on the project. Smaller developers with little equity may not be able to survive the hit, which would result in bankruptcy.

The Reality
Bonding company underwriters are professionals when it comes to financial risk analysis; after-all, that is a big part of what makes a bond a good risk or not. An underwriter would be a fool to approve a subdivision bond without ensuring that the funding for the project is in place. They also make sure that the developer has substantial mark-up on each unit. The large mark-ups build the necessary cushion in the event of a market decline like we are currently seeing. The falling real estate prices will no doubt hurt the pockets of developers, but it is not likely that they dip down far enough to where the developer is losing money on the project.

ConclusionSubdivision Bond Requirement
The bonding companies get to look at the developer’s most intimate financial details to decide whether it is a good risk or not. While it is impossible to predict when the housing bubble would pop, any good underwriter would plan for it when reviewing an account. The surety carriers certainly are not happy to see the housing recession, but they clearly are not too concerned, as subdivision underwriting guidelines have not changed.