Surety Bond News

We decided to close our doors early yesterday around lunch. A storm of sleet and ice came through our area knocking out our Internet and later our power. Rather than stick it out, we decided to send all employees home as a safety precaution.

Another storm is expected to hit our area over the weekend. If the forecasts are accurate, our office will be open for regular hours 8:30am to 4:30pm.

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…
The 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…
As 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.

Conclusion:
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.

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.

Dog 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 (see: PA Dept. of Agriculture). 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

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 home 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.

Conclusion
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.

Starting a new business can be a daunting task. There are so many things to consider prior to opening for business. One of the most important items any business owner needs to research is finding out what government licenses need to be obtained and what type of bond has to be filed with it. Obtaining the proper insurance coverage is equally important prior to start-up. In this article we will review what is means to be bonded, the benefits of doing so, what type of bonds your company needs, and what you need to know prior to purchasing a bond.

What Does it mean to be “bonded”?

The phrase “licensed and bonded” is one you might see on the side of a contractor’s truck, on a mortgage broker’s business card, or on an auto dealer’s billboard. Obviously, they are all using the phrase for a marketing advantage over their competitors to show they are safe to do business with. What does it mean for these companies to be bonded? It means that a bonding company (also known as a surety) is guaranteeing the performance of their business per the terms of the filed license. If the bonded business (the principal) fails to fulfil the bond guarantee, then the obligee (whoever is requiring the bond) can file a claim to recoup losses incurred.

The process of obtaining a bond:

The government requires a bond of the business. The business then obtains the bond from a surety company.

These bonded companies are not purchasing bonds simply for advertising purposes, they obtain them because they are required to by the government to legally operate. There are literally hundreds of different occupations that are required to post a surety bond to local, state, or Federal governments. It is extremely important to find out whether you need to post a bond to run your business. Operating without a bond when one is required always results in the government halting a businesses operations. Typically, the bonds are filed to obtain a license to operate. However, there are instances where the government does not require a business to be licensed, but does require a bond to be posted. There are simply too many business types to go over them all in this article, so feel free to ask about your business getting bonded on The Surety Bond Forums.

What type of bond do you need?

There are two main types of bond products that people refer to when referring to “getting bonded”. The first is a surety bond, which is the type we were referring to above. The second type is a fidelity bond, which is a completely different product than a surety bond. As we learned above, a surety bond involves three parties: the obligee (typically the government), the principal (the business in need of the bond), and the surety (the bonding company backing the bond). A fidelity bond is actually a type of insurance product, not a type of surety. With fidelity bonds, there are only two parties involved: the principal (the business obtaining the bond) and the carrier (the bonding company backing the bond). Since fidelity coverage is a type of insurance, the principal (you) are the beneficiary in the event of a claim. An example scenario would be a fidelity bond that insures your company from employee theft. If a an employee were found guilty of theft, the bond would pay out.

Now that we know there is more than one type of bond, we can answer which one you need. The answer is usually pretty simple. If there is someone requiring the bond of you, it is a surety bond, as there are then three parties. If no one is requiring the bond and you simply want to protect your own interests, it is a fidelity bond.

Benefits of getting bonded

Surety bonds and fidelity bonds are different products and therefore have different benefits (as well as different downsides).

Surety Bonds:
As we went over in the beginning of the article, business often list that they are bonded on marketing materials. What other benefits does a surety bond provide for your company? Not many, as the bond is required by the government to protect the public, not your company. Funds from a bond claim would be distributed to those effected by your company’s lack of compliance with government regulations. One might ask, how is a bond beneficial to my company then? You have to remember, you need to post the bond to operate. The alternative is to never open business or post a irrevocable letter of credit (ILOC). An ILOC typically costs 1% and will require 100% collateral, where a bond usually costs 1-3% and requires no collateral. When you look at the alternatives, it is clear that a bond is very beneficial to your company’s operations.

Fidelity Bonds:
Fidelity bonds are rather strait forward, they are insurance product that protects your business from loss. Unfortunately, a claim will only payout in the event that the individual accused of stealing is found guilty by a court of law. On the bright side, they are relatively inexpensive and can be used for advertising in the same way that a surety bond is. Typically lock smiths and janitorial services will advertised that they are “bonded and insured”. When stating this, they are referring to fidelity coverage.

What you should know before purchasing a surety bond

You will be held responsible for any claims!
A surety bond is not insurance, it is more of a form of credit. Keep in mind the bond is guaranteeing that your business performs as required. If you fail to do so, it could result in a bond claim. Since bonds are not insurance, the bonding company will ultimately hold you and your company responsible for repayment of any losses. They are extending surety credit, not insuring your company. The bonding company will require your company and all owners to sign an indemnity agreement to ensure the bonding company is held harmless against any losses. The agreement can not be modified and they will not bond you if you do not sign.

The process of a bond claim:

The government files a claim with the surety. The surety turns to the business for repayment of losses.

Shopping for bonds can be tricky
Bonding companies are usually hesitant to review applications that they have received from multiple agents. Some carriers will decline an applicant simply because they have received the submission from too many agents. Therefore, it is best to submit to only one agency that is appointed with a large variety of different markets to properly place you bond. You can submit to more than one agency, but it is a good idea to inform all agents that you have applied with others. Any agent worth a grain of salt will then ask what bonding companies your application has been sent to. It is imperative that the carriers are not repeatedly submitted to, otherwise you may shut yourself out from the lowest rates.