Technically, the ceiling is still at $5 million (see: SBA FAQ). The changes allow up to $10 million only when “the contracting officer certifies that the guarantee is in the best interests of the government”. However, most news agencies are reporting it as a flat increase.

The SBA surety program is quite paper intensive as is. Certainly, there will be more paperwork to show the contracting officer agrees that it is in the best interests of the government.

One of the main differences in underwriting using the SBA program is how they calculate working capital. Under the SBA program a bank line of credit is considered working capital, which is not the case with normal surety underwriting. This allows contractors to qualify for bond lines that are larger than they could obtain through traditional avenues. Unfortunately, the credit crunch has caused banks to reduce or close line of credits previously available to contractors. Such changes to our financial system have had a direct impact on bond lines provided through the SBA program.

This leaves me to wonder, would there be more benefit in reviewing the current SBA procedures rather than increasing the maximum bond amount? Sure, it wouldn’t look as good in the news headlines, but it might have more of an impact with the contractors they are trying to assist.

Like insurance, the surety industry is recurring. In the mid 90s, the surety industry was very pliable, and there was little underwriting being performed. A combination of the slowing economy and the poor underwriting practices from years prior caused the surety industry to suffer for the first five of five consecutive years in 2000. However, a booming economy led to more bond approvals and issuance, even for applicants that were less than qualified.

Fortunately, these losing years caused the market to fluctuate almost overnight underwriting standards were tightened and premiums increased substantially. Capacity quickly became an issue for contractors, particularly at both the small and large ends of the spectrum. Small, emerging contractors were finding it increasingly more difficult to obtain any bonding capacity and large contractors were also feeling the affects of the more stringent industry. The market has fluctuated over the past couple of years, and contract bonds and some commercial bonds can still be difficult to obtain. Some items that are crucial to obtaining prior to applying for a surety bond are:

A surety bond is a form of credit. The underwriter requiring financial information from an applicant is making a credit decision without ever meeting the contractor or applicant.. There may be a substantial amount of paperwork required; however, it may be the extra paperwork required that will get an applicant approved for a bond. An underwriter will most likely request the following:

Business financials It is beneficial and most often a requirement that these are prepared by a CPA. If it is a new company, submitting the most recent business financials will suffice.

Up until around 1989 the surety industry had experienced a fairly consistent low loss ratio, with moderate times of increasing and decreasing loss amounts, combined with considerable premiums being earned, newer players entered the market and began competing with previously existing players. This resulted in a much more lax standard on background checks for the principals applying for the bonds as well as driving costs down. It is widely noted that many bonds began to be written with little regard to risk consideration due to this more aggressive market with underwriters competing with each other. Around 2000 the economy experienced a faltering that resulted in principals getting into financial difficulties, requiring support of the surety bonds and ultimately the bond companies. The number of claims that were experienced between 2000 and 2002 were staggeringly high, resulting in a huge direct loss ratio that contradicted to original model of zero loss. Many carriers were forced to withdraw themselves from the market as others became insolvent.

While the terrorist attacks on September 11, 2001 did not directly affect surety companies in the same sense as careless underwriting did, there was an adverse effect that was experienced. The insurance companies that paid out money for property and casualty losses were in many cases the sureties’ parent companies as well as their affiliates. This caused the insurance companies to tighten up on requirements from the primary sureties that they owned, which in turn caused bond underwriters to make more disciplined decisions while trying to place their bonds. Around this same time period Enron filed for bankruptcy, which in turn had a negative impact on economy. Once again this created a difficult time for principals that were trying to maintain their bonds, relying on help once again from the surety bonds causing more claims.

All these events have led up to this current state of conservative guidelines for underwriters to consider while they issue the bonds, although this does have a positive consequence for all parties involved in the bonding relationship. The surety companies can avoid hazardous claims and work back closer to a zero loss ratio, stabilizing the bond market which will ease guidelines and pricing in the near future. Principals also benefit from this; companies that would have a difficult time meeting their requirements won’t get into any obligations that will hurt them financially in the long run during this unstable economy.