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"I have been doing business with your company for several years and I wanted to take this opportunity to let you know how pleased I am with your service. The staff is always very professional and courteous and I am very impressed with their efficiency and promptness in handling my very need."
- Sandi Ortiz, Pinnacle Estate Properties
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Understanding Collateral
The surety underwriting process for being approved for a bond is often similar to the process of qualifying for a loan through a financial institution. Under circumstances where an applicant or company does not initially qualify for a surety bond, the utilization of collateral is a valuable negotiating tool. Collateral, by a surety’s definition, would be an asset pledged as a means of being provided underwriting approval of a surety bond. Furthermore, collateral is a security held by the bonding company for reimbursement against a surety loss.
Throughout the course of the underwriting process, the dollar value of the cash collateral being required by the surety company can range based on a percentage of the bond penalty but also can be conditioned as being equivalent to the full face value of the bond.
The terms and conditions for the pledging of collateral on a surety bond obligation are set forth in the bonding company’s collateral security agreement (CSA). This agreement is drafted by the bonding company and must be acknowledged by the individual posting collateral upon the collateral filing.
Collateral is typically held by the surety company for the complete duration of time in which the bond is filed, in effect and/or the project associated with its guarantee is completed. Generally, Bonding company’s require proof of the bonds cancellation, exoneration or completion of the project for which the bond was issued to initiate the collateral release process. In addition, there is typically a 90 waiting period for release of such collateral subsequent to the cancellation, exoneration or project completion.
The three most commonly accepted forms of collateral a surety bond company will consider are:
- Cash
Collateral in the form of cash is typically filed with the surety bond company in the form of a cashier’s check. In most cases, the cash collateral is deposited into an interest bearing escrow account for which the surety company will often pay interest, based on a set percentage rate which is set forth prior to the collateral being filed.
- Irrevocable letter of credit (ILOC)
An irrevocable letter of credit is an instrument issued by a bank or financial institution which cannot be cancelled. It acts similar to an open credit line, for which the only entity that can withdraw funds against the line would be the surety company. Most lending institutions assess a fee for issuing irrevocable letters of credit however, it is often a more desirable form of collateral when securing a surety bond, as it does not tie up liquid cash assets.
It is important to note that most ILOC’s are drafted with an expiration or renewal date. A surety company’s collateral requirements are generally set forth to remain on file and/or open during the full term in which there is open bond liability. As a result, should your surety bond renew or remain open for a period of time which extends past the irrevocable letter of credit term, renewal of the ILOC is mandatory. Should a notice of cancellation or nonrenewal of an irrevocable letter of credit be received by a surety company prior to their liability being exonerated under the bond being guaranteed by the ILOC, the bonding company reserves the right to draw against the line of credit. In other words, the surety can “cash” the line of credit up to its full face value. Under such circumstances, additional fee’s and/or interest charges may be assessed by the banking institution.
- Real estate equity
In light of the challenges and uncertainty facing today’s real estate market, collateral in the form of a deed of trust against a piece of real estate property has become a less than desirable form of collateral to surety company’s. Nonetheless, a select few are still open to it being considered. Most bonding companies do not entertain commercial or undeveloped parcels of land as a means of collateralizing a surety bond obligation. Developed, residential, properties are reviewed based on its current equity position, which is calculated by its current assessed value less all encumbrances (first and second mortgages, home equity lines of credit balances, liens, etc.) In addition, most surety company’s discount the equity position of a property anywhere between 20-40% as a means of covering market value fluctuations. The surety company often charges fees for appraisal costs the property, charges to file the deed of trust and assesses a fee for filing the reconveyance upon release of the property as collateral. In the event a property, posted as collateral with a surety company, must be refinanced, subordination of the deed of trust will be required by the bonding company. As most surety company’s file an open deed of trust on property’s taken as collateral, it is next to impossible for the property to be sold without its reconveyance.
The Bond Exchange strives to deliver creative solutions to clients no matter what their present financial condition or personal credit position might be. The utilization of collateral as a means of securing a bond approval is utilized when no other option is available. In the event collateral is a must, our goal is to negotiate the best possible terms for our clients and work to reduce or eliminate its need in the future.
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