Surety Bond Authority Weblog

Enacted on July 10, 2009, Arizona HB 2486 mandates that the state’s commercial mortgage brokers now be subject to the existing laws regulating residential mortgage brokers. This existing law requires that all mortgage brokers (residential and commercial) be both licensed by the state, and obtain the necessary mortgage broker bond. The surety bond amount shall be determined by each individual mortgage broker’s class of investors. Mortgage broker bonds for brokers with just institutional investors must be for $10,000. If any investors are “non-institutional”, the bond must be for $15,000.

Effective on October 2, 2009, Arizona House Bill (HB) 2143 mandates that all mortgage loan originators operating in the state must be officially employed by either a consumer lender, mortgage banker or a mortgage broker. These mortgage loan originators must also be covered by their employer’s surety bond (mortgage broker bond).

HB 2143 also created a recovery fund, which will be funded by: 1) an amount determined by the Superintendent of Banking for those originators attempting to acquire their original license; and 2) fees acquired via annual license renewals (only when recovery fund drops below $2 million). The recovery fund covers only actual out of pocket losses, as well as court costs and attorney fees, and has a $200K limit per claim against the fund.

Effective on November 21, 2009, Alabama SB 232 created a new surety bond requirement for the state’s mortgage brokers. This bill allows the State Banking Department to require mortgage brokers to obtain a mortgage broker bond in place of meeting current net worth requirements. Surety bond amounts will be determined by the Banking Department.

2008 saw a large increase in the amount of legislation pertaining to mortgage broker bonds and mortgage lender bonds (types of commercial bonds). Most of the legislation focused on tightening regulation on mortgage brokers and lenders, and also on increasing the specific license bond amounts. While a good amount of legislation has been passing, many states are willing to wait and see what the US Congress’ economic stimulus plan entails this year, which will aim to alleviate economic problems in general as well as the significant problems in the housing markets, and what impact such changes will have on the surety bond industry. Before making any significant changes with regards to mortgage broker bonds or mortgage lender bonds regulation, some states wanted to see if any actions taken by Congress would significantly decrease the demand for the renewal of these surety bonds. In the aftermath of the subprime mortgage market meltdown, many mortgage brokers have been forced to go out of business, or have voluntarily shut down their operations.

This past year, numerous states, as well as the District of Columbia, passed bills that created either a new mortgage broker bond and/or mortgage lender bond requirement, or increased an existing bond amount.

States with changes to their required bond amounts:
• Connecticut’s House Bill (HB) 5577 doubled the required amount for mortgage broker bonds from $40,000 to $80,000.
• In Iowa, HB 2556 doubled the amount for mortgage brokers and bankers from $50,000 to $100,000.
• Maryland’s HB 363 & Senate Bill (SB) 270 also doubled the required amount of the license bond needed for mortgage lenders depending on the loan volume. Loan volumes of $3,000,000 or less saw the surety bond requirement increase from $25,000 to $50,000. Loans of $3,000,000-$10,000,000 rose from $50,000 to $100,000. The surety bond requirement for any loan greater than $10,000,000 went from $75,000 to $150,000.
• Conversely, Idaho’s HB 450 got rid of the $10,000 license bond required for loan originators.
• District of Columbia Bill 1020 added a net worth requirement on mortgage brokers to go along with the current license bond requirement. The recently enacted bill gives mortgage brokers the option of paying into a recovery fund, as prescribed by the Commissioner of Insurance, in lieu of meeting the previously mentioned net worth and license bond requirements. The surety bond amount is based off of the loan volume of the respective mortgage broker, with a $12,500 minimum and a $50,000 max.

Other changes to requirements pertaining to mortgage broker bonds (and/or lender):
• With the enactment of HB 2463, North Carolina mandates that “mortgage servicers” must be subjected to the same licensing and bonding requirements as mortgage brokers and lenders operating in the state.
• Similarly, in Pennsylvania, HB 2179 requires that “correspondent lenders” post the license bond required for mortgage brokers.
• Wyoming’s SB 44 changes the forfeiture requirements under the existing law for the license bond required for mortgage brokers and lenders. While the previous law required that the entire surety bond be forfeited to persons suffering damage as a result of a violation by a mortgage broker or lender, the new law requires that the bond only be forfeited in a sufficient amount to right the wrong. In the event that the violation exceeded that amount, the entire penal sum of the license bond could be forfeited.

All states are under a time crunch to rapidly implement Title V of 2008’s Housing and Economic Recovery Act. As part of this bill that Congress recently passed, there are a number of new federal mortgage broker licensing standards.

Under these provisions, mortgage originators in each state must become licensed in their state/s of operation in order to at least meet the new minimum standards set forth by this new federal law. One example of these new requirements pertaining to licensing is that all mortgage originators must do one of the following:

1.  Provide payment into a recovery fund.
2.  Obtain a surety bond for the specific loan amount.

States have only two years to comply with the Housing and Economic Recovery Act of 2008, and put in place the minimum licensing requirements for all mortgage originators. After this two-year period, all that do not comply with the new standards may be subject to penalty from a system yet to be determined by the Department of Housing and Urban Development (HUD).

While many states already had a mortgage broker surety bond requirement, to date it appears that most states are opting for the surety bond requirement under the new law. One new component to this law is that the surety bond must be based on the loan’s actual dollar amount. This is a requirement that some bank commissioners will have to adjust to. The Surety & Fidelity Association of American (SFAA) has given all states guidelines to assist with the new state regulations, and have provided regulatory language and a description of a mortgage broker bond. They suggest a mortgage broker bond amount in the range of $12,500-$50,000, which as previously stated will be based on the loan volume of the mortgage originator.

At first glance, some people may assume that mortgage bonds (mortgage banker bonds, and mortgage broker bonds) are all the same. While there are some similarities between the two types of commercial bonds mentioned above, there are also some clear differences which this article will outline.

Mortgage Banker vs. Mortgage Broker: Most surety bond companies classify mortgage banker and mortgage broker bonds in a similar fashion, but there are some operational elements to each that differentiate the two. Mortgage brokers serve as a “middleman” by bringing principals together with banks that end up loaning qualified principals funds. Mortgage bankers (also referred to as mortgage lenders) are the entities that actually lend money to the principals, and they act as both the banker and broker for the loan. Understanding the difference between a mortgage broker and a mortgage banker (or lender) is the first step toward understanding similarities and differences between mortgage broker and banker bonds.

Bond Amounts: Perhaps the most obvious difference between the two types of bonds lies in the amounts in which they are commonly written for. Mortgage banker bonds are typically much larger, or written for much more money, than mortgage broker bonds are, and can be two to three times the size of mortgage broker bonds. Therefore, qualifying for mortgage banker bonds can be much more challenging for a prospective principal.

Bond Forms: Every state will have a separate bond form for mortgage banker and broker bonds, which will spell out exactly that the specific bond guarantees. The bond forms may differ depending on the language of each state. While any given state’s bond forms for each type may appear similar, it is important to carefully read the bond form, or work with a knowledgeable bond agent, to ensure you understand exactly what is being guaranteed.

Similar Risk for Mortgage Bankers and Brokers: Contrary to popular belief mortgage banker and mortgage broker bonds both have very similar risk factors. Seeing that the bond amounts for mortgage banker bonds are on average significantly higher than those of mortgage broker bonds, most people would think that mortgage bankers face more risk, however that assumption is not necessarily accurate. While the nature of a mortgage banker’s job makes the risk they face obvious to most, the many challenges mortgage brokers face seem to level the playing field when it comes to risk. Recent studies have further proven that the claims ratios for both types of bonds are comparable.

Over the past decade, the surety bond industry has seen some significant changes that have changed the industry landscape, particularly when it comes to high risk bond programs. Companies that were dropped by their bond companies as a result of bad credit, etc, have been forced to find new bond agents in order to help them attain new surety bonds. This created a slew of challenges for agents, as they now have to find markets for these customers with credit problems, and will typically require significant collateral in order to write a bond for someone with bad credit. To serve these types of principals, Bad Credit Surety Bond Programs came into play.

High Risk = Higher Premium: Before there were high risk bond programs, underwriters of surety bonds would only write bonds for customers (or principals) that presented little to no risk of having a claim arise against them. In other words, they went after a “0% loss ratio”, and the bond companies were in a position to do so. With Bad Credit Surety Bond Programs, the underwriters of bonds are able and willing to write bonds for principals that are higher risk (of having a claim), and can do this by approving them at higher premiums. Similar to insurance companies, surety bond underwriters can approve a wider array of customers, but approval for those more likely of having a claim obviously comes at a cost to the principal… higher rates.

Collateral vs. Increased Premiums: Early on in the process, Bad Credit Surety Bond Programs brought about a need for bond companies to require collateral from principals. This tends to be a cumbersome, time-consuming process that involves a lot of administrative effort, and therefore many bond companies decided to avoid the collateral requirement by offering higher premium rates to their principals. Customer preference depended on the specific principal’s financial situation. Typically, however, the bond programs that offered higher premiums vice collateral were less expensive for the first year of the bond, but over time those that required collateral proved to be less expensive. This was due to the fact that the collateral would eventually be returned to the customer (roughly a year after the bond’s release) if no claims arose.

Knowing Your Options: It is important for principals with bad credit to understand what all of their options are. While many Bad Credit Surety Bond Programs are designed to meet the needs of customers with poor credit, and often times prove to be the most cost-effective option, they are not the only option available. For example, an Irrevocable Line of Credit (ILOC) is an alternative whereby the bank will freeze liquid assets of a principal in an amount equal to the total amount of the surety bond they would need to purchase. This would only be more preferable for principals with enough liquid assets to comfortably have the amount of the ILOC frozen by a bank. For customers that truly value their liquidity, and ability to quickly have cash on hand, an ILOC is probably not a viable option. While ILOCs have traditionally had service fees of around 1% the cost of the line of credit, the money market rate will have an impact on that as well, and can significantly raise the annual rate of the ILOC for the customer. For example, if the money market rate is 5%, and the service fee for the LOC is just 1%, the actual annual rate the principal pays for the ILOC is 6%. Customers must understand the choices available to them, and should choose the option that best fits their specific needs.

Outlook: High Risk Surety Bond Programs have been around for more than 5 years now, and it does not appear that they are going anywhere in the foreseeable future. More and more companies are willing to write surety bonds for principals with bad credits, and those that carry some sort of risk of having a claim arise. While increased premiums are part of what makes bonding companies willing to do this, the increasing number of bonding companies writing high risk has created competition. Competition is obviously a good thing for the customers, in this case the principals with bad credit, because it will eventually drive premium rates down, making Bad Credit Surety Bonds more affordable.

In July 2008, North Carolina House Bill 2463 was passed, and contained a number of changes to the state’s “Mortgage Lending Act” (Article 19 of G.S. 53).  While Article 19 applied to just mortgage bankers and mortgage brokers, HB 2463 extended coverage to include “mortgage servicers” in the state of NC. 

This bill requires mortgage servicers to post a $150,000 license bond (type of commercial bond/surety bond), the same type/amount already required by other mortgage lenders operating in North Carolina. 

With the signing of this bill, the NC Banking Commission is now authorized to charge a fee for expenses incurred during examinations of any licensees’ books/records in order to ensure compliance.  Before HB 2463, such examinations were paid for by the Commission. 

To clarify, the term “mortgage bankers” pertains to a person that makes mortgage loans, while “mortgage brokers” are people who solicit applications for such loans, issue loan commitments, etc. 

Legislation was recently passed that now places Alaska-based mortgage bankers and mortgage brokers under the direct regulation of the state’s Division of Banking and Securities. The new legislation requires all brokers and lenders that apply in the state after 1 July 2008 to ensure compliance with the new regulations. The law requires all mortgage brokers and mortgage bankers throughout Alaska, not just new applicants, to be in compliance with the new regulations no later than 1 March 2009.

Some of the new regulations under the Alaska Division of Banking Securities are a more extensive background check, additional monitoring of company records and applications. There will also be a mandatory examination and annual continuing education requirements for Mortgage Originators. A surety bond in the amount of $25,000 will be required as well. However, since Alaska is not considered to be a “brick & mortar state”, physical offices will not be required for mortgage brokers/bankers.

To understand surety bonds, and how they work, it is best to start off by breaking them down into larger groups or categories. There are two major categories of surety bonds: Contract and Commercial Bonds. In this article, I will briefly explain what each of the previously listed bond types guarantees, and will also provide you with a few examples of each.

The first category of bonds I will discuss are contract bonds. Contract Bonds are purchased by a contractor (or principal) from a surety at the request of a project owner (obligee), and essentially provide obligee with assurance that the principal will perform in accordance with the terms of the contract (i.e. complete the work, pay subcontractors, material suppliers, etc.).

Examples of Contract Bonds:
• Bid Bonds - Bonds that guarantee that a contractor will enter into a contract at the amount bid and post the appropriate performance bonds.
• Construction Bonds - These are bonds designed to guarantee the performance of obligations under a construction contract.
• Payment Bonds - These bonds guarantee payment of the contractor’s obligation under the contract for subcontractors, laborers and materials suppliers associated with the project.
• Performance Bonds - Guarantee performance of the terms of a contract by a contractor.
• Site Improvement Bonds - These bonds guarantee that any public property that was disturbed or altered during the conduct of a private project will be completely restored upom completion of the project.
• Subdivision Bonds - May be required by local government to ensure that landowners follow-through and complete mandatory public improvements made to their property by builders.

The next category of bonds we will cover are Commercial Bonds. There are dozens of different types of commercial bonds, which guarantee the obligee that the principal (purchaser of the bond) will perform per the terms listed on the bond.

Some examples of the many types of Commercial Bonds are:
• ARC Bonds - Required by the Airlines Report Commission.
• Auto Dealer Bonds - Bonds required by each state to ensure auto dealers abide by state regulations.
• Broker Bonds - The different types of Broker Bonds available are Freight Broker, Insurance Broker and Mortgage Broker Bonds.
• Cigarette Tax Bonds - Cigarette distributors may be required to obtain this type of bond to ensure payment of taxes.
• Collection Agency Bonds - Bonds required by a governing body to ensure collection agencies operate within rules and regulations.
• Freight Broker Bonds (BMC-84) - These federally-mandated bonds must be obtained by freight brokers to ensure delivery of brokered goods.
• License & Permit Bonds (not listed) - Due to the very high number of bonds nation-wide that fall under this category, this link will provide general information on license & permit bonds.
• Liquor Tax Bonds - Bonds required to guarantee the payment of taxes collected on liquor and other alcoholic beverage sales.
• Mortgage Broker Bonds - Bonds that are required by many states to ensure that mortgage brokers operate in accordance with all pertinent rules and regulations of that particular state.
• Sales Tax Bonds - Required by the government to ensure timely payment of sales tax by a company.
• Telemarketing Bonds - These types of bonds are required by the state to ensure that telemarketers, or phone solicitors, follow all rules and regulations set forth by that particular state in the conduct of their solicitation.

 
Contract and Commercial Bonds can also each be further broken-down into many more sub-categories (i.e. A License & Permit Bond is a sub-category of Commercial Bonds), and some of these sub-categories can have numerous different types themselves. Each and every sub-category of surety bond is underwritten differently by the surety bond companies, and there may also be different application requirements for each types as well.