bid bonds

Secrets of Bonding #37: Counting Counts!

Steve GoliaLeave a comment

One for you, one for me.

Two for you; one, two for me.

Three for you; one, two, three for me!

What fun, unless you are a surety underwriter and you’re incorrectly evaluating a financial picture.

When we review a new applicant for bonding, a range of factors are considered and the financial aspect is always one of them.  Sureties want to be confident that the company is stable and will be able to perform the bonded contract.  This includes the financial capability to finance the start of the work and deal with any issues that arise.  Such problems, if left unresolved, are the things bond claims are made of.

Who is the typical applicant for performance bonds?  Most often it is a privately owned company.  The focus of the financial evaluation is the fiscal year-end (FYE) of the company, which frequently is December 31st.

A range of elements are reviewed to determine the health of the company and its ability to survive the issues that often arise on construction projects.  One element is Cash.  Always the first (most liquid) asset listed on the Balance Sheet, you’ve heard the expressions: Cash is king, Cold hard cash, A cash cow!  A strong cash position is universally recognized as a sign of health.

As part of the primary financial evaluation, underwriters calculate the company’s FYE cash position.  Secondarily, the finances and cash position of the company owners will be reviewed.  These parties are indemnitors to the surety even though they are not direct bond applicants (bond “Principals”).  In the event of loss, the surety is entitled to look to these parties for salvage and subrogation (financial recovery) – so the financial strength they add to the picture is relevant.

Trick Question: If financial statements show that the company has $100,000 cash at the 12/31 FYE and the owners personally have $100,000 on 1/31, do you have $200,000 for underwriting purposes?

Answer: You do unless that’s the same $100,000 that you’re counting twice.

Company owners may loan money to the firm and later pay it back. Money gets moved around, sometimes quickly.  There should be corresponding debt entries on the financials.  But if people “forget” to show them, readers can be tricked into counting the same asset twice.  How can underwriters prevent being fooled into double counting dollars?

The solution is to always require concurrent financial statement dates.  We will always request personal financial statements as of the fiscal year-end date of the company. Personal year-ends are automatically 12/31.  But if the company has chosen a different date, that will be the personal FS date we want.

It is also typical, when reviewing unaudited (unverified by an independent third party) financial reports, to ask for proof of the cash assets – such as bank or brokerage statements.

So there you have it.  When bond underwriters count the cash, they prevent counting the same dollars twice by requiring business and personal financials as of the same date, because Counting Counts!

Call us with you next Contract, Site or Subdivision Bond.

FIA Surety / First Indemnity of America Insurance Company
2740 Rt. 10 West, Suite 205
Morris Plains, NJ 07950
Office: 973-541-3417

An “A Rated” Carrier

Visit our Free CE school.

Secrets of Bonding #36: When Gross Profits are Gross!

Steve GoliaLeave a comment

Gross Profit, Net Profit, “I can’t remember which is which.”

Here’s an easy way to remember: Gross profit is the larger number.  A Gross of something is a big amount: Picture 144 baby chicks hopping around…  In this case, Gross means “big” not “bad.”

Net profit is the smaller number. Think of when you pour something through a net or  sieve: Less comes out.

OK, so Gross Profit is found by subtracting Direct Costs from Revenues (or Sales).  These numbers always appear on a company financial statement (FS) in the “Profit & Loss” or “Statement of Income” section, near the top.

For a masonry contractor, examples of Direct Costs are bricks, mortar and the labor to install them.  Some Indirect Costs would be rent, phone expenses and office salaries.

You may have seen a Work In Process schedule which shows the financial status of open contracts. That is literally the same as the Gross Profit analysis but is specific for  each project. (Keep this in mind when you read the cool bonding tip at the end.)

Now in order to be successful, companies need to produce a Gross Profit sufficient to cover all their indirect expenses and then yield a Net Profit (which always appears at the bottom of the page.)

As surety agents, we often see companies that are suffering from lack of work. Their projects are profitable, but they don’t have enough of them.  They show a Gross Profit but cannot cover their Indirect Costs and therefore produce a Net Loss (they lose money for the year.) Maybe if they had laid off non-essential staff, closed an office or reduced other expenses, the Net Loss could have been avoided. The point here is that the contracts were performed successfully, but other expenses were not adequately managed and a Net Loss occurred.

The inspiration for this article was a FS we received that showed a negative Gross Profit. Pretty unusual.  So what did it mean?

In this case the company lost a significant amount of money on one contract.  The loss was so great that it exceeded all the gross profits earned on other projects resulting in a negative Gross Profit (a loss). Next comes the Indirect Expenses which resulted in a significant Net Loss.

When a negative Gross Profit is produced, it is almost impossible for a company to have a profitable year.  In that case, the Gross Profit is Gross – meaning bad!

Here’s an example of what you’d see on the Statement of Income:

Statement of Income

Income

          Current Earnings – $1,000,000

          Current Costs – $1,250,000

          Gross Profit (Loss) – ($250,000)

Indirect Costs

          General & Administrative Expenses – $75,000

Net Loss – ($325,000)

Cool Bonding Tip: The Gross Profit section of the P&L describes the accumulated results of past projects, similar to the WIP schedule which shows today’s projects individually, during their performance.

By comparing the expected GP % of incomplete jobs on the WIP schedule to last years P&L, you can predict if the new projects are likely to result in a NET profit for the upcoming year-end financial statement (assuming other factors, such as expenses and total revenues, are similar to the prior year.)

Business owners facing such circumstances should consider immediately cutting indirect expenses in a proportionate amount  so a fiscal year-end net profit is more likely.

Call us with you next Contract, Site or Subdivision Bond.

FIA Surety / First Indemnity of America Insurance Company
2740 Rt. 10 West, Suite 205
Morris Plains, NJ 07950
Office: 973-541-3417

An “A Rated” Carrier

Visit our Free CE school.

Secrets of Bonding #32: Bond Definitions – Take the Quiz!

Steve GoliaLeave a comment

Answers appear at the end of the article – good luck!

“You may begin.”

1. Bid Bond

a. Required by Auctioneers
b. A very small bond
c. Bond that accompanies a construction proposal

2. Surety Consent (to accompany bid)

a. Promises to provide the related Performance and Payment Bond
b. Agrees to all conditions in the related contract
c. Agrees that bond claims will be paid within 30 days

3. Bid Bond Percentage

a. Ratio of successful bid proposals
b. Portion of bid bonds used in one calendar year
c. Determines the dollar value of the bid bond

4. Performance Bond

a. Always makes reference to a written contract
b. May not be cancelled by the surety
c. Both a. and b.

5. Balance of Contract Amount

a. The point at which a contract becomes profitable
b. The unpaid portion of the contract
c. Relationship between labor and material costs

6. Payment Bond

a. Used to guarantee loans and leases
b. Guarantees payment of proper union wages
c. Guarantees suppliers of labor and material will be paid

7. Third Tier Sub

a. A class of subcontractors not covered by the Payment Bond
b. Submarines that go very, very deep
c. Low quality subcontractors

8. Subdivision Bonds

a. Similar to Submultiplication and Subaddition bonds
b. Similar to Site Bonds
c. Similar to submarines that go very, very deep

9. Penal Sum

a. Dollar value of a bond
b. Often a source of envy
c. When two penals are added together

10. Site Bonds

a. Guarantees improved vision after Lasik eye surgery
b. Guarantees the construction of public improvements
c. Guarantees a construction contract

11. Single Job Limit

a. The largest job a contractor ever performed
b. The largest job a contractor is interested in undertaking
c. The largest job a surety is willing to bond

12. Work on Hand

a. Remaining “cost to complete” for open projects
b. Underbillings
c. Costs relating to labor performed by hand

Extra Credit:

13. “Full” Indemnity

a. The indemnity of the applicant company including all of its assets
b. The indemnity of the applicant company, all owners and spouses, plus other owned/controlled companies
c. Indemnity equal to the full value of the bond amount in question

Answers:

1: Bid Bond – Bond that accompanies a construction proposal (C)

2: Surety Consent – Promises to provide the related Performance and Payment Bond (A)

3: Bid Bond Percentage – Determines the dollar value of the bid bond (C)

4: Performance Bond – Always makes reference to a written contract AND may not be cancelled by the surety (C)

5: Balance of Contract Amount – The unpaid portion of the contract (B)

6: Payment Bond – Guarantees suppliers of labor and material will be paid (C)

7: Third Tier Sub – A class of subcontractors not covered by the Payment Bond (A)

8: Subdivision Bonds – Similar to Site Bonds (B)

9: Penal Sum – Dollar value of a bond (A)

10: Site Bonds – Guarantees the construction of public improvements (B)

11: Single Job Limit – The largest job a surety is willing to bond (C)

12: Work on Hand – Remaining “cost to complete” for open projects (A)

Extra Credit: “Full” Indemnity – The indemnity of the applicant company, all owners and spouses, plus other owned/controlled companies (B)

Congratulations: You passed!

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site, Subdivision, Bid and Performance Bonds since 1979 – we’re good at it!  Call us with your next one.

Steve Golia, Marketing Mgr.: 856-304-7348

First Indemnity of America Ins. Co.

(Don’t miss our next exciting article.  Click the “Follow” button at the top right.)

Secrets of Bonding #26: Bond Request Forms (The Gift That Keeps Giving)

Steve GoliaLeave a comment

For the agent and client, there is plenty of paper to handle on contract surety bonds.  So just when you get through the questionnaire, business plan, resumes, references, WIPs, and financials there is STILL ONE MORE DOCUMENT THAT WE NEED!

Yes, it is true.  Bond Request Forms are the gift that keeps giving because you get the opportunity to do one as each bond comes up.  So, considering these forms are not going away, let’s get comfortable with them.

Why Needed

The Bond Request Form is a summary of key factors concerning the specific contract and bond in question. The form is used for both Bids and “Final” bonds (Performance & Payment). It covers basics such as the name of the contractor and obligee, description of the work and the specific bonding requirements.

The form is used for underwriting and administrative purposes.  The underwriters review the details and may literally sign their approval on the form.  The admin staff will type the bond based on the Request Form – so completeness and accuracy are crucial.

Let’s break it down and go over some key areas:

  • The Principal is the contractor and the Obligee is the party paying for the work.  Sometimes the word “Owner” is used interchangeably with Obligee. If you see Owner on the Bond Request, it is not asking for the name of the owner of the construction company; it means “Obligee.”
  • The description of the work should read as stated on the related contract or bid invitation.  If you are bonding a roofing contract, the description should not be “4th Avenue Elementary School.” It should say “…roofing…”  On a final bond such errors are embarrassing. In a bid situation an incorrect job description could result in a bid protest (by the second bidder) and loss of an award.
  • For Bid Bonds, show the estimated contract price (ECP), not the actual bid amount.  This is to protect the bid confidentiality.  Sometimes we bond more than one contractor on the same bid.
  • Always submit a sufficiently high ECP to allow room for a last minute bid increase. (See Secret # 8.)
  • Show the actual bid date, not the day before for “safety.”
  • Bid results are important to show if they are available.  Typically they are on public work.
  • When indicating the final bond requirements, do not indicate “100% P&P” unless the spec actually calls for this.  Some projects require a Performance Bond but no Payment.  It would be important to not automatically issue a Payment Bond, since they are the most frequent source of surety claims. The Principal and Surety should never voluntarily assume this risk.
  • Work On Hand: The current WOH figure is comprised of the “estimated cost to complete” of all open work – excluding the project in question.
  • Be sure to fully complete the form, include required attachments and sign if necessary.
  • Points of interest:
    • Sureties are usually reluctant to provide a 125% P&P Bond.
    • If the bond is for less than 100% of the contract amount, there may be no reduction in the bond cost.

Bond Request Forms: We love them and you should too!  Every one is a chance to serve your client and  make money. 

Call us with you next Contract, Site or Subdivision Bond.

Steve Golia

FIA Surety / First Indemnity of America Insurance Company
2740 Rt. 10 West, Suite 205
Morris Plains, NJ 07950
Office: 973-541-3417

An “A Rated” Carrier

Visit our Free CE school.

Secrets of Bonding #25: World’s Cheapest Audit

Steve GoliaLeave a comment

When it comes to financial statements prepared by a CPA (Certified Public Accountant), there are three levels of presentation:

Compilation – This is the lowest level and does not include any checking or verification of the numbers by the accounting firm. The numbers are merely “compiled” by the CPA.

Review – Some checking and “review” by the CPA.

Audit – The CPA performs analysis and verifications to authenticate the numbers.

Bond underwriters expect better prepared financials for higher amounts of surety credit.  This means contractors that have large bonding lines must provide Audited company financial statements (FSs).  Sureties and bankers are more confident when analyzing an audited FS – we assume everyone would have these high quality financial reports if it wasn’t for the cost.

Because of the time and human resources involved, a Review is less expensive than an Audit, and a Compilation is the least expensive of the three.

So in comes your contractor client who, for a number of reasons, decided to have a Compilation at the last fiscal year-end.  Now a large project needs to be bonded, and from a size standpoint, the underwriter normally expects a Reviewed FS.  If it is not practical to go back and upgrade the Compilation to a Review, what are your options?

The underwriter may be willing to work with the Compilation FS if some key elements are documented and / or verified.  Such an analysis is the heart of the difference between a Compilation and a Review.

At the minimum the underwriter is likely to ask for proof of cash, aged receivables (A/R) and payables (A/P), and a Work in Process (WIP) Schedule.  Let’s go over each one briefly.

Cash: If the FS date is 12/31, the idea would be to provide proof of the cash amount shown on the FS on that date.  If the FS shows $52,125 cash, you need bank or brokerage statements adding up to that figure for 12/31.

A/R & A/P: These reports should be as of the FS date and add up to the receivable and payables listed on the FS.  The A/R should be broken down by age showing how much is current, 60, 90, and over 90 days old. Retainages should be identified since they are not regular “trade receivables.” It is also beneficial to indicate which receivables were subsequently collected after the fiscal date. Payables should also be aged.

WIP Schedule: Needed as of the fiscal date to support the analysis of the company balance sheet.

This strategy is not as good as actually having a CPA Review, but the analysis performed by the underwriter could substitute for a Review and justify issuance of a bond. Plus, such services performed by the underwriter are free!  So, even though this is not really an Audit or Review, you can think of it as the “World’s Cheapest Audit.”  It can be just what you need to get a bond and keep moving forward with the file.

For the future, if similar sized bonds are likely, the client should plan on having a Review performed at the next fiscal year-end – it will help with surety and bank credit.  Added bonus: The company will have better documents for management review and the accountants will provide professional guidance that is not included with a Compilation.

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site, Subdivision, Bid and Performance Bonds since 1979 – we’re good at it!  Call us with your next one.

Steve Golia, Marketing Mgr.: 856-304-7348

First Indemnity of America Ins. Co.

(Don’t miss our next exciting article.  Click the “Follow” button at the top right.)

Secrets of Bonding #24: Manage the Bond Manager

Steve GoliaLeave a comment

Q. Who is your bonding company?

A. Jimmy at the Smertz Agency

Am I the only one who thinks this is a strange answer? It always amazes me when contractors have no idea who their bonding company is.  It could mean that the agency is doing a fantastic job of managing the account.  But it is more likely that the contractor is doing a bad job of managing the relationship with the surety.

Who’s on first?

The bond agency plays a vital role in guiding the process forward, advising the client and supporting the underwriting process.  But for the most part, the Bond Manager controls the underwriting decisions – even if some measure of discretionary authority has been granted to the agent.

To put it simply, the Bond Manager has life or death control over the bond account. If there is a bond the manager is not interested in supporting, the contractor can kiss those revenues and profits goodbye. 

For major accounts that produce significant annual premiums and require substantial capacity, the surety will probably make themselves known.  They may ask for an annual meeting to discuss fiscal year-end results and plans for the new year.

For smaller accounts, the contractor is just a name in a computer record.  Flat.  No personality or rapport.  So when that stretch or exceptional bonding need comes up, they have nothing extra going for them.  The gate keeper doesn’t know the contractor from Adam, and there will be no special consideration.  How do you prevent this?

Manage the Bond Manager

The first step toward a good rapport is to establish open communications.  The contractor’s file should make it obvious that full disclosure is provided and the surety is appreciated as a partner – not just a vendor.  Answer all the written questions completely and candidly.  It makes the reader confident that everything relevant (the good and the bad) is all being laid out for review.

During the initial evaluation, the underwriter should visit the contractor’s business.  It is a chance to kick the tires and see the company in action.  Hey, they’re not just a file, they’re real people!

A periodic underwriting meeting with the bonding company is appropriate.  At IBCS, we like to meet with the contractors when a draft of the year-end data is available.  This is a great opportunity to provide guidance before the final version of the financial statements is produced.

Summary

The point is that bonding is based on information and the underwriter’s confidence.  Building a rapport with the decision maker is as important as any piece of information. With the help of the agent, Manage the Bond Manager and maximize the bond account for everyone’s benefit.

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site, Subdivision, Bid and Performance Bonds since 1979 – we’re good at it!  Call us with your next one.

Steve Golia, Marketing Mgr.: 856-304-7348

First Indemnity of America Ins. Co.

(Don’t miss our next exciting article.  Click the “Follow” button at the top right.)

Secrets of Bonding #23: Myth Busting the T-List

Steve GoliaLeave a comment

Technically the correct name is “Circular 570.”  The federal Treasury Department produces this list, thus the nickname “T” list. Website: “fms.treas.gov/c570/c570.html”

It is re-issued each July first and contains all the corporate sureties reviewed and approved by the Treasury Department.  It also states the largest single bond amount they may provide on a federal contract. Let’s look at some common assumptions about the T-list.

Myth: The IRS tried to withhold tax exempt status from the Tea-List.

Finding: False! (Just wanted to see if you’re paying attention.)

 

Myth: The government somehow “backs” the sureties on the T-List.

Finding: False! The companies on the list are merely pre-approved for the convenience of the government when administering contracts. The purpose is not to benefit anyone outside the government.

 

Myth: T-listed sureties are the best in the industry.

Finding: False! Acceptance on the T-List indicates that

1. The surety chose to apply for approval, and…

2. They obtained it.

Being T-listed does not indicate the relative strength of one surety compared to another.  For example, there are excellent surety companies that have never sought T-List approval – so they’re not on Circular 570.

 

Myth: It is illegal and / or impossible to waive a T-listed requirement if it is stated in a project specification.

Finding: False! Private obligees, such as a General Contractor offering a subcontract, have complete discretion and can modify the requirements if they so choose.  It is common to reserve the right to waive any technicalities if the obligee feels it is in their best interests.

 

Myth: When projects include federal funding (such as a local housing contract), federal bonding requirements automatically apply.

Finding: False! The party offering the contract may set their own requirements.  They could chose to follow some portion of the federal requirements or simply use their own. Federal requirements (as stated in the Federal Acquisition Regulations) only apply to direct federal contracts such as the Army Corps of Engineers, etc.

 

Myth: When it comes to corporate surety bonds, only the federal government is obligated to use Circular 570 sureties.

Finding: False! If other jurisdictions choose to adopt such a requirement, it would then be mandatory.

Conclusion: The T-list is a convenient tool for federal contracting officers when administering government projects.  It is also helpful for outsiders when evaluating a corporate surety bond.  Circular 570 is easy to access online and it provides a list of sureties accepted by the federal government.

However… NOT being on the list does not necessarily mean anything negative.  Not all sureties find it beneficial to seek approval on the list, so they just don’t do it.  They could still be great companies with strong bonds worth taking.  In fact, they could be the best surety in the country, and still not be on the list.  

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site, Subdivision, Bid and Performance Bonds since 1979 – we’re good at it!  Call us with your next one.

Steve Golia, Marketing Mgr.: 856-304-7348

First Indemnity of America Ins. Co.

(Don’t miss our next exciting article.  Click the “Follow” button at the top right.)

Secrets of Bonding #22: Bonding Started Projects – Adverse Selection or Awesome Opportunity?

Steve GoliaLeave a comment

On Performance Bonds (not proceeded by the surety’s bid bond), underwriters commonly ask if the project has started. Why is this relevant and what are the implications?

On private contracts where the performance bond may be optional, there is a concern that the bond is being required retroactively because some performance or payment concern has arisen.  This is where the Adverse Selection comes in. No surety wants to write a bond and immediately have a claim: “No premium is worth a claim.”

However, such bonds can be successfully produced.  It helps if the bond was always a written requirement.  This can be proven by reviewing the project specifications.  The underwriter will also review the financial condition of the project such as a WIP schedule, obtain current lien releases, the last pay application and an All’s Right letter from the obligee (confirming the work is satisfactory thus far.)

What about the Awesome Opportunity? There could be legitimate reasons for requesting the bond late.  Perhaps the contract start date was critical.  The contractor was given notice to proceed even though the bonds was not yet filed.  When this happens, the obligee may insist on the bond prior to paying of the first requisition (monthly payment to the contractor.)  This situation is not that unusual, especially for subcontractors.

Do we like these circumstances? Think of what the bond guarantees: Performance of the contract and Payment of the related bills for suppliers of labor and material.  If part of the performance obligation is completed, that extinguishes a portion of the risk – and the bond fee is still the same!  Bond fees are normally based on the contract amount, not the bond amount nor the uncompleted project amount. So it makes sense that underwriters should embrace these projects assuming they can get past the issues we discussed.

Unfortunately not all do.  But producers who know the red flags, have a fighting chance to address them and gain underwriting support from the surety.

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site, Subdivision, Bid and Performance Bonds since 1979 – we’re good at it!  Call us with your next one.

Steve Golia, Marketing Mgr.: 856-304-7348

First Indemnity of America Ins. Co.

(Don’t miss our next exciting article.  Click the “Follow” button at the top right.)

Secrets of Bonding #21: Church Projects

Steve GoliaLeave a comment

Think about it – what could be better than writing a bond to build a church?  What could possibly go wrong?

The sad truth is that these projects can be high risk for the contractor and surety.

Here’s why:

Unique Risk #1

Church construction contracts include obligations for both parties.  The builder must perform the construction correctly, on time, and for the agreed price.  The church (the “owner”) must pay for the work as it progresses.  When compared to public work such as for the city or state, church work (and other non-profits) can be more hazardous if the owner does not have all the funding in place.

Suppose they are depending on a successful fund drive?  If the contractor performs work, incurs costs, and is then not properly paid it could be detrimental to both the contractor and surety.

Unique Risk #2

An additional threat arises from the design and administration of the contract.  If there is no architect, or if the architect is terminated or withdraws during the project, the contractor may be answering to the church building committee.  This is likely to be a loosely organized group of non-professionals with no construction design experience, each with their own ideas on how to proceed – bad for the contractor!

Summary

To assure a reasonable level of professionalism and predictability on church work, it is important to confirm full funding in advance (prudent on ALL private contracts).  This could be in the form of an approved building loan or funds on deposit in an escrow account.

It is also necessary to have an architect engaged throughout the process.  Note: Design / Build contracts present more risk, not less. (Projects where the contractor is responsible for both design and construction.)

Church projects can be a heavenly experience if the proper safeguards are followed.

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site, Subdivision, Bid and Performance Bonds since 1979 – we’re good at it!  Call us with your next one.

Steve Golia, Marketing Mgr.: 856-304-7348

First Indemnity of America Ins. Co.

(Don’t miss our next exciting article.  Click the “Follow” button at the top right.)

Secrets of Bonding #20: Subordination Agreements

Steve GoliaLeave a comment

“Instant Net Worth!”

Here is another gem for your tool box.  A Subordination Agreement can solve a Net Worth deficiency problem easily – in some cases.

Why is Net Worth (NW) Important?

Net Worth is the value of the company if all its bills are paid and it is liquidated.  It is a measure of strength and staying power, and therefore is relevant to surety bond underwriters.

In a corporation, NW (aka Stockholders Equity) is typically comprised of the money initially put in to start the company (Capital Stock) plus all the net profits earned over its lifetime and retained in the company.

Sometimes the NW is insufficient to support the current bonding needs.  This problem cannot be fixed by instantly earning more net profits.  It could be addressed by adding additional capital stock, but this is heavily taxed (capital gains) upon withdrawal – so this may not be a good solution, especially if the need is viewed as temporary.  So in comes our Subordination Agreement.

Here’s how it works:

Let’s assume that an owner who originally put money into the company by purchasing capital stock has now loaned funds to the corporation.  Both are debts of the company. Here is the important difference: Capital Stock is considered Equity, and a permanent debt (because of the tax penalty assessed upon withdrawal) whereas a loan is called a Liability and is temporary since it may have periodic payback terms and there is no capital gains tax assessed.

When making bonding decisions, does an underwriter consider loaned money as valuable as capital stock?  Is money the company has temporarily as valuable as funds it holds permanently? No, of course not. The purpose of the Subordination Agreement is to make the loaned funds just as valuable, by allowing them to be viewed as permanent.  From an analysis viewpoint, this moves the loaned money from debt to equity.

The Subordination Agreement is executed by the creditor (lender of the money) for the benefit of the Surety.  It states that the creditor will not demand payment without the written consent of the surety in advance. It locks the money in.  Having this degree of control can allow a surety to treat the subordinated loan as Instant Net Worth!

Two words of caution:

  • Not all sureties are willing to rely on this strategy or may not do so for a major portion of the total NW.  We will!
  • Also, it is important to inform the CPA regarding the subordination so it can be memorialized in the financial statement notes.  The subordination only works if the creditor remembers to observe it.

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site, Subdivision, Bid and Performance Bonds since 1979 – we’re good at it!  Call us with your next one.

Steve Golia, Marketing Mgr.: 856-304-7348

First Indemnity of America Ins. Co.

(Don’t miss our next exciting article.  Click the “Follow” button at the top right.)