Finance 431SuretySlide 3Slide 4Slide 5Slide 6Slide 7Slide 8Slide 9Slide 10Slide 11Slide 12Slide 13Slide 14Slide 15Slide 16Slide 17Slide 18Slide 19Slide 20Slide 21Slide 22Slide 23Slide 24Slide 25Slide 26Slide 27Slide 28Slide 29Slide 30Finance 431Surety BondsSurety Will introduce some new concepts to youSurety businessContract and commercial bondsDistinguish from and compare to insuranceCompare to bankingSuretyWhat is surety ?Ancient processBiblical commentaryBabylonianRoman timesEnglish historyU.S. historySuretyPersonal suretyLegal developmentCommon law v statuteStatute of fraudsDevelopment of corporate suretySuretyEssence of the surety relationshipThree party arrangement Surety guarantees the obligation of a primary obligor(principal) to a third party ( the obligee) Surety -- Principal -- ObligeeSuretyIndustry highlights$ 5 billion business-approximately 1% of annual p/c revenues135 or so groups of companies write bondsMultiline and specialty companiesTop ten write approx. 70% of businessSuretyBonds support both public and private transactionsBonds are typically statutory in nature85 to 90% of contract industry premium relates to public works projects99% plus of commercial premium relates to statutory obligationsSuretyClassifications of bondsContractCommercialSuretyContractBidPerformance PaymentSuretyThe bid processDiscussionUnderwriting processThe three Cs of Credit extensionAn expensive and in-depth processSuretyCharacterToo often a given, but essentialStature in community/reputationRelationship with other business partnersExperience says watch out if an underwriter is aware of character issuesSuretyCharacterExampleContractor takes money out of company w/o telling you … or invests in business unrelated to his construction business …Bankruptcy…Other …SuretyCapacityProven track record on similar size,scope and location of workOrganization Comprehensive business planPerformance record plus the ability to meet obligations on current and future work load, bonded and unbondedContinuity planSuretyCapacity-common issuesContractor’s experience is on $ 5 million highway project Wants to bid on $ 25 million highway jobHighway contractor wants to build a $ 25 million commercial buildingSuretyCapitalCPA certified audited f/s for 3 to 5 yearsWork in process for bonded and un bonded workCost control systems Investment strategy Perform complete analysis Trends over time in profitability and liquidityCredit historyBank relationshipsAccounting systemCFO/financial stafReputation of CPA performing audits and other servicesSuretyCapital-common issuesPoor accounting systemLack of accounting and finance personnel Contractor lost money in three of the past four yearsBank debt and overall debt is growing Disputes on projects leading to slow A/R A number of jobs are losing money –drain on company’s financial resourcesSuretyCommercialFiduciaryLicense and permitCourtPublic officialSuretyCommercialFiduciaryExecutor or administrator of estateGuardianship of minor Trustees in bankruptcySuretyLicense and permitVirtually all businesses will have some license bondsCompulsory obligationsAgents/brokersReal estate brokerPermit when signs extend over a public walkwayTruckers on road with overweight loadContractors licenseTax bondsReclamation bondsSuretyCourtPlaintifs and defendantsAttachment bondsPlaintifsRelease of attachmentAppeal bondsHigh profile casesAuto companiesOil companiesSuretyPublic OfficialAdministratorTreasurerTax CollectorSuretyUnderwriting processVery similar to contract but diferent too…Complex due to many types of obligationsIndustry analysisMany obligations are long termMany obligations are non- cancelableSuretyTwo phases in underwritingAssessmentWhat is the obligation ?Can the principal do it?Protective How can/will the underwriter protect themselves ?What indemnity and what form ?SuretyFactors of significanceReputation and standingAbility to complete obligationFinancial conditionQuality of financial data prep and presentationIndemnity providedGeneral agreement of indemnityCollateralSuretySurety’s ResponsibilityFulfill the commitments to various stakeholdersPrincipal’s responsibility to suretyComplete the obligationIndemnify against lossMay be asked to provide collateralSuretyLegal remedies in case of lossPrincipal is primarily responsible for the obligationIn case of lossIndemnificationSubrogationSuretyInsurance v surety bonds ComparisonsBoth regulated by statutes/reqs at state levelTransfer of risk/assumption of riskPremium paidProtection against financial lossContract defining the riskSuretySome key distinctionsTwo party (insurance) vs. three party (surety)Third parties receive protectionPrincipal is not protected by bondLaw of large numbers does not applyLoss expectation v no loss anticipatedPrincipal is always primarily responsible for completion of the obligationMost surety obligations are not cancelablePremium non payment is not valid reason to cancel the obligationSuretySurety and bankingSurety like banking is an extension of credit; monetary v non-monetary obligationsAnalysis of business very similarRepayment of credit or obligationBanks and sureties expect repaymentBanks and sureties do not expect a lossRights to pursue defaulting principalCollateralIndemnitySuretyQuestions?Special thanks to Professor Vonnahme for the use of his