A common question asked of my office is where is the collateral held. First, let us go through the four types of collateral.
1. Cash Deposit
When you are depositing cash, it is wired to the surety company, which holds it pending the resolution of the matter. The cash is deposited with them and held in their account, where it will remain until the bond is canceled. Different surety companies pay various levels of interest depending on the amount deposited and for how long the funds will be held. I work with a company that pays interest tied to the 3-month treasury bill less a .4% (4/10 of 1%) management fee. While another surety company pays only 1% interest. Rates will fluctuate along with the amount of interest that will accrue. I always suggest asking your surety bond broker how much interest will accrue on your deposit.
2. Letter of Credit
The letter of credit (LOC) is a financial instrument issued by a bank. It is a guarantee from the bank to the surety. The bank sends the surety the original letter of credit, which is held pending resolution of the matter. The surety will require that the bank be acceptable to them (i.e., an acceptable credit rating and quality). The surety will also require that the bank use a format required by the surety in order to accept the LOC.
3. Pledge of a Non-Retirement Brokerage Account
Depending on the wealth manager, they may have a pledge agreement. The surety reviews that agreement and deems it acceptable to them. They can use that agreement to secure a non-retirement brokerage account.
The word non-retirement is necessary because if you pledge retirement assets, the transaction is now a taxable event. If it’s a non-retirement account and the wealth manager has an acceptable form for the surety, they can, in many cases, then take a pledge of the brokerage account.
Something with which to be aware when pledging securities is they fluctuate. The surety may take a buffer on the securities of approximately 130% compared to the bond amount, so if the securities decrease in value, the surety is protected.
4. Real Estate
Different states have different forms that are required to secure real estate. Generally, the surety will file a mortgage or a deed of trust against the property. After an independent appraisal is conducted, an attorney will draft the mortgage or deed of trust. They are going to have a title policy for that property and also are going to perform a title check.
All of these outside costs are borne by the client obtaining the bond and are separate from the bond premium. Another thing to note is that in certain states, there may be a mortgage recording tax, the cost of which is also borne by the bond principal or the entity applying for the bond. Different states have different fees to have mortgages filed. In New York State, the process is very costly, while in New Jersey it is significantly cheaper.
These are the four most common types of collateral and their different ins and outs. If you are required to put up collateral for a bond, have an expert who has frequently taken collateral for bond matters, so they can guide you through the process and make it as painless as possible. Feel free to give me a call. — Neil Pedersen, Pedersen and Sons Bond Agency, Inc.
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