Bonding: Subprime is Not a Dirty Word

The term “subprime” has had a bad rap, and with good reason. After all, it’s associated with predatory lending practices that have had a lot to do with the current financial crisis in the United States.

But subprime lending isn’t bad by definition; it simply means extending credit to less qualified borrowers, who pay a higher interest rate to compensate the lender for its increased risk. And it isn’t new — historically, most financial and insurance products have had some sort of subprime market.

In construction, subprime bonding works essentially the same way as traditional bonding. Performance bonds, payment bonds and other products are available either by the job or as part of a bonding program. The key difference is that subprime sureties charge higher rates (often double those charged for traditional bonds) to cover the additional risk.

In addition, subprime sureties usually demand personal guarantees from the owners as well as collateral, which may have to be in cash. For a particularly risky contractor, the surety may also require the use of an arrangement (funds control) to receive project payments, pay subcontractors and meet payroll.

A Sign of the Times

Naturally, subprime bonding shouldn’t be your first choice. But in the construction industry, access to bonding can be critical to a firm’s survival. And subprime bonding offers a viable option for contractors that don’t qualify for traditional bonding in today’s tight market. Contractors who were very bond worthy not long ago are now beginning to consider these options out of necessity.  Subprime bonding may also be appropriate for contractors that are entering new geographical markets, tackling new types of work or bidding on larger projects to stay competitive.

Check Your Options First

Before you pursue subprime bonding, consult your advisors to be sure you understand the risks and structure the best deal possible. As always, good business planning is a must.

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About Alan Sandersen

Mr. Sandersen is the firm's Senior Partner, responsible for general management as well as development of the firm's tax practice and governmental audit practice. He is a graduate of Texas A&M University and a licensed CPA in Texas. Mr. Sandersen frequently provides financial/tax commentary and analysis in both print and television media.

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