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Construction Lending Roadblocks? Consider a Surety Bond Alternative

May 24, 2023

Surety bonds are an essential risk-management tool for the construction lending industry. They offer a financial buffer in the event that a project is left incomplete or fails to meet its agreed upon terms and conditions. Although bonds are often a required part of construction projects, there are a number of reasons why securing a bond is not always feasible or desirable.听

Despite their shortcomings, there hasn鈥檛 been a suitable alternative to surety bonds for the lending community 鈥 until now. 麻豆放映免费, as part of an exclusive partnership with SureBuild, is pleased to announce an innovative new product called Project Completion Insurance (PCI). It provides the assurance a lender may require, without the hassles of a surety bond.

In this blog, we鈥檒l compare and contrast some of the key differences between a surety bond and PCI.

Surety Bonds: A Brief Definition

Put simply, a surety bond is a financial instrument that protects a lender if their borrower defaults and cannot complete a project. Lenders often require project owners to obtain a surety bond before they鈥檙e awarded a loan.

The bond serves as a contract between three parties:听

  1. The project owner who takes out a loan for the project and secures the bond.
  2. The bond company, or surety, who issues the bond and agrees to provide financial backing for the project owner.
  3. The lender.

How Surety Bonds Work听

Let鈥檚 say a project owner wants to build a new shopping center, but he needs a loan to fund the project. As part of the loan approval process, the lender requires him to obtain a surety bond. The project owner secures the loan and begins construction on the shopping center.听

After months of work, the project grinds to a halt, half-finished. The project owner is out of cash and has to default on the project loan. The lender works with the surety company to determine whether the terms of the bond will trigger a payout, so they can complete the project.听

Meanwhile, the project sits stalled, losing valuable time and a great deal of money.听

Challenges with Surety Bonds

Although surety bonds are an effective tool for protecting a project and loan, there are a number of reasons why a bond may not be a viable option.听

  1. A project owner/borrower may not want to tie up their assets for collateral. In addition to the premium the project owner/borrower pays the surety company for a bond, they are also required to provide collateral. If they fail to meet the terms of the bond, the surety company can use the collateral to cover losses. This collateral ties up the project owner鈥檚 cash flow, because the funds set aside for collateral aren鈥檛 accessible or able to be used for other purposes. If the project owner needs those funds for a new project, they鈥檒l need to wait until the current project is completed and the collateral is released.

  2. Once bonding limits are met, a project owner/borrower isn鈥檛 able to secure additional bonds. Surety companies put limits on the amount of bonding capacity they鈥檒l provide a single project owner. These limits are determined by a project owner鈥檚 financial strength, experience, and reputation. Once a project owner hits their bonding limit, they may not be able to get additional bonds for new projects. They鈥檒l either need to wait until current projects are completed and their bonds are released, or they鈥檒l need to seek alternative sources of financing.
  3. Unfavorable market conditions can make surety companies reluctant to provide bonds. Surety companies are, understandably, risk averse. They may decline a bond request if the project owner operates in an industry or geographic region that is facing unfavorable market conditions. For example, if the construction industry is experiencing a downturn or there is a high level of competition in the market, the surety company may be reluctant to issue bonds.

  4. The cost of a surety bond can be prohibitive. Project owners/borrowers must pay a premium to the surety company to secure the bond. The premium is typically a percentage of the bond amount and varies based on the project owner’s risk profile. This cost can be a significant expense for project owners, ranging anywhere from 50-300 . Bonds can be particularly expensive for project owners who are new to the industry or deemed to have a high risk level.

  5. A project owner/borrower may not meet the terms required for a surety bond. When deciding to issue a project owner a bond, the surety company evaluates a project owner鈥檚 overall financial health and stability. If the project owner is in a weak financial position, the surety company may consider them a risky applicant and decline the bond request. In addition, surety companies prefer working with project owners who have a proven track record. This puts project owners who are new to the industry or new to a particular type of work at a disadvantage, because surety companies may consider them higher risk.听

Project Completion Insurance: A Better Alternative to Surety Bonds

In partnership with SureBuild, 麻豆放映免费 is introducing a new product called Project Completion Insurance, which can take the place of surety bonds.听

Similar to bonds, PCI serves as protection against situations where a project owner is unable to complete a project or fails to meet a project鈥檚 agreed-upon terms. However, the beneficiary of a PCI claim is the lender, not the project owner. If the borrower 鈥 the project owner and/or developer鈥 defaults on their loan, the lender is able to step in and take back the project and complete it. The PCI policy funds up to 90% over the original hardcost budget amount.

This provides a financial safety net for the lender and gives the borrower the financial backing that鈥檚 typically required for large projects.

PCI is Project Protection 鈥 Without the Hassle or Added Costs

Available in 40 states, PCI sidesteps common challenges and problems with surety bonds.听

  • Unlike a bond, PCI doesn鈥檛 require collateral, freeing up operating cash for the borrower/project owner.
  • PCI costs less than most surety bonds. Compared to the 50-300 that鈥檚 typical for bonds, PCI runs between 40-60 bps. These cost savings can free up capital for other purposes.听
  • If a borrower/project owner has already met their bond limit, PCI enables them to take on new projects without having to wait until existing projects are completed and those bonds are released.听
  • Because the beneficiary of a PCI claims payout is the lender, it provides protection to the lender who may be wary in the midst of unfavorable marketing conditions. It removes some of the risk from the lender, giving them more confidence to take on loans they may not otherwise. For example, they may be more willing to award a loan for something the borrower hasn鈥檛 previously tackled (e.g., larger projects, projects in new geographic areas, or innovative project types).
  • PCI isn鈥檛 reliant on the same terms as surety bonds, so a project owner that is unable to be bonded, for any variety of reasons, may still be eligible for PCI.听

If you鈥檙e a retail agent working with construction businesses, a construction industry professional looking for a surety bond alternative, or you have a surety practice, PCI is an innovative addition to traditional risk-management tools. Learn more about and request a quote today.听

The 麻豆放映免费 Construction Insurance Team

The 麻豆放映免费 Construction Insurance Team

麻豆放映免费鈥檚 construction experts specialize in a variety of construction-related coverages鈥攆rom commercial general liability and professional liability to wrap-ups and workers鈥 compensation, and beyond. 麻豆放映免费 has dedicated teams of construction brokers for every risk type, account size, and geographic area in the country. We have broad market access to brokerage and binding authority and can offer exclusive program solutions to fit any construction need.
construction | Project Completion Insurance | Surety Bonds

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