David Hadlock
Net worth a barrier

New bonding requirements for Massachusetts mortgage brokers and lenders, along with proposed changes in responsibilities for the companies that bond them, are combining to cause confusion and worry.

Mortgage companies soon must be bonded to stay licensed, but many brokers and insurance industry watchers say it may be difficult, or at least costly, for some mortgage firms to fulfill that requirement.

“I’m guessing it won’t be as easy to get bonds today as it used to be,” said Alain Valles, president and owner of Hanover-based Direct Finance, a Massachusetts-bonded lender, and president of the Massachusetts Mortgage Association, a broker trade group.

Insurance agents told Banker & Tradesman and the Division of Banks – which recently imposed a $75,000 bond requirement on state-licensed brokers, increased the requirement to $100,000 minimum for lenders and proposed broad “forfeiture” requirements on insurers who offer either one – that the companies they deal with aren’t eager to bond under the Bay State’s new requirements.

“There aren’t very many companies that want to provide this,” said Phil Crawford, president of A.A. Dority Co., an insurance agent in Boston.

The “mess” in the mortgage industry today doesn’t help, as risk-averse insurance companies are already feeling more pressure to make good on bonds in other states where they are required and where brokers and lenders have run into problems, he said.

Crawford nevertheless has written three new bonds for brand-new broker businesses and one for a brand-new lender, he said. The bonding requirements went into effect for new businesses in September but won’t apply to existing license holders until Dec. 31, 2008.

Each newly bonded business paid “up to 2 percent” of the bond amount, Crawford said – which comes to $1,500 per brokerage company and $2,000 for lenders.

His agency has gotten about 50 calls from brokers and lenders concerned with the new requirement, he said. “People are very concerned whether or not they are going to qualify, because their license is their livelihood.”

Bonds are a form of insurance in which the bond company guarantees it will pay a verified loss to a third party if the bond-holder runs into problems. Check cashers, wire transfer companies and construction companies typically hold them, and most states also require them of mortgage brokers and/or lenders. The cost typically is anywhere from $3 per $1,000 in bond value for some industries up to between $25 and $30 per $1,000, which wire transfer companies pay.

Massachusetts wanted to add mortgage broker bonds and increase lender bonds so that companies that were “unable to perform [don’t] run away with consumers’ money,” said Division of Banks Chief Operating Officer David Cotney.

DOB is reacting, in part, to a wave of consumer losses and foreclosures due to predatory subprime loans.

The state’s new $75,000 bond requirement for brokers is high compared to other states and is the highest in New England, Crawford said. Formerly, most Massachusetts brokers did not have to post bonds.

Several agents said companies they work with don’t like a “forfeiture clause” in the lender and broker bond forms they will have to sign on behalf of clients and guarantee to the state.

The sentence in question orders that “In the event of the insolvency, liquidation or bankruptcy of the [bond holder], or the expiration, surrender or revocation of the relevant license, the full amount of the bond shall become due and payable to the [state of Massachusetts].”

Only Pennsylvania has a similar clause, which accompanies a $100,000 bond requirement for mortgage brokers, said Carrie Hammock, a bond specialist with Scott Insurance Agency in Lynchburg, Va., which bonds Massachusetts mortgage companies.

Scott Insurance also can write such policies for Pennsylvania brokers, she said. At least in theory. But so far no brokers from that state have become bonded because they are unwilling to meet the “very strict approval requirements” the insurance company wants and choose not to pay the $1,500 it would cost.

Pennsylvania doesn’t require brokers to post the bond if they don’t collect up-front fees from a borrower before the loan closes, Hammock said, indicating that brokers there have decided to change their way of doing business rather than post a bond.

She said the broad circumstances under which Massachusetts’ proposed form allows the state to collect a bond could include something as simple as a company going out of business.

Insurers that her agency works with, including Great American Insurance Co. and The Hartford, haven’t gotten back to Hammock’s company about whether they’ll write Massachusetts bonds under the proposed requirements, she said, but “they don’t like them.”

The Hartford did not return Banker & Tradesman’s call by press time.

Qualifications and Costs

In public comments the state Division of Banks collected on the bond form between late December and Jan. 11, three more agents voiced similar concerns.

“The [forfeiture clause] alone would prevent us from writing the bond,” wrote Matt Stevens, an underwriter with Accredited Surety and Casualty Co. of Florida.

DOB’s Cotney said his agency never before had its own bond form, but produced one because the industry asked for it.

“In order to comply with that request, we drafted one,” he said.

“If appropriate, we will make changes, but we have to review the full record,” Cotney said. New applicants must to use the draft form, he said, but to date, all but one – Next Home Mortgage Corp. of Westlake, Ohio – have chosen to wait until a final version is available.

Eric Nelson, owner of Milford-based brokerage United Funding, said his company currently pays about $200 to $500 a year to be bonded in each of several states, including Connecticut, Virginia and Florida – all of which have smaller bond requirements than Massachusetts.

“I’d be interested to hear what they are charging for the [Massachusetts] bonds,” he said.

Nelson said that if insurance companies can’t quantify the risk of offering a bond, the cost may go up, much in the same way interest rates on jumbo mortgage loans have gone up in recent months. The loans are now harder to get, and therefore more expensive for borrowers, since they are too big for backing from a government insurer such as Fannie Mae and are instead funded by mortgage-backed securities that many Wall Street investors consider too risky to buy.

Mike Gilbert, the treasurer of DeSanctis Insurance in Woburn, said the bond form language as written will “intuitively Â… exclude an awful lot of people from being eligible.”

Bonds are better applied when the risk can be defined clearly, he said. The current Massachusetts bond language “makes it very hard to quantify the risk Â… we don’t know what type of claims or how many” might be expected, he said.

Gilbert said insurance companies he talked with last week, including The Hartford and National Grange (now NGM Insurance), indicated they’d write the bonds “very much selectively and case by case – and where they do write them, I think it’s reasonable to expect they’ll be looking for individuals who [are] possibly willing and able to provide collateral either via a letter of credit or cash.”

Crawford predicted many brokers probably will offer collateral such as a bank check for the bond amount when they apply. Bond companies likely will expect them to own property, have a credit score of at least 650 and a net worth of five to 10 times the bond amount, he added.

If an applicant doesn’t have the minimum credit score, they’ll probably be able to get a bond with a letter of credit from a bank, but banks also might require the applicant for such a letter to have a similar net worth.

Unlike the Division of Banks’ new $25,000 net-worth requirement for brokers and its recently increased $200,000 net-worth minimum for lenders, which stipulates that the value of the broker’s or lender’s home be excluded from the calculation of his or her net worth, net-worth requirements for bonds or bank letters of credit allow a broker’s equity in his or her residence to be included, Crawford said.

Still, he predicted, “I am sure a lot of the smaller mom-and-pop shops will have trouble qualifying.”

That’s what Valles, of Direct Finance and MMA, also believes, and it upsets him.

“This now impacts the competitive playing field,” he said. “From our point of view, Economics 101 says that if you have many players in a market, it will keep everyone very competitive. If you reduce or eliminate the number of mortgage brokers, if you end up with just one bank, they could charge whatever they want.”

Kevin Cuff, executive director of the Massachusetts Mortgage Bankers Association, which represents lenders and brokers, predicted that “a flood of brokers” will apply for bonds later this year and some may find they can’t get one. David Hadlock, the Massachusetts Mortgage Association’s general counsel, agreed that could happen.

Last year, he noted, many brokers fell below the state’s “positive” net-worth requirement when they lost business due to some lenders’ disappearance from the market.

Going forward, he said, they’ll have to meet bond companies’ requirements in addition to the new, higher state-imposed net-worth requirement, and it could be a problem for some.

“What the cost will be to the average broker,” he said, remains “the $64,000 question.”