Key Components to the Commitment Letter
A commitment letter for a developer bond facility is a 10 page document. There are many parts to this terms letter all of which are important to know however there are five main components which have the biggest impact on your bottom line. We have decided to highlight these factors in this article.
Tarion Bond Rate
This is relatively self-explanatory. It’s the annual rate charged for the Tarion Bond. This rate can range from 1% to 2% and depends on the financial strength of the developer, the merits of the project being bonded and the developers experience and track record for delivering quality projects.
Holdback Security Retained Against Tarion Warranty Obligations
With respect to the Tarion Bond, the bond company will often hold security for the first year at the end of the project. The security is held to cover any potential warranty claims that may come through. This security can be in the form of cash from the proceeds upon registration or it can be a charge against units that are part of the development.
Deposit Release Terms and Release Ratio
The release terms portion of the terms letter will have the largest impact on the bottom line. The release terms govern the cost of your deposits as well as how and when deposits can be released from the trust account.
By way of an example, let’s take a deposit release facility with a rate of 1.0% annual and a release ratio of 1:1, bank to bond company. When the project monitor authorizes a release of $1,000,000, here’s how it would happen:
The bank would release $500,000 at the rate specified by your bank agreement and the trustee would release $500,000 at a rate of 1.0% as specified in your bond agreement. This would continue until all of the deposits are released and then the bank would continue to fund the remainder of construction.
Release terms can vary up to a ratio of 3:1 and in some instances when the developer is very strong, the bond company may release deposits prior to the bank releasing any money.
As you can see with a deposit financing rate of 1% the differential between the cost of deposit money and bank financing can be quite substantial. It is in the developer’s best interest to have the deposits released as soon as possible.
Indemnity and Security Agreement
Any and all bond facilities are written with indemnity agreements in place. The indemnity is usually required to be entered into corporately and personally by the shareholders. In the case of Developer surety, the bond company will typically take the same security as the bank, with collateral security on the project and subject land in second position.
Legals and Other Costs
The developer will be responsible for the legal costs involved in registering the bond company’s security as well as the on-going costs associated with administering the deposits from trust. In addition there is a commitment fee associated with the Bond facility and it’s generally in the range of $3,000 to $10,000 depending on the nature of the deal.
As you can see variations in these components can affect the cost of bonding quite significantly. In highlighting these five components we don’t want to take away from the other aspects of the commitment letter because they are all important to understand.