Beware: if your building doesn’t have one, that could give the bank a license to kill a sale.
Matt Kells thought he was home free. After months of back and forth, he had finally located a buyer for his condo apartment in Brooklyn’s Boerum Hill. He and his wife had found a new rental apartment and scheduled a moving day.
Then, a week before the closing on the condo sale, Kells got a call from his lawyer, informing him that California-based Countrywide Financial, the buyer’s mortgage lender, would not approve the loan unless the condo building had a fidelity bond.
Kells, a television producer who had served on his condo board for four years, including the past year as its president, was mystified. He answered his lawyer’s question with a question: “A fidelity what?”
A fidelity bond, the lawyer explained, is a form of insurance that protects a co-op or condo building in the event the property manager or a board member steals money. It’s sometimes called a “crime policy” or “employee dishonesty policy.”
Back in December, in response to the mushrooming credit crisis, Fannie Mae and Freddie Mac, which purchase co-op and condo loans from the original lenders, announced that they would begin enforcing a rule that has been on the books for years but rarely enforced. The rule states that any co-op or condo building with 20 or more units must carry fidelity coverage equal to three months of the building’s total maintenance or common charges. In years past, Fannie and Freddie routinely waived the rule if a building carried as little as $25,000 in fidelity coverage. Fannie Mae also announced that it was requiring fidelity bonds for new and established condos.
Countrywide Financial had recently been absorbed by Bank of America. But whatever the name, the lender, like virtually all its competitors, now requires that a building follow the letter of the Fannie and Freddie rules before it will approve lending to a co-op or condo.
Upon learning this, Kells understandably flipped. “It was unbelievable,” he says. “After months of negotiations, to have the bank ask for a fidelity bond one week before closing – I have an issue with that.”
But Kells had no time for disbelief or anger. He needed to close the deal quickly because he was paying for both the condo and the rental apartment. Following a little research – and taking into account what he knew from his four years of service on the board – Kells realized that persuading the full board to buy the bond would take time he couldn’t afford.
“After realizing that the bank was not going to approve the loan without the bond,” Kells says, “I knew that I needed to buy the bond to expedite its acquisition. So I called the board president and asked that she conduct a board vote to allow me to buy the bond for the building. I wrote a check to the [co-op]. We called it a ‘move-out fee.’ It only took 10 days, and it did the trick.”
Julie Twitmyer, Kells’s successor as board president at the 24-unit building, says the five-member board will probably renew the policy when it expires next January. “I think it’s likely we’ll continue it because of all the new regulations on selling apartments,” she says. “Besides, when you’re giving any individual access to large sums of money, it’s smart to have this kind of insurance.”
And Twitmyer and her fellow board members don’t want to see a repeat of Matt Kells’s unpleasant surprise. “We want people to be able to sell their apartments,” she says.
Craig Blattberg knows how Matt Kells feels. Blattberg owns two women’s shoe stores in Manhattan, and with business hurting because of the recession he decided to ease his pain by refinancing the mortgage on his Park Slope condo. His broker, Shaul Betesh, managing director of Manhattan Mortgage Company, found an attractive 30-year mortgage with Wells Fargo that would cut Blattberg’s interest from 6 percent to a fixed rate of 4.75 percent.
“A couple of days before I left on a big business trip,” Blattberg recalls, “my broker called and said the building needed a fidelity bond. I didn’t know what that was. I talked to the board, and they said they’d never heard of it either.”
“That was the first time fidelity bonds had come up,” says Joseph Doucette, who was then president of the building’s board. “Craig needed to get it done quickly, and we were in between board meetings, so he offered to pay for it for the entire building. Our managing agent sent me an e-mail, and I circulated it to the other board members to see if they had any objections.” No one did.
While these machinations were taking place, Blattberg got more bad news. He learned that his window for locking into the fixed interest rate had expired, and if he wanted to keep the rate he would have to pay $125 a day until the loan was approved. Suddenly Blattberg, like Matt Kells, found himself in a race with the clock.
“It behooved me to go ahead and buy the policy for the whole building,” Blattberg says. “I paid somewhere between $600 and $800 for a one-year policy, and the board agreed to reimburse me if they renew the policy after one year.”
His loan was finally approved at the 4.75 percent rate, but Blattberg was left with a bitter aftertaste. “Even at the point we’re all at today,” he says, “the government and banks can still figure out ways to screw us. This is normal right now. People slip in things all the time – and we have so little say. We’re at the mercy of banks and credit card companies. The American dream has all changed.”
Betesh, Blattberg’s mortgage broker, adds wryly: “Early this year, banks that sell mortgages to Fannie Mae and Freddie Mac began insisting that buildings comply with the fidelity bond rules. Now, everyone requires it. It’s one of the wonderful new rules we have to follow.”
Bad News Banks
Josh Blackman is CEO of Brownstone Management, which manages more than 60 properties in Brooklyn, including the Boerum Hill condo building where Kells used to live and the Park Slope condo building where Blattberg struggled to refinance his mortgage. As far as Blackman is concerned, the banks’ demand for a fidelity bond is just one more dose of bad news in a real estate market that has already endured more than enough.
“It’s hurting buyers and sellers,” says Blackman. “I’ve never heard of banks saying, ‘Buy it – or else.’ Now that’s what they’re saying. But boards are not inclined to [buy a fidelity bond] in this economy. It’s not that much money, but boards don’t always feel it’s essential to protect their property. Some insurance is in everybody’s interest – property coverage, liability, Directors and Officers to protect board members, and possibly an umbrella policy.”
Yet Blackman, like Kells, realizes that financial finickiness is simply the nature of the times in which we live. “Banks made a lot of mistakes and lost a lot of money,” he says, “and bankers don’t want to be left holding the bag if someone steals from a co-op or condo.” With a philosophical shrug, he adds: “Life gets more expensive every day.”
But Barbara Strauss, executive vice president of the insurance brokerage York International Agency, believes that a fidelity bond is an added expense that may actually be in the best interests of co-ops and condos. “Right now, everyone is gun-shy about lending money,” Strauss says. “What’s happening, due to the economy, is that banks are requiring boards to carry a fidelity bond that’s equal to three months’ maintenance. It’s a big deal because it ends up costing the building money, but it’s also a great safety measure for the building. It’s a small amount of money to get a lot of coverage that you might need one day. I can understand why the banks are requiring it.”
The good news, as Strauss points out, is that the insurance is not terribly expensive. If a co-op or condo has annual income of $1.2 million from its maintenance or common charges, it will need a $300,000 fidelity bond. Such a policy, with a $5,000 deductible, will cost about $600 a year.
Insurance broker Michael Spain, president of the Spain Agency, agrees with Strauss that it’s money well spent. “Everyone thinks theft can’t happen to them,” Spain says. “The problem is that it does happen – a lot – and it usually happens over a long period of time. A person finds some crack in the system and starts siphoning off money. It usually starts small and gets bigger.”
And sometimes it starts big and gets huge. In the 1990s, the New York co-op world was turned upside down when dozens of managing agents and management companies were indicted for accepting bribes and kickbacks from construction companies and other vendors. In addition to the kickback schemes, there was also some bald thievery. During the first of two blizzards of indictments, the board president at one Mitchell-Lama co-op pleaded guilty to theft and agreed to return $100,000 to the building’s coffers as part of his sentence.
While fidelity bonds may be obscure to many New York co-op and condo boards, they hardly qualify as something new under the sun. Fidelity and Casualty Company issued the first fidelity bonds way back in 1878. But the need for crime insurance didn’t become apparent to most co-op boards until the management scandals of the 1990s.
Some managing agents take out their own fidelity bonds to protect co-ops from theft by the management company’s employees. Now, because of the changed banking landscape, co-op and condo boards are being forced to buy their own fidelity bonds to protect the building from theft by employees, directors, and the managing agent. Six months ago, the requirement existed only on paper; today, it’s almost universally enforced.
There’s yet another option. “Many fidelity policies bought by boards to protect the building now automatically include the managing agent and his employees,” says James Samson, a partner in the law firm of Samson Fink & Dubow. “But you’ve got to look at the policy and make sure. It doesn’t cost anything to spell it out. That’s the best solution – always own your own insurance. I don’t have a problem with a bank demanding that a co-op have adequate insurance coverage.”
CitiMortgage, like many other lenders, is following the new guidelines set down by Fannie Mae. “We’re looking for a fidelity bond that’s equal to the largest balance you have in your reserve fund at any one time,” says CitiMortgage spokesman Mark Rodgers. In other words, the bank wants to be sure that the co-op or condo is insured for the maximum amount that someone could steal.
There are exceptions. “If you have adequate internal safeguards in place – such as a separate bank account, if you pay from invoices, and if you require double signatures on major checks – then the coverage has to be equal to three months’ maintenance or common charges,” Rodgers adds.
No one claims that buying a fidelity bond is an onerous or outrageously expensive burden. Rather, some see it as one more hoop for co-op and condo boards to jump through at a time when many are exhausted from jumping through hoops. To make matters worse, the Matt Kells and Craig Blattbergs of this world have tended to learn about the new requirement at the worst possible moment.
In the end, a poetic blogger may have said it best. Being forced to buy a fidelity bond at the eleventh hour in order to close on a loan or apartment sale is, he wrote, “a hiccup that no one would want to address while under the gun.”