Like all of my favorite finance topics, this one was inspired by my daughter’s question, as we slowly drove in the car past the county correctional facility: “Daddy, what are bail bonds?”
Prior to her question, my knowledge of the industry came from watching Robert DeNiro in Midnight Run. Fun movie.
I tried to answer as best I could. “Well, first you need to be arrested for a crime. Then, you really don’t want to spend much time in jail waiting for your trial, so the judge says you have to pledge money to guarantee you’ll return for trial later. But then, you don’t have enough money to pledge. Worse still, you don’t know anybody who has enough money to pledge. So you walk into a bail bonds company trailer…”
Then I kind of got lost, thinking as a banker might, trying to underwrite this financial risk. I’m imagining how awfully risky this must be on the business side. Criminal defendants. With no money. Also, no collateral. That is a rough way to lend money, compared to a bank.
Oh, how I was wrong. Having sat down with bail bondsman David Fernandez of Jailbusters Bail Bonds, as well as Susan Monsalvo of Express Bail bonds, both of Bexar County, I’ve come to a few opposite conclusions.
First, I could see how bail bonds might be very profitable; even more so than a traditional bank.
Second, the underwriting of bail-bond financial risk harkens back to some old-school lending criteria that traditional banks won’t or can’t do anymore.
Let’s talk about the potential profitability first. A typical bail bond company charges a 10 percent fee to customers, meaning if a judge sets $5,000 bail, the defendant pays a $500 fee to the bail bond company, who pledges the $5,000 on his behalf. (I’m using the male pronoun for defendants because, duh, men commit most crimes.)
When the defendant shows up in person for trial, the bail bond company’s $5,000 risk is released and the bail bond business keeps the $500 fee. Now, the first thing to notice about this deal is that any finance company that can earn 10 percent on its capital for just a few weeks or even a few months of financial risk has the potential to earn an extremely high annual rate of return on its capital. This sounds potentially very profitable.
But wait, that’s not even the best part. Bail bond companies do not have to hand over the $5,000 in pledged money to the county court. In the vast majority of cases, no money ever changes hands. The bail bond company just takes the $500 fee upfront and pledges money for the future, in case the defendant skips bail. In the meantime, it keeps the money. A huge advantage.
This, you should notice, is a way better deal than what a typical bank gets. Banks have to actually give their money over to borrowers, and if all goes well they only get their money back slowly, with interest, over time. The fact that bail bond companies only virtually pledge money, but in fact don’t give any money, is pretty awesome for bail bonds businesses.
There’s even more coolness. Bail bond companies, in order to get and keep a license to do business, have to prove that they have assets, either in cash in the form of a bank CD, or in property. Their license typically allows them to underwrite bail bonds up to ten times the value of their proven cash assets. This creates what a finance nerd like me would call leverage.
One of the magic tricks that traditional banks get to do is called “fractional reserve banking,” in which a bank lends out many more times in money than it ever actually has in capital, sometimes close to 10 times its capital. Bail bonds companies get to do pretty much the same thing, because if a bail bond company has a $100,000 cash CD, its license allows the company to underwrite up to $1 million in bonds.
Finally, there’s the underwriting process, which I mistakenly assumed would be extremely difficult. Actually, according to both Fernandez and Monsalvo, they use a combination of personal judgment and reliance on the accused’s mom to take appropriate risks. That’s right, more often than not, mom (or another female significant other) is the co-signer on the bond.
Regular banks don’t do this kind of touchy-feely thing anymore. With traditional banks, it’s all algorithms, credit scores and heartless, technology-based lending.
With bail bonds, the owner often has to take a leap of faith, engaging in a sort of character-based lending. Often that’s Mom’s character. Or Grandma’s. See? This is just like George Bailey in “It’s a Wonderful Life,” or like “Leave It To Beaver” type lending.
An additional support for this type of old-school personal-judgment based lending is the preponderance of repeat customers in the bail bonds business. Fernandez of Jailbuster’s usually ends his discussion with customers with the admonishment: “I don’t want to see you again,” but of course he does see them again. A combination of repeat customers and personal referrals make up the majority of his business, according to Fernandez.
Monsalvo of Express Bail Bonds describes working with her father’s criminal defense attorney business and later her mother’s Express Bail Bonds business, where “as a result I know multiple generations of [her father’s] customers. In some cases the grandfather, father, and son. Or I might see a customer who I knew in diapers and think, like, I remember you as a baby.”
If that doesn’t warm your heart, I don’t know what will. Shouldn’t we all start a bail bonds business together?
Now that I’ve helped you, like me, fall in love with the business of bail bonds, I need to warn you about the bad news for the business. 2017 so far has proved to be a terrible horrible no good very bad year for bail bonds in cities like Houston, and in states like New Jersey, where they’ve practically been banned. More on that in a follow-up, on the threats to the business.
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