The surety market and your bonding capacity
Construction companies and contractors should be aware of the market
The bonding market has improved somewhat since the days after the 2008 recession, but the surety industry is still somewhat conservative. Where does your construction company stand? Have you assessed your bonding capacity lately?
Generally, when it comes to bonding, construction companies and contractors should be well aware of their bonding capacity, since it severely limits the numbers of contracts you can take on, as well as the size of prospective jobs. Bonding assures that your company will complete construction projects and pay your subcontractors, suppliers and workers (employees or independent contractors).
The 2012 and 2013 surety industry financial performance was strong. According to the National Association of State Budget Officers (NASBO), states are still facing “recession-induced challenges,” partly caused by fewer public funding sources and the level of nonresidential construction spending, which is lower than 2008.
Surety bond results tend to lag behind overall economic trends and a construction company’s performance is often directly tied to the economy.
For example, a performance bond secures the contractor’s performance on the construction contract, and a payment bond secures the contractor’s obligation to pay subcontractors and suppliers. The contractor’s successful performance on that contract depends somewhat on its financial strength as a company.
Economic conditions often affect that financial health of the contractor and the quality of project opportunities. The possible outcome can be increased loss activity on performance and payment bonds.
The largest surety bond companies, which handle about half of the market share, will likely adhere to the processes and underwriting standards the industry has been experiencing recently, with smaller bonding providers likely falling in line behind them.
Maximizing bonding capacity
Startup construction companies could face more difficulties in obtaining bonding.
Sometimes independent contractors try to establish an equity position based on previous experience. Unfortunately, even the strongest history of bringing in profitable contracts for another construction company doesn’t translate into accumulated earnings for the startup business. Underwriters will be looking for equity on your balance sheet to prove that you have enough cash flow to cover loss jobs.
If your construction company already has surety limits that you want to maintain, or you may want to increase them, be sure to work closely with your financial advisor as well as bonding and insurance agents. They can help you find ways to increase your working capital.
Other contractors who have found it difficult to obtain enough bonding may begin to see some flexibility from surety companies. Regardless of where you company stands in securing bonding, to maximize your bonding capacity, there are a few best practices every construction company should follow to improve your opportunities:
• Demonstrate adequate working capital (current assets minus current liabilities) and your ability to finance operations
• Show steady work-in-progress and bid results to demonstrate job history and work in the pipeline
• Provide evidence of a strong banking relationship with the capacity to borrow
• Maximize your cash flow – most surety losses are caused by cash flow failure
Remember, your bottom line isn’t the only factor in determining your bonding capacity. Being able to supply substantial letters of credit, concrete personal guarantees and more expansive financial statements can also help qualify you for additional bonding capacity.
It can take several years to nurture a strong relationship with a surety. If you think you have an existing relationship with a bonding provider that understands your construction company, your goals and is easy to communicate with, you should focus on strengthening that relationship by keeping open lines of communication about your business condition – sureties don’t like surprises! In addition, provide timely financial information to your surety partner.
Nationwide trends are showing that the remainder of 2014 should not bring sudden fluctuations in the availability or pricing of surety bonds. Some sureties could go against nationwide trends, depending upon their own financial positions. If your own company’s financial results have been relatively stable, your own bonding capacity shouldn’t change all that much either.
David V. Jean, CPA, is a principal with Albin, Randall & Bennett in Portland, Maine. He is also a Certified Construction Industry Financial Professional (CCIFP) and a member of the Real Estate Construction Advisors Association (RECA). He may be reached at email@example.com.