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Maximizing Bonding Capacity in 2017

by: Smith and Howard

January 12, 2017

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Good news, contractors: You should have plenty of options when it comes to bonding this year. A strong surety market has drawn new players to the field and spurred competition among carriers. When it comes to obtaining a bond and expanding your bonding capacity, however, the game remains the same.

Pat yourself on the back

The roots of the surety surge lie in steady, if unspectacular, construction growth over the past several years. Many contractors — particularly those that survived the Great Recession — learned to better manage their companies and emerged stronger from the experience. Construction businesses that accepted low-margin projects just to stay operational during the downturn are now able to identify and complete profitable projects more readily.

And how have sureties been doing through all of this? Just fine, thanks. In fact, according to an October 2016 article in the CE Risk Management e-newsletter, 2015 was the most profitable year in the history of the bonding industry — with total direct-written premiums of $5.62 billion and a very low 18.3% loss ratio. (Data for 2016 was unavailable as of this writing, but the general consensus is that sureties remain strong.)

Be a good risk

Even with bonding firms doing so well, you still have to qualify. Remain selective about the projects you pursue so your surety knows the work is within your core competencies. Also, to the extent possible, retain a qualified and experienced team to manage projects, enforce procedures and control costs.

Bonding firms continue to look for a good fit between the job’s requirements and the contractor’s capabilities and experience. They want evidence that you have the skills, financial resources and equipment to perform the work. They also want to know that the project’s owner and general contractor are on solid ground financially. Sureties check for any special challenges posed by the project’s design or location, too.

Stay prepared to explain and substantiate the reasons you’re well qualified to take on the contract in question and perform the work successfully. For example, clarify how you’ll handle any change orders that may arise during the course of the job. In doing so, you’ll assure the bonding firm that the project is a good fit.

Communicate openly

Obtaining bonding is only half the battle; the other half is maintaining it and, preferably, increasing your bonding capacity over time. Fostering a good relationship with your surety is key. Keep your bonding rep up to date on your company’s financial condition and any issues that could affect it, either positively or negatively. Sureties tend to focus on three “Cs” when both issuing bonds and evaluating ongoing performance:

  1. Capital: overall financial position,
  2. Capacity: financial strength based on various ratios, as well as the experience and skill set to complete the job, and
  3. Character: history and reputation for doing business fairly and ethically.

Communicate openly and actively about anything falling into these categories. Report on your current and projected financial results. Provide information on your bank line-of-credit agreement, including your anticipated borrowing capacity. Keep the surety apprised of any significant underbillings or potential construction claims, as well as the status of significant construction litigation. Offer updates on your project backlog, including any signs of profit fade. Estimate your tax liabilities and their impact on cash-flow requirements.

Get an expert’s help

As you’re likely aware, financial statements play a starring role in bonding capacity. This set of documents is even more important now that your construction company may have more leverage with its existing bonding provider or another working in today’s aforementioned strong surety market.

For expert help, contact your CPA. He or she is well equipped to help you compile and present your company’s financial information in ways that will facilitate a surety’s evaluation. Don’t hesitate to also solicit his or her advice on how to make your bottom line even stronger.

Large general contractors, SDI may be for you

About 20 years ago, the insurance industry introduced a new product marketed as an alternative to surety bonds as a way for general contractors and construction managers to manage the risk of subcontractor default. Called subcontractor default insurance (SDI), it can be an attractive option in certain situations.

SDI offers several potential benefits, such as lower premium costs, control over the prequalification of subcontractors, no investigation period by a surety after a subcontractor defaults, and coverage of entities otherwise unqualified for a bond. There are differences in the protection offered by SDI and traditional surety bonds, so it’s important to understand how such policies work and what they do and don’t cover.

First, SDI is a two-party agreement between an insurer and the general contractor or construction manager. The general contractor pays the premium and, if the subcontractor defaults, the insurer compensates the general contractor for the loss, minus a substantial deductible. A surety bond is a three-party agreement in which the surety company prequalifies a subcontractor and then guarantees the sub will perform as required, while promising to compensate the general contractor in the event of a default. The surety also protects the sub from nonpayment.

Some caveats are in order: Carriers say SDI is generally only cost-effective for large general contractors and construction managers with annual subcontracted values over $75 million. Deductibles range from $500,000 to several million dollars, and some sophisticated administrative and accounting activities may be called for. Furthermore, SDI generally doesn’t meet bonding requirements for publicly funded projects. Subcontractors working under an SDI agreement forgo payment protection, and may risk an unwarranted default claim.

For more information on Smith & Howard’s construction advisory services, contact David Lee at 404-874-6244 or simply fill out the form below.

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