One of the most frustrating parts of being a contract surety bond underwriter is having to decline bonding capacity to a contractor that appears to possess the prerequisite experience, expertise, character and financial stability to accomplish his/her project. The review or prequalification process is the most important moment for a contractor to demonstrate his/her reputation and the ability to meet all current and future contract obligations. Initial submissions to a surety must be detailed, complete presentations to avoid a negative impression. That being said, the disapproval of otherwise well-qualified applicants is often due to one of the following three reasons.
1. Realistic Lead Time
It is unreasonable for a contractor that has not previously qualified for program bonding capacity to submit a request the day before a bid bond or final bond is due. The underwriter must be afforded ample time to digest the biographical information provided by the contractor, read and understand the contract and, therefore, the nature of the bonded obligation, retrieve and review credit and financial rating service feedback and properly analyze the contractor’s financial statements paired with work-in-progress (WIP) schedules. During this review process, concerns may arise that require clarification through telephone calls and/or emails to the contractor and the project owner. Small contract surety requests don’t require the same effort as larger ones. Regardless of the project size, the same underwriting fundamentals apply.
2. Inappropriate Financial Presentation
In efforts to offer bonding to small and emerging contractors, most sureties have created “quick-bond” or “fast-app” programs. It is understood that new and small contractors are unlikely to have CPA prepared financial statements. The cost of formal financial reporting can be difficult to budget.
As project values increase, underwriters must be able to trust the accuracy of the working capital, revenue, efficiency and billing figures contained in a financial statement.
Presentations prepared to review or audit standards are absolute prerequisites for larger bond requests. Offering formal statements also provides the underwriter with an indication of a contractor’s financial management maturity and understanding of the basic principles of credit application. A contractor’s unwillingness to quickly provide the requested financial information prepared to the appropriate standard is a big red flag.
As part of an application review, the surety underwriter necessarily compares the size and complexity of the proposed project with projects that the contractor has successfully accomplished in the past. Bidding on jobs that are significantly larger in scope or complexity or are outside of the contractor’s primary work specialty are leading causes of surety request declinations. Often coupled with a proposed project location distant from the contractor’s normal geographic center of operations, overextension is a serious concern.
All three of the aforementioned factors are within the contractor’s control. Understanding how these components affect an underwriter’s overall opinion of a contractor’s ability to be bonded and taking the appropriate actions to provide for them is key.
Addressing the three principal reasons for bond request declinations is part of this process. Underwriters of contract guarantees primarily seek to establish and affirm the three Cs: character, capital and capacity.
Capital does not necessarily mean liquidity, which is essentially the amount of cash in a contractor’s operating account. Working capital is a ratio of the contractor’s current assets to current liabilities.
Capacity is a subjective judgment of the contractor’s capability. This may include expertise specific to the work, proper equipment and supplier relationships, managerial maturity, which includes both accounting and workforce management skill and the likelihood of the contractor success in the geographic location of the project.
Character is a judgment of the contractor’s willingness and history of fulfilling his/her promises. Attention to these fundamentals are key to getting the attention of surety companies.
Clear, open lines of communication with the bond underwriter are essential to establish each one of the three Cs, and to address any weaknesses that the underwriter would perceive as a significant weakness. If put into practice, more contractors will obtain the surety capacity they require for a project.