What Will 2009 Mean to the Surety Industry and Your Ability to Secure Bonds?

Calendar year 2009 was indeed an interesting year for the construction community, and there is no doubt 2010 will be challenging as well with continued aggressive competition and increasing scrutiny from the surety community.

Understanding what has gotten us to this point, what is in store for the surety community in 2010, and how you may actually be able to benefit from the surety industry’s upcoming difficulties will be helpful to know.

With the near total elimination of residential work and a significant reduction in commercial work, a surge of construction firms have entered into the public and federal arenas.  Many of these firms have little to no prior experience working in these fields.  With some firms taking work at or below costs in an effort to retain employees and stay in business, the ripple effect has been significant throughout the construction community.  Not only are some of these firms suffering financially, but these aggressive bidding practices have impacted the traditional public and federal work contractors.  These traditional firms have seen a sharp reduction in low bids resulting in revenue reductions, layoffs, and in some cases, losses.

Surety companies, except for those that were heavily involved in subdivision bonds, have not been significantly impacted by the results of 2009.  Losses in the surety community generally lag behind construction firm losses based on the nature of the surety relationship.  Until such time as construction defaults occur and/or labor, subcontractor or supplier payments are not made, surety bonds are not directly impacted by poorly performing projects.   Recently, there has been an increase in claim activity indicating that losses are beginning to occur.  This is clearly just the beginning of what is going to be a tumultuous ride in 2010.

The surety industry expects losses to occur as the economic climate is simply pushing businesses this way.  We are all hopeful for an improved business climate some time in 2010, but it will not come soon enough to curb the challenges of 2009 in order to stem failures from occurring.

We anticipate the surety market will begin to get more conservative in 2010.  As claim activity increases and year-end financials showing losses or underperforming jobs begin to be presented, surety companies will begin to ask more detailed questions of their contractors.

Surety companies will be scrutinizing financial results and job performance closely this coming year-end.  Construction firms that have lost money as a result of not taking work at unacceptable margins will be perceived less risky than firms with significant backlogs of low margin work.  The long term tail effect of twelve to twenty-four backlog months of underperforming to nominally performing work will be viewed much riskier when deciding to extend future bond liability.

While sureties always want to understand your business, you can expect them to be very interested in your plans for 2010.  Specifically you can anticipate questions regarding how you are going to manage risk associated with increased competition, lower margins, lower revenues to support overhead and potentially owners that you have not worked with in past.

The big picture is that if you have had an open line of communication in the past with your broker and surety, then things will not be all that different for you from a surety perspective.  However, if you have treated your surety relationship more as a necessary evil than as a partner, you may experience some pain.  In our experience, this later scenario does not lead to strong communication or a smoothly run surety program.  It is likely your surety partners don’t know your business, risk tolerance and game plan to deal with the changing environment as well as they should to really be comfortable you are in a position to succeed.

Times are tough. We all have heard this a hundred times now and are probably tired of hearing it.  However, with a proactive approach to managing your surety relationships, you can at least improve your chances of success/survival depending on your situation.

Take the time to meet with your surety partners, not just at a year-end meeting but also during the year to talk about how things are going.  What are you looking at pursuing, how do you plan to manage the risks and what is your year looking like?  Believe it or not, breakeven and even a manageable loss is not all bad news.  The story behind the results and what actions you have taken to adjust to the current environment matter more to your surety credit partners.

If possible, position your company from a financial perspective to meet or exceed your anticipated surety needs.  A little extra financial strength in today’s market could go a long way to helping a surety extend credit on unique opportunities that may involve a new owner, territory, scope change, etc. Those opportunities will be looked at much less favorably if you are trying to manage your company to the minimally acceptable financial levels.

In short, the market is what it is right now.  Continue work hard, position your company for success, communicate with your professional advisers and ride it out.

 

Construction Business Owner, November 2009