The Impact of COVID 19 on Surety Bonds
The ability to adapt and change on the fly has been a key component of any successful strategy for a construction company in 2020. What began as a very promising year, quickly became one filled with uncertainty as job sites closed and offices shuttered with the onset of the COVID-19 pandemic. Thankfully, our industry quickly found its footing by early May as construction’s designation as an essential industry was solidified. However, this new reality brought a significant burden as construction companies had to adapt to opening in a pandemic environment. There were the extra costs for PPE, site management challenges, supply chain delays, contractual disputes over pandemic delays, unexpected quarantines for key staff and trades and many more uncontrollable issues. The financial impact on contractors due to these issues has yet to flush through income statements and balance sheets. This has left the surety industry nervous of the potential impacts in late 2020 and early 2021 as the potential for cash flow issues increases and the uncertainty regarding public infrastructure funding continues.
In 2020, the surety industry had been hoping for a recovery after a few years of challenging results due to a few larger claims. However, the onset of COVID-19 has led to additional uncertainty within the industry. Appetite for new business has declined in certain pockets and sureties are becoming more stringent on receiving reporting from contractors on a timely basis. If cash flow issues and losses do start to show up in late 2020 this could represent the start of a challenging year in 2021.
So how can we as an industry prepare for this expected tightening? Well it starts with understanding how surety underwriters assess risk. A surety company will traditionally rely upon the ‘Three C’s’ of underwriting when considering bond support for a construction company. Capital, Capacity and Character. Capital is arguably the area sureties focus on the most. Capital is the numbers side of a contractor’s business and most commonly focuses on profitability and balance sheet strength. One area sureties focus on more frequently within the Capital bucket is Working Capital. Working Capital is defined as current assets minus current liabilities and is a measure of a contractor’s ability to generate short term liquidity. Generally speaking, bond companies expect to see working capital grow from year to year as excess profits are retained in the business; however, with all of the extra cost burdens this year, that may not be the case for many.
This is where the ‘Capacity’ and ‘Character’ aspects become so important as these are the intangibles that tell the true story of a construction company. Capacity is a measure of how much work (and the type of work) a company can reasonably manage at any given time. Character is a measure of moral excellence. These are the 2 C’s that all surety underwriters and brokers should be focusing on and accessing when a contractor hits a bumpy road.
So how can you as a construction company owner properly convey your capacity and character to your bonding company? This comes down to the often unspoken ‘R’ and ’T’ in surety underwriting. Relationships and Trust. Now more than ever your relationship with your surety broker and surety underwriter are vital. Ensuring that you have an open dialogue with your bonding team, discuss the corporate strategy, identify and mitigate risks and explain challenges and how you are learning and adapting will all help build comfort and allow you to maintain your bonding capacity even despite a reduction in Capital. The current narrative must be about adaptability and perseverance. The financial results will follow.