The construction landscape is changing daily, bringing new challenges for contractors—including dealing with new competition, taking on work in new markets, and navigating supply-chain issues, labor shortages and more. Companies who succeed in this competitive environment must then deal with the changes that come with new growth. And in a market brimming with new federal opportunities, contractors need to pay particular attention to what surety underwriters are looking for to ensure they have the appropriate character, capacity and capital to secure bonding.
IIJA AND BONDING
Now more than halfway through its five-year authorization lifespan, the Infrastructure Investment and Jobs Act has allocated $454 billion in funding for 57,000 infrastructure projects of various kinds nationwide, according to the U.S. Department of Transportation. Though the mechanisms, requirements and other complexities of the massive federal legislation have frequently meant delays in project starts, many projects are underway across the United States, with the influx expected to continue in the coming months.
As some experts see it, IIJA may not alter bonding. As Paul A. Healy, national practice leader, contract surety, for AON’s Construction Services Group, reports, “We do not see changes specifically triggered by the IIJA.”
Jason Dettbarn, senior vice president, national contract surety leader for Merchants Bonding Company, echoes Healy’s point. “Our surety underwriting experts do not expect any changes to bonding in light of the IIJA. Even so, we are pleased to see increased spending on infrastructure supported by the IIJA,” Dettbarn says. “We do see our infrastructure clients having larger backlogs and more opportunity for work due to the legislation. This has been a positive for the construction industry as well as for the surety industry.”
Along that line, Chris Hillman, surety underwriting manager for Philadelphia Insurance Companies, points out: “The IIJA is expected to generate significant opportunities for contractors, particularly those in the public sector. The surety requirements for federal work should lead to more bond needs and activity throughout the surety industry.”
READY, FED, GO
Faced with any new opportunity, construction companies have to weigh the pros and cons of taking on potential projects based on the nature of the work, their own capabilities and a range of other factors. And when it comes to the influx of public projects, a number of contractors are forging ahead.
“A major change we have already begun to see is more contractors returning to public works spaces, either because private opportunities have slowed or in preparation for sizable infrastructure projects at the federal, state and local levels,” Hillman says.
With more public works contracts and RFP respondents comes more competition and lower rates, which can prompt contractors to seek out different avenues for their next project—be they new owners, territories or work scopes. Each of those can pose challenges that a contractor must consider. Hillman points out that surety underwriters are particularly vigilant in evaluating such things.
“Contractors should work with their surety broker to anticipate and prepare for underwriting questions,” he says.
Any way you slice it, federal work and its bonding need to be done just so, as with any project, client or contract. “Federal work requires strict adherence to contract administration and federal requirements. If you are planning to do federal work, be sure to be well educated in the administrative requirements and regulations,” Healy says. “It’s best to start with a small federal job to get experience with the requirements.”
CONTRIBUTING FACTORS
The influx of federal projects is one significant factor in an overall construction scene that presents some other pressing issues for contractors. “A lot of the jobs coming out are large, and some are very complex,” says Michael Heidrick, head of construction surety for The Hartford. Among other things, there can be pricing implications as a result. “This may limit the competition of contractors for this work. Inflation is already impacting the price of the jobs contractors are taking today, so not having enough contractors to bid this work may mean additional pricing increases,” he explains.
“Increasing job size increases backlog dollars as well,” Heidrick continues. “Some contractors have been able to grow their balance sheets to support their increased credit needs. Some are not keeping up. This is a challenge for both the contractor and the surety.”
Heidrick sees other factors at play as well. “Supply-chain issues continue,” he points out, particularly for specialty items such as switch gears and generators, among others. And if that wasn’t enough, contractors have had to become experts at logistics in order to meet domestic sourcing rules in the IIJA, which requires, for one example, that all steel and iron used in such projects be sourced domestically. Hillman likewise points to supply-chain disruptions, which he believes “are still affecting the availability and pricing of work equipment and building materials.”
Not every company can cope with every contingency. “The upshot is that the IIJA increases the demand for a finite amount of contractors qualified to do the work,” Heidrick says. “But that could possibly exacerbate the supply of an already stretched skilled-labor market.” The point is apt: Skilled-labor shortages continue, with the construction industry alone falling about 501,000 workers short. “First and foremost is the challenge of finding enough skilled labor, particularly in the areas of construction growth supported by the IIJA,” says Dettbarn.
That shortage also extends across job positions as IIJA unfolds. “We’re seeing a significant void of skilled labor and job supervisors, which is a continued challenge to both prime and subcontractors,” Hillman says. “New work opportunities associated with IIJA should intensify demand for skilled workers, even if spending slows in other sectors.”
CHALLENGE…ACCEPTED?
“There are other prevalent and recurring challenges for contractors as we underwrite new job requests,” Hillman says, explaining that those challenges could continue as IIJA works continue to unfold. Those include incomplete or unachievable designs, such as when contractors are regularly asked to bid from incomplete plans. “Incomplete plans make it more difficult for owners to quantify how much they can expect to spend for delivery, while forcing contractors to carry means and methods that may or may not be necessary,” Hillman says.
“As a result, we have seen contractors be the low bidder on jobs that have far exceeded budgets because of design flaws, at which time the owner either needs to make scope adjustments or search for additional financing,” he explains, pointing out that contractors in such a situation will experience delays and other challenges. Hillman continues: “From a surety perspective, the surety views that project as part of a contractor’s backlog, and it could impact available surety credit, limiting other opportunities.”
Hillman and his colleagues are also seeing an increasing tendency for owners to group projects together under one contract. “These jumbo-type contracts roll multiple locations or scopes under one master contract.” While doing so can streamline processes and oversight, Hillman argues that it also “drastically alters competition among contractors as it severely limits companies that can participate. Contractors then face choices whether to attempt to directly compete on something much larger than they are accustomed to, which is a significant surety challenge, or develop new or different backlog sources.”
Contractors seeking bonding should also bear in mind that depending on the sector, showcasing risk-management efforts is key. “A primary risk for general contractors is subcontractor pre-qualification and management of subcontractor performance,” Healy says. “For specialty contractors and heavy-civil companies, where they self-perform a large percentage of the work, access to skilled labor and specialty equipment is critical.” Healy recommends that contractors get with their bonding companies and walk them through the controls and methods for those key risk areas.
“We’re also looking at experience and level of sophistication,” Heidrick says. “Generally, large contractors have larger balance sheets, more experience, better business practices and more resources to handle the inevitable challenge. However, there are also plenty of small contractors out there who have figured it out. They have found a niche they excel in, and by extension take a lot less risk,” he says.
On the other hand, contractors shouldn’t bite off more than they can chew. “Loading up on work is dangerous,” Heidrick cautions. “New work uses cash. Cash-flow planning is critical, along with getting proper bank credit to handle unforeseen cash needs. Building liquidity in the balance sheet to safeguard the enterprise is more important than ever.”
According to Heidrick, it boils down to project selection and risk mitigation. “The most important thing a contractor can do to ensure success is picking the right work for themselves,” he says. “Having a project selection process—a discipline within the organization to make the project ‘go’ or ‘no-go’ decision—is imperative.” He also recommends further mitigating risks by negotiating contract terms, especially the payment and change-order terms.
GOOD GROWTH
Even for companies with all their ducks in a row, there’s also the matter of handling new growth that may come with more and larger federal contracts—a good problem to have, but a problem nonetheless. So, how do contractors manage?
“We’re often asked how construction firms can handle increased growth, and it remains at the forefront of our discussions with construction companies,” Dettbarn says. “It all revolves around two key aspects in terms of growth: operational and financial,” he explains. “Operationally, does the construction company have familiarity with the owner, type of work being performed, the size of the project and location? When too many of these are new, we see increased risk for a project failure. Our experience tells us that growing firms have increased risk for cash-flow constraints.”
Dettbarn emphasizes that construction firms must also ask themselves: Does their firm have the financial strength to get through this constraint? “We highly recommend working with a construction-oriented certified public accountant as well as insurance agents that are experts in surety,” he says. Seeking out the right advice can help contractors be cognizant of how things may play out in new arenas.
“Surety underwriters want to see good liquidity and consistent profitability,” Healy says. “It’s important for contractors to manage cash flow. This includes managing startup/mobilization cash flow related to new work and staying on top of receivable management to get timely payments.” He adds: “Managing change orders/claims is becoming more important as it can significantly affect cash flow if costs are incurred before there is a firm contractual commitment and funding to pay for the change orders.
“All told, we’ve really seen things go either way for contractors,” Dettbarn says. “There are some for which one or two jobs helped take the company to the next level, and we’ve also seen where one or two jobs caused significant financial harm.” In Dettbarn’s view: “The main difference we see between those that grow and those that fail is the discipline and risk-selection process that companies use to move up to the next level.”
