Most contractors know of inherent performance guarantee, or surety bond, mandates required to win contracts when performing local, state or federally sponsored projects. However, upon entering this post COVID-19 era, where new risks have emerged, inserting themselves into the risk management playbook, bonding capacity has also emerged as a topic of thoughtful consideration for various other stakeholders, alongside contractors, both domestic and global.

Bonding capacity is the maximum amount of surety credit provided to a contractor to meet their backlog and profit goals at any given time. This matters because it requires a contractor to work within their surety means, by not taking on a level of work that exceeds their ability to manage and support financially. It dictates how a future backlog is taken on and managed, thus allowing for the contractor to thoughtfully forecast operational requirements and cash flow.

Bonding capacity is becoming more important in select areas where surety can help mitigate exposure at various levels.

Global

Carillion and Astaladi are two large global contractors to suffer catastrophic default in recent years. While there were a myriad of issues leading to their defaults, one critical contribution (or rather lack thereof) was the absence of a prominent surety process globally, outside of North America. Much of the international market relies on a small percentage performance guarantee system, covering only a fraction of total contract exposure. Does that mean total bonding capacity is adjusted down by a similar factor? Not necessarily. The underwriting performed internationally tends to be on a quantitatively leaning, credit metric basis, one could say less scrutinizing of equally important surety principles - character and capacity. While the credit profile may support capacity, the firm and its ability to prosecute the work may run stretched, increasing risk of default.

As globalization makes its return, foreign entities looking to enter the U.S. market must thoughtfully consider what that means from a risk portfolio perspective. If planning to establish permanent operations stateside, what’s entailed in getting rooted in constructing a reasonable surety program initiative as well. One that can grow with their American presence. Often the requirements can be quite startling compared to their familiar operating territory.

Consolidation

A wave of construction merger and acquisition activity has flooded the industry as long-time owners search for an exit strategy to support the firm's future and their retirement. As generational in-family succession becomes less commonplace, construction outfits are embracing private capital as a source for a liquidity event where existing ownership can take some or all their chips off the table.

As ownership changes into the hands of private equity firms and other private capital, more sophisticated bonding programs may be required to support the accompanying new business plan set in place. This is where the surety process becomes a critical risk management tool for an acquiring portfolio, where bonding capacity must be considered to support growth strategies.

These transactions can be tricky when continuing a meaningful surety program is essential to the future revenue stream of the acquired asset. Private equity firms are particularly averse to providing cross guarantees vertically above the acquisition level or laterally among fund portfolio companies. This runs completely counter to surety underwriting principles.

It's critical to ask the correct questions throughout due diligence. Failure in doing so runs the risk of a slew of problems that might prevent or delay the strategic implementation of a post-acquisition business plan after it has been completed. Or worse, the shocking realization of now owning an asset that should have been walked away from.

Real Estate

While in construction, surety bonds are mandated on government funded projects, construction risks don’t just disappear in the private sector. Surety tends to be optional on the private side, but a useful risk mitigation tool at the owner and contractor levels, nonetheless.

The commercial real estate sector is no stranger to general contractor and property developer defaults. Especially in this pandemic driven, supply chain disrupted market, stalled and busted projects can happen resulting in costly delays or worse. The ability for a contractor to bond a project or provide evidence of bonding capacity not only signals their ability to perform but indicates to the owner that the contractor possesses the financial wherewithal and business acumen to manage unforeseen risks and deliver the project.

For contractors and stakeholders alike, fundamental U.S. surety principles prevail in how to manage portfolio construction risk while securing adequate bonding capacity.

What to consider:

• Choose revenue sources with care. It's never been more crucial than it is now.
• Tighten up cost controls.
• Embrace what technology can do to advance goals.
• If new to a market, learn about the specifics of performance guarantee or performance bond requirements in territories planning to operate. Or consider strategic partnerships.
• Clearly define objectives and shift resources (financial, physical, human) to achieve a predetermined strategy.
• Investigate surety underwriting standards and criteria with the assistance of a professional surety broker who can help achieve strategic plans.

These are critical components of the surety process. Whether seeking additional bonding capacity or not, adherence to these guidelines represents sound construction business practice and readiness when that time inevitably does come.