Fueled by a recovering economy and a construction boom, more sureties are entering the bond market. As a result, available surety capacity is at an all-time high and underwriting remains relatively soft. There is unprecedented competition among bond companies largely driven by their agents, who work on a commission-basis.
Express Bond Programs
In the past, traditional surety underwriting required contractors to be well-established, experienced and provide all of the underwriting paperwork (such as financial statements, work in progress schedules, prior contract references and bank references) even for relatively small bonds. Many small and emerging contractors were faced with a classic Catch-22: They couldn’t get bonds because they lacked experience and had insufficient financial strength. Yet without bonds, they could not obtain the larger, bonded contracts that they needed in order to gain the experience and capital base bond underwriters want to see.
Today, almost every surety market offers an “express,” or credit score-based program for small bonds. While program limits and underwriting criteria vary slightly by surety, all of these programs are designed to allow contractors to bond single jobs in the $200,000 to $450,000 range with a simple one-page application. This enables a contractor to obtain bonds without having to provide financial statements or any of the other underwriting paperwork, which can seem quite cumbersome for a small contractor. While there are some restrictions (e.g., no environmental projects), if a contractor’s personal credit score is acceptable, it can be approved relatively quickly. Even the SBA Bond Program now offers a “Quick Bond” Program up to $400,000 with a simplified SBA Form and no financials required. These express bond programs have been a huge game-changer, empowering small contractors to grow their businesses much faster than ever before. But there are down sides to these programs that can adversely affect a contractor’s bond ability.
One Size Fits All
Not having to provide underwriting paperwork is a major benefit of any express bond program. On the other hand, it can prevent the contractor from understanding what its true bonding capacity might be. For example, a contractor may have a high credit score that results in an approval of $400,000, but may not have the capital or experience required to tackle a project exceeding $100,000. This can result in disaster for both the contractor and surety. By contrast, a contractor may have an actual bond capacity to perform multi-million-dollar projects, but will be hindered by the small limits available within the express program.
Understanding express program limits can be challenging, due to aggressive marketing of the express programs as sureties and agents vie to provide the most capacity with the least paperwork. For instance, both a single and aggregate limit may be offered (e.g., at 0,000) based solely on credit. These same programs may offer higher aggregate limits, but require company and personal financial statements to be considered for higher limits. Contractors may think they have the higher single bond capacity when in fact they are limited to the lower single bond limit. Unless the contractor has provided financial statements, the aggregate bond capacity is likely to be set at the single bond capacity. Aggregate bond capacity is defined as the total value of outstanding bond obligations. This includes the bid amount for outstanding bid bonds plus the cost-to-complete of any bonded jobs in progress. This aggregate hard cap on the express programs makes it tough for contractors that want to actively bid on bonded work, especially on projects for which the bid results may not be known for several weeks.
Another down side to the express programs is the bond cost. Because the surety asks for such minimal information, the rate is higher than the traditional programs. For example, an express bond premium can be a flat rate of 3 percent of the contract. Traditional bond rates for similar sized jobs are significantly lower, usually around 2 percent.
Traditional Surety Capacity
With such easy access to bonding in the current express bond market space, it might seem counterintuitive to seek traditional bond capacity. But it actually makes more sense now than ever. The market is soft and underwriters and agents are hungry for bond business at the larger levels. This has significantly loosened the traditional underwriting requirements. For example, many sureties no longer require CPA-prepared financials for bonds up to $1 million. A high-quality internally prepared financial statement can propel a contractor to significant bond capacity in today’s market.
Another reason to seek a traditional surety line is because traditional capacity is usually not hard-capped. Underwriters have the ability to stretch bond capacity on a case-by-case basis and will often do so to accommodate their better accounts.
What Is Bond Capacity?
Outside of the express programs, bond underwriters use a myriad of data to determine a contractor’s surety capacity, including credit reports, the largest single job size completed, financial statement presentation, and bank line of credit usage and availability. The surety will thoroughly analyze balance sheets, and typically requires a contractor to maintain a certain level of working capital (current assets minus current liabilities) and equity (total assets minus total liabilities) in relation to total backlog (cost to complete), plus the requested bond amount. The standard working capital and equity requirement is in the range of 7.5 to 10 percent of total backlog, depending on the type of contractor and the amount of bond capacity needed.
The Ladder of Surety Success
Building surety capacity is like climbing a ladder. The safest method is to take each rung one by one. Skipping rungs in order to quickly advance to the top will usually result in a painful fall. For most contractors, the best strategy is to start with a credit-based express program to get a few small jobs under their belt. The next step is to incrementally increase capacity with good project references and high-quality internally prepared financial statements. To obtain full bonding capacity at the most competitive rates, a contractor will need to invest in annual CPA-reviewed financial statements and keep their interim financials up to date. It is highly recommended that a contractor use an experienced surety agent with an extensive bond background to help guide them through this process.
No matter which bond program a contractor is in, it is important to know and understand what its bond capacity is at all times. Utilize an express program if it is beneficial, but understand its limitations and that it is a program rather than a true measure of bond capacity. Every contractor should ask its agent for an annual surety capacity letter that states its current single and aggregate bond limits. This will prevent confusion and can be incorporated into the contractor’s qualification statement.
