Archive for the ‘Construction Bonds’ category

The Significant Advantage of Bid Bonds

February 25, 2011

The days of a contractor being able to simply bid a job without solid surety bonding in New York are on their way out.  The economy has burned all of us to some degree.  Everyone has had to tighten their belts – from the banks lending money for projects all the way down to the NY Construction firms and NY Trade contractors.  No one has been immune.  In fact, many have had to close up shop entirely.  According to BizMiner, of the1,155,245 contractor firms in operation in 2006 – 20.37%  had gone out of business by 2008.  Now, in 2011, that number has steadily risen.

The work that is available is becoming harder to get. A contracting firm can no longer rely on their reputation to win contracts.  More firms are bidding the same job including ones that do not have the proper experience with the work involved.  Many are stepping out of their comfort zones and taking on projects they probably shouldn’t just to stay alive.  This has not gone unnoticed by project owners and their lenders.  Both want a return on their investments and have taken steps to tighten requirements for the contractors bidding the jobs.

One increasingly popular method is taking a page out the playbooks of local, state and federal agencies – Surety bonds.  Obtaining a NY Surety line, or NY Bonding line is quickly becoming a necessity to stay competitive.   A viable NY Bonding line tells the job owner two very important things: Firstly, if you have the financial security and experience to obtain the bonding line you are more likely to be able to complete the project without much issue.  Secondly, and arguably more importantly, if something should happen and your firm is unable to complete the work or pay your suppliers and/or subcontractors, the Surety Company will step in to make sure the project is completed.  At the end of the day both the project owner and lenders have a lot to lose if the job isn’t finished.

Contacting a NY Surety Bonding Agent to establish new line or increase your current bonding line is an important first step before bidding that next job.  Many projects now require bid security , or reatianage – typically 10% of the contract amount bid.  This can either be provided as a check in that amount , , or as a bid bond.  While it may seem easier and quicker to put up your own funds as collateral for the bid security, it is not the most prudent option.  You are tying up your own funds that may be needed elsewhere and while 10% may not seem like much, if you’re bidding on, or working on six, seven or eight figure project – that security can suddenly become a harder nut to swallow.  If have several bids out at once, you can have a substantial amount of your available funds and/or credit tied up that have been applied to reinvestment into your firm or set aside for emergencies.

Having a Surety Bond line set up prior to bidding a job allows you the financial flexibility of using bid bonds.  Once a line is established, a bid bond can be approved in about 24-48 hours, and in some cases that same day.  Bid Bonds are issued at little to no initial cost to you thereby keeping your own funds available to you.

Another important factor in setting up your surety line with your NY Bonding Agent prior to bidding is that it could greatly reduce the time you need before you are able to begin the work.  Once approved by the Surety Company, a bid bond becomes a guarantee that payment & performance bonds will be issued should the contract be awarded.  The Payment & Performance bonds must be in the owner’s hands before any work can be started.

Conversely, just as job owners & lenders have tightened their requirements, so too have Surety Companies.  The time, amount and viability of information needed to establish (or increase) a bonding line has increased substantially. As such putting up your own funds as collateral for a bid affords no guarantee that a bonding line can be established and payment & performance bonds obtained prior to the scheduled start date.   If this should happen, the job could be defaulted to the next highest bidder or re-bid entirely and your security retained by the owner for their trouble.  You lose your cash, your reputation is soiled and it all but ensures that you will not be allowed to bid another project for that owner again.

Establishing a NY Surety Line, or a NY Bonding Line can give your NY Construction Company a significant competitive advantage against your competition. Further it allows Best Practice NY Construction firms to better and more efficiently deploy their critical cash resources. We welcome your phone calls, and inquiries as it relates to obtaining or increasing a NY Surety or NY Bonding line . We encourage you to  contact a Risk Advisory at Metropolitan Risk Advisory for all of your NY Surety or NY Bonding needs.

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NY BONDING ALTERNATIVES

February 22, 2011

Below is a list that breaks down the advantages & disadvantages for : Completion Guaranty , Letter of Credit, Sub Contractor Bonding , Sub Contractor Default Insurance, Contractor Payment & Performance Bonds. Hopefully you will find this useful. For more information contact Metropolitan Risk Advisory for a free consultation on obtaining or increasing your surety line. To better view the write up, click on the actual image to blow it up.

 

NY Bonding Alternatives

How To Better Position Your Company Financials To Improve Your Bonding Capacity

February 20, 2011

Many NY Construction Companies , and the Accountants that advise them have overlooked a very powerful tool in securing or augmenting bonding capacity. The tool I speak of is Subordinated debt to help secure surety credit. Readers of this article will get a better understanding Subordinated debt, and how it may be a useful tool as you look to get an initial bonding line , or raise an existing one .

If you have been in the bonding market for even a short period of time you have seen NY Surety Underwriting tighten, bonds rates have increased, and bonding capacity has diminished considerably since the financial market meltdown. The good news is that there is some capacity coming back into the market in the form of surplus insurance company capacity, however their appetite for risk in deploying that capital has tighten which is why properly positioning your companies financials is so critical.

Focus On Relationship

In a previous article title THE BASICS OF SURETY CREDIT , I spent a lot of time talking about how important the relationship is between the Surety & Obligee (You). I espoused that the relationship should be viewed like any banking relationship, a silent partnership if you will. A NY Surety , like a  bank has the ability to really help propel a well run company by providing the financial fuel necessary for growth. Beyond the numbers, transparency, timely and detailed communication builds trust, which can be critical when your company runs into a tough period.

Increase Your Equity Investment

Let’s assume we have nailed the relationship component of the program , and are on solid footing, however your companies financials aren’t as robust as you would like to support your NY Bonding Line, or NY Surety Line. One option is to infuse the business with additional paid in capital or increasing your equity investment basis in the company by depositing additional funds  to give your balance sheet financial muscularity.

Before you do this please consider the following: If you increase your paid in capital through outside investors , you will have in all probability have diluted your current ownership position which may be less than ideal. Additionally if you company is a “C-Corp”, the additional paid in capital will be subject to the double taxation rule, as ‘C  Corp'” are taxed at both the corporate level , AND the personal level if capital is paid out in the form of a dividend. Before you pull the trigger and jump to the quick, please consult with your accountant or financial advisor.

Using Subordinated Debt As a Tool To Increase Your NY Bonding Capacity

Thanks for staying with me so far and not jumping over to Utube , so here comes the good stuff. Instead of paying in additional capital to the company to increase the balance sheet, LOAN the company the funds. Don’t stop there as we are not finished; most NY Sureties will treat shareholder loans to the company as both a long term liability, and as a capital investment IF THE LOANS ARE SUBORDINATED TO THE SURETY. Translation if anything goes amiss the Surety has dibs on that “SUBORDINATED LOAN” before you do, which means you lose the “investment”.

By using this financial mechanism you accomplish two goals in short order;

  1. You increase your balance sheet to a position consistent with your goal of increasing your bonding line.
  2. You avoid the double taxation if you are a C Corp, diluting your investment.

Preparing The Agreements For A Subordinated Loan

Referencing the Surety Association of America there are 2 standard types of Agreements that may be used to properly execute the transaction. The difference between the two contracts, the “Special” form applies to bonds for a single contract, whereas the “general form” applies to all bonds before and after the effective date of the agreement. It’s been our experience that most sureties prefer the general form as it’s broader applicability contractually makes it a more efficient financial instrument from the NY Surety Underwriting, and NY Surety Claims handling perspective.

Critical Contractual Provisions

  • The Creditor ( typically the business owner / person who loaned the money to the NY Construction Company) , subordinates or sits in the 2nd position to the NY Bonding Company, or NY Surety Company. In effect they sign away all primary rights to the loan or capital infusion against the construction company for losses the NY Surety Company may experience as a result of providing the bonding line.
  • The Assets of the NY Construction Company are paid out to the NY Surety Company before they are paid to the creditor/ business owner.
  • The Contractor & Creditor agree that the debt will not be extinguished until the bonded obligations have been satisfied and released.
  • The Creditor assigns to the NY Surety Company it’s rights and claims upon the debt should a bankruptcy or insolvency occur on the part of the NY Construction Company.
  • Lastly the creditor agrees that any breach of the subordination agreement all property, cash and cash equivalents received by the creditor will be held in separate trust on behalf of the NY Surety Company.

Surety Decision Points

By no means is this a done deal. Just because it can be done, it’s critical that the Obligee ( NY Construction Company ) , Creditor ( NY Construction Company Owner) , and the NY Surety ( NY Bonding Company) providing the line come to an agreement that IF the Obligee & Creditor take the aforementioned steps , prepare the provisions and agreements that are acceptable to the NY Surety Company , that the goals of the Construction Company are attained, which is either a higher NY Bonding line, or obtaining an initial bonding line in the first place.Additionally the NY Surety Company will also look at the following as critical decision points in determining that Subordination of Debt is an acceptable mechanism.

  • Historical Performance of Construction Company – In analyzing the financials of the construction firm it’s revealed that the construction company has not derived a profit from several of the last construction projects they worked on, then the potential solve is not depositing more capital in the company, thus the surety may take a hard view on this and not approve the bond line or additional line.
  • Unique Considerations – The NY Surety Company is more likely to look favorably upon the subordinated debt as a means to strengthen the balance sheet where some unique considerations are in play such as a temporary issues like a large backlog of work, investments into equipment which may have eroded the companies financials , stock repurchase, large bonus payouts or expansion of company personnel , or perhaps acquisition.
  • Capital Source : Typically loans from banks, or other debt is not looked upon favorably, however excess cash from the Owner Obligee may be. It’s also common that contribution of salary, bonus, profit distributions, sale of assets , or dividends is used to support the subordinated debt position. The NY Surety may also used in their analysis promissory notes , however they don’t love this due to the administrative burden it presents to the NY Surety.

In Summary :

One of the most important variables in the NY Surety underwriting process is that the construction firm have adequate capital At Risk consistent or relative to the scope of work or project specs. Each NY Surety Company defines this ratio differently, some are more aggressive and will allow a larger spread, others are more strict and want to see a much smaller spread in the ratio.

Using subordinate debt as a tool to augment your NY Construction Companies financial position is just one technique. Refer back to this blog periodically for more NY Bonding tips and intuitive ideas to achieve your Surety goals. We also encourage you to speak to a Metropolitan Risk Advisor to assist you in achieving your company’s business goals. To contact a Metropolitan Risk Advisory PLEASE CLICK HERE.

A special thank you to R. Neuschaefer who I met years ago at a NY Bonding conference who shared this idea with me. It made perfect sense. He was happy to share it with me, and I with you, which is what’s it’s all about in the long run.

The Basics of Surety Credit

February 13, 2011

Why has the NY surety marketplace changed  and have become so tight ? With significantly higher loss ratios for the surety industry in the last several years and prospects for still worse results ahead growing in large part out of the Banking Crisis, there is a move by both reinsurers and primary surety writers to return to more consistent and fundamental underwriting standards. Surety premiums are a very minor share of the revenue base for most insurers. The business, however, holds significant exposure for large losses as defaults like Enron  and others have  underscored.

The insurance companies who are the “parents” of most surety operations were already suffering from effects of a prolonged soft market and the affects of the banking crisis. Therefore, if you are an insurance executive managing risk, you may view the surety business as a low revenue business with a potential for big losses. Your choices appear quite clear: exit the line entirely; restrict your writings of this line; and/or implement sound underwriting standards. That is what is happening and it very likely will affect your current bonding arrangements.

The days of easy underwriting are gone:

Even without the financial melt down, their was an apathy as it related to the underwriting of the surety industry. In years past it’s  almost as if anyone could obtain a bond regardless of experience, character, or financial acumen. Such an environment may have generated additional surety premiums for cash starved  insurers, but it was also a disservice to the many surety principals who earned their surety credit,

This project was made possible by a solid surety relationship

resulting in a dilution of the bond issuance itself. It was also a dilution to owners, general contractors, and other obligees that relied on the surety’s much touted “prequalification” process. Therefore, bonding  and surety programs that far surpassed the contractor’s financial base or experience, the unwarranted elimination of personal indemnity, or continually lower bond rates has  come to an end.

Self-Assessment :

How do we navigate this new surety environment when their has been such a tectonic shift? In our estimation we believe the first thing should be to perform a self-assessment litmus test. Has your bonding credit grown at a much faster rate than your financial base? Has the surety released the personal indemnity of the owners and or owner’s spouses?  Has your bond rates decreased several times in the last few years?

If the answer to one or more of these areas is “Yes,” then you may expect some change(s). To the extent that you earned each of these benefits, you should work with your NY Bonding Agent and be prepared to support your position. Surety insurers want to continue their business relationships based on solid fundamentals, and the burden will fall on you and your agent to demonstrate that you meet those new standards.

The Relationship

The perennial challenge is how to make your account more attractive to a surety underwriter.  To better help or clarify that challenge, it’s essential that you as the obligee understand what it is the bond underwriter does.

The surety becomes your partner and is guaranteeing your contractual performance on a particular project, or many projects. The surety is effectively becoming a silent business partner. When it approves your bond, it says to the world that it believes you have the capacity in every respect to complete the bonded contract as stipulated. Like any partnership the foundation must be  built on a mutual respect and transparency . If  you view the bonding relationship  as a partnership, then the responsibility to each  of the parties becomes quite clear.

Transparency :

What a surety looks for in their ideal client partner is full transparency as it relates to your past and present operations, including any affiliated business activities that may impact the operations and/or financial status of the obligee, (you). You have a pretty good idea of what events will impact the financial result of a given project, and you know in the context of your overall backlog how this may impact your company’s financial results.

The surety does not want or need a day-to-day accounting on each job, but if a major subcontractor defaults or there is a payment problem, it is probably a material event that should be shared with your agent and the bond underwriter. Bonding companies can deal with bad news, but what can really impair the relationship are surprises.

The surety’s approval of a particular contractor’s project and/or overall work program is made based on certain financial and operational parameters. If those conditions change for any reason, the rules of transparency and the surety partnership  require full and timely disclosure.

Recall that what really caused the downfall of many contractors, and financial institutions  was the  failure to provide full and timely disclosure of its activities and financial position. That resulted in a failure of confidence in a business that relied heavily on trust. Your surety relationship is also based on trust, and if either party breaches that by failure to fully and timely disclose relevant information, it destroys that relationship. Bottom line: don’t hide or manipulate the data. Neither party should ever surprise the other. Strong , timely, transparent  communication is essential.

Actionables:

With a tightening of the surety markets, what are the critical actionables  you could  do to improve both the  your bonding line and your business? Begin by retaining a professional  NY Surety Bonding Agent who will take the time to understand your business and help you to communicate your story with an appropriate surety market. You should retain a CPA who is active in the construction accounting arena.

You also should preferably secure an annual certified audit with adequate supporting schedules and footnotes that fully disclose and communicate your operations and financial picture. Review level financial statements may still be acceptable for smaller accounts, but my expectation is that sureties will increasingly demand fully audited financial reports. Compilations or in-house statements are of little or no value except perhaps for interim statements and then only if they reasonably “mirror” the format of the CPA prepared statements.

Personal Indemnity

The issue of personal indemnity may become a discussion point. Depending on the financial structure of your company relative to work program, how much money the owners regularly take out in the form of salary and bonuses, the amount of net worth outside the company, and/or the length and quality of your past surety relationship all will bear on whether personal indemnity is appropriate.

Some NY sureties will consider a homestead rider that would exclude the indemnitor’s primary residence. Some may be willing to exclude specific assets, such as monies inherited by the spouse. Some may consider a personal indemnity cap limiting the financial exposure of a personal indemnitor. In the case of Sub-S entities, the surety may consider a Net worth/Working Capital Maintenance agreement to maintain a specific level of NW/WC in the corporation or personal indemnity triggers.

Spousal indemnities are nearly an absolute requirement if the owners are married and have mingled assets. It’s important that this is communicated with your spouse. Many sureties won’t issue a bonding line without this.

Bank Line

It’s critically important to have a bank line of credit that supports your business plan. . While revolving bank lines create no working capital per se, they do provide a facility to obtain cash to meet anticipated or unforeseen shortfalls in cash flow. On a relative basis, contractors have always been considered more hazardous than most other borrowers. Bank of America announced awhile back that they were exiting all contractor bank lines of credit nationwide.

The number of banks willing to provide unsecured revolving line of credit is also growing more limited. Nonetheless, the surety views an unsecured revolving bank line as fundamentally  critical in risk management. Without a bank line, the surety may be one step closer to becoming your bank of last resort in the event of a cash flow problem. Having a bank line is important for your fiscal management and to enhance your relationship with the surety.

Cash Is King

Acknowledging the economy has become more difficult, the ability to acquire new profitable work has become   more difficult, and the financial condition of NY owners and NY subcontractors  more precarious, you would do well to manage your business to enhance your firm’s working capital position. A contractor with a strong net cash position may be able to fund problems without turning to third parties, e.g., the surety , banks, or others.

The adage “Cash is king” becomes more true during difficult times. Therefore, you may expect that with a tightening surety market, your working capital level and balance sheet composition will receive more scrutiny.

Conclusion

In summary the more salient points of this article I would say that the three most important fundamentals to a solid business partnership  with your surety are:

* Understand, appreciate, and support the surety partnership . Understand it truly is a partnership.

* Encourage transparent, timely, and accurate  communication with the surety.

* Effectively identify, allocate , and mitigate your business risks.

If you understand, and appreciate these points , you are well on your way to establishing a solid bond line, or even better increasing an existing one. To obtain a bond line, or make an inquiry on how you may get started on the process contact a Risk Advisor at Metropolitan Risk Advisory.