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Secrets of Bonding #9: Capacity – Cure or Lure?

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Bonding Capacity is a key point for many contractors along with rate (the cost of the Performance & Payment Bonds) and the approval terms.   Capacity is the amount of bonding the surety will provide, both the “per job” limit, and the total amount.  Let’s look at how all this works. 

Traditionally, the capacity amount is defined as Single and Aggregate.  The Single is the per job amount for any one contract and bond, which is the way bonds are actually issued.

The Aggregate is the maximum at any one time, comprised of:

  • The remaining “costs to complete” on started projects
  • The full amount of all awarded, signed but unstarted contracts
  • The full contract amount for low (winning) and undecided bids

Typically, the Single is no more than half the Aggregate. It is also common for the Aggregate to include all contracts, both bonded and unbonded.  The Aggregate is not just an expression of how much the surety will provide.  It is also an indication of how much work they feel the contractor can undertake without being overextended.

Here are some underwriting elements surety underwriters may review when making a capacity determination:

  • Working Capital (WC) and Net Worth (NW) of the company – The benchmark is for each of these to not be less than 10% of the Aggregate.  i.e. $100,000 WC could support $1 million Agg.
  • Secondary Financial Resources – Available bank credit, personal financial strength, affiliate companies and strong credit reports could help justify support.
  • Prior Experience – The Single is normally not more than 100% greater than the largest similar single contract successfully completed. Company longevity and expertise of key individuals is also considered.
  • Current Work On Hand – Even if the applicant has a good financial condition, underwriters may be unwilling to add to their workload if company resources appear to be fully utilized or if exisiting contracts have problems.

There needs to be balance between the elements.  For example, support will be withheld from an applicant who has good prior experience but no financial resources.

Bottom line is that bonding capacity is important.  It influences which projects the contractor will pursue and directly affects their annual revenues and profits.  Having adequate capacity can be the Cure for construction companies seeking better financial performance and market penetration.  It also Cures the bond agents need for increased commission income.

Capacity can also be a Lure. The promise of increased capacity can be a hook to draw in a contractor’s account.  Lines of bond capacity are always conditional.  Any bond can be declined for various reasons – meaning: “We’ll actually give you the capacity if we feel like it.”

It’s best to look at the credibility, reputation and stability of the provider of the line. Make sure the capacity you rely on is a Cure, not a Lure.

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site Bonds since 1979 – we’re good at it!  Call us with your next one, Bid and Performance bonds, too.

Steve Golia, Marketing Mgr.: 856-304-7348

First Indemnity of America Ins. Co.

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Secrets of Bonding #8: Bid Bonds

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“It’s only a Bid Bond.  If you can issue it now, we’ll complete the underwriting later.”

Unfortunately it doesn’t work that way.  In this article we’ll talk about the purpose of Bid Bonds and how to deal with them effectively.

Every surety bond contains a promise that something will happen.  For example, a Performance Bond guarantees the correct performance of a written contract.

A Bid Bond is often required to guarantee the bidder’s sincerity on projects funded with tax dollars (public work such as federal, state, and municipal projects.)

The promise contained in the bid bond is that one of two things will happen.

  1. If the bidder receives a contract award, they will sign the contract, produce the required Performance and Payment (P&P) Bond and commence with the work.  Or in the alternative…
  2. Pay the difference between their bid and next higher proposal.

For the benefit of the taxpayers, this assures that if the low bidder does not proceed, the work will still be performed for their price – which was the lowest price bid.

Bid Bonds are part of construction bonding or what we call “Contract Surety,” but they are really Financial Guarantee Bonds.  Sureties are always careful when issuing these.  So you can throw away the “It’s only a bid bond” comment.  Sureties view Bid Bonds as part of the acquisition process for Performance Bonds.  If the underwriting is not resolved for the P&P bond, the surety has no motivation to issue a financial guarantee/bid bond.

Other points worth knowing:

  • When ordering a bid bond, the underwriter does not want to know the actual bid price so the confidentiality is protected.  Just round up the number.
  • Award of the contract based on a bid bond indicates the obligees approval of the surety – which presumably is then transferred to the upcoming P&P bond.
  • Bids that are more than 10% below the next bidder will require a written explanation (prior to the P&P bond) to assure there are no calculation errors and an adequate profit margin.
  • Bid bonds are sometimes capped, meaning the bond will not support a bid higher than the bid estimate the underwriter approved. In such cases, it is important to use an ample figure on the Bid Bond Request form.  If there is a last minute bid increase, such as a subcontractor or supplier coming in higher than expected, the bidder will not be able to bid a dollar more than the pre-approved figure.  Remember, there is no downside to bidding less than indicated.
  • Postponements – when bid dates are rescheduled, the obligee may permit the original bids bonds to be used even though the stated bid date will now be incorrect.  Check with the obligee to see if you must re-issue the bid bond to show the new date.
  • When a bid is outstanding (undecided), the contract amount is considered “in use” in regard to their available capacity.  Therefore, “not low” bids should be reported promptly to the surety.
  • Bid Bonds are considered terminated upon issuance of the P&P bond, or after 90 days.
  • The bid security of the low three bidders is usually held until the contract is signed and bonded by the low bidder (see our following comment about using a check!)

One last word of caution: A check may be accepted as an alternative to a bid bond.  However, it is subject to forfeiture if the bidder receives an award but cannot produce the P&P bond.  Always use a Bid Bond if possible!

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site Bonds since 1979 – we’re good at it!  Call us with your next one, Bid and Performance bonds, too.

Steve Golia, Marketing Mgr.: 856-304-7348

First Indemnity of America Ins. Co.

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Secrets of Bonding #7: Bond Forms

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This probably sounds like a boring subject. “Mundane” comes to my mind. But you’d be surprised how important it can be.  The bond form can bring an agent’s production opportunity to a screeching halt.  They can also turn a previously good project into an ugly mess.

Let’s break it down.  Bond forms can be categorized in the following groups:

STATUTORY / STANDARD – required by statute or regulation such as city, state or federal forms. There are also industry standard forms such as the American Institute of Architects (AIA).

COMPANY FORMS – devised by the surety itself.

SPECIAL OBLIGEE FORMS – These are written specifically (manuscripted) to satisfy the expectations of a private obligee such as a general contractor (GC) who requires subcontractors to use them.

So how do you recognize each category and what happens next?

A STATUTORY FORM is stipulated by a public body (such as federal form 25 Performance Bond).  It will have their name pre-printed on the form and may have edition numbers or other ID showing it is theirs.  If you bond a federal contract, you MUST use this – no option.  STANDARD FORMS are used when the bonding requirements say an AIA bond form must be issued.  These are reasonably fair to all parties and are well accepted by all parties involved.

COMPANY FORMS are written in a manner the surety prefers.  These are the underwriter’s first choice and may be accepted by the obligee (party requiring the bond) if no mandatory bond form was indicated. Spot these by their ID numbers or copyright info.  The surety’s name will be pre-printed on the form.

SPECIAL OBLIGEE FORMS – may look different than normal.  Sometimes they are extremely short.  Less is not more in bond forms.  Generally, short forms omit the “rules of the road” that determine what should happen when trouble occurs, how a claim is made, what remedies are available, etc. These forms can be troublesome.  With perfectly good, tried and proven bond forms available such as AIA, why would a GC spend time and money to invent a new one? Assume such special forms are more beneficial to the GC and less fair for the subcontractor (called the Principal) and the Surety. Sometimes these forms are practically normal.  But most often we find they place unique burdens on the Principal and Surety.

Since the GC is a contractor, in the event of a default, they may just want to step in, finish the subcontractors work (not worrying about the cost) and then hand the bill to the surety.  This would be evident when reading the bond form.  The surety will consider this a forfeiture bond or financial guarantee because they were deprived of the opportunity to arrange for the economical completion of the work. Such bond forms can prevent the surety from supporting the project, no matter how confident they are in the contractor.

Summary: Contractors and their bond agents cannot ignore the bond forms.  The contractor may only be concerned about signing the contract.  But experienced bond agents and underwriters will always evaluate the forms.  If the surety throws up a red flag, the contractor should be equally concerned.  Problems caused by a bad bond form may start with the surety, but they end up on the shoulders of the contractor.

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site Bonds since 1979 – we’re good at it!  Call us with your next one, Bid and Performance bonds, too.

Steve Golia, Marketing Mgr.: 856-304-7348

First Indemnity of America Ins. Co.

(Don’t miss our next exciting article.  Click the “Follow” button at the top right.)

Secrets of Bonding #6: Christmas in February

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This gift is for you – even if you don’t celebrate Christmas!

In the world of Bid and Performance Bonds, there are annual cycles.  Certain things are important at different times of the year.  For example, construction may follow the seasons and be less active in winter. The underwriting relationship tends to follow the contractors accounting cycle which revolves around the company’s “fiscal year-end” (FYE).  This day is the end of the fiscal year, and is when federal and state taxes are calculated.  The most common FYE date for companies is December 31st.  Therefore, February is crucial because their fiscal year recently ended, but it is likely that CPA prepared financial statements are not yet ready.  When they are produced, they will be an important building block for re-approval of the bond account and to determine capacity levels for the coming year. (Our comments here are applicable regardless of when the FYE date actually occurs.  You just apply the principles to that annual cycle.)

So here is the gift: This time, during the first quarter of the contractors new year, is the prime opportunity to assure the financial presentation is maximized. The contractor worked all year to produce good results that will enhance bonding and banking relations and carry the firm into the new construction season. Now is the final chance to manage and maximize that critical info.  Here’s how:

The contractor’s business plan for the current year should determine the amount of surety capacity needed.

The surety should review the internally prepared (i.e. QuickBooks) company FYE Balance Sheet and Profit & Loss Statement.  If a draft of the CPA financial statement is available, that’s even better.  The question to ask is “Based on this preliminary FYE info, does it appear we will qualify for our desired amount of surety capacity: $___ per contract and $___ in the aggregate (maximum at any one time)?”

If the answer is no, NOW is the time to make adjustments before the documents are produced in their final version.  Talk to the surety about the issues.  Talk to the accountant about how to address them.  Not everything can be corrected. But some problems are caused by discretionary actions that ARE reversible.

This procedure is important because it facilitates the discussion that prevents capacity problems that can last all year. No back pedaling allowed, only forward!

Maximize the bonding, increase revenues and produce higher profits.  Everybody wins.

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site, Subdivision, Bid and Performance Bonds since 1979 – we’re good at it!  Call us with your next one.

Steve Golia, Marketing Mgr.: 856-304-7348

First Indemnity of America Ins. Co.

(Don’t miss our next exciting article.  Click the “Follow” button at the top right.)

Secrets of Bonding #5: Three C’s of Bonding – Plus One!

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Students of the industry are familiar with the “3Cs of Bonding” which are intended to describe the key elements of decision making in surety bond underwriting:

  • Character: Does the Principal (bond applicant) have a credit record and other history suggesting good character and that they will be faithful to their obligations?
  • Capacity: Does the Principal have the skill, experience, knowledge, staff, plant and equipment necessary to perform their contracts?
  • Capital: Do they have the financial wherewithal to finance the new project as well as other current obligations and address any problems that arise?

To understand why these are relevant, let’s take a step back and review the premise under which surety bonds, such as Performance Bonds for construction contracts, are given.

If you read our previous issues of “Secrets of Bonding,” you will recall that bonds are not insurance and sureties do not anticipate claims or losses the way insurers do.  Therefore, the underwriting process is intended to reveal if the bond applicant is likely to succeed without involving the surety.

Surety underwriters dig deep, ask questions, and require proof.  As far as humanly possible, their goal is to have certainty that the Principal can fulfill the obligations that are covered by the bond.

At the end of the underwriting process, the underwriter should arrive at what we’ll call the “4th C of Bonding.”  It is the most important one of all because no applicant has ever gotten a bond without it.

It is CONFIDENCE. When the 3 Cs are evaluated, if the underwriter is confident in the principal’s ability to perform, the bond is approved and issued.

With this in mind, applicants must work through a sometimes arduous underwriting process where information must be gathered, submitted and sometimes re-submitted.  Banking records, references, and supporting documents may be requested.  It can go on for weeks. If you like paperwork, raise your hand!

However, the underwriting process must be viewed as an opportunity for the applicant, not a burden.  The mind of the underwriter is like a blank canvas on which the applicant will portray their bond worthiness. It must be a picture of Confidence.

The 3Cs are all important. But now you know about the critical 4th C.  Without it, no bond was ever written.

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site, Subdivision, Bid and Performance Bonds since 1979 – we’re good at it!  We get to know our agents and bond applicants to maximize Confidence.

Call us with your next Site, Bid or Performance Bond.

Steve Golia 856-304-7348

First Indemnity of America Ins. Co.

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Secrets of Bonding #4: Working Capital

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The Magic Wand: WORKING CAPITAL.

Surety bond underwriters base their decisions on a wide range of factors including the contractor’s prior experience, quality of staff, credit history and financial condition.  Many of the factors are subjective but some are just cold hard facts. Working Capital (WC) is among the more straight forward elements, and is easily identified.  It’s worth knowing about because it is an unavoidable piece of the underwriting puzzle, and to many sureties it is one of the most important. If there is a magic wand you could wave over an account to get it accepted, this is it!

What is Working Capital and how do you find this element?

Working Capital is a prediction of the company’s future, near term, cash flow.  Based on one day in time, it predicts the amount of cash that will flow through the business to pay bills, finance new ventures and solve problems that arise.  These are all important factors for surety bond underwriters.

WC is located on the company’s most recent year-end financial statement (FS).  The most common date for this is 12/31 of the preceding calendar year. Turn to the Balance Sheet, then the Assets column, and then the subtotal called “Current Assets.”  Now find the corresponding figure in the Liabilities called “Current Liabilities.”  The difference between these numbers is called “Working Capital as Given” meaning it is taken right off the FS without analysis or adjustment. Underwriters will hope to find that the WC is about 20% of the single contract size the client wants to bond.

Example:

Current Assets: $600,000 – Current Liabilities: $400,000 = Working Capital of $200,000

$200,000 is 20% of $1,000,000 which could be the maximum single job size (assuming other factors are also in line.)

If the WC is too low, the account may be found financially deficient for the amount of capacity requested.

  • That’s the cut and dried part.  Now comes the art.  What can be done if the WC is insufficient? Some ideas:
  • First, it is important to review a draft of the year-end FS so an early version of the numbers can be evaluated. This is the time to make adjustments before the FS is carved in stone.
  • On the asset side, debt collection from stockholders / owners (money owed TO the company) directly helps WC.
  • Refinance fixed assets.
  • Unused equipment and other fixed assets such as real estate can be sold and the proceeds held as cash.
  • WC can be increased by shifting bank debt from current to long term.  Companies with all their debt as current should consider refinancing for a longer payback period.
  • Money can be loaned temporarily or permanently to the company by owners. If there is room to add bank debt, it could be beneficial if the payback is long term.
  • The draft FS is the key to this process.  Get the underwriter’s opinion regarding the capacity desired.  If the FS doesn’t support the figure, make adjustments now so that surety capacity will not be inadequate for the next 12 months.

Working Capital can be a magic wand if you know how to wield it!

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site, Subdivision, Bid and Performance Bonds since 1979 – we’re good at it!  Call us with your next one.

Steve Golia, Marketing Mgr.: 856-304-7348

First Indemnity of America Ins. Co.

(Don’t miss our next exciting article.  Click the “Follow” button at the top right.)

Secrets of Bonding #3: How Taxes Affect Bonding

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There are many factors that contribute to the underwriting decisions on bonds.  The contractor’s history is considered along with credit and financial analysis, estimating, project management, equipment – a variety of elements.

For many contractors the process of seeking surety bonds is mysterious and frustrating.  Not having them can prevent the company from graduating to larger projects and greater financial success. Seminar attendees often ask us for the silver bullet.  “What must I do to get bonded?” So now we reveal what, for many, will be the key to qualifying for bid and performance bonds:

Pay More Taxes!

Sound crazy?  Often company managers struggle to manage (reduce) tax payments.  They feel a low bill (or no tax bill at all) is proof of a successful financial strategy.  So why can paying more taxes help the company qualify for bonds?

Surety underwriters intend to write bonds for successful firms that are likely to succeed on their bonded contracts.  What better sign of success than to have made a profit in the prior year?  Profits prove the vitality of the company.  They show that company management acquired enough work, with a sufficient margin and controlled expenses, resulting in a net profit.  The point is – you only have taxes if the year was successful and the company made money.  The profits strengthen the foundation of the company assuring continued stockholder and creditor support.  Profits and growth are all elements that, when combined with other relevant factors, lead to confidence on the part of the underwriters.  That’s when bonds get issued!

Summary:

Paying taxes is an important part of bonding not because the taxes are beneficial; but because the tax payment is indicative of good record keeping, profitability, cash flow and growth all of which are good for the company and the surety that supports it.

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site, Subdivision, Bid and Performance Bonds since 1979 – we’re good at it!  Call us with your next one.

Steve Golia, Marketing Mgr.: 856-304-7348

First Indemnity of America Ins. Co.

(Don’t miss our next exciting article.  Click the “Follow” button at the top right.)

Secrets of Bonding #2: Full Disclosure

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FULL DISCLOSURE: WHAT DOES IT MEAN? WHY IS IT IMPORTANT?

Bond underwriters intend to make a broad review of the applicant’s qualifications. This includes many aspects: Financial condition, technical expertise and prior experience, staff, equipment, banking and supplier relations, affiliates, legal issues and more.

Underwriters will avoid an account if there is a suspicion they are being manipulated. Underwriting questions are designed to reveal the applicants strengths AND weaknesses.

Certain aspects of the underwriting information are obtained from independent third parties such as CPA prepared financial statements, banking records, credit reports and supplier references. Other items may come directly from the applicant who is not independent but rather an “interested party.” This is a fact of life in the development of every bonding file. Therefore, the underwriter must rely on the applicant to be honest and forthright with the information. Without this certainty, there can be no underwriting relationship.

To foster this good rapport, the applicant can take these steps:

1. Answer questionnaires and forms completely and honestly. Sign and date the document. If there are negative items, describe them candidly but attach a written explanation or other documents that may help.
2. Be sure to include other owned companies, all lawsuits, and bankruptcies even if old. If there are banking or tax issues, describe them. The underwriters will probably unearth these during the process, and it looks better if you volunteer the facts and then take the opportunity to give your explanations.
3. Describe the strengths of the company such as bonus & employment agreements with key people. Include their resumes. Describe any special training, licensing and certifications, awards, and provide good guy letters.

Keep in mind that sureties make money by writing bonds. So even if it doesn’t always seem the case, they do have motivation to say yes.

Remember that, in effect, you are asking the surety to become your business partner. The surety will succeed on the project if you do. So how will you treat your new partner? Be candid and forthright! Don’t try to hide the negative factors – you probably won’t succeed, but you will do irreparable harm to the relationship.

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site, Subdivision, Bid and Performance Bonds since 1979 – we’re good at it!  Call us with your next one.

Steve Golia, Marketing Mgr.: 856-304-7348

First Indemnity of America Ins. Co.

(Don’t miss our next exciting article.  Click the “Follow” button at the top right.)

Secrets of Bonding #1: Bonds are NOT Insurance

Steve Golia1 Comment

This is always where the conversation starts. Why? Because if you think a bond is an insurance policy, you will have the wrong set of expectations. If you are seeking a bond, you’re likely to become very  frustrated unless you have a correct understanding and the expectations to go with it.

Here are two basic differences between insurance and bonds:

1. Insurance transfers risk of a specific event from the insured (policy holder) to the insurer. (Example: The risk of financial loss due to fire is transferred from the insurance applicant to the fire insurance company.) With a bond, the bond applicant HOLDS the risk.

2. Insurers charge rates that expect a certain number of claims and losses. Sureties do not expect to have claims or losses and do not charge enough to pay for them.

There are other additional differences, but let’s focus on these two. With a bond, the surety is backing the bond applicant performance for the benefit of the party paying for the work. If a problem develops, it is still up to the applicant to solve it. In fact, contractors give their indemnity to the surety (promise to reimburse the surety if they fail to perform and cause a loss.) So when a bond is in place, it is even more important for the contractor to perform correctly. With insurance, you pay a premium to reduce your risk. With bonds you pay the premium, but have even more at stake than on an un-bonded project.

On the second point regarding rates, this helps explain why bonds are hard to obtain. If the surety has no tolerance for claim or loss, they can only provide bonds for the most qualified applicants. This means you must present yourself in the best manner possible if you hope to obtain a bond. Doing so requires good financial reporting, record keeping and complete disclosure. We’ll talk more about this later in this series.

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site, Subdivision, Bid and Performance Bonds since 1979 – we’re good at it!  Call us with your next one.

Steve Golia, Marketing Mgr.: 856-304-7348

First Indemnity of America Ins. Co.

(Don’t miss our next exciting article.  Click the “Follow” button at the top right.)