If history is any indication, surety companies will likely begin to turn a more critical eye toward their contractor clients during the COVID-19 crisis. They’ll begin to fear widespread failures and start tapping the brakes on bonding credit without working capital.
A surety bond is a necessary fact of life for most contractors. In the hard-bid and public works markets, they must be able to get both bid and performance bonds to bid, win, and construct a project. It’s essentially an insurance policy – should a contractor fail to complete a project, the surety takes over.
Like a line of credit at a bank, there’s a maximum amount a contractor can bond, determined by their financial health, the size of their work backlog, and their ability to do the work. These requirements become more stringent during unpredictable times, as surety companies raise the bar and ratchet down bonding credit/capacity. Where a contractor’s bond capacity might be 20 times their discounted working capital in a normal environment, that multiplier can be drastically reduced when financial markets are unstable.
With so much uncertainty in today’s economy, sureties are particularly interested in a contractor’s cash position and discounted working capital. They’re drilling down deeper into a contractor’s financial picture and could soon begin requiring interim financial statements, in addition to the annual statements, from those they feel are a higher risk.
Steps a Contractor Should Take Now
To be sure, a well-established company with a strong cash position is going to appear more attractive to a surety. In that regard, there are some important steps a contractor can still take to maximize their bonding capacity and remain competitive.
First, they should closely watch and “work” their receivables to ensure collections are coming in on time. A contractor should also ensure their clients have adequate financing and have no limitations on credit, as well as do their “due diligence” on subcontractors.
Next, refinance debt for longer terms. If a contractor has an impending balloon payment on a large debt, they should consider refinancing the debt for a longer period. By doing this, the debt immediately drops out of current liabilities and improves working capital. That can be a particularly wise move in an unstable environment when interest rates are typically low.
Also, consider borrowing money against long-term assets over a four- or five-year term to put cash in the bank. Of course, selling idle equipment helps, too, as it eliminates a long-term asset and immediately converts it into cash.
Contractors should be careful about investing in equity securities, as these can be drastically discounted during a financial crisis due to market instability, and they can have a large impact on discounted working capital.
Finally, closely monitor and restrict cash payments. If you need new work trucks or other equipment, finance them rather than pay cash to avoid impacting working capital.
It’s a Unique Situation
Uncertainty is nobody’s friend in the business world, and COVID-19 has injected a big unhealthy dose of it into the construction market. While large, established contractors can merely adjust their strategy and bid on smaller jobs, it becomes a bit of a perfect storm for the small- to medium-sized contractor who finds themselves competing for a smaller pool of work even as bonding capacities get squeezed.
Some of the more seasoned companies have used lessons learned during the 2008 Great Recession and increased their liquidity. CRI can provide valuable guidance in that regard by examining a contractor’s balance sheet and pinpointing problem areas that create drags on cash flow – e.g. high volumes of long-term debt, underutilized equity in equipment, slow account receivables, etc.
With the proper guidance, a contractor can maximize discounted working capital and put themselves in a healthier position for weathering the current financial storm. Regardless of their cash position, however, most contractors could experience reduced bonding capacities during these troubling times. That means a good relationship with your surety company goes a long way, too.