By Jack Kehl
During my 20-plus years in the surety industry, I have been asked one question more than any other: “What is my bonding capacity and how is it determined?” Unfortunately, this simple question is the most difficult one for a surety agent to answer and merits a clear explanation.
Bonding capacity is the maximum amount of surety credit a surety company will provide to a contractor. It is generally expressed in terms of the largest single project the surety would be willing to issue and the maximum amount of contract backlog a contractor can hold. This is referred to as single job limit and aggregate limit.
For example, a contractor with a $5 million single/$25 million aggregate limit could expect that bonds requested for up to $5 million would be “pre-approved” by the surety, provided the backlog of the company at the time of bidding is $20 million dollars or less. In other words, if the job would push the company over the aggregate limit of $25 million, then it would have to be submitted for review and approval by your surety underwriter. Bonding capacity is merely an estimated capacity limit designed to allow your surety agency to meet your company’s needs. It is not the absolute limit of your company’s ability to bond a job.
How do surety underwriters determine single and aggregate limits? There is no one-size-fits-all answer to this question, but there are some common elements to the underwriting process that most surety companies use: the quality of the organization, the quality of financials, and the contractor’s overall experience.
The quality and composition of the contractor’s employee base is a key factor in determining the surety’s comfort level in extending credit. If your organization and team is below par, then so will your capacity be. Accounting staff and systems will be the first to be reviewed as their work product (the financial reports) is likely to be seen before the underwriter meets anyone at your company. Accurate and detailed financial information on a timely basis is a must. A WIP, A/R aging, or financial report that is 2-3 months old does not allow for a PM to correct problems in a timely manner and shows the underwriter you place little value on this information.
Estimating is another area that greets your underwriter long before they set foot in your business. A review of past projects along with your WIP report provide the underwriter with a good idea of the quality of your estimating department. Jobs that have margins 3-5% higher at the start of a job compared to where they are at job completion will speak volumes about about your estimating staff. Is the estimating department using up-to-date software? Does the estimating tie into the job costing systems so costs can be tracked and captured for future bidding? These factors affect the decision an underwriter makes.
The management team, who will likely spends the most time with the underwriters, also impacts the capacity of the business. Does management have some skin in the game as owners or are they just hired hands? Are they leaders in their industry and related associations? These are all subjective elements that affect an underwriter’s decision in extending surety credit.
This is a much less subjective area of evaluation. Although there are countless ratios and metrics that can add to a financial analysis, three factors set the stage for everything else: equity, liquidity, and debt.
Surety underwriters weigh the importance of equity to a contracting firm in varying degrees. Some are more focused on the strength of the equity, particularly the retained earnings of a firm, and measure that against the overall debt levels of the company as well as the backlog. A well-capitalized company is always viewed favorably, but moreso when the level of debt is less than twice the company’s equity. Sureties also find that a company with backlog that is less than 10-15 times the equity of the firm is less of a risk.
Liquidity is of critical importance to any business, but of particular importance for a contractor. Few companies are asked to front such large sums of money for a customer for 60-90 days and then have them hold back 10% in retainage, all while being expected to be on schedule and under budget at the end of the job. Accordingly, surety companies like to see liquid assets or working capital equal to at least 7-10% of the remaining cost to complete backlog for subcontractors and no less than 5% for GCs. Of course, there are exceptions.
Nothing can stop a request for added surety credit like a full bank line, bank debt greater than 2x equity, or no bank credit. Although operating debt (A/P, over-billings) can be a concern, third-party debt from banks and lenders create the majority of concerns for an underwriter. A heavy equipment company (e.g., site and utility companies or highway firms) understandably carries great levels of bank debt, but a GC with high levels of debt is frowned upon. A contractor’s ability to run a company without depending on the bank’s money is treasured by every surety, resulting in the greatest level of support.
Since most sureties require the financial statements to be audited, reviewed, or at least compiled by a CPA, choosing a CPA that understands the construction industry and its unique financial requirements is critical.
A contractor that has demonstrated success on jobs of $1 million should not assume success on jobs of $10 million. The dynamics change, parts and pieces move differently, and the stakes increase. While it can be merely a question of more pipe, brick, or asphalt, it can also be a question of more capital, manpower, management, and expertise. An underwriter will need to make a judgment call in an area he or she has little, if any, direct experience.
A contractor’s past performance is everything. One bad job or badly managed situation can taint the opinion of the surety on future work for years to come. Be proactive in sharing praise from owners and architects with your surety. The same goes for your team. When one of your employees gets an award, share it with the surety. Make sure the surety has resumes of your company’s key employees. All this goes into forming a good impression.
Show off your work to your surety. Rather than meeting with the surety in a conference room, get him or her on to the jobsite. Show your process and planning in the field and your safety and control measures. Let the surety see what you’ve built. On a larger project, break the job down into subcontractor costs and billings by month over the life of the project so that an underwriter can see the job in smaller pieces. Explain how you intend to mitigate the risks of the job (e.g., by bonding subcontractors, financial reviews of the key subcontractors, payment terms, etc.).
In summary, increased capacity is contingent upon a top-notch organization, strong financial presentation, and experience. How you present this information to your surety is key to maximizing that capacity. A professional surety agent is your guide and should be walking you through the process of preparing for the request for more surety credit. If not, you may very well be getting your capacity shorted by your surety.
Jack E. Kehl, AFSB, Surety Manager, is a professional surety bonding agent at Overmyer Hall Associates. His career in surety spans more than 20 years. Beginning as a surety underwriter for a major regional insurance company, Jack has worked for both locally owned insurance agencies and large national brokers. Jack can be reached at email@example.com.
About Overmyer Hall Associates
Overmyer Hall Associates is one of the fastest growing agencies in the country, quickly becoming one of the largest property and casualty insurance agencies in Central Ohio. Overmyer Hall Associates provides clients with insurance and risk management, specializing in Business Insurance, Surety Bonding, and Home & Auto Insurance. Since its founding in 2011, the firm has been awarded Columbus Business First’s "Fast 50" and "Best Places to Work" awards, the IIABA’s “Best Practices Agency” recognition, Columbus CEO Magazine’s “Best Insurance Broker” and the Columbus Young Professionals Club’s “Wonderful Workplace for Young Professionals” award. www.oh-ins.com