A frustrating part of being a contract surety bond underwriter is finding oneself obligated to decline a performance bond to a contractor that appears to possess the prerequisite experience, expertise, character and financial strength to accomplish his or her project. The review or “underwriting” process is the most important opportunity for a contractor to demonstrate his or her reputation and ability to meet all current and future contract obligations. Initial submissions to a surety must be detailed, complete presentations to avoid a negative impression. That being said, it is my experience that disapproval of otherwise well qualified applicants are due to one of three reasons. These are by no means exhaustive.
Realistic lead time
It is not reasonable for a contractor that has not previously qualified for bonding capacity to submit a performance bond request the day before it must be filed. An underwriter must be afforded ample time to process the biographical information provided by the contractor, read and understand the contract specifications and therefore the nature of the bonded obligation, order and review credit reports and financial rating service feedback, and properly analyze the contractor’s financial statements/work in progress (backlog) schedules. During this review process questions may arise that require clarification through telephone calls and/or emails, between the underwriter, the contractor and the project owner. Very small contract surety requests don’t require the same level of scrutiny as larger ones however the same underwriting fundamentals apply regardless of the project size.
Inadequate financial statement preparation
In efforts to offer bonding to small and emerging contractors most sureties have created “quick bond” or “fast-track” applications. Performance bond underwriters understand that new and small contractors are unlikely to have CPA prepared financial statements. The cost of formal financial reporting can be a challenge for small contracting firms. As project values increase, contract surety bond underwriters must be able to trust the accuracy of the working capital, equity, revenues, billing figures contained within financial statements. Presentations prepared to review or audit standards are absolute prerequisites for larger bond requests. Offering formal statements also provides the underwriter with an indication of a contractor’s managerial maturity and understanding of the basic principles of credit extensions. As a general rule, “If you want to play in the big boy game, you have to be willing to play by big boy rules.” A contractor’s unwillingness to quickly provide the requested financial information prepared to an appropriate standard can be an immediate ‘deal killer’.
As part of an application review the surety underwriter necessarily compares the size and scope of the proposed project with projects that the contractor has successfully completed in the past. Bidding on jobs that are significantly larger in complexity, outside of the contractor’s primary work specialty and/or far from the contractor’s general geographic operating area are leading causes of performance bond request declinations. Over extension is a serious concern.
All three of the aforementioned factors are absolutely within the contractor’s control. Understanding how these components affect an underwriter’s overall opinion of a contractor’s bondability and taking the appropriate actions to provide them is imperative.
These preceding “reasons for decline” are only part of the underwriting picture. Performance bond underwriters seek to establish and affirm the “Three Cs” (character, capital and capacity). Capital does not necessarily mean liquidity, which is essentially the amount of cash in a contractor’s operating account. “Working capital” is a ratio of the contractor’s current assets to current liabilities. Capacity is a subjective judgment of the contractor’s ability with respect to the type and size of the work to be accomplished and managerial experience, i.e., expertise specific to the work, proper equipment and supplier relationships, managerial maturity which includes both accounting and workforce management skill, and the likelihood of the contractor success in the geographic location of the project. Character is a judgment of the contractor’s willingness and history of fulfilling his or her promises. Attention to these fundamentals IN ADDITION to recognizing the preceding ‘red flags’ are key to getting the attention of surety companies.
Clear, open lines of communication with the performance bond underwriter are essential. The underwriter must perceive each one of the Three Cs, and address any weaknesses that he recognizes as a significant weakness. If these observations are put into practice, contractors will find it much easier to obtain the performance bond capacity that they require.