Construction Surety Bonding: What is a Bond and How do I Structure to Bond Routinely? Presented to Pikes Peak NCMA May 15 th, 2014
Six & Geving Insurance, Inc. Largest Local 3,000+ Business Clients 28% Construction Broad Market Access 39 Direct Insurance Contracts 14 Surety Contracts Responsive 99% of calls returned same day Our existing clients are our best advertisement ask them about us!
Your Presenter Underwriter vs.. Agent Perspectives Distinguished Graduate USAF Lead-In Fighter Training Football Award Winner NASBP School F-15C Eagles at Langley, VA Distinguished Graduate National Association of Surety Bond Producers (NASBP) William J. Angel Advanced Surety School
Overview This is a Mid-Level Seminar Assumptions: You ve infrequently or never bonded You may or may not have a surety relationship You re unfamiliar with the process or want a refresher Topics: What is a bond and how do I get one? We may curtail depending on audience What are the basics of surety underwriting? Or, How do I structure to bond regularly? How do I maximize my Surety Credit? Or, I already bond, but how do I get larger or more frequent bonds? Question & Answer
What is a Bond? The 6,000+ types of Bonds Commercial Surety Fidelity bonded and insured Financial License & Permit Contract Surety This is what we re really talking about bonding of a construction contract
Common Elements of Surety Primarily talking about Contract Surety Some of the elements are common to all bonds CONTRACTOR PRINCIPLE Performs work and pays bills
Common Elements of Surety OWNER or CONTRACTOR (that you work for) OBLIGEE Requires the bond CONTRACTOR PRINCIPLE Performs work and pays bills
Common Elements of Surety OWNER or CONTRACTOR (that you work for) OBLIGEE Requires the bond CONTRACTOR BOND COMPANY PRINCIPLE Performs work and pays bills SURETY Guarantees Performance and Payment
Common Elements of Surety OWNER or CONTRACTOR (that you work for) OBLIGEE Requires the bond CONTRACTOR PRINCIPLE Performs work and pays bills Arranges The Surety Relationship AGENT BOND COMPANY SURETY Guarantees Performance and Payment
Common Elements of Surety OBLIGEE PRINCIPLE
Common Elements of Surety OBLIGEE Bond is a Contract over the Contract PRINCIPLE Performance Principle will do the work or we ll do it for them Payment Principle will pay the bills or we ll pay for them
General Indemnity Agreement OBLIGEE This is what makes it all possible PRINCIPLE Principle will repay the surety Any costs associated with any claims This is not insurance
Why are Bonds Required? Miller Act of 1935 With Updates Performance Guarantees Government s don t want to spend time in court arguing over a construction project Payment Guarantees Lien Laws You can t lien a public work Subcontractors To mitigate GC/Prime financial/legal risk
When are Bonds Required? Federal Work Prime Construction Contracts > $150,000 State and Local Work Varies wildly Typically Construction Contracts > $100,000 Subcontractors No mandate, but very common some states (New Mexico) require all to bond
A Note About Risk Proverbs 25:15 He that is surety for a stranger shall smart for it; But he that hateth suretyship is secure. Webster s Surety is One who becomes responsible for another. Surety Information Office (SIO) A careful, rigorous, and professional process in which surety companies prequalify contractors and then assure project owners that these contractors will perform the contract according to its terms and conditions at the contracted price, deliver on schedule, and will pay certain laborers, subcontractors, and suppliers associated with the project.
A Note About Risk Surety is not in your best interest It s in the Obligee s best interest It is required by law in many instances So you frequently have no choice GC s use bonds to mitigate their own risk Having a bonding relationship: Helps you get work Makes you a better contractor (as a benefit)
Types of Bonds for Contractors License and Permit Completion Contract Bonds Bid guarantees they ll sign the contract Performance guarantees performance Payment guarantees payment of suppliers and subs Supply guarantees supplies Maintenance (Warranty) guarantees performance of contractual warranty work
How do I Get a Bond? Through Agents similar to insurance Because most bond companies are insurance companies The Three C s of Surety Character without it, no bonds Capital need adequate funds to do the work and pay the bills Capacity need experience and available workload to do this specific job
How do I Select an Agent? Check with your Business Insurance Agent My Selection Criteria Expertise bond expertise is a bit rare Market Access requires unique insurance contracts Responsiveness National Association of Surety Bond Producers www.nasbp.org Find an Agent
Two Paths for Getting a Bond See Hand-Out What are my Surety Options? Two basic methods: Fast Track or Quick Contractor approach For Contracts < $350,000 One or Two Page Application plus Contract Simple Credit Check of Owners Traditional Underwriting Requires more time and much more info Larger bonds at lower marginal rates possible
Typical Traditional Underwriting Personal & Business Credit Check Contractor Questionnaire Job References 3 Years of Business Financials CPA Reviewed if contracts > $1MM Personal Financial Statements Bank Reference Letter Insurance Information Job Specific Info for each bonded job
A Note on Financial Presentation CPA Involvement If jobs > $1MM per contract or Gross Revenues > $3MM annually Most Sureties will expect Review level Statements on Annual Basis From a Construction Oriented CPA In Construction Oriented Format Percentage of Completion Method This may cost $5,000+
Underwriting Methodology The Funnel Surety s Model is Tight Tightens as you Grow Many successful contractors outside the funnel They just don t bond Maximizing Surety Credit Means Embracing the Funnel Or finding a different one START-UP Successful Contractors Properly Capitalized Profitable Building Equity PCM Quick Ratio Managing Debt Job Costing Reviewed Bond Back Audited 3 MM 25 MM 100 MM Assumes 100% Business Success Assumes 0% Chance of Bond Claim
Biggest Picture Underwriting Sureties underwrite for two things Underwriting for Loss Can they pay us back? Underwriting for Performance Can they get the job done? If you meet the Performance Criteria, you probably meet the Loss criteria
Different Funnels Sureties come in Three Typical Flavors Equity Underwriters (rare) Working Capital Underwriters (typical) Hybrid (both methods atypical but not rare)
Terminology Working Capital (WC) Current Assets Current Liabilities Equity or Net Worth (WC) Total Equity Backlog Open Contracts Profit Completed Portion Surety Case Your Case is WC BL or NW BL
Equity (Net Worth) Underwriters All Sureties Watch Equity Because they are Underwriting for Loss Rare Methodology Basic Underwriting Philosophy Compare Total Equity to Backlog Usually 10x or 15x Equity to Backlog Corporate or Personal Net Worth Some Sureties will Include Personal NW Primary Residence & Retirement Off Limits
Working Capital (Net Quick) UW All Sureties watch Working Capital Because they are U/W for Performance Compare WC to Backlog Typical Case WC > 10% of Backlog WC x 10 = Acceptable Maximum Backlog Called a 10% Case for WC BL > 10% Some (very few) WC > 5% of Backlog WC x 20 = Acceptable Maximum Backlog
Hybrid Underwriters Use some combination of both methods These companies are most flexible Also very rare method for Sureties
Other Key Parameters Profitability Gross & Net Margins Debt to Worth < 4:1 (many 3:1) Cash to Current >25% Costs Job Costs comparable to industry segment Overhead <100% of NW Job Size Experience tackle <2x largest There are many, many others Too many to go into great detail here today
Math Practice WC Working Capital (WC) Current Assets Current Liabilities
Math Practice NET WORTH Equity or Net Worth (WC) Total Equity
Math Practice BACKLOG Backlog Open Contracts Profit Completed Portion
Practice Math CASE Surety Case Your Case is WC BL or NW BL
Back to the Underwriting Funnel Underwriting for Loss Can they pay us back? Can they take a punch? Two? Underwriting for Performance Can they perform this job? Is this job a good fit? Could this job kill the contractor? Are we doing everything to mitigate risk? Interest of Surety and Contractor Merged (until there is a claim) START-UP Successful Contractors Properly Capitalized Profitable Building Equity PCM Quick Ratio Managing Debt Job Costing Reviewed Bond Back Audited 3 MM 25 MM 100 MM Sureties don t like Anything Risky
How do I get Bigger-More Bonds? Keep as much money in the company as you can stand Properly Capitalized businesses are successful businesses Don t need the bank (bank dependency) Often pay subs regardless if they ve been paid Borrowing costs reduced, maybe even profit Take Hits yet keep going Pick & Choose jobs More WC & NW makes everything easier
Make (and Report) Profit! Equity can only grow with Infusion of Capital Profit Retained in the Company Pursue Profitable Work Study your work to find your Sweet Spots Report Profit We all know it s possible to be Profitable yet not Report Profit this pushes you outside the funnel
Bonding vs. Taxes Tax Avoidance strategies typically negate surety credit Because they try to report no profit Which means equity will not grow If you re successful, you will pay taxes If you pay no taxes You ll probably get no bonds
Retain, retain, retain More WC & NW makes everything easier Bonded Return on Equity (ROE) Example Trade Subcontractor 25% Jobs Bonded Retains $100 Net Profit = 10% $100 equates to $1,000 of bond capacity Profit is 10% of $1,000 = $100 of which $25 is attributable to bonded work ROE for bonding is 25%
QUESTIONS??? Please feel free to ask any questions you may have.
Backup Questions More on Other Types of Bonds Do I need a CPA Review? Sunshine Letters and Prequal Statements Non-Standard Terms Bonding SBA Bond Program Effect of Bond-Back Often confused with Co-Surety
What about Tough Cases? Who Cannot Bond Absolutes Unresolved Federal/State Tax Liens Un-discharged Bankruptcy Negotiable Bad Personal or Business Credit Don t meet basic underwriting guidelines (funnel) Typical non-standard terms Flat Rates as high as 3.75% 10-100% Collateral (usually 25-25%) Escrowed Funds Control SBA Bond Guarantee Program NOT a typical solution for those outside the funnel
Bond Premium Premium is a fee for underwriting services Assumes ZERO claims Typically 0.25% - 2% of the total contract price Higher for Subcontract and small dollar bonds Rate is a function of Nature of the Contract (how hazardous the work) Difficulty of Underwriting Premium is an estimate Approved change orders change the premium
Typical Bond Rates Fast Track type typically 3% flat rate Traditional typically 1.5% marginal rate Rarely see rates above 3.5% CLASS B Contracts Class B is for: General Building Construction Contract Price Preferred Rate Standard Rate DEV Rate Dikes & Drainage Ditches Painting First 100k $10.00 $15.00 $25.00 Electrical Wiring Sewer & Water Next 400k $10.00 $15.00 $15.00 Excavation & Grading - Site Work Transmission Lines Next 2M $8.00 $10.00 $10.00 Plumbing Wells Next 2.5M $6.50 $7.50 $7.50 HVAC Landscaping CLASS A Contracts Class A is for: Bituminous Resufacing Contract Price Preferred Rate Standard Rate DEV Rate Boiler Retubing & Repair Street Lighting Systems First 100k $9.00 $11.00 $15.00 Fire Alarm Systems Traffic Control Systems Next 400k $9.00 $11.00 $10.00 Floors Sidewalks Next 2M $6.50 $7.00 $7.00 Kitchen Equipment Next 2.5M $5.00 $5.50 $5.50 Metal Windows