Surety 2016: It’s Time to Polish Your Balance Sheet

Where we are-

The Surety Industry remains strong through the first half of 2016 and we expect this to continue through this year.  This strength provides for what is known as a “soft” market.   So, you ask, what is a soft market and what factors contribute to creating this sort of market? 

A “soft” market describes the situation where surety underwriters broadly provide more liberal offers as a means to acquire greater market share and obtain and retain quality clients.  Typically we see a general loosening of the terms the sureties offer in three areas: pricing, size of the credit facility and indemnity.  Each of these areas could provide an opportunity to contractors with strong balance sheets and a history of profitability. 

Why we’re here-

First and foremost, surety losses remain low.  In addition, reinsurance is available to the surety industry at what are considered to be historically inexpensive rates.  With sureties able to transfer greater amounts of risk at low rates, they become more aggressive in pursuit of market share.  All of that creates a high level of competition providing underwriters with the impetus to improve their terms for existing profitable accounts.   

As is the case in any industry experiencing increasing profits, new players are also entering the market.  Add that factor to an aggressive industry core and you can understand how the greater capacity translates into a soft market. 

The back story-

Behind all of this, of course, is the improving construction market.  Activity is up and margins are finally widening toward pre-recession levels.  So long as there is continued stability in the market and contractors remain vigilant in their business practices we would expect steady growth.  The caveat should be that sometimes when capacity is growing at a faster rate than the demand; underwriters can become too aggressive and can take on too great an amount of risk.   

The risk-

And to be sure, it’s clear that surety is an industry that detests risk.  The main reason is that in surety the potential losses can be huge compared to the premium charged.  Imagine a site contractor on a $15mm project that paid $150,000 for his bond.  Chances are that if that there is a problem resulting in insolvency the costs to be incurred by the surety to complete the project will far exceed the amount that can be recovered.  Hiring a replacement contractor, fixing substandard work, legal costs… they all add up quickly.  It doesn’t take many losses for a surety to consume a substantial amount of its prior profits.   

When’s the right time-

Fortunately, we’re currently in some part of the mid-cycle which isn’t a time when sureties see a number of large losses.  Losses are more likely to occur – and this seems counterintuitive – at the beginning of an up-cycle when contractors are tempted to take on too much work at too low of a margin.  Cash flow becomes strained by the growth and one bad job or too much rain or unforeseen job conditions come together to cause a bad loss that isn’t sustainable.  Another susceptible time is mid down-cycle for contractors who may be overly reliant on line-of-credit financing.  Banks have been known to have a change in appetite and begin to call LOC’s as they try to limit their own risk to the construction industry.  When that happens, contractors can be caught with no time or market to support a refinancing. 

What to do now-

So how does this translate to users of surety bonds?  We’re in a strong mid-cycle.  Your jobs should be going well and you should be pushing to expand margins taking on the most lucrative work you can possibly get.  It’s also a great time to polish up your balance sheet.  Retain your earnings.  Restructure your debt by terming out as much as you can at these low rates and lessening your vulnerability to your bank line of credit.  Improve your working capital.   

And when that’s done you should be asking yourself whether your surety agent talked with you about positioning your company to maximize your surety credit line and terms.  Because now is the time.