Few of us like surprises, least of all a surety company. Each year, Zurich’s underwriters sit down with its customers to go through their financials and discuss backlogs and their progress against plan. Most of the time, the discussions hold no surprises — the surety’s expectations around the results and the discussion have been shaped by updates throughout the year. However, with the recent turbulence in the construction market, there have been rough meetings where the underwriters were handed a surprise, due to profit fade, restated earnings or a projected profit turned into a loss. These are difficult and uncomfortable meetings. And they generally result in less surety credit available for the company.
To avoid this problem, a contractor needs to be open and transparent. At Zurich, we often repeat the old saw “underpromise and overdeliver.” But that is key to managing the expectations of the surety. We have heard the excuses before: The contractor is working through the “bad” job; the contractor let go a “bad apple” to turn around the company; the contractor has a plan to turn the “bad year” into a profit. We understand the optimism that is necessary for a contractor to be successful. But we want to see the contractor deliver. One of the surety fundamentals, one of the three “Cs” (in addition to capacity and capital) integral to surety credit, is character. An important part of character is living up to one’s word. Character comes into question when a customer cannot deliver.
As the overall economic recovery starts to move forward, the public construction economy has fallen further behind. Conventional wisdom states that the financial statements of construction firms lag the general economy by at least 24 months. The financial results we are seeing today have their roots in business that was put on the books in 2011, well into the current crisis. Across the market, the number of customers with net losses continues to increase. Given the material decrease in backlogs, the heightened competition and the thinner margins, this was not unexpected. At the market level, results align with our expectations — smaller firms are showing more problems than larger companies are, and some specialty contractors appear to be harder-hit than others. According to the Surety & Fidelity Association of America (SFAA), the overall loss and loss expense ratio for the surety market increased by more than 36% in 2012 compared to 2011, a sure sign of the deterioration in the credit quality of the accounts that sureties are bonding.
With that said, there are positive signs of economic recovery and a sense of optimism in the construction community. That sense of optimism seems like a fundamental requirement of the business. Clearly, surety credit plays a vital role for all contractors involved in the public market and commercial construction. Today, we see customers in two categories regarding surety credit. First, there are companies that have a strong presence in their marketplace or niche and have done well despite the recent problems. Because of this profitability, sureties are working hard to meet the credit needs of these customers. These customers generally report that surety capacity is strong and they have the support they need for the next 12 months.
Customers in the second category are those that have not posted profitable results. Many in this class were unable to adjust their overhead and administrative costs quickly to match the “new normal.” For the remainder of 2013 and into 2014, this group will require surety support more than ever before in order to successfully compete for work in the government and private sectors.
Firms that posted unprofitable results in 2012 must work extra hard to maintain and grow their surety capacity in order to acquire the type of work that they need to succeed. When approached by our customers in these circumstances,
we offer the following guidelines:
- Focus on the traditional three Cs of surety — character, capacity and capital. Surety underwriters will no doubt emphasize these factors to help them select the best customers. Contractors must also focus on the three Cs of communication, communication, communication, so there are no surprises.
- Keep your surety advised of your progress throughout the year and do not wait until year-end results are finalized. Keep it posted about problems on jobs and difficulties with problematic owners. Sureties do not like to receive bad news, but it is worse to receive bad news late in the game. That builds ill will with the surety right at the time when you need its support more than ever.
- Understand the capabilities of your firm and make certain you have a business plan that makes sense in terms of size of jobs, geographic reach and sectors served. Take a fresh look at your expense structure and ensure that it matches with the opportunities that you realistically see in the next 18 to 24 months. Tough choices may need to be made (again), but it is vital to make sure your firm is as right-sized as can be until the economy gets to where we all hope it will be. Articulate that business plan, make sure your entire organization understands the plan, communicate it to your surety, and follow it.
The business plan demonstrates a sense of strategic direction. Where do you see yourself not tomorrow, but next month and next year? Articulate that plan.Deliver on the plan. Demonstrate that character.
- Be sure to understand completely any requirements identified by your surety. Make certain those requirements are realistic and reachable, and work to achieve those goals. Manage expectations and live up to your word — it is all about the character.
Have the best team on your side to help build and maintain the surety credit you need. You need a surety that understands you and is willing to support you. You also need to work with a professional surety-oriented agent or broker, a trusted advisor with construction experience and a construction-knowledgeable CPA. There is good reason why some agents specialize in the surety needs of construction firms like yours and why your best-in-class competitors use particular construction-oriented CPA firms. It is because of the value these professionals bring to their clients and the ways they help you present yourself to the surety marketplace in the most positive manner.
Red ink does not have to mean a reduction or elimination of surety credit. Many successful construction firms have worked their way through difficult times by building on their surety relationships. In times of market volatility and economic uncertainty, sureties respond most positively to customers with a strong business plan and that communicate in an open and honest manner.
Mike Bond is head of surety at Zurich North America. He can be reached via email at email@example.com.