Since the recession started in late 2007, the ability to present adequate surety capacity at a competitive cost has become increasingly critical for prime contractors and subcontractors to satisfy owner and lender requirements on private work. In many cases, bonding capacity and cost have been key determinants in winning—or losing—private jobs. Similarly, with public-private partnerships (P3s), it is essential for a contractor (or consortium of contractors) to find an innovative surety partner that is willing to accept obligations and risks that exceed what they traditionally bond.
The Quest for Private Work
Historically, prime contractors on most large, negotiated private jobs were not bonded; that continues to be largely true today. But owners and lenders increasingly scrutinize a contractor’s ability to bond—and the associated cost—when evaluating a firm’s overall quality and creditworthiness.
It is common on private work and large projects at the local, state and federal levels to see as many as five contractors submit project proposals. The contractors are evaluated based on a variety of factors, some of which were not as critical five years ago as they are today (e.g., the contractor’s bond rates and capacity, general liability insurance rate, workers’ compensation rate, line of credit rate and capacity).
For owners and lenders that are examining every possible way to reduce costs, eliminating the bond premium of a qualified prime contractor is a simple way to help a project’s budget “pencil out” because it does not affect the quality or proposed scope of the contractor’s work.
A prime contractor’s bond rates and capacity assure the owner and lender that the contractor is well-regarded by the surety industry and can bond the job if it’s awarded the contract. It is a key responsibility of the contractor’s broker to ensure the contractor remains rate-competitive compared to other companies.
For subcontractors, there has always been a tendency to obtain bonding for building projects because they incur most of the performance risk in terms of labor. This tendency is increasing as owners and lenders remain financially conservative. On a negotiated private job, a subcontractor that demonstrates it can be bonded at a better rate than competitors has an advantage when the owner, prime contractor and design team determine which firms they want to hire.
As P3s continue to arise as a way to overcome dwindling construction budgets, surety capacity and cost have become critical elements to the overall credit-worthiness and feasibility of a project. Given the complexities and risks related to P3s, it is essential for contractors to select a surety partner that can address the issues of both the owner and the lender.
One of the keys to getting a public-private project off the ground is the ability to ensure the government entity that financially benefits from the project (e.g., money from a toll road) will be paid damages if work is delayed. These damages can be quite substantial, even for a relatively short delay.
In response, the contractor (or consortium) building the project may need to provide additional assurance through a traditional letter of credit or within the surety guarantee that provides the government owner a reasonable level of confidence that such damages would be paid in a timely manner.
For contractors hoping to participate in P3s, the credit-worthiness of the surety (including its ability to address possible damages paid to the government) and the lender’s confidence that the surety can meet those types of obligations are additional behind-the-scenes variables on which the contractor is judged.
The recession has forced contractors and subcontractors to work smarter in just about every area of their businesses. For contractors performing private and public-private work, that extends to their bonding capacity and relationships with their surety providers.