Navigating The Challenges in Obtaining Surety Bonds

This article appeared in the November 2024 edition of Construction Executive magazine.

For construction contractors, securing surety bonds is not merely a formality but a critical aspect of their business operations. Surety bonds serve as financial guarantees that contractors will fulfill their contractual obligations, providing assurance to project owners and stakeholders. However, the path to obtaining these bonds has challenges that require careful navigation and proactive communication with the surety producer and the bonding company. That is why it is vital for construction firms to maintain strong relationships with their surety agent since they are most skilled at understanding the key elements that will need to be addressed when obtaining project surety bonds.

Surety bonding lines between the contractor and surety firm are very similar to that of a banking line of credit. While a construction firm’s banking line of credit is extremely important and is underwritten with financial scrutiny, a company’s bonding line can be even more important and have a more intense underwriting process. Surety firm credit analysts are well versed in the nuances of construction firms and skilled at dissecting and evaluating financial statements, work in progress schedules, as well as the global operating level of a contractor.

It is important to have a clear understanding of how a bonding company evaluates a construction firm for surety bonds, what information the underwriters need, and how to communicate both positive and negative company and job information. Ultimately, the quality, accuracy and reliability of the contractor’s financial statements are one of the most critical elements used by the surety producer when they present contractors to the bonding company.

Surety firms will evaluate many variables prior to determining bonding capacity and establishing bonding lines at the project level and company level. Here are the five most common:

Financial Reporting

One of the primary challenges contractors’ faces is providing timely, accurate, reliable financial statements prepared by a CPA firm experienced in the construction industry. These financial statements should include a complete and accurate work-in-progress schedule so the bonding company can gain insight into job performance and backlog. Bonding companies scrutinize financial statements, job timeline projections, cash flow forecasts, and debt management practices to assess a contractor’s ability to manage project costs and fulfill bond obligations.

Bank Lines of Credit Terms and Conditions

Bank lines of credit are critical for general company operations, but even more important for access to a proper bonding program.  Surety firms tend to focus on several items as they relate to the line of credit, including terms and conditions. The best-in-class construction firms generally have significant lines of credit that typically are not borrowed on and have a term greater than two years.

Project and Performance History

Another significant challenge lies in demonstrating a successful track record and ability to deliver projects on time and within budget. Surety firms assess a contractor’s project history, including past performance, job issues, geography of projects and profit improvement, deterioration trends, and adherence to contract completion deadlines.

Job Gross Profit Improvement / Fade Trends

Effective contract management, job bidding processes, and contract fiscal management are key attributes that a surety firm will closely scrutinize. The surety firm wants to be confident that jobs are completed on time and within budget. Gross profit improvement is always the goal, but construction is tricky, and fade does occur. But too much fade, too often, is a red flag to the surety.

Change Order Management

Changes are part of the delivery of any construction project. But to keep the project on schedule and within budget, those changes must be managed and converted to financial changes within the contract.  A change order (or an amendment) is a mechanism that identifies, defines, and tracks those changes in a way that is acceptable to all parties. Surety firms scrutinize a contractor’s change order conversion rate to realize financial gains.

Surety producers play a vital role in working with contractors to manage and enhance surety bond programs and are vital partners to any construction firm. Surety producers are able to work with construction business owners to understand how important quality internal and external financial reporting and transparent communication is to obtain and maintain a strong bonding program. While robust performance has a way of curing most issues, there is no substitute for open, continuous communication with the surety producer and ultimately the bonding company.