The recently revised edition of “The Basic Bond Book” is a collaboration between the Associated General Contractors of America and the National Association of Surety Bond Producers. Copies of the book are sold on AGC’s website, and the book is also available to NASBP members. The publication aims to offer a “peek behind the curtain” into the surety process for the many contractors, certified public accounts, bankers, public contracting officials and attorneys who might view surety as only “something on a checklist of required items to obtain in the construction process,” said Matt Cashion of The Cashion Co. in Little Rock, Ark., who is one of the book’s principal authors. Cashion, an NASBP member and past president, recently answered a series of questions regarding the book and some issues involved in surety today.
What was the reason for the updated version of “The Basic Bond Book”?
Surety has traditionally been an industry that undergoes very few major changes.
The finance world, however, has made many sweeping changes over the decades employing new analytical tools. These additions have filtered into the extension of surety credit.
Some underwriting tools that had gained popularity and acceptance, such as the use of collateral and credit modeling [or scoring], were some of the drivers behind the revision. The ever-changing legal environment that surety bonds operate within, along with the continued watering down of required surety thresholds on public works, also weighed on [principal author the late Jack Curtin’s] decision to revisit the text.
The book outlines the many steps sureties take in evaluating a contractor’s ability to carry out a contract. What are the main aspects of a company that a surety typically examines and what are some red flags that would give pause?
[T]he basic tenets of the “three C’s” of surety [a contractor’s character, credit and capacity] are consistent. First, a surety wants to determine if the people behind the firm are of sound character. Knowing that at some point in time, each construction firm will hit the proverbial “bump in the road,” having a sense of the people within the organization and how they might react goes miles in reassuring a surety that the construction firm will do whatever is necessary to fulfill its contractual obligations. No matter how badly someone wants to finish a project, there is always the question of whether they can. That’s where the examination turns to a construction firm’s credit, assessing the financial wherewithal of the firm. Closely tied to the credit equation is the third “C,” capacity. Does the firm have the people, expertise, tools and equipment, and access to any other resources that will enable it to complete the contract?
As varied as the questions can be, so can be the red flags. At any point during the underwriting process, a surety may come across information that leads them to decide unfavorably for the contractor. That doesn’t necessarily make the contractor un-bondable, it just means that particular contractor doesn’t match up to the underwriting appetite of that particular surety. This is where the role of a professional surety agent, such as the membership of NASBP, is vitally important to a contractor.
Some of the red flags in underwriting vogue currently include a contractor’s heavy reliance on bank credit, declining revenues, inflexible overhead, use of a non-construction oriented CPA, and a sudden change in a contractor’s geographic operations and/or niche.
One chapter mentions the effort to promote foreign countries’ use of surety bonds instead of irrevocable letters of credit. What benefits would come with using the bonds in lieu of ILOCs, and what are the obstacles to making that change?
Irrevocable letters of credit almost always require some form of collateral to guarantee their issuance.
Surety, on the other hand, traditionally issues their credit based on general indemnity agreements executed by the construction firm and its owners.
The U.S. surety market is based largely on the federal Miller Act of 1935, which requires surety bonds on public projects. Other countries do not have this legal requirement.
Surety bonds instead of ILOCs benefit the contractor by not tying up assets they need to execute their work. The obstacles of promoting the use of surety bonds instead of ILOCs include, but are certainly not limited to, uncharted legal territory within unfamiliar court systems, different banking regulations and environments, and the instability of certain foreign governments.