How Can Bond Producers Guide Contractors Now?
In construction, many variables are adding to an already difficult forecasting process. Predicting the Federal Reserve’s monetary policy, government and private spending, interest rates, unemployment benefits, inflation, global supply issues, availability of skilled labor, and the impact of virus variants and their effect on national and public policy is a daunting proposition.
The Fed’s monetary policies appear set to deal with future liquidity issues when market stress leads to a global demand for cash. Setting up a standing repo facility to separate domestic and international market demand sounds promising but is yet untested. With continued inflationary pressures, the Fed may need to address a more systemic issue sooner rather than later. A sizable tightening of credit may have a compound effect on markets and stall economic progress.
Contractors have been challenged with inflationary pricing and supply chain issues. Though the cost of such items as lumber has retreated, overall material costs remain high and unstable. Even those with pricing escalators in their contracts haven’t kept pace with recent increases. Vendors are only providing extremely narrow windows to lock materials, which further hampers the bidding process. Those who can’t obtain firm pricing are experiencing profit erosion pressures not seen in some time, which will manifest for many into continued pressure and resulting losses. As some contractors seek greener markets, lengthening bid lists exacerbate the problem of securing work with reasonable margins.
At some point government spending will slow. Combined with the unknowns of COVID variants, this could prove a drag on economic drivers. Should these factors cross with an increase of interest rates, the proverbial perfect storm may strike.
Moreover, even as discussions continue regarding the government’s position on unemployment benefits, wage-based inflation and competition for labor continue to challenge all contractors, impacting efficiency and returns on investment.
Responsible sureties have always preached the fundamentals of liquidity and debt management, but we are in an unprecedented bull market and long into this economic cycle. The soft market has fostered complacency, but preparation to weather the next downturn is critical.
We see heightened concern among lending institutions. Some are contemplating a pull back and tightening credit facilities and requirements. Sweeping cash balances and closing lines of credit or calling loans could devastate contractors’ liquidity and their ability to meet the capital demands of running their businesses. Advise contractors to closely review all lending covenants, interview these institutions to determine their current appetite, how they’ve responded in prior cycles, and any insights into their future intentions.
Also encourage your contractors to communicate proactively and strategically with their surety. Review their history and bench strength. Find out how they have reacted over prior cycles. Sureties that take the time to understand a contractor’s unique culture, business model, strategy and plans tend to be the ones looking at the long-term picture. Their critical support will often include constructive feedback and assistance ahead of an issue, as opposed to allowing adverse surprises.
Contract terms and conditions continue to slide, as obligees make dramatic shifts, pushing even greater risks downstream — causing customary project risks to be exceeded. Some obligees have learned to weaponize the surety bond and apply more leverage to the surety, rather than the contractor. Facilitating a contract review among all partners can help the contractor understand various scenarios and how best to avoid issues, should the surety be required to respond to owners’ demands. Many contractors end up being swept into litigation and distracted from their operations for months or years.
A seasoned and engaged surety agent who actively monitors a wide array of economic conditions and the markets that provide lending and surety credit, is an invaluable resource. During a soft market, sureties experiencing losses are generally the first to tighten credit, which may hamper the orderly credit flow on which contractors depend. Help your contractors review and update their contingency plans and discuss them with their surety.
Construction is exciting and rewarding, but challenging. With the continued downstream risk transfer via changing contract terms and conditions, you and your contractor should work in tandem with the surety to understand and mitigate risks. Your cogent consultation can help contractors navigate turbulence, grow their business and take advantage of market opportunities.