Specialty Underwriting

Our Goal:

To find solutions where the contractor or principal is having difficulty in obtaining surety bonds and demonstrates one or more of the following attributes:
  1. Is a newcomer to the surety arena by virtue of being a small and emerging contractor with limited financial resources and/or experience with bonding.
  2. Is a more established contractor that has gone through financial difficulty or upheaval resulting in the need for more creative tools to secure bonding.
  3. Is an established or even larger contractor that has a more nontraditional business model, financial presentation, or composition of assets than typically required in the standard surety marketplace.
We have a track record of assisting contractors in restructuring, building and sometimes rebuilding their businesses in the public works and commercial contracting environment where bonds are needed.

Risk Mitigation:

Specialty risk mitigation involves any or all of the following:

  1. Collateral:  This can include real estate, cash or equivalents, cash value of life insurance (CVLI), and irrevocable letters of credit (ILOC).  Each form of collateral presents some challenges and limitations:
    • Real estate equity:  In most cases our interest rests in taking a first trust deed position on unencumbered property.  In rare cases we can consider taking a second trust deed or third trust deed position. In the current credit environment, real estate is discounted heavily to recognize the illiquid nature of the collateral, possible sale and/or foreclosure costs, and the market fluctuations that can be violatile at times.  In most cases, real estate collateral will be accompanied by the use of Funds Administration or other risk mitigation tools.
    • Cash or equivalents:  Though widely taken in specialty situations as stand-alone collateral, removing cash from a contractor’s operation can also increase the stress on the business and impairs liquidity.  We evaluate the possible impacts to operating cash flow when underwriting with the use of liquid collateral and it is often taken in conjunction with the use of Funds Administration.
  2. Funds Administration:  This involves running the construction proceeds through an escrow account in the contractor’s name and with their full consent but managed by the funds administrator on behalf of the surety.  All payments to vendors, subcontractors, etc. are paid through the job specific escrow account but with input and validation of progress payables by the contractor.  As a practical matter, this process can give good insights into the contractor’s back room in terms of internal controls, job costing and accounting procedures and can serve to protect the surety from payment bond exposures.  The involvement by funds administration staff can also serve to provide a valuable source of objective input and feedback to assist the contractor in optimizing these back office functions.  Although widely used as a stand-alone mitigation tool in the specialty segment, it does not protect the surety in situations of under-bidding or other performance related errors.  In some cases, the surety may also require that the escrow account be “pre-loaded” with additional funds that may be used as project specific working capital funds to support job cash flow needs.
  3. Bond Guarantee Programs (various):  The SBA and a number of regional guarantee programs can be used to support specialty business bonding.  The SBA Plan A gives 80-90% guarantees.  Some regional programs will give up to 40% in ILOC collateral to be used in conjunction with Funds Administration.

Market Segment:

Historically, specialty risk comes from three directions:

  1. Transactional:  These are contractors/principals who rarely need surety credit.  Often the accounting and financial presentation is outside the surety norm but there is clearly financial substance and experience.  In a number of cases the contractor does not appeal to mainstream surety markets due to the lack of a predictable bond premium flow to the surety.
  2. Small and Emerging:  These contractors may be new in business, or migrating from private/commercial work to public works.  This segment includes 8A, MBE, WBE or DVBE deal structures, often supported by mentoring or other arrangements that are clearly non-standard.  Related to these are the bond guarantee programs, including the SBA, which are working in this arena.
  3. Challenged or Distressed:  These are contractors who have fallen out of standard markets and cannot qualify for surety credit without the use of specialty tools such as collateral, funds administration or bond guaranty programs.  If the ‘red flags’ do not portend bankruptcy in the near term and the contractor and its principals continue to have adequate financial resources and experience, such accounts can often be written in a specialty manner.
  4. Highly Complex, Untraditional or Non-Sticks and Bricks:  These contractors may not demonstrate any of the above attributes but are in one of the other following categories:
    1. Non-traditional class of business that few sureties have interest in.
    2. Have a highly complex financial composition and presentation such that mainstream sureties have little interest.
    3. May have substantial resources outside the bonded entity combined with a distaste or inability to allow the construction business to be fully capitalized for the desired bond program needed.  One example here may be the general contractor wanting to minimize equity growth to reduce potential legal exposure but can provide the necessary indemnity and financial resources with specialty tools to support their bond needs.

Specialty Underwriting, generally speaking:

It is difficult to summarize the specialty underwriting process.  With transactional and emerging contractor business, there are often issues with the quality of financial information available.  The type of financial analysis expected in standard markets is often not plausible. The underwriting decision will be largely predicated upon evidence of proper experience, reasonably good credit and apparent short-term liquidity buttressed by one or all of the mitigation tools set out above.  Some of these contractors can be coached to improve their financial presentation.  The goal of Vista Surety is to work in partnership with the contractor and representing agent in hopes of optimizing the contractor’s opportunities for growth, success, and possibly an eventual transition to the more standard markets.

With challenged and distressed contractors, there can be many types of issues (e.g. prior year losses, a former bankruptcy, a prior surety claims situation, non-renewal of bank lines, tax liens, etc.).  These all present different issues for the surety.  Some are un-writeable under any scenario.  To a great extent this underwriting process is forensic.  Can the contractor be returned to financial health with specialty support and are the rest of the fundamental underwriting pieces in place?

While exhaustive discussion is beyond the scope of this article, some general observations on other differences between ‘standard’ and ‘specialty’ follow:

  • Financial Presentation:  Often includes in-house or CPA compiled financials of mediocre to poor quality.  The underwriting then often involves additional verification of assets on the business and personal statements and review of corporate and personal tax returns.
  • Time-sensitivity:  In many cases, because the deal has already been shopped around and declined in standard markets, often the ‘opportunity’ will arrive at the specialty underwriting desk with little time for additional research and analysis.  Deals are decided upon in this environment with extra emphasis on ‘follow-up’ items in addition to application of the risk mitigation tools available.  Best practice is to make the agent/contractor aware that the deal structure may have to change if new information emerges after the fact; for example, if the real estate equity is discovered not to be as advertised, etc.
  • Transactional:  Specialty surety is best viewed as transactional business, even when a ‘program’ is contemplated.  As such, it is often not possible to function with ‘bond lines,’ etc.  This is particularly true with challenged or distressed contractors where each deal has to be viewed in light of the short-term financial picture, the bonded aggregates on hand, and the effectiveness of current risk mitigation tools that can be applied. Often the contractor is trying to re-structure to re-enter standard markets (or simply survive near-term) and the surety has to be integrally involved in that process.