In today’s nonresidential construction market, contractors face increased competition thanks to a slowdown in work coming out for bid and fewer new market entries from residential construction. Some contractors also may have more difficulty obtaining bank loans due to sub-prime and mortgage losses. Furthermore, gasoline and diesel fuel prices remain high, construction materials prices have not leveled off as some projected a year ago, and the country continues to experience a stagnant economy and rising inflation.
So what can contractors learn from the surety industry about adapting in this changing economy and positioning themselves to emerge successfully from these and other challenges?
Having analyzed the construction marketplace and evaluated contractors for more than 100 years, surety industry professionals—bond producers and underwriters—can offer a unique perspective. Not only have they observed the peaks and valleys of the construction market, but they also have experienced the volatility firsthand. The surety industry has a symbiotic relationship with the construction industry. When construction is strong and contractors are profitable, so, too, is the surety industry. When the construction market tightens, so, too, does surety industry capacity.
It is in the surety industry’s interest to help position contractors to succeed. This means ensuring they are qualified to perform the work on which they are bidding, maintain their profitability and grow in a disciplined manner.
Understanding the surety market can help contractors manage their risks in a changing economy. Throughout the 1990s, as the economy boomed and interest rates dropped, surety was a profitable industry. The strong economy kept contractors busy and failures low. Excess capacity built up the surety market as a number of new surety companies emerged. Many companies relaxed underwriting standards as they competed for market share.
In the early 2000s, as the economy faltered, sureties suffered record losses due to a significant number of contractor and subcontractor defaults and large claims.
The Surety & Fidelity Association of America (SFAA) reports that sureties have paid more than $11 billion on contractor defaults since 1994. Half of that was paid between 2002 and 2005.
The surety industry adapted to these losses by returning to more disciplined underwriting standards, risk management and project analysis—stabilizing capacity by restoring profitability and preserving capital. The industry posted excellent results in 2005, 2006 and 2007, which positioned sureties to survive the current economic downturn.
To manage for the long term, sureties build balance sheet strength by expanding their capital surplus and reserves during good years, enabling them to pay for losses in poor years.
According to the SFAA, $718 million in contract surety claims were incurred in 2007—a dramatic drop from the $1 billion paid in 2005, but an increase from the $312 million paid in 2006.
Looking ahead, surety executives expect 2008 will reflect positive results, mostly because several contractors began the year with solid backlogs, and nonresidential construction should grow nominally in 2009.
The U.S. Census Bureau reports the seasonally adjusted value of nonresidential construction spending grew 10.7 percent in August 2008 compared to August 2007. Nonresidential construction spending marked 29 consecutive months of double-digit growth, peaking at 18.1 percent in November 2007 compared to November 2006. In August 2008, manufacturing (61.5 percent), lodging (29.3 percent), power (26.8 percent), public safety (22.5 percent), water supply (13.5 percent) and office (10.6 percent) construction performed the strongest.
Surety executives anticipate a slowdown in nonresidential construction in late 2009, however, and growth is not projected to return until 2010.
The long-term outlook for the construction industry ultimately depends on the resiliency of the credit markets and any changes that occur after the election season. Despite the challenges from a growth standpoint, many surety executives remain bullish on the surety industry beyond 2009. They insist surety capacity will be available to qualified contractors.
Contractors that spot trends, maintain profit margins and an agile cost structure, and adapt to differing situations hold the keys to surviving the current cycle.
What should contractors do to sustain the current economic downturn? Surety industry executives recommend contractors:
- Maintain profit margins—bid the job, not the competition.
- Preserve capital and stay liquid.
- Reduce overhead and fixed charges.
- Lock in prices early.
- Hold on to talent.
- Avoid bad jobs.
- Enhance workflow.
- Maintain focus on safety education and training.
- Adjust business plans.
- Communicate with their surety.
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Friday, September 3, 2010