1. Surety Basics 2013 Construction Opportunities Conference
Phil Condra- Bonds Southeast, Inc.
2013 Construction Opportunities Conference
Tennessee Small Business Development Centers
February 26th, 2013
Oak Ridge, Tennessee

2. What is Surety Bonding? Principal Obligee Surety (Contractor) (Owner)
A surety bond is a three-party agreement where the surety company assures the obligee (typically the project owner) that the principal (most often the contractor) will perform a construction contract.
Surety bonds in construction are referred to as contract surety bonds.
Surety bonding is a careful, rigorous, and professional process in which surety companies prequalify contractors and then assure project owners that these contractors are capable of performing the contract according to its terms and conditions and that they will pay certain laborers, subcontractors, and suppliers associated with the project.

3. Suretyship vs. Insurance
Principal / Insured
Insurer
Policy = Two Party Contract
Surety
Principal
Obligee
Bond = Three Party Agreement
Contract/Obligation
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4. Insurance vs. Suretyship
Premium paid by Principal and the Obligee derives the benefit
Bond obligation dictated by law or underlying agreement
Underwrite to zero loss ratio
Premium covers expenses not losses
Non-payment of premium does not negate coverage/bond still in force
Similar to obtaining bank credit
Risk is NOT transferred from Contractor / INDEMNITY
CERTAINTY
“Hope it’s not covered”
Insurance
Premium paid by Insured (Principal) and the Insured derives the benefit
Coverage drafted by Insurer and filed in various states
Law of large numbers
Expect premiums to cover losses
Non-payment of premium may terminate policy
CHANCE/ PROBABILITY
“Hope it’s covered”
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5. Types of Surety Bonds Bid Bond Performance Bond Payment Bond
There are three basic types of contract surety bonds. The first is the bid bond which provides financial assurance that the bid has been submitted in good faith, that the contractor intends to enter into the contract at the price bid, and that the contractor will provide the required performance and payment bonds.

6. Types of Contract Bonds-
Bid Bonds
Guarantees that the bidder will actually enter into the contract at the proposed price and provide the required performance and payment bonds.
Performance Bonds
Indemnifies the owner for financial loss caused by the contractor's failure to perform the contract in accordance with all the terms and conditions of the contract.
Payment Bonds
Guarantees that the surety will pay for certain labor, material, and supply bills and subcontractors associated with the project if the contractor fails to pay these costs.
Supply Bonds
Guarantees that the supplier will provide a specified amount materials in a specified time frame.
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7. Functions of Bonds REQUIRED BY LAW No liens
Smooth transition from construction to permanent financing
Provide support to contractor
Project completion
Surety Bonds
Surety bonds relieve the private project owner from risk of financial loss arising from liens filed by unpaid subs & suppliers and protect taxpayer dollars on public projects.
In the absence of liens, the transition from construction to permanent financing is much smoother.
If the contractor requests help, the surety may offer technical, managerial, or financial assistance. This may help the project move forward and significantly reduce the likelihood of default.
Should the contractor default, the surety arranges for project completion.

8. Underwriting- (The YES or NO’s)_
Capital
Financial Statements
Indemnity
Working Capital
Work-in-Progress
Capacity
Resumes
Experience/
Previous Project
Contingency Plan
Business Plan
Equipment
Character
Reputation
Relationships
References
In terms of character, the surety wants contractors with good reputations. The surety expects the contractor to have established, positive, and ethical relationships with subcontractors and suppliers, owners, and lenders.
In addition, the surety underwriter may look closely at the project’s contract terms and the contractor’s contract review process, liquidated damages, warranty requirements, and the owner’s performance history. The underwriter may also review the contractor’s subcontractor and supplier selection criteria. Successful contractors leave nothing to chance. They have a clearly defined business plan, know their costs, have financial controls in place, and can compile accurate forward-looking financial projections.
Sureties check references with bankers, CPAs, owners, architects, suppliers, and subcontractors.

9. 1 C = CAPITAL Working Capital Net Worth Debt : Equity
Bank- Line of Credit
Aging of Accounts Receivable

10. Financial Statement Analysis
Opinion
Page
Balance
Sheet
Income
Statement
Financial Statement Analysis
Cash Flow
Statement
Background
Investigation
Account
Schedules
Financial statements are vital to any business that grants credit, and sureties are no exception. Depending on how long the contractor has been in business, the surety will want to see fiscal year-end statements for the past 3 to 5 years.
The financial statement should include:
Accountant’s opinion page, which discloses whether the statements were prepared according to audit, review, or compilation standards.
Balance sheet, which shows assets, liabilities. and net worth of the company. This helps the surety assess the working capital and overall financial condition of the construction company.
Income statement, which measures how well the business performed. The surety will asses gross profit on contracts, operating profit, and net profit before and after tax provisions.
Statement of cash flow, which discloses the cash flow movements from operating, investing, and financing activities.
Accounts receivable and payable schedules
Schedules of work in progress and contracts completed, which show the financial performance of each contract and provides insight into the potential for future earnings from contracts in progress.
A schedule of general and administrative expenses, which reveal how well overhead expenses are controlled and managed.
Explanatory notes that the accountant may have included with the financial statement.
Explanatory
Notes
Contract
Schedules
Financial
Statement
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12. 2 Different Surety Approaches
WORKING CAPITAL Underwriting
(Majority View)
Vs.
NET WORTH Underwriting

13. Surety Evaluation Good character
Experience matching contract requirements
Necessary equipment
Financial strength
History of paying subs and suppliers on time
Bank relationship
Established line of credit

14. SOURCES for Surety Bonds
Traditional sureties
Traditional Underwriting OR
(Short form applications/ credit based) Smaller bond size
Specialized sureties
(Collateral based/ Funds Control)
SBA program
(Surety Company backed by government for majority of any loss)

15. Underwriter’s Warning Signs
Slow Accounts Receivable
Inability to Forecast Cash Flow
Past Due Bills
PROFIT FADE
Bank Lines of Credit Exhausted/ Non- renewed
Continued Operating Losses
Bid SPREADS
New (expanded) Geographic Territory / Scope of Work

16. Advice for Today's Market
Contract terms
Bond forms
Construction CPA
Adjust overhead
Bank line of credit
Conserve capital
Bond subcontractors
CPA, Surety, Legal
Contractors
Understand the contract and look for effective and equitable contract language
Read the bond forms and watch for onerous terms.
Use a construction-oriented CPA
Don’t “buy” a job to keep employees busy – adjust overhead and maintain profit margins. Bid the job, not the competition.
Have a bank line of credit available to support the company’s business plan
Conserve capital – stay liquid
Do what you do best. Protect your top talent, who will manage projects well no matter what the market conditions are
Procure materials and lock in prices whenever possible
Bond subcontractors – requiring bonds on subs is an effective way for contractors to manage risk on projects. Subcontractor bonding policies should also be established – especially in today’s economic climate. Subs should be bonded when:
they represent a key trade to the project or a significant portion of the work;
they are the sole source for anything; or
when the contractor is unfamiliar with the subcontractor.
Qualify the surety by contacting your state insurance department.

17. Advice for Today's Market
Know rights & responsibilities
Stay within capabilities
Show Me The Money
Manage growth & overhead
Learn why contractors fail
Communicate & Communicate & Communicate
“DRIVE THE BOAT”
Prepare for the next “Boom”
Contractors
Contractors do have rights and responsibilities to owners, creditors, and others. In addition, contractors need to understand the surety’s rights and responsibilities toward them and the owner.
Accurately assessing one’s capabilities speaks for itself. It’s important to look at operating profitability and completing contract profitability. Construction accountants typically use percentage-of-completion accounting, which allows contractors to take accruing profit on work that has not been completed. When you take the completed contract profitability of a company over a four- or five-year period and subtract the overhead that has been incurred during that same period of time, it really shows the true growth the company is achieving, what type of real enhancements in their retained earnings are taking place, and whether they’re making money at the business that they’ve chosen.
Learn causes and warning signs of contractor failure. The Surety Information Office’s free brochure , “Why Do Contractors Fail?” is available at by selecting “Free Brochures & CDs.”
Communicate good and bad news to the surety bond producer and company underwriter if or when problems begin. The most important thing a contractor can do is keep the surety informed when problems arise. Many surety companies will work with the contractor to help him/her through the problem if possible. Construction is cyclical and contractors should prepare for the pent-up demand that will build during recession. As world demand creates materials and equipment shortages and we face domestic labor shortages, contractors need to protect their core resources and be ready to bid work when the economy rebounds. The surety is a critical partner through good times and bad and can help owners and contractors manage the changing economic climate.