Secrets of Bonding #9: Capacity – Cure or Lure?

Bonding Capacity is a key point for many contractors along with rate (the cost of the Performance & Payment Bonds) and the approval terms.   Capacity is the amount of bonding the surety will provide, both the “per job” limit, and the total amount.  Let’s look at how all this works.

Traditionally, the capacity amount is defined as Single and Aggregate.  The Single is the per job amount for any one contract and bond, which is the way bonds are actually issued.

The Aggregate is the maximum at any one time, comprised of:

  • The remaining “costs to complete” on started projects
  • The full amount of all awarded, signed but unstarted contracts
  • The full contract amount for low (winning) and undecided bids

Typically, the Single is no more than half the Aggregate. It is also common for the Aggregate to include all contracts, both bonded and unbonded.  The Aggregate is not just an expression of how much the surety will provide.  It is also an indication of how much work they feel the contractor can undertake without being overextended.

Here are some underwriting elements surety underwriters may review when making a capacity determination:

  • Working Capital (WC) and Net Worth (NW) of the company – The benchmark is for each of these to not be less than 10% of the Aggregate.  i.e. $100,000 WC could support $1 million Agg.
  • Secondary Financial Resources – Available bank credit, personal financial strength, affiliate companies and strong credit reports could help justify support.
  • Prior Experience – The Single is normally not more than 100% greater than the largest similar single contract successfully completed. Company longevity and expertise of key individuals is also considered.
  • Current Work On Hand – Even if the applicant has a good financial condition, underwriters may be unwilling to add to their workload if company resources appear to be fully utilized or if exisiting contracts have problems.

There needs to be balance between the elements.  For example, support will be withheld from an applicant who has good prior experience but no financial resources.

Bottom line is that bonding capacity is important.  It influences which projects the contractor will pursue and directly affects their annual revenues and profits.  Having adequate capacity can be the Cure for construction companies seeking better financial performance and market penetration.  It also Cures the bond agents need for increased commission income.

Capacity can also be a Lure. The promise of increased capacity can be a hook to draw in a contractor’s account.  Lines of bond capacity are always conditional.  Any bond can be declined for various reasons – meaning: “We’ll actually give you the capacity if we feel like it.”

It’s best to look at the credibility, reputation and stability of the provider of the line. Make sure the capacity you rely on is a Cure, not a Lure.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s