The COVID-19 crisis has changed every aspect of our lives, from how we work, interact in public, socialize and stay connected – nothing has been untouched. In a continuation of our conversation, this article delves into the potential implications of stock market turbulence from a surety perspective.
If you missed the first article, check it out here.
Mike's Comments from a Surety Perspective:
As the pandemic began to spread throughout the United States and state-by-state shutdown/slowdowns became a reality, the stock market plummeted.
As sureties begin to receive a large influx of construction clients’ CPA-prepared financial statements, their underwriting process will be kicking into high gear. A major part of this entails analyzing financial statements.
The surety analysis includes making many adjustments to the financial statement provided.
As part of their financial statement analysis, most sureties take a “conservative” approach in dealing with the balance sheet asset of marketable securities and typically will discount the asset by 20-25%.
- This will have the effect of decreasing working capital and net worth in the surety’s analysis (both key metrics used in determining program parameters).
- If the marketable securities actually were to decline from 12/31/19 to 3/31/2020 by say 30%, the surety would still most likely discount this asset by an additional 20% in their analysis.
A visual demonstration shows the net effect of such below (holding all other assets constant*):
“As Stated” – Financial data provide by CPA
“As Analyzed” – After adjustments made by Surety
*Note: we recognize that all other assets would not be constant. However, the focal point here is the potential net effect (specifically through the lens of surety analysis) of marketable securities as a major asset and liquidity for a contractor.
In summation: Many 12/31/19 CPA financial statements will represent a snap-shot from a 2019 economy that is no longer a reality today.
Contractors who may have had significant investments in the stock market may be feeling the strain both from an actual liquidity and working capital standpoint. In turn, it could affect future surety credit extended. Furthermore, how a contractor interprets their company’s net worth versus how a surety analyzes their net worth may very well differ.
As with any ongoing business happenings of significance, communication with your agent and surety underwriter is key.
Bob's Response from a CPA's perspective:
Mike, these are great points. It is easy to forget that a financial statement is a “historical” document. The Income Statement is telling you what happened over a 12-month period (that could have started 15–18 months ago depending on when the CPA finishes the year end financials). And the balance sheet is a snap shot of balances on one particular day, 12/31/19 for the sake of our discussion.
Sureties are going to have to rely heavily on the CPA to provide Subsequent Event disclosures along with interim statements. CPAs have a responsibility to disclose any material transactions or events that occur subsequent to the balance sheet date. If a portfolio of investments declined a significant amount before the financial statements were issued, that would potentially be an item that would be disclosed as a subsequent event.