Coronavirus-Related Language and the Effects it has on the Construction and Surety Industries

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This is the fourth in a five-part series brought to you by Bob Teska, CPA, Partner-in-Charge of Construction Services, and Mike Tresidder, Director of Surety for Insurance Office of America.

Insurance Office of America

Not Another COVID-19 Article: Webster's Dictionary, Pandemic Edition!

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 immortality and the renewed focus on continuity planning.

If you missed our previous articles, you can access below:

Part 1: Where’s my bond, Where’s my financial statement?

Part 2: Contractor or Day Trader?

Part 3: Think You’re Immortal?

Mike's Comments from a Surety Perspective

Mike Tresidder
Michael Tresidder, Director of Surety

“COVID 19, unprecedented times, the new normal, essential vs. non-essential, PPP, PPE” have become staples in our everyday conversations and lives. I have seen Coronavirus glossaries available on-line defining the many, now often used terms we see come across our e-mail inboxes and newsfeeds. 

What does it all mean? And more specifically, what does it mean for the construction and surety industries?

The Coronavirus has been largely negative for most businesses, the global economy and certainly in the United States. Although construction activity has varied greatly across state borders, the US economy as a whole is starting to slowly come back to life.

Common areas of concern for construction companies include the following:

  • Regulations, distancing requirements, PPE, new procedures, and a constantly changing environment.
  • Projects being delayed and/or cancelled (reduced backlogs or future reduced backlogs)
  • Labor availability, efficiency/productivity issues
  • Subcontractor and supplier availability
  • Nonessential business shutdowns and slowdowns
  • Precautionary sickness measures and actual coronavirus infection cases (resulting in shut downs)
  • Potential liability related to COVID-19
  • Availability of critical materials, supply chain interruptions and price escalation
  • PPP availability and the new loan guidelines conundrum/uncertainty

Obviously, there are many more concerns impacting construction companies and this does not represent a fully comprehensive list. As will be the case with many industries, I believe it is safe to say the construction industry will feel the impact of COVID-19. Not all contractors are created equal. Many factors such as territory, type of construction, private/public, etc. will play a part into 2020–2021 results and overall impact.  

Construction employment declined by approximately one million jobs in April (according to a new survey by the AGC). The total effect of Coronavirus will remain largely unknown for many months, if not years.

I do believe the construction industry is well positioned to handle the fallout from Coronavirus (specifically compared to other industries). Contractors are resilient. Construction is driven by problem solving. It’s what contractors do every day.

However, I think we would be naive to think that all companies will survive and there would be no major implications looking into the future. Companies who may have entered the pandemic crisis with operational issues, financial issues (dependency on bank credit, questionable assets, thin net worth and/or working capital) bloated overhead, minimal backlog, etc. could feel the compounding effect of COVID-19 and be vulnerable to failure.

Many contractors across the country have successfully applied for PPP loan relief and how this offsets potential financial difficulties over time remains to be seen.

The Surety Industry

As with the construction industry goes the surety industry, and I expect surety may feel an overall adverse impact as a result of COVID-19. The last five-plus years have represented a soft, ultra-competitive market with many new industry entrants. This has resulted in less stringent terms and conditions (think indemnity/rates), increased capacity and overall loosened underwriting standards. It has created an environment that leaves the surety industry susceptible during the economic downturn.

Historically, the surety industry follows the economy on an 18-24 month type lag period. Although contractors’ backlogs may be healthy at the present moment the long-term effects remain extremely uncertain.

Similar to contractors, some sureties will continue to show strong results and perform at a high level while others will struggle. Sureties live vicariously through their contractors that collectively represent their book of business. If a contractor fails or goes out of business, there is a very good chance the surety will have a loss on their hands.

Sureties who have maintained consistency and discipline in underwriting will be in a great position to weather the storm of potential economic fallout as opposed to aggressive sureties (possibly new entrants) who have operated with less stringent surety underwriting standards.

In speaking to many surety professionals over the past several weeks, some have already noted potential signs of a hardening of the surety market. A hard market is typically defined by the tightening of underwriting standards, firmer terms and conditions, increases in pricing (rates), and a potential reduction in exposure (or accounts within a portfolio determined to be high risk).

As with all industry leaders who are tracking legislation, state-by-state guidelines and timelines on reopening and the ever-changing environment, it’s a safe bet surety company executives are actively and strategically planning to get in front of the pandemic fallout.

As previously discussed in prior articles, specific underwriting items such as: being in the financial “know” via interim updates; business continuity (or lack thereof); heavy marketable securities holding as a percentage of analyzed working capital/net worth; and many other topics (contractual language, force majeure, PPP, etc.) may be critical and front and center during annual meetings. 

As the year transitions into the second half and as the US continues to gradually reopen, the economy is expected to rebound. However, the growth trajectory will depend largely on the path of the virus and how well it can be monitored and controlled as things open back up.

Unfortunately, no one has a crystal ball and whether we do enter a hard market cycle will depend on the speed of economic recovery and true overall effect and impact COVID-19 has on the construction industry.

A common theme across our various articles that holds true to even this broader scale topic is communication and transparency with your surety agent, surety underwriter, and critical partners. This is key in managing through any challenging times to avoid and surprises or interruptions in surety support.

Bob's Response from a CPA's Perspective:

Mike, after our last verbal sparring back and forth, I was really expecting some lacrosse analogies to liven things up?? I am mildly disappointed, but I digress …

You did a great job summarizing a lot of information. I agree that the total effects of the pandemic will not be able to be tallied for quite a while. Until there is more certainty related to a cure or vaccine, productivity will be depressed.

I think the unfortunate casualties of the economic pull back are going to be the thinly capitalized contractors – those that operated on the razor’s edge of barely having enough capital in the company to meet payroll week-to-week and relied heavily on the bank line of credit. Those contractors that were more conservative and built a strong balance sheet are going to be able to weather the storm.

Construction is like gambling, and in this instance, the contractors that maintained reserves are going to beat the “House.”

In regard to the Surety market, I believe that it is going to be more difficult to obtain a bond going forward. In my opinion, “tightening of the belt” is a logical response to all of the economic upheaval we are experiencing.

I have joked in the past that my dog could get a bond with a financial statement scratched on a napkin. While that is certainly an exaggeration, it does speak to the fact that the abundance of capacity in the Surety market led to sureties being willing to extend credit to individuals that would be highly suspect in harder markets.  I’m not saying “Winter is Coming”, but even Jon Snow would be a little concerned.

I think the transition back to work on job sites is going to be something to watch. In talking to some clients, the productivity is much slower than originally scheduled. Trades have to be scheduled to work consecutively as opposed to concurrently.  This could lead to delays and claims.  I think it is safe to say that the New Normal is going to have a steep learning curve.

… To Be Continued. Check out part five in this five-part series.

Michael Tresidder is the Director of Surety at Insurance Office of America. Contact Mike at (315) 728-3926 or Michael.Tresidder@ioausa.com.

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Bob Teska

Bob Teska

Bob Teska, CPA, CCFIP, is Partner-in-Charge of Construction Services at Bowers & Company CPAs PLLC. Reach him at 315-234-8157 or RMT@bcpllc.com. Bowers & Company aims to offer helpful information to our clients and friends. Learn more about how we can help should your construction business need accounting services.

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