How Bond Companies View Bank Lines and Why You Probably Need One

SBA Bond Program

An important tool for all contractors is a bank line of credit. In a perfect scenario, all construction companies would have bank accounts full of cash at all times. Unfortunately, this is not always the case. Construction is a very cash intensive business that typically involves paying for labor, material, equipment and other costs before getting paid by the owner or upstream contractor. This gap can create a need for financing either internally with cash or from an outside source which is usually a bank line.

Bond companies want to see a bank line of credit in place. Ideally, they are looking for minimal or no borrowings on the line. They view it as a potential safety net in the event that the contractor gets into a cash crunch or has a problem job. Bank borrowings are okay for subcontractors but here are a few tips to keep in mind:

Demand Clauses

Almost every bank line of credit I’ve ever seen has a “demand clause”. In other words, the bank can call the line whenever they like and the contractor will have to pay it back on demand. This is why most bond companies will count your bank line as a current liability even though it may not be due for more than 1 year. Unfortunately, I have seen banks put contractors out of business using this clause. When times get difficult, the bank can pull the line, putting the contractor in a liquidity crunch. Usually when this happens, the contractor goes out of business. Banks will say they never do this but I’ve seen it happen to multiple accounts. I’ve also seen this happen when banks get acquired. New ownership often means re-underwriting their accounts and contractor bank lines are an easy target.

Cash vs. Borrowings

Most bond companies will want to see that your cash and receivables are greater than your bank borrowings. Unless you want the bank to run your company, you need to be able to have the ability to pay them off if necessary. It’s difficult to do this without liquid assets.

Creating Working Capital

Many bond companies are working capital oriented. Working capital is simply current assets minus current liabilities. Since a bank line is typically considered a current liability, moving it long term will create working capital. So how do you do this? Simply take a portion or all of your bank line and convert it to a term loan. Unfortunately, you will lose some flexibility and maybe even have your line of credit reduced. However, you will create working capital and increase your bond capacity in most cases. Further, terms loans will protect you from the demand clauses discussed earlier.

Extend the Maturity Date

As we discussed, most bond companies will view your bank line of credit as a current liability no matter how far out the maturity date is. There are some bond companies that will move a portion of the debt long term though if you can extend the maturity date out to 2 years or more. Keep in mind that you will still need to extend this date every year or it will quickly all become current again.

As we discussed, banks and bank lines of credit are vitally important to contractors. I have seen contractors get into binds and the bank lines kept them going. However, they need to be used correctly and managed responsibly to maximize your bond capacity.