Banking relationships are important to surety bond underwriting. By now we all realize that COVID-19 has changed the economic outlook for 2020. A $2 Trillion Stimulus Package should help the U.S. Economy but the long term implications are unknown and many believe we are headed for a recession. Fortunately, for construction companies, most have been considered “Essential” and can still work off existing backlog. New work for 2020 is a different story and it is time to prepare your balance sheet and operations for lower volume. Contractors would be wise to get their banking house in order.
Lending is crucial to contractors and surety bonding. Having the ability to maintain a bank line of credit for a rainy day or to finance cash shortfalls is vitally important to a contractor’s success. What would happen to your company if that relationship went away? The Great Recession was over a decade ago, but there are some hard lessons that could come back into play.
Lines of Credit Are Not Guaranteed
I am often told by contractors that they can move money over from their bank line whenever they want with a click of a button. This of course is true, until it is not. Most commercial lines of credit can be clawed back at any time. Contractors during The Great Recession may have learned this the hard way. Many banks during this time reduced lines of credit, increased interest rates or collateral requirements. I can assure you, it made it very difficult on contractors who were used to relying on that credit. You may think your bank would never do this. I remember asking one of my contractors to borrow against his bank line and inject the money into his company to create some liquidity. He set up a meeting with the President of his bank who he had known for years. The President told me and my contractor that this was “a ridiculous idea”. There was no reason to pay interest on this money when he could move it from his bank line anytime he needed it. Unfortunately, he did need it later that year. By that time, the bank had reduced his line of credit. The bank was sorry, but the contractor is out of business.
Most lines of credit contain demand clauses. In essence, that means the bank can call the line anytime and require repayment of the outstanding balance. During The Great Recession, this was common and took a number of our contractors out of business. Not many banks were refinancing loans at that time and demanding payment further decreased the companies’ liquidity.
Did you read your bank agreement before you signed it? If you did, you probably noticed some items in the loan covenants pertaining to “tangible net worth”, “debt to tangible net worth”, ect. Recessions tend to have significant impacts on company balance sheets. If debt increases or net worth falls, it could trigger a default on your bank line. In turn, the bank is usually given the option to non-renew, demand payment, demand collateral, increase your rates or even offset.
Watch Your Cash Account
Offset is the bank’s right to take your cash to pay off a debt that you owe them. Again, I’ve had contractors realize this the hard way. Cash that they thought was safe and could be used to pay their obligations was pulled to repay loan balances. Fortunately, most agreements require that you be in violation of your loan or behind on payments for this offset language to kick in.
What Can Contractors Do?
The intent of this article is not to bash banks or lenders. As I said, they are vital to contractors and surety bond underwriting as well. I have also worked for a national lender and been a consultant for “loan workouts”. I know that in times of crises, these institutions can panic and escalate liquidity issues either by choice, or by regulation. The lesson contractors should learn from this is that cash is vital. Stockpile cash now. Although paying down interest-bearing debt is great, cash and liquidity are better in tough times. Treat your bank line of credit like an uncertainty because it is. Remember the old saying that it’s hard to borrow money when you really need it. Because of offset language, contractors may want to consider holding some cash at a separate institution.
Surety bond underwriters will be heavily looking at contractors’ bank dependence during these tough times. They will be more skeptical of contractors who rely on a lender to fund their operations. COVID-19 will pass and the construction economy will get back on track. In the meantime, prepare your company so that it does not have to rely on the bank. If you have any questions or concerns about how your borrowing could affect your surety bond capacity, contact MG Surety Bonds. We are surety bond experts and we would be happy to help you anytime.