What a Difference a Year Makes!
Or should we say a few months…
In February 2019 we opined about the shortcomings of global surety bond requirements, as exposed by the collapse of Carillion. In its wake there has been a resurgence of calls (mostly in the UK and EU countries) to raise bonding requirements to a sensible level.
Notably, not much has occurred. However, with governments worldwide emptying their coffers to stave off the economic collapse occasioned by the pandemic, we can’t help but wonder how they will be able to absorb another such catastrophe. Or why, for that matter. History will write that story. Because if you don’t think any number of possible large, global contractors aren’t vulnerable to even a short-term lapse in cash flow, you’re mistaken.
Enough about that. What we seek to address is the impact Covid-19 will have on the global operations of these firms and other industries heavily dependent on readily available surety bond capacity.
- The pandemic driven anxiety follows closely behind 2018/2019 meltdown of several large, international EPC firms (notably from Italy), which had already created a tightening of surety underwriting standards for global firms.
- While no longer the factor they had been, AIG provided an ofttimes solo bridge to surety capacity for private and state-owned enterprises from the Far East. In 2019 they announced their departure from the surety business.
- Insurance (surety) companies, established and relative newcomers alike, will be hit with shock losses, which they didn’t even experience in the economic meltdown of 2008/2009. Those who haven’t had the time to build reserves will face challenges, from their Board to their reinsurers, and some will likely exit the business.
- Those more established sureties will be fine (for the most part), but with the diminishment of competitors, they will drive harder terms for the large users. On a global stage the diet of “pay on demand” bonds will ripple thru the international surety companies and reinsurance community, tightening their credit model underwriting. It is important to note that the availability and pricing for large surety credit users is driven by reinsurance capacity, even in the U.S. We expect shock losses on the commercial surety side globally to diminish reinsurance capacity on all lines of surety, forcing primary carriers to take a larger share of risk going forward. Additionally, there is beginning a wave of pressure from the government sector to force insurers to pay out to cover Pandemic losses that were not contemplated when policies were issued. There will also be massive litigation on this from impacted insureds. Adverse outcomes would reach deeply into the reinsurance community.
- Bond rates will rise, capacity offerings will shrink.
- What seemed like a “can’t miss” business sector for the newer entrants will discover new critics. We cite the recent AM Best and Dowling Partners articles, essentially “downgrading” the entire surety industry.
- Credit facilities are already tightening and will likely incur sizable write-downs associated with business failures of all sorts. Construction has never been the favorite menu item for lenders, and companies that are highly dependent on debt will find themselves short of options, further challenging their surety availability.
The international fissures exposed by the pandemic will also play a role in affecting the terms and conditions of global surety availability. Nationalization, not globalization, will gain a strong following. We predict there will be a pronounced move by the underwriters to require meaningful assets on the ground and in the balance sheets of companies where they operate, not where they reside.
Parental indemnity will be much less attractive, resulting in the demand for capital at risk where the bonds are needed. Especially here in the U.S. Even well capitalized global companies will likely experience balance sheet and cash flow deterioration as a result of project shutdowns, cancellations and the resulting constriction in the credit markets.
Those firms with direct balance sheet exposure to concession activity may feel an added pinch, as we have seen a marked reduction in travel of all kinds, reconsideration of future education delivery and the like.
So, what can you do to prepare?
- Carefully target your revenue stream. It has never been more important.
- Learn the specifics of performance guarantee / performance bond requirements where you intend to operate or acquire.
- Research the underwriting companies and criteria in those regions with the consultative support of a professional surety broker competent to help you manage through this period.
- Deploy your resources (financial, physical, human) to achieve a targeted plan.
This pandemic is presenting an array of untested variables to the worldwide business community. The surety industry is no exception.
