What is my bond capacity? And how is it calculated? What does it mean? What is the value of this information to me and my company?
These are questions we at KOG International, Inc. (www.kogbonds.com) encounter every day, from both existing, as well as prospective customers, all the time.
What is bond capacity? Bond capacity, also known as bond “program” is actually two numbers!
Single and Aggregate
Single-When a bonding company underwriter issues a “bonding line of credit” to a customer, he/she usually defines it in terms of two numbers. The first number generally represents the largest single project that the bonding company is willing to bond for the particular customer. The “single” number is determined after a thorough review of the customer’s previous experience with successfully completed projects. Underwriters may also consider the previous experience of the owner(s) of the company or other key employees within the organization.
Depending on the nature of construction or business activity, underwriters may agree to single project commitments that exceed previous completed job amounts by multiples of 1.5 times or even 2 times. Construction specialties or trades that tend to be repetitive in nature, such as concrete or roofing, often lend themselves to larger increases in “single” capacity.
Aggregate-The second of the two capacity numbers is known as the “aggregate”. This number represents the maximum amount of construction “backlog” the underwriter will consider for the contractor client to undertake at any one point in time. In a bond underwriter’s mind, backlog includes all jobs in progress, not just those that are bonded. The main reason for defining this number is that backlog creates financial strain on a construction company. As jobs start, financial capability is needed to mobilize labor, pay for materials, etc.
Underwriters will make a determination regarding aggregate commitment based on a number of factors:
- Annual volume of the contractor/client
- Net analyzed equity of the contractor/client (measure of financial strength)
- Net analyzed working capital of the contractor/client (measure of financial strength)
- What the contractor/client needs to cover overhead and be successful
Although not set in stone, underwriters will often support “aggregate” backlogs of between ten and twenty times the contractor’s equity and working capital.
How is the aggregate number calculated? This number changes regularly!
Most underwriters define backlog as the balance of costs remaining to be completed on projects that are in progress at a fixed point in time. Consider, for example, a $500,000 contract with $400,000 in anticipated costs. After expending $200,000 in costs, underwriters would define the “backlog” for that particular job to be $200,000 (remaining costs to complete) . After incurring $300,000 in costs, the backlog would recalculate to $100,000. This means backlog can decrease or increase just about daily as projects are completed and new ones are taken on and started. All projects in progress are calculated accordingly, to comprise a contractor’s “total” backlog.
Most contractor/clients are asked to update their backlog report for the underwriter once or twice a year, and often more frequently for clients with consistent bond needs.
Underwriters will often add the costs of pending bids to a contractor/client’s backlog until the results of those bids are known.
To summarize then, what we’ve discussed above, a bond line of $1 million single/$2 million aggregate suggests the underwriter is willing to consider a single project of up to $1 million, as long as the backlog does not exceed $2 million. Most underwriters will consider deviations from these limits based on circumstances at the time of the request. Some of these circumstances might include when projects are scheduled to begin, how much of backlog will be run off until the project(s) expected to start, etc. However, the concept remains the same, whether the backlog is $2 million or $200 million.
As a bonded contractor, what does it mean to me?
So….What is my capacity? As we’ve seen, a contractor’s capacity to take on additional work, whether bonded or not, depends on what remains to be completed in the totality of all jobs in progress. Contractors are encouraged to have a good idea of their bonding capacity so they can sense in advance if an upcoming project will be covered by their suggested limits.
Do you have a question about bond capacity or program limits? Do you feel you’re not getting what you need/deserve from your bonding company? Are you limited in bidding by what you feel is overly restrictive limits and underwriting from your bonding company? If you answered “YES” to any of above questions, we encourage you to contact one of the experts at KOG International, Inc. Philadelphia PA Regional Office – (610) 399-4080, Central PA Regional Office – (717)-732-9066, DE Regional Office-(302) 382-7489 (www.kogbonds.com) We can help!