Surety bonds – a cru­cial part of any de­vel­op­ment

Irish Independent - Business Week - - APPOINTMENTS -

I’ll wa­ger that few in the prop­erty in­dus­try know much about surety bonds, but no de­vel­op­ment could take place with­out this spe­cial­ist ser­vice. To find out more, I met Paul Far­rar, Gen­eral Man­ager with Ad­vent Risk Man­age­ment and a recog­nised ex­pert in the area.

There are two main types of surety bonds. Un­der a build­ing con­tract, the main con­trac­tor is usu­ally re­quired to pro­duce a per­for­mance bond. This cov­ers the em­ployer for the ad­di­tional cost of com­plet­ing a project, if the con­trac­tor fails to do so. If the con­trac­tor fails, the em­ployer usu­ally re-ten­ders the job, and the ex­tra cost of com­plet­ing it, in­clud­ing in­creased build­ing costs and fees, are paid by the in­surer, un­der the bond value. Bonds gen­er­ally cover be­tween 10 and 15pc of the orig­i­nal con­tract price, which is the usual range of loss.

The re­cent his­tory of the surety bond mar­ket in Ire­land is in­ter­est­ing. Some in­sur­ers suf­fered losses es­ti­mated at ap­prox­i­mately €100m, aris­ing from the fail­ure of sev­eral large Ir­ish con­trac­tors. Much of these losses were suf­fered by UK in­sur­ers, who promptly ex­ited the mar­ket. They were then re­placed by other over­seas in­sur­ers, who also suf­fered losses and sub­se­quently with­drew. Paul Far­rar puts those losses par­tially down to the dif­fi­culty in as­sess­ing lo­cal risk from a long dis­tance.

See­ing an op­por­tu­nity, Far­rar and oth­ers worked with Ad­vent In­sur­ance DAC, now a lead­ing player in the sec­tor, and one which has writ­ten bonds for projects with a value of over €1bn this year.

Far­rar told me that they as­sess the risk at­tached to the con­trac­tor, un­der the head­ings of ‘char­ac­ter, cap­i­tal and ca­pac­ity’. Ques­tions asked in­clude: ‘does the con­trac­tor have the re­sources to com­plete this project, and, have they built this type of build­ing be­fore, or are they over-stretch­ing them­selves?’. Ac­cord­ing to Far­rar, if a con­trac­tor passes the scru­tiny of a pro­fes­sional-surety un­der­writer, then there should be very few de­faults.

That said, Far­rar told me that they as­sume one ma­jor loss ev­ery five to seven years. Ad­vent has had one claim in the last five years, and Far­rar says that di­ver­sity of risk is part of the in­surer’s strat­egy. Ad­vent In­sur­ance DAC ‘lay off ’ about half of their risk, with in­ter­na­tional in­vest­ment-grade rein­sur­ers.

Con­versely, a con­trac­tor should ideally have some form of pay­ment guar­an­tee from the em­ployer, although, as Far­rar points out, this is not writ­ten into the build­ing con­tract, and it’s ‘caveat emp­tor’.

“The con­trac­tor has to as­sess the em­ployer,” he told me. “For ex­am­ple, is it an Ir­ish shelf­com­pany, funded by a hedge fund in New York, through a bank in Lon­don?” Some con­trac­tors are good at this ac­cord­ing to Far­rar, but oth­ers are “go­ing in blind” and “not ev­ery­one has learned the les­sons of the past”.

A weak­ness in the sys­tem, Far­rar sug­gests, is that build­ing con­tracts don’t re­quire the pass­ing of any credit test, a min­i­mum worth, or a min­i­mum credit rat­ing, and this is lead­ing to con­tracts be­ing awarded to com­pa­nies which do not al­ways have the ca­pac­ity to com­plete them.

The sec­ond type of bond in the mar­ket is a de­vel­op­ment bond, which is a surety pro­vided by a de­vel­oper, in favour of a lo­cal au­thor­ity, to cover costs in the event that the de­vel­oper fails to com­plete works re­quired un­der con­di­tions in a plan­ning per­mis­sion. This typ­i­cally cov­ers ar­eas such as roads, light­ing and drainage. Again, Far­rar tells me there is a lot of money tied up un­der these bonds. From my ex­pe­ri­ence, de­vel­op­ers of­ten com­plain that lo­cal author­i­ties are slow to re­lease these bonds, whilst the de­vel­oper is cov­er­ing main­te­nance and risk. Con­versely, lo­cal author­i­ties have been caught out, where they re­leased bonds and then dis­cov­ered that works had not been com­pleted.

Paul Far­rar be­lieves most com­pa­nies could do more to im­prove their credit rat­ing.

“The weaker your credit rat­ing, the more ex­pen­sive it is to get bond­ing, and the greater the pres­sure on your cash-flow,” he says.

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