Construction News explores how a string of high-profile insolvencies have made it harder for contractors to obtain bonds. But hope could be on the horizon.

The market for surety bonds is under pressure. Clients are increasingly demanding adequate bond cover as a condition of doing business, with a 10 per cent performance bond a standard contract requirement to protect against contractor failure.

But in the wake of major insolvencies like ISG last September – and before that, Readie, Henry and Buckingham Group – many providers have tightened conditions or withdrawn protection entirely. The decision last year by QBE Europe, one of the biggest bond providers, to largely exit the market was another body blow for contractors struggling to find cover. So, how big a threat to contractors is a nervous surety bond market?

“These events have shaken confidence in the industry, prompting tighter scrutiny and reducing the availability of performance bonds”

Paul Reidy, Arbuthnot Latham

Where bonds are available, they are likely to be more expensive and – because of tighter underwriting standards – more time-consuming to secure. According to Kirsteen Milne, a partner at law firm Brodies, the shortage of bonds is proving a challenge even for large firms. 

“Some contractors are actually saying they can’t get a performance bond, or at least they can’t get a 10 per cent performance bond, which is what is standard in relation to construction projects,” she says. “It’s making contracts more difficult to negotiate and take longer to come to a landing, which for any project isn’t ideal because it just increases the amount of legal fees the employer and contractor may be required to pay.” 

Civil Engineering Contractors Association (CECA) chief executive Alasdair Reisner says that a recent survey of his members found that 37 per cent are dissatisfied with bond availability. The high cost of bonds, the time taken to agree them and the level of information required by bond suppliers were their main complaints. 

Reisner says it is understandable that clients would want to use bonds to protect themselves against poor performance. “However, where they are used, there are a number of issues that can make the process unnecessarily difficult for companies to secure appropriate bonds, including the amount of bond required and the time allowed for the bond to be put in place,” he says. 

“Members tell us that bond providers do require significant information to secure bonds, and the process can take much longer than is perhaps expected.” 

Generally, contractors would have a conversation with the client to reach an amicable solution, Reisner says. 

But where the contractor is unable to secure affordable bonding capacity and the client proves inflexible, firms may be blocked from entering certain projects. 

According to Paul Reidy, head of construction banking at Arbuthnot Latham, the market impact of large-scale failures such as ISG has been considerable. 

“These events have shaken confidence in the industry, prompting tighter scrutiny and reducing the availability of performance bonds,” he says. 

Market ripples 

The ISG bond bombshell had been coming for some time. The collapse of Henry Construction two years ago was the first major shock in the bonds sector, with the contractor thought to have had over £150m in live bonds, spread across 13 providers, at the time of its demise. 

A few months later, sureties took another hit when Buckingham Group went under. Then logistics firm Readie failed in February last year, owing £43m, with its administrators citing the company’s difficulty in obtaining bonds. 

But it was the eventual downfall of ISG following months of speculation that really spooked the market. The UK’s sixth-biggest contractor went down owing trade creditors over £300m – which they are unlikely to see again, administrators have warned. 

The market’s caution in issuing bonds to ISG limited the fallout, as the taps had already been turned off well in advance by providers anxious to run down their exposure. By the time the contractor hit the buffers, it is thought to have held bonds worth £60m, down from a peak of around £150m. 

For Milne, ISG’s fate is a warning to employers that size is no guarantee against failure. “Even if it is a contractor of a pretty significant covenant, that doesn’t necessarily mean that they won’t go into administration,” she says. 

Collapses on that scale will inevitably affect confidence, says Sean Dorgan, chief executive of construction bond provider Nationwide Sureties. Subcontractors seeking bonds can expect to be asked about potential exposure to the liquidation of ISG or other major players, as the likelihood of recovering any debt is seen as very low. “Now some of the big boys have gone bust, it has put ripples through the market,” he says. 

Greater rigour 

However, there is no doubt that the sheer volume of due diligence has ramped up across the board. Providers say they are increasingly relying on third-party bank information instead of firms’ own management-information data. There is also a far greater focus on current and future trading prospects – rather than simply past results – before an agreement to issue bonds is reached. 

“We expect challenging economic conditions for the construction sector to continue, not least the trend of heightened insolvency levels”

David Weale, Allianz Trade

While that increased rigour may prove a source of frustration, it has provided sureties with an improved understanding of the markets in which firms operate. “They are a lot closer to their clients now – they understand the clients better within the trade segments they’re in,” says Chris Davies, managing director of DRS Bond Management. 

Employers who insist on a performance bond will benefit from the reassurance of extra scrutiny by underwriters, says Dorgan. “But for some contractors and subcontractors, it has become more difficult to obtain bonds due to the knock-on effects of the recent liquidations of high-profile companies,” he says. “We may have to use the whole of the market to try and find a surety that is willing to take on the risk.”

If that proves challenging, contractors might need to negotiate with employers to agree to a lower level of bond. “That’s exactly the kind of conversation we may have with some of our clients: ‘Can the bond value be negotiated down from 10 per cent to 5 per cent so it is potentially more palatable to underwriters?’” says Dorgan. 

Higher retentions are emerging as a key part of the deal. “We have seen a steady increase in requests for retention bonds, which would indicate that they may be sought after as an alternative to surety bonds,” says Andrew Wright, director of trade credit at insurance firm Gallagher UK. 

While performance bonds are generally released at practical completion, he has also noted an increased demand for bonds lasting until the end of the makinggood- of-defects period. “Sureties are consequently pushing back with fixed long-stop expiry dates to keep exposure finite,” he says. 

Ultimately, expectations around the level of risk acceptable to the market must be realistic. “Some of the bond wordings being stipulated by funders surety market,” says Wright. “Work needs to be done to raise more awareness of what is acceptable – this will make the process of securing the right level of support from the sureties easier for our clients to navigate.” 

Search for providers 

In the past, firms might have had the luxury of sticking to a single provider that, having already carried out due diligence, was happy to provide favourable terms. Now, they are being forced to go out into the market to seek bonds from different providers, some of which may be new to the UK or European markets, with no name recognition or established pedigree. This, from an employer’s perspective, “might mean you’re getting a bond, but actually enforcing the bond could be difficult in practice”, says Milne. “Ultimately, the bond is only as good as the provider.” 

As the market evolves, she believes expectations around the level of performance security could change, with, for example, an acceptance of 7.5 or 5 per cent becoming the norm, not 10 per cent. However, some kind of performance security will continue to be required. “People will still want to protect against insolvency because construction is always going to be quite a volatile industry and I can’t see that changing,” she says. 

According to David Weale, head of surety and guarantee for UK and Ireland at insurer Allianz Trade, pressure on firms shows little sign of abating in the current climate. “We expect challenging economic conditions for the construction sector to continue, not least the trend of heightened insolvency levels for the foreseeable,” he says. “But there are more providers in the surety market than ever before so, broadly speaking, market capacity is unlikely to be restricted.” 

More likely, individual providers will continue to face decisions about where to deploy their capacity, and under which terms, conditions and security requirements, he says. For companies anxious to ensure their bond needs are met, he advises “early engagement, full transparency and clear and detailed information provision”. 

“Working with an adviser who can help identify the right surety bond provider for a particular project can also be valuable,” he says. 

Cautious optimism 

However, there are signs that the bond market is starting to recover. “There has been a slight improvement in the surety market over the past year, as underwriters begin to recoup losses through premiums,” says Reidy. 

He says that there is now a sense of “cautious optimism”, although systemic issues such as late payment and cashflow challenges still need to be tackled. 

Davies agrees that the availability of bonds has improved, partly because legacy jobs taken on during Covid and the early stages of the war in Ukraine, when inflation spiked, have now passed through the system. 

“The good news is that the market is definitely freeing up relative to where it’s been […] and I think that in part is commensurate with the reduction in acute levels of insolvency in the industry,” Davies says. “Although bonds are still not straightforward to procure, they are easier, they’re happening more quickly and there is more appetite than there was in the previous two calendar years.” 

Inevitably, some companies will continue to do better than others and the “trickle effects” of insolvency will continue to be felt, says Davies, adding: “But all the dominos have fallen – including one or two that weren’t expected to fall – and that’s been priced in, in terms of both the availability and pricing of capacity.”

Risky business

DRS Bond Management’s Chris Davies estimates that over the last two years, bond rates have increased by between 10 and 25 per cent in the wake of business failures in the industry. “The highest increases would be seen in those firms that are regarded as high risk – where a company has been losing money, has low levels of cash reserves or is engaged in a sector of construction where more losses have come than others,” he says.

“If a specific segment or company shows characteristics of a higher default risk, that could impact pricing”

David Weale, Allianz Trade

Subsectors such as modular buildings, cladding and facades still tend to get a wary response from surety providers, although bonds may still be available for firms that can demonstrate robust financial health. Mechanical and electrical services is also seen as a high-risk area, with JS Wright and Co, Sana Mechanical and Electrical and TNA Electrical all having appointed administrators this year.

New perceptions of insolvency risk could trigger pricing adjustments, says David Weale, head of surety and guarantee for UK and Ireland at Allianz Trade. “If a specific segment or company shows characteristics of a higher default risk, that could also impact pricing,” he adds. “For companies that have suffered significant losses and face weakened balance-sheet positions, that will inevitably be factored into risk-based pricing models.”