If you’re blaming all the contractor and subcontractor defaults lately on the recession and how thin times lead to management mistakes, such as chasing unprofitable work, here’s yet another concern. Business in some sectors is picking up enough or may pick up soon and could create perils from recovery risk.
Contractors face recovery risk on the back end of a recession when they take on too much work after they’ve depleted their staff and cash resources during hard times and don’t have enough resources to finish projects. It’s a little bit like a starving man suddenly finding too much food and eating himself sick.
“We’ve seen it in other cycles,” says Mike Hill, senior vice president of Baldwin Cox Agency, a surety and insurance broker based in Dallas. “When work does come back, we’re expecting more problems at that point because so many companies were weakened in the last four years and don’t have cash reserves,” he says.
Some defaults by fabricator-erectors in the first half of 2012 gave the impression that capital-intensive subcontractors with manufacturing operations and equipment fleets were most vulnerable as the construction recession dragged on.
Based in Farmers Branch, Texas, Trainor Glass shuttered its nine locations Feb. 22 and has made no public statements since then. Trainor was one of two major cladding fabricators and contractors to get into financial trouble this winter. The other was the default and temporary shutdown just before New Year’s Day of Whitestown, Ind.-based ASI Ltd., a principal subcontractor on the $825-million Barclays Center in Brooklyn, N.Y. That default delayed completion of the arena’s enclosure and forced extra effort by the prime contractor, Hunt Construction Group, to stay on track for scheduled completion later this year.
“It’s hard to get riskier than the exterior cladding on a structure,” says one contractor risk manager. “Those are the ones struggling the most.”
Emerging depleted from a recession can leave a contractor short not only of cash but also qualified craft workers, managers and production equipment, says Matt Stevens, a management consultant in Winter Park, Fla., and faculty member at the University of Melbourne. If a contractor can’t find veteran 10- to 15-year project managers or field superintendents to run its new projects, the inexperienced staff can get the contractor into trouble, Stevens says.
Equipment mismatched to a project or task is another problem. “If you have too large or too small a bulldozer, it hurts the productivity rate,” and project profits suffer, says Stevens.
Doug Irvin, vice president and unit manager for global insurance broker Lockton Cos., has no dealings with either ASI or Trainor or their projects. But he says that less capital-intensive and asset-based companies tend to fold earlier in a recession than companies with more borrowed money and equipment and assets, such as Trainor and ASI Ltd.
“What we’ve seen mostly up to this point is a lot of (smaller) subcontractors starting to fail, ones that just ran out of cash,” Irvin says.
Ultimately, contractors with more borrowed money and assets will fail if they haven’t been booking and executing profitable work. Irvin adds that, in addition to glazing contractors, others now prone to financial problems include utility contractors. Unable to find work building residential subdivisions, some took on utility projects with slimmer profit margins but didn’t have the skills to succeed, says Irvin.
Measures of financial health can help sureties and others involved with a contractor if the information is accurate and the contractor is willing or required by contract to share it. For example, 30 days cash on hand has been a rule of thumb, but it’s not hard and fast.
“It’s taking everybody longer to get paid nowadays,” says Hill. Instead of 30 days of cash, he thinks firms need more like 90. “We typically don’t check financial statements more than quarterly,” Hill adds.
However, too-little cash won’t always prevent a company from obtaining a surety guarantee, says Irvin. In those situations, brokers will look harder at asset quality and ensure that a contractor is current and liquid.
“If you don’t have cash, that makes bonds more difficult, but there’s not a hard-and-fast rule,” Irvin says. “It’s more an overall look at total liquidity and debt to equity and capital structure.”
Survived the Recession? Beware Recovery Risks
June 5, 2012