Statement on UK Construction Sector and Surety Market Outlook

A number of DRS’ clients have approached us in the last week or so seeking clarification on current surety appetite and our assessment of the direction of travel for Construction per se.

Sector Background
2019 was a challenging year, particularly in H2 and acutely in the run up to the United Kingdom General Election. Insolvencies in Construction were a steady trickle until September and in the last 6 months to March 2020 have accelerated appreciably, particularly in the £20M to £150M Turnover band of Main and Principal Sub Contractors, where surety bonds are prevalent. The daily alert e-mail from Construction News typically contains details of an insolvency, often several.

Delays in starts on site were common throughout 2019. The certainty provided by the General Election result, prior to the discovery of Coronavirus led to a number of long awaited projects proceeding, which was welcomed. Unfortunately, this increased contractor insolvencies as companies tried to mobilise new sites without funding whilst in many cases lacking the cash flow to do so due to poor performing legacy contracts.

Prior to Coronavirus, our expectation was that H1 2020 would be challenging in terms of contractor insolvencies but H2 would see these begin to reduce and construction output to grow steadily.

The Government’s iterative response to Coronavirus, (based on the best scientific and medical advice available), by comparison with other developed countries appears to be relatively measured and economically proportionate. It is clear however from the last 48 hours that as we enter the “delay” phase in earnest that increasing restrictions, on the grounds of public health and to mitigate pressure on the NHS, will have profound economic effects in the coming weeks.

We expect to see site shutdowns increase, particularly in London and other hotspots for Coronavirus. The Google HQ is the first to have done so and is currently undergoing a deep clean. In this case, the interruption has been limited to 2 working days, which should be capable of being caught up without too much difficulty. It is inevitable that as more site staff choose to self isolate, in line with government advice, progress on sites is likely to slow and contractors will be seeking extensions of time under the force majeure clause of their contracts. We expect this situation to continue until the peak of the spread of the virus has been flattened and our most optimistic assessment of this is mid to late May.

Surety Market
Contractors who were struggling for liquidity prior to the Coronavirus pandemic will face extreme challenges to remain solvent in the coming 10 weeks or so. The resilience of supply chains will be severely tested and the weakest points of resilience broken.

In addition to the already highlighted flow of contractor insolvencies, current conditions have a number of negative features, beyond mere “headwinds”:
failure and potential failure of property developers and Employers through inability to service debt;
key indices’ volatility on the major bourses;
high profile difficulties at Costain and Kier;
funders starting to delay starts on site to reassess feasibility.

There are 4 main reinsurers for Surety bonds:
Munich Re;
Swiss Re;
Hanover Re;

Between them they have over 90% of the market place so irrespective of which surety we as brokers place bonds with, ultimately, they will be reinsured in most cases by 1 or more of these 4 companies. These companies also have sectoral exposure in mainland Europe, with significant and sustained losses in Italy, France and Spain in particular.

Against the backdrop of increasing frequency of contractor insolvencies, combined with the losses incurred as a result of the collapse of Carillion in 2018, reinsurers are increasingly seeking much more forensic due diligence to be undertaken by the sureties. This leads to much longer lead in times around bond wording check responses, many more bonds needing to be shared between 2 or more sureties and a much slower sign off process as even straightforward applications require multiple sign offs and in some cases, several credit committee layers to obtain approval.

Whilst Thomas Cook is clearly not a failed contractor, the whole surety market was involved in their ABTA/ATOL bonding requirements and the gross loss exceeds £200M.

Coronavirus adds a further negative dimension as even in the most optimistic scenario around containment and delay phases of the pandemic, significant economic interruption is likely until at least the end of May 2020.

Sureties are asking increasingly invasive questions around:
quality of management (board and site);
sign off processes for bids;
a contract by contract profit assessment;
regular provision of management information;
details of Coronavirus contingency planning.

Bond wording acceptance is also tightening appreciably. Bond wordings that were accepted in principle even 3 months ago are now being routinely rejected.

DRS is committed to continuing to source the capacity our clients need at equitable cost and we expect to have work ever harder to do so in the coming months.

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