Colbeck Capital Management Discusses Off-Balance Sheet Risks Associated With Construction Lending
When lending to commercial construction companies, one aspect that is generally ignored by commercial lenders is the risk associated with construction bonds (also known as surety bonds). The risks are typically not clearly stated on the balance sheet. Colbeck Capital Management tells us that they look for ways to mitigate this off-balance-sheet risk when working with these types of borrowers.
The construction bond brings into the equation an independent third party, known as the Surety (typically an insurance company), who takes the responsibility of independently guaranteeing the contractor’s reputation and ability to complete a project to a project owner. Suretys typically complete similar underwriting on commercial construction companies as commercial lenders, becoming acquainted with the contractor’s reputation, operational, financial and performance history, and the contractor’s ability and fortitude to complete certain projects.
Colbeck Capital Management notes that there are generally three types of construction bonds: (1) Bid Bonds, which assure the project owner that the contractor will sign a contract tied to a qualified bid; (2) Performance Bonds, which assure the project owner that the contractor, or in the case of a default, the Surety, will facilitate the completion of the agreed upon scope of work defined by an executed contract; and (3) Payment Bonds, which protect the project owner from risk that the contractor will fail to make payments to any subcontractors or suppliers for services related to the project which could result in liens on the project owner’s project.
Construction bonds are typically written in an amount equal to the total value of the underlying contract. Where this may become an unforeseen issue for a commercial lender is when a lender is unaware of the total value and impact on cash flow of executing on bonded contracts in a downside scenario. In a scenario whereby the commercial construction contractor is no longer able to execute on its agreed upon contract with the project owner, the surety company would then “step into the shoes” of the contractor to execute on the project, with rights ahead of any senior secured commercial lender given statutory rights of subrogation. Rights of subrogation are the surety’s right to undispersed contract funds (i.e. accounts receivable and remaining contract balances) should the surety be required to step into the shoes of the contractor and complete the project owner’s defined scope of contract work. A key point to note is that while the surety steps into the shoes of the commercial contractor to complete work on the project, the contractor remains fully liable for the full value of the original obligation, including reimbursement to the surety for any costs over the original budget incurred by the surety to complete the project.
For many commercial lenders, who rely on asset-based formulas governed by advances against the commercial construction company’s accounts receivable, the lender would effectively move to a subordinated position to the surety company on projects secured by a bond, (1) largely wiping out a portion of the commercial construction company’s asset-based collateral and (2) bringing into question the use and availability of any shared resources that the surety and the commercial construction company may be utilizing to complete projects. With this in mind, when lending to commercial construction companies, it is important to understand (1) the scope of the company’s bonded contracts, (2) the company’s relationship with their surety provider, and (3) identify the impact of bonded contracts on the commercial construction contactor’s cashflow/asset-based in a downside scenario.
About Colbeck Capital Management
Colbeck Capital Management was founded in 2009 by the two Managing Partners, Jason Colodne and Jason Beckman and has offices in New York and Los Angeles. The principles have over 75 years of experience managing credit investing businesses and have underwrote over $22B of total loan volume. Colbeck provides strategic loans to companies going through periods of transition when traditional sources of capital are not readily available.
About Jason Beckman
Jason Beckman co-founded Colbeck Capital Management in 2009 and is a Managing Partner. The foundational years of his career were spent at Goldman Sachs as the Head of Distressed Product Loan Sourcing, Fixed Income Currencies and Commodities Division at Goldman Sachs. Prior to founding Colbeck, Mr. Beckman attended Union College and The London School of Economics.
Mr. Beckman’s philanthropic efforts include supporting the arts as a benefactor of The Metropolitan Museum of Art and Art Production Fund and global humanitarian issues through the International Rescue Committee originally founded by Albert Einstein.
About Jason Colodne
Jason Colodne is the senior transaction partner at Colbeck and oversees all aspects of investment execution and portfolio management. Mr. Colodne co-founded Colbeck as a Managing Partner in 2009.
Mr. Colodne’s investment experience spans more than twenty years. Mr. Colodne was the Head of Proprietary Distressed Investing and the Hybrid Lending Group in the Fixed Income Currencies and Commodities Division at Goldman Sachs. Mr. Colodne joined Goldman Sachs after gaining distressed investment and investment banking experience at UBS and Bear Stearns. Following Goldman Sachs, Mr. Colodne was a Managing Director and the Head of the Strategic Finance Division at Morgan Stanley.
Jason Colodne holds board seats on multiple portfolio companies. Mr. Colodne is a member of the Young Professionals Organization – Metro New York (YPO), is a Board member of the Centurion Foundation, and a longtime supporter of the Children’s Tumor Foundation. Mr. Colodne is a graduate of the University of Pennsylvania.