Preparing for the Recession

Published on April 7, 2020

By Dan Huckabay, President
Commercial Surety Bond Agency

On March 16th, UCLA Anderson forecast officially declared that the “U.S. economy has entered a recession, ending the expansion that began in July 2009.” Because of construction being deemed “essential”, most of our construction clients have yet to feel the full impact. We have had very few of our contractors report of jobs being shut down and only a handful have had projects delayed or canceled although that could change as San Francisco recently put additional restrictions on construction.

While the lack of job shutdowns to date is positive news for the construction industry, it’s important to begin planning now for the slowdown that will inevitably come. According to UCLA’s forecast, residential building permits will decline the remainder of 2020 and rebound in the first quarter of 2021. On the other hand, UCLA forecasts that nonresidential construction will decline by 15% hitting a bottom in the second quarter of 2021 and won’t recover to the current levels until the second quarter of 2022.

Conditions are continually changing, and there is no way to truly determine how long or deep the impact of Covid-19 will be on our economy, because much of that depends on the time it takes to contain the spread of the virus. Some are predicting a quick bounce back in the economy in the summer, but that is far from certain. In a separate study by UCLA also published on March 16th, Dr. Andrew Atkeson concluded that, “The main message for economists derived from simulations…is that it will likely require severe social distancing measures maintained for an entire year or even 18 months (until a vaccine can be developed) to avoid severe public health consequences.”

Back to the drawing board
With so much uncertainty, contractors will need to revisit their revenue forecasts for 2020 and beyond. Several of our contractors have redone their forecasts for 2020 based on a few different scenarios ranging from best to worst case including less work bidding, job shutdowns due to a crew getting infected with Covid-19, and a state mandated shutdown of all jobs for a period of time. To create their projections, our customers estimated a decline in revenue ranging from 10% to 70% based on the scenario or combination of scenarios they came up with. Picking the scenario they believe to be most likely for 2020, they are starting to reduce overhead most of which involves non-staff cuts such as eliminating investments in technology and equipment, reducing marketing, freezing pay, and lowering bonuses or retirement plan contributions. As one of my customers put it, “We are eliminating anything now that isn’t critical to us performing our work this year.”

As things continue to develop, contractors will need to update their projections throughout the remainder of the year and have various plans for potentially cutting overhead further if needed. While preserving our workforce is a top priority (because we all know that human capital is our most important asset) contractors that are proactive in their planning will be able to scale down quickly if necessary. Those that wait will likely incur losses eroding their hard earned and hard to replace capital. Avoiding losses and retaining capital is key during this time for contractors, because surety companies have already started to show signs of tightening, which will only compound an already challenging environment.

Conclusions
The balance of planning ahead while remaining flexible to adjustments as new information emerges will test us all. Planning for the worst and hoping for the best is an approach that every contactor can benefit from. While this might sound negative and pessimistic, there is opportunity in all of this. It provides a chance for contractors to refine their operations, to cut waste and eliminate ineffective initiatives. Further, those contractors that remain well-capitalized will likely find some of their competitors are limited by their capital and surety capacity. Now is the time to prepare for those opportunities.