Securing Your Tomorrow

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Copyright 2014 C&S Associates, Inc.

Construction Credit:Overcome Challenge & Risk

NCS WhitePaper

Copyright 2014 C&S Associates, Inc.

NCS WhitePaper

“a situation involving exposure to danger” and “the possibility of �nancial loss.” (A de�nition provided by the omniscient Google.) Risk is inherent in everyday actions and interactions; whether we are driving a car, investing money in the stock market or extending credit to a customer without collateral, we take risks every day. Fortu-nately, there are ways to reduce these risks – we adhere to tra�c laws when we drive, we diversify our accounts when we invest in the market, and we implement credit policies and utilize credit tools when extending credit to our customers.

Risk:

The EconomicsWe are proactive not reactive, therefore we are prepared in the event we are “exposed to danger”.

We are here: �ve years into the Economic Recovery. It has been seven years since the�nancial crisis, also known as the demise of the construction industry. There have been many changes since the onset of the crisis, including a dramatic change in lending for commercial development, tax uncertainties, an unstable stock market and the reduction of long-term asset purchases by the Federal Reserve that have interest rates teetering on the edge of increase. In addition to �nancial uncertainties, many businesses have reduced the sta� of their credit teams, making pro�tability and growth much more di�cult to attain andmaintain. The construction �nancial landscape has transformed and businesses are being forced to evaluate credit risk di�erently.

“How well, to what degree, and how fast you can perform the task of risk assessment…can have a huge impact not only on your company's bottom line, but also on sales growth,controlling credit costs, and your ability to collect accounts receivable…Each year, we are asked to make credit decisions faster, do more with less, keep bad debt to a minimum, and support sales growth. We need to be innovative to meet these challenges, while at the same time, protecting our greatest asset, the ability to determine risk.” – Craig Combs, Director of Financial Services, Dole Packaged Foods Company1

Listen to the Experts. Credit professionals are bombarded daily with a wide variety of data – aka “Big Data.” When making credit decisions, it is imperative to listen to and consume this big data; listen to credit experts and analysts, review credit indexes, credit reports,bankruptcy reports as well as lien �lings & foreclosures. It is important to analyze thecollective opinions and statistics of these various sources to e�ectively create a complete and comprehensive credit picture.

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Copyright 2014 C&S Associates, Inc.

NCS WhitePaper

Credit Experts, Analysts & Indexes: ABI, Reed, McGraw Hill, Experian & PMI

• “The Architecture Billings Index (ABI) serves as a leading economic indicator that leads nonresidential construction activity by approximately 11 months. The indexes are developed from the monthly Work-on-the-Boards survey, where survey panelists are asked to report whether billings during the previous month significantly increased, remained about the same, or significantly decreased from the prior month…A score above 50 indicates that firms in aggregate are reporting an increase in activity that month compared to the previous month, while a score below 50 indicates that firms are reporting a decrease in activity”. The ABI experienced a record high of 57.9 in January 2007 and a record low of 33.3 in January 2009. In 2013, there was growth between the months of May and October, followed by dips in November and December. In the first quarter of 2014, January and February showed a modest uptick at 50.4 & 50.7 respectively, but March dipped to 48.8 with April squeaking in slight growth to 49.6.2

• In May, Reed Construction Data (Reed) reported the total construction spend increased 0.2% in March to $942.5 billion, according to the U.S. Census Bureau. Reed further predicts “Total construction spending is forecast to increase 9.0% in 2014 and 11.3% in 2015, with non-residential and heavy engineering construction gaining strength and residentialconstruction continuing its expand.3”

• McGraw Hill reported an anticipated increase in commercial building for 2014 of 17%, an increase over the 15% gain estimated for 2013. Yes, 2% growth is encouraging; however, it is still 28% below the 2007 peak.

• Earlier this year, Experian reported that despite Florida’s rise in construction activity, there is a cash-flow crisis. “In Miami, an alarming 38.8% of construction firm’s balances are being paid on average 20 days beyond contracted terms. The situation is even worse in Orlando; 39.4% of balances are being paid an average of 24 days late…” But Florida isn’t the only state with slow-paying issues; Experian also mentions these major metro areas have reported high delinquency rates: Chicago at 38.44%, Cincinnati at 41.36% and Tacoma at 34.01%. Author, Gary Stockton, said it best “This is not a local phenomenon.” Cash �ow is a signi�cant obstacle, throughout the country.4

According to the Experts

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Did You Know? The ABI indicated expansion in 16 of the last 20 months, however, there isabout a nine month lag between a rise in the index and a rise in construction spending.

Did You Know? Let’s say you have 10 accounts paying an average of 20 days late and eachis invoicing at $50,000. Individually, a $50,000 account may not have a great impact on yourcash �ow, but as a collective 10, you could have $500,000 + outstanding.

Copyright 2014 C&S Associates, Inc.

NCS WhitePaper

• Purchasing Managers' Indexes (PMI) are economic indicators derived from monthlysurveys of private sector companies focused on construction and manufacturing. "The May PMI® registered 55.4† percent, an increase of 0.5 percentage point from April's reading of 54.9 percent, indicating expansion in manufacturing for the 12th consecutive month.” This is according to Bradley J. Holcomb, CPSM, CPSD, chair of the Institute for Supply Management® (ISM®) Manufacturing Business Survey Committee. Holcomb goes on to say a PMI in excess of 43.2%, over a period of time, generally indicates an expansion of the overall economy.5

• Be mindful of the fiscal health of financial institutions. Credit goes beyond your customer and their financial bottom line. It is good to know the financial health of the bank lending money to your customer – if the institution is unable to maintain a solid balance sheet, be weary of the funds your customer may have available. Standard & Poor’s as well as Moody’s Corporation rate financial institutions (among other companies and areas of business) and provide information on the likelihood of an institution default or inability to meet credit obligations.

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Did You Know? In 1 hour of an 8 hour work day, 88 businesses close their doors for good;it would be unwise to pull a credit report once and to never look again.6

Did You Know? Since 2009 nearly 500 banks have failed, according to the FDIC. That’s anestimated loss of over $65,000,000,000!

Did You Know? One individual surveyed by the PMI said “Volume is picking up in somesectors, but pro�tability still elusive. Suppliers indicate similar di�culties in getting priceincreases.” While another said “Defense industry contracts are shrinking, customer isexercising minimum options, or less than minimum.” – Economic challenges know no bounds

Credit Resources & Tools: D&B, Experian, The Distressed Company Alert, NCS LienFinder™

• Credit reports are the detailed outline of a company’s financial story. Providing the reader, the credit analyst, with a company’s creditworthiness, payment history, financial statements, and even recommendations on whether or not to extend credit. There are many credit reporting agencies including Experian, D&B and Equifax. If extending credit to a company, it is important to consistently and to continually monitor the company’s credit report. Accord-ing to The Data Warehousing Institute, bad data costs businesses $600 billion annually.

Expert Resources

Copyright 2014 C&S Associates, Inc.

NCS WhitePaper

• Carefully investigate the validity of performance and payment bonds. Utilize The National Association of Surety Bond Producers and US Department of Treasury Listing of Approved Sureties to check the validity of your customer’s bond and the surety backing the bond. In November 2013, ENR.com reported a “…coast-to-coast internet-and-telephone crime spree…spread fake Chubb completion bonds across the U.S.” At the time of the report, twenty two contractors in nine states lost more than $3 million.7

• Mechanic’s liens speak volumes. Roughly 4% of active construction projects are bogged down in fiscal entanglements. Out of 418,308 nationwide projects, 17,386 mechanic‘s liens were filed in the first quarter of 2014, according to NCS’ LienFinder. The filing of a mechanic’s lien is often indicative of payment issues on a project and should be a red flag to anyone extending credit. Mary Cowan, President of NCS, asks “Do you know if your customer has been involved in projects with mechanic’s lien filings? To know about the filings, beforecontracting with your customer, means you have the opportunity to mitigate loss. You have the opportunity to save valuable time and money; be proactive not reactive.” Cowan further explains reviewing mechanic’s lien filings are not just about your customer “Go to LienFinder, search, review and understand all of the project information and each party within thecontractual chain. Cross reference the parties within the contractual chain to other projects throughout the country. Before you know it, you will have a comprehensive view ofcontractors, lenders, and sureties, not to mention the ammunition to make a better credit decision.” Lastly, Cowan reiterates the convenience of monitoring all parties and projects “Take advantage of project and party monitoring. With services like LienFinder and D&B, you can set email alerts to advise you of any project or party activity. If someone files a lien on a project you are working on, wouldn’t you want to know as soon as possible? I would think so!”

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Did You Know? 53% of construction start-ups are out of business after four years10. Whatcauses the failure? “Unbalanced Experience or Lack of Managerial Experience” with a speci�cpitfall of “Poor credit granting processes”

Did You Know? During an average hour 385 suits, liens or judgments are �led againstcompanies11.

Did You Know? Always con�rm the validity of the payment bond. Serving a preliminarynotice will not secure your bond claim rights if the payment bond is fraudulent.

• A company’s financial status may ebb and flow and it is important to be aware of thefluidity of their finances. Any opportunity to establish a “monitoring” system to alert you of changes to a client’s financial situation should be a welcomed opportunity. Resources like The Distressed Company Alert, BankruptcyWatch, LienFinder™ & NCS Corporate Monitoring provide credit professionals a monitoring solution, alleviating some of the hands-onreviewing. The Distressed Company Alert “alerts subscribers to significant recent events reported by U.S. Public Companies indicating possible distress.8” Notifying the subscriber of a default, audit concern or debt being traded at a significant discount.

Copyright 2014 C&S Associates, Inc.

NCS WhitePaper

Without question, implementing a Mechanic’s Lien/Bond Claim Process is one of the greatest �scal weapons available to the construction credit professional. Leveraging your position as a secured creditor will have a positive impact by reducing your DSO and bad debt write o�s, while improving your working capital. In fact, NCS clients experience an average of 25% reduction in DSO, with some clients experiencing reductions as high as 50%.

Each state in the U.S. and U.S. Possessions and the Canadian provinces have laws in place to protect companies that supply materials/labor to the permanent improvement of a property. However, contractors and suppliers must strictly adhere to the rules set forth in the statute in order to perfect their security. Let’s think of the mechanic’s lien process as a three stepprocess (albeit this is an over simpli�cation): Notice > Mechanic’s Lien > Foreclosure.

• Gather project information – always. It is imperative for a creditor to know who lies between you and your money. Know the contractual chain (owner, general contractor, sub-contractor, lender etc.), where the project is located and the various milestone dates, uncover the information necessary to properly secure your mechanic’s lien/bond claim rights. Make this a standard practice, much like securing credit references or running a credit report. Gather this information at the time of the contract; it is infinitely easier to gather project information at the onset of the project, including obtaining copies of payment bonds. Everyone is happy and excited at the beginning of a project and typically willing to provide information to anyone and everyone. Waiting until your claim deadline to ask the general contractor for a copy of their bond? Be prepared for the emphatic “No!” – People have a tendency to be tight lipped when there are disputes – an unwillingness to share information is nearly a guarantee.

• Become familiar with the mechanic’s lien statute for the state in which your project is located. It’s important to know the deadlines for each action, in advance, allow ample timeto follow the state’s guidelines & do not miss out on any opportunity to protect yourreceivables.

• Serve a Preliminary Notice (aka Notice to Owner, Notice to Contractor, Pre-Lien Notice) on every project. It is a low cost way to ensure you are taking the proper steps to securemechanic’s lien rights. If serving a notice on every project doesn’t fit within your model, then set a dollar threshold. Determine what you are willing to lose in the event of default and serve a notice on any order over that value – e.g. serve notices on all projects that have a contract of $10,000 or more.

Be Secure: Create & Execute an Expert Mechanic’s Lien Process

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Did You Know? NCS research shows, 92% of the time, companies who consistently serve apreliminary notice on every project, are paid without the need to proceed with a mechanic’slien or bond claim.

Did You Know? If you intend to serve preliminary notices on your own (i.e. without theassistance of a preliminary notice expert), make sure the documents are aligned with thestatute requirements. Too many companies have found themselves with an invalidatedmechanic’s lien because of errors in their preliminary notice.

Copyright 2014 C&S Associates, Inc.

NCS WhitePaper

• Send a Demand Letter before proceeding with a mechanic’s lien. Often times, slow-paying clients will respond to the force and time constraint of a demand letter, without you having to spend additional funds on a mechanic’s lien. Ensure the demand is clear and concise, e.g. “We are writing to you in connection with the above balance, which is seriously past due. It is requested that payment be made in accordance with the terms of our invoice(s). This letter is written to afford you the opportunity to arrange for payment amicably. In the eventpayment is not received in full within ten (10) days from the receipt of this letter, all available remedies may be taken, including but not limited to the filing of a mechanic’s lien and/or a claim against a bond.”

• File a mechanic’s lien. If the preliminary notice and subsequent demand letter do not prompt payment, then it is time to proceed with a mechanic’s lien. It is recommended to have copies of invoices, bills of lading, the statement of account and copies of variouscommunications, to support your claim. (Some states actually require the invoices be attached to a copy of the mechanic’s lien when sent for recording.)

• In the event you remain unpaid, the final step is to proceed with suit to enforce themechanic’s lien. Suit is typically a slow (and costly) process, due to the various facets oflitigation. It is best to utilize an attorney who is well versed in construction/mechanic’s lien laws and familiar with the project itself (including issues surrounding change orders, back charges, etc.).

The REAL Cost of Write-O�sServing notices regularly, reduces the need to file a mechanic’s lien or proceed with suit, however, what if you do not serve the notice and have to write off the funds? It is important to understand the costs associated with a write off. For example, let’s say we make a business decision to write-off $50,000 in bad debt. It’s not as simple as “We wrote off $50,000 so we just need to make $50,000 elsewhere.” The cost of write-offs to a company can be crippling. Consider a write off of $50,000 at a 30% margin. You would have to generate $166,666 in additional sales to recover that lost profit. If you operate at a 15% margin the additional sales mushrooms to $333,333. In truth, several large write offs could severely impact cash flow, or worse, force a company to close its doors.

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Did You Know? NCS research indicates, once a process is in place and you are regularlyserving preliminary notices, it is likely that only 8% of your projects will require you to �le a mechanic’s lien, and less than 2% of your projects will require you to proceed with suit toenforce your claim.

Copyright 2014 C&S Associates, Inc.

NCS WhitePaper

NCS recommends every credit professional have a Credit-Management-Arsenal at the ready. Credit Management requires an array of accessible resources and considerations. There are many terri�c resources available to credit professionals; here are a few for your Credit-Management-Arsenal:

• Credit reports through agencies such as D&B and Experian.

View and review risk factors such as the company’s net worth, payment history, thelikelihood of default and credit limit recommendations. • Financial distress alerts through The Distressed Company Alert and BankruptcyWatch.

• Monitor economic forecasts and subsequent performance through the Architectural Billings Index, Purchasing Managers Index and Credit Manager Index.

• Subscribe to publications from companies like The Credit Research Foundation, McGraw Hill Construction, Reed Construction Data and Engineering News-Record, for news and updates on national construction activity.

• Search and monitor mechanic‘s lien activity for projects and parties nationwide via NCS’ LienFinder™, as well as NCS’ Corporate Monitoring to receive alerts when a company’s name or status changes with the State Corporation Division.

A review of mechanic’s lien �lings may uncover signi�cant �nancial woes. If a company has been party to several mechanic’s lien �lings it should raise concern. Red Flag: are the liens �led around the same time? If there has been an in�ux of lien �lings and your customer’s name appears quite frequently, your customer could be experiencing cash-�ow issues. It’s also important to look for releases of mechanic’s liens which indicate the payment issue has been resolved. Beyond the mechanic’s lien is foreclosure. If your customer is involved in a lien foreclosure, it is in your best interest to �nd out why. • Implement a mechanic’s lien process. Take proactive control of your receivables, to secure your tomorrow.

Make it standard practice to include security language within your credit application or con-tract. This will not negatively impact your customer, unless of course, they fail to pay you. Take the time to evaluate the surety and/or lender for projects. “…con�rm that the surety is licensed in the jurisdiction of the project and that the bond has been authorized by that surety.” This advice is from The National Association of Surety Bond Producers. Take the time to review ratings on the lending institution as well; understand the likelihood of an institution default or inability to meet credit obligations.

Most importantly, do not limit yourself. There are innumerable resources available. Take the opportunity to review all data, carefully, before you make the decision to extend credit. Dollars and cents are nothing without insight and action.

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Arm Your Credit-Management-Arsenal

Copyright 2014 C&S Associates, Inc.

NCS WhitePaper

References1. Combs, C. (n.d.). Credit Scoring Modules: A Credit Manager's Best Friend. Credit Scoring Modules: A Credit Managers Best Friend. Retrieved June 10, 2014, from http://www.credittoday.net/public/Credit_Scoring_Modules_A_Credit_Managers_Best_Friend.cfm2. Pressroom: Press Releases. (2014, May 21). AIA RSS. Retrieved June 10, 2014, from http://www.aia.org/press/releases/AIAB103843 3. May 2014 construction spending forecast overview based on March Census Bureau data. (2014, May 27). Reed Construction Data -. Retrieved June 10, 2014, from http://www.reedconstructiondata.com/Market-Intelligence/Articles/2014/5/A-Di�cult-First-Quarter-for-Construction-Spending-Comes-to-an-End-1000175W/4. Stockton, G. (2014, February 18). Will You Be Able to Survive the Construction Industry Recovery? | Experian Business Information Services. Experian Business Information Services RSS. Retrieved June 10, 2014, from http://www.experian.com/blogs/business-credit/2014/02/18/will-you-be-able-to-survive-the-construction-industry-recovery/5. Cahill, K. (2014, June 2). ISM - ISM Report - May 2014 Manufacturing ISM® Report On Business®. ISM - ISM Report - May 2014 Manufacturing ISM® Report On Business®. Retrieved June 10, 2014, from http://www.ism.ws/ismreport/mfgrob.cfm 6. A Day's Worth of Business Information in the Age of Big Data [Infographic]. (n.d.). MarketingProfs. Retrieved June 10, 2014, from http://www.marketingprofs.com/chirp/2014/24888/a-days-worth-of-business-information-in-the-age-of-big-data-infographic#ixzz33CvevoXS 7. Construction, Building &; Engineering News: ENR | McGraw-Hill (2013, November 4). . Retrieved June 10, 2014, from http://enr.construction.com/ 8. New Generation Research - Experts in Bankruptcy Research. (n.d.). New Generation Research - Experts in Bankruptcy Research. Retrieved June 10, 2014, from http://www.distressedcompanyalert.com/ 9. BankruptcyWatch. (n.d.). BankruptcyWatch. Retrieved June 10, 2014, from http://bankruptcywatch.com/ 10. Startup Business Failure Rate By Industry. (n.d.). Statistic Brain RSS. Retrieved June 10, 2014, from http://www.statisticbrain.com/startup-failure-by-industry/11. D&B | Business Information for Government | (800) 424-2495. (n.d.). D&B | Business Information for Government | (800) 424-2495. Retrieved June 10, 2014, from http://www.dnb.com/government

To Learn more: Call 800-826-5256 email SecureYourTomorrow@ncscredit.com web http://home.ncscredit.com

Securing Your Tomorrow

®

®Portions of this whitepaper originally appeared in theCredit Research Foundation’s newsletter “CRF News” (2nd Quarter, 2014)

About the Author/CompanyNCS assists credit professionals throughout the U.S. and Canada secure their receivables through the mechanic’s lien process. With more than 40 yearsof experience, NCS has gained national recognition as the premier leader for securing accounts through mechanic’s liens and UCCs. NCS has educated more than 90,000 credit professionals on securing their receivables and reducingtheir risk. Empower yourself with free webinars, OnDemand webinars, seminars, videos and social media. NCS also o�ers software and web based solutions such as LienFinder™, The National Lien Digest©, LienTracker® and LienDirect Online.These resources help manage credit risk, provide time and information requirements, monitor deadlines and generate notices.