Elements vital to effective risk mitigation – construction industry
Construction is the third largest industry in Australia based on the number of people it employs and its contribution to GDP (Gross Domestic Product). However, construction is the second largest industry when it comes to corporate insolvencies, with a pre-pandemic five-year average of 1,590 per annum. Understanding the nature of the industry is extremely important for effective credit management.
Overview of current risk in the Building & Construction industry
Despite the spate of high-profile company collapses over the last few months, which have sent shockwaves through the industry, overall insolvency numbers remain low compared to historical numbers. However, insolvency experts are warning that the construction industry is a “bubble waiting to burst”, and that more companies will go under in the coming months (S Sharples News.com.au 25 Feb 2022) . This is probably accurate, but just how many will go under is the burning question.
There is no doubt that insolvency numbers have started to rise again, with average insolvencies per month up by almost 14% on last financial year. However, this is still 29% lower than the five year average pre-Covid. Construction industry insolvencies as a percentage of all insolvencies has also increased by around 6% during the Covid era.
What is actually happening?
BICB’s data clearly shows how the debt percentage above 60 days in the construction industry has decreased during the Covid era. This trend is more than likely a legacy of the stimulus measures. Recent feed-back from BICB members suggests that payments are continuing to be paid within the agreed terms, or close to terms in most cases. This anecdotal information is reflected in the payment data, below.
It is also interesting to look at ‘construction insolvencies against the number of Australian private dwelling commencements. During the pre-Covid period 2014 to 2019 insolvencies as a percentage of dwelling commencements (IAPDC) averaged 0.73%. During the Covid era, January 2020 to December 2021 insolvencies as a percentage of dwelling commencements dropped to 0.51%. However, there was a sharp increase in insolvencies in the fourth quarter of 2021 resulting in the (IAPDC) rising back to 0.65%.
Factors contributing to this elevated risk
While current payment trends and overall insolvency numbers are looking OK, there are multiple heightened risk factors still at play. We know that the industry is currently under tremendous pressure due to the elevated level of demand that has driven up material and labour costs, and extended build times by around thirty
percent. Also, many builders on fixed-price contracts have made substantial losses. There is no doubt these issues are putting many businesses at risk.
It is expected that the recent spate of high-profile construction business failures, which include Probuild, Condev, Privium, and B. A. Murphy, will lead to further insolvencies. These businesses owe around 2,000 creditors an estimated $1.5 billion.
The big unknown factor, of course, is the extent of the unpaid corporate tax debt. The ATO’s softly, softly approach over the last two years is a major reason for the lower insolvency numbers. The Tax Office has recently warned tens of thousands of directors to act on company tax debts or face the risk of full enforcement action. It is expected that the ATO will again begin to pursue delinquent tax debts through the Supreme and Federal Courts during the second half of 2022.
Tips on how to manage risk in the current environment
Know Your Customer
Front and centre of managing your risk is having a strong understanding of your customers. This is essential for any business looking to succeed in creating reliable credit risk management processes. Assessing any customers’ credit risk profile is only possible with access to data that is comprehensive, accurate and up-to-date. ‘Credit Risk Management’ techniques and models that are supplied with rich data sets will help significantly improve credit risk processes.
Whether onboarding new customers or, reviewing existing customers, access to meaningful data is critical. This information is generally sourced through Credit Reporting Agencies and Industry Trade Bureaus that provide online access to current and historical trading data, comprehensive Court action reports and alerts, ASIC data, Licencing Regulators and Trade References from other suppliers. Both of these sources provide their own unique valuable data to feed into a comprehensive risk management process that enables the credit team to make the most informed decisions.
The value of good credit management data systems and procedures
Key elements of good credit management systems incorporate risk polices with dynamic reporting and alerts that highlight customers at risk and ensure real-time risk profiling. Systems that incorporate real-time analysis with early warnings of potential issues to keep you on the front foot and provide greater insight on trends in customer behaviour.
These systems should:
- Incorporate data from sources that provide — current and historical payment patterns (a customer may be paying you, but are they paying other suppliers), Court actions, both current and historical, industry licencing regulators, ASIC information, defaults.
- Create automated alerts when adverse information is detected.
- Incorporate risk policies and strategies that monitor change in characteristics and automate credit limit reviews.
- Include pre-defined risk policies along with the flexibility to create new policies if required.
The value of data for successful risk mitigation
We live in a world where data is king. And with so much information available, the most effective risk mitigation systems will pull data from multiple different sources as no single source is able to provide the complete picture.
However, for data to be useful in managing risk it needs to be accurate, comprehensive and, most importantly, early enough to provide advanced warning so you can be on the front foot to mitigate your risk in real-time. Some data sources are retrospective in nature and provide great clarity after the fact, but these have limited value as situations evolve. Fortunately, there are a number of other excellent tools available to credit managers that can identify deteriorating trends and potential red flags months in advance of eventual business failures. Use of these tools within your credit management processes can add significant value to your business.