Project finance and cashflow remain the most critical challenge in this crisis, as construction firms, not just in the UAE but around the globe, question their survival over the coming months.
Lack of financing and accounting discipline by contractors in general compounds their struggle to secure bankrolling during periods of contraction in the economy. The infamous "need to borrow", generally with no clear structure, has taken down many contractors during such difficult cycles.
Due to the Covid-19 pandemic, projects under way are experiencing delays in achieving completion due to interruptions across the supply chain. Productivity has taken a hit as contractors adhere to social distancing guidelines on site. Operational costs have risen as money is diverted to mitigate the risks of the novel coronavirus.
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Meanwhile, developments in early stages find themselves struggling to raise debt in the manner the project sponsors had originally anticipated, resulting in several projects either being halted or shelved entirely.
Communication channels between construction companies and their lenders are more crucial now than ever before. Such communication needs to be candid and focused on the desired end-results that safeguard the interest of both parties and allow for the completion of projects on hand with the best possible outcome.
Restructuring existing lines of credit, taking into consideration the changing tides, are necessary for the survival of contractors and their projects. Banks are very pragmatic today more than ever to reach this desired outcome.
One observation that lenders have made both during the financial crisis of 2008 and the current pandemic crisis is that contractors that ring-fence the cashflows of their projects are likely to fare better and raise finance for those projects faster.
This is where the contracting finance model, a term used by lending banks, comes into the picture. The model is dependent on the "what":
- Initial project cashflow
- Project execution plan
- Legal contract defining scope, time, cost and responsibilities
Once the above are analysed, the required financing instruments or the "how", will be structured around:
- Contractual warranties that need to be provided by the contractor (performance, advance payment and retention bank guarantees)
- Procurement requirements, be it materials or equipment (documentary credit)
- Temporary cashflow deficits, which arise due to the timing of incurring cost and the receipt of payment from the project owner as per the terms of the contract (short-term loans or overdrafts)
For the ring-fencing to work, all payments made or received should be within a specific bank account that is used only for the purpose of completing this project. Upon completion of the project, the account will cease to operate.
Communication channels between construction companies and their lenders are more crucial now than ever before
Such an arrangement will require the contractor to assign the proceeds to the account held with the lender and for the project owner to recognise and accept the same, ensuring the payments are only made to the project-specific account. However, the refusal of some project owners to accept project proceeds assignments makes it difficult for contractors to source the right cashflow financing from their banks.
Under the above model, banks will try to extend all possible support for project completion, which will result in the return of the guarantees and rundown of exposure. Banks will offer support if the source of repayment is clear and identified; they will offer more support if payment is assigned and made to the project account.
This arrangement also helps contractors and their finance teams maintain the discipline of ring-fencing projects and avoid the malaise of using a specific projectís funds to shore up other struggling projects, which ultimately leads to the failure of the first project.
When the music stops, such projects suffer tremendously due to a shortage of new inflows to cover the earlier withdrawals outside the project cashflow.
Therefore, it is an ecosystem that needs to exist if we are to protect and enhance the performance of this crucial industry. All parties need to realise that no one can operate in isolation, and a failure by any party is a failure of the project.
Time for change
Now is the time to set this practice in place and work with regulators to facilitate, maybe mandate, the assignment of project proceeds to the bank that is issuing the guarantees. It is also time for us bankers to reconsider what burdens we place on the contractor: lopsided contracts, delayed certifications and the size, text and tenure of project bank guarantees.
This is a conscientious decision we need to make, which will allow us to start addressing the real issues constraining the evolution of this industry: writing fairer contracts; promoting the use of technology; and building sustainably. Now is always the best time to change.
Going forward, any planning after securing projects under execution needs to factor in the possibility of a second wave of the Covid-19 pandemic. We all hope we do not face such a calamity again, but if it does happen, we need to be prepared for it. Learning from the existing crisis is the most important outcome of our situation today.
About the author
Mohammad al-Shouli is the executive vice-president and global head of contracting finance at Mashreq Bank
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