The COVID-19 pandemic has caught everyone by surprise. Everyone’s lives were affected, and almost all industries incurred huge losses as lockdowns and other restrictions were implemented not only in the US but all over the world.
The construction industry is one of the hardest-hit sectors by the still ongoing public health crisis. Many construction projects were ordered to close down to prevent the virus from spreading further, and various capital projects were also canceled. Even after the economy has started to open up, there are still owners and developers who are hesitant to start a new project.
Now that vaccines have been made available, economic projections are pointing upward for the construction sector. Despite the good news, this is still not a reason to remain relaxed and lenient, especially for material suppliers and credit managers. It is best to prepare and put into action concrete plans that will allow your company to thrive in a post-COVID-19 world.
Lending Risks and Challenges During COVID-19
The pandemic has introduced unique challenges to credit managers, especially in the construction sector. Prevailing issues in the industry were also worsened by the COVID-19 crisis, which pushed many construction companies, especially material suppliers, to remain on their toes.
- Payment delays and defaults due to project closuresRisks of late and missed payments got worse when the pandemic hit. The construction industry is already notorious for payment disputes and delays, and these payment issues were only exacerbated after construction projects were indefinitely postponed, if not canceled altogether.
- Supply disruptions leading to steep prices of materialsBecause of the pandemic, the construction sector has had to deal with major supply chain issues. The disruptions in supply availability had caused building material prices to skyrocket, which made it even more challenging for lending companies and credit managers to deal with the increasing demand for materials.
- Borrower delinquencies causing increased collection costsMany construction companies struggled to maintain their cash flow, especially when projects started to get canceled. The increasing cases of missed payments forced construction credit lenders to intensify their payment collection efforts. Additional payment collection efforts also meant extra costs that creditors had to shoulder just so they could recover the money they lent out.
Mitigating Post-COVID-19 Credit Risks
Even though the pandemic still does not have a definite end in sight, it is important to start preparing for the post-pandemic world. Setting strategies for the future must be done as early as now, and all the challenges that you faced during the COVID-19 crisis must be taken into account when crafting your plans for the future.
Assess existing trade credit policies
If you have not done so yet, you should begin by evaluating your current trade credit policies. This is important as you may need to adjust your existing policies to tailor them to your company’s needs and goals.
In a post-pandemic world, your company’s objectives may change. Some material suppliers, for example, may choose to be more risk-averse when approving or rejecting trade credit. Your trade credit policies should reflect this, which means that your company may need to rethink your existing approval standards and develop more stringent requirements.
Develop an effective post-crisis plan
After evaluating your existing credit policies, it is also important to come up with a concrete post-crisis plan. Whether you plan to implement your plan now or after the pandemic, the key is to develop actionable steps that will keep your company from going under in case another major economic downturn occurs.
When developing a plan, you should recognize the strengths and weaknesses of your current credit management model. Review everything, from your trade credit policies to your KPIs, and make sure that you are able to address existing cracks and holes.
Execute and evaluate the plan as you go
A plan is just a plan until it is executed properly. Once you have already implemented your new credit policies and plans, you should also regularly evaluate them. There is no perfect plan, and there may be issues that you weren’t able to capture before you executed your plan.
Be sure to have audit measures in place and also be ready to adapt to new technologies. Credit managers and assessors should leverage the technologies available to them to help them make the right decisions and allow them to flag and intervene in high-risk situations.
Credit Risk Management After COVID-19
Developing a granular approach for credit risk assessment
In a post-COVID-19 world, credit managers should pay close attention to every credit application, even if this means investigating even the smallest details in an applicant’s financial profile. This is an important step to assess the risks associated with every potential and even an existing client.
Being detailed in your approach to trade credit risk assessment will not only help you make decisions regarding the approval or rejection of an application, but it can also guide you in setting the right trade credit limit that your client can afford.
Other than the basic credit reports and scores from credit bureaus, you can also look into the following data sources:
- Expense records on utility payments, rental payments, etc.This will help you get a fuller picture of how customers spend their money, especially regarding their fixed expenses. For instance, you want to know how much they pay for rent if they have an office or just conduct their operations remotely. These small details are helpful in understanding and assessing a company’s cash flow.
- Expanded credit reports including debt-to-income ratio, cash flow variables, etc.Credit reports can also include expanded details regarding debt-to-income ratio and other variable costs that a company shoulders. You can also investigate their payment collection practices, including their DSO. Knowing how much a company owes and how much money their make will also help you understand their finances better.
- Mechanics lien records and practicesOther than financial records, encumbrances such as mechanics liens should also be taken into account when performing a credit risk assessment. Does a company regularly deal with plenty of mechanics liens? Do they have internal policies in place for serving preliminary notices, etc.? A prudent company will be proactive in submitting preliminary notices and in filing mechanics liens, if necessary.
Evaluating and adjusting payment terms and conditions
After the pandemic, contractors and subcontractors are also expected to become more risk-averse. Some customers will prefer to have longer payment terms with lower payment interests, and this is understandable. You should be willing to evaluate your policies and adjust to client preferences.
At the same time, you should refrain from being too lenient, which can potentially expose you to losses. Be ready to adjust your terms and conditions, but do so only after conducting a thorough analysis of your own finances and the customers’ financial profile. Also, be ready to monitor every client, perform forecasting analysis, and intervene, when needed.
Assessing payment delays and other delinquencies
When assessing and monitoring the payment delinquencies of your clients, you should look into the root causes of their payment issues. Are they just experiencing a temporary financial bottleneck, or are there structural cracks in their financial practices that block their cash flow?
It is important to investigate each of your client’s financial status, especially when they fail to honor their payment obligations. It is just as important to mitigate potential payment delinquencies by consistently running credit reports and mapping industry trends.
Trade Credit Risk Assessment for New and Younger Portfolios
New clients are more difficult to assess, especially since they have no lengthy financial records to present. It is difficult to predict their payment practices when they do not have an established credit record yet, but this does not mean that you should just simply approve them and give them the benefit of the doubt.
By the time the COVID-19 pandemic is over, you should have expanded your resources when conducting trade credit risk assessment on a new or young customer. Some alternative data that you can ask for include the following:
- Total debtHow much money do they owe from other creditors or lending institutions?
- Debt-to-income ratioHow much do they owe, and how much do they make or expect to make?
- Industry trendsWhat are the economic forecasts that affect the industries they work for (e.g., airline, hospitality)?
Trade Credit Risk Assessment for Established Clients
Take advantage of credit bureau reports and other financial data
Credit bureaus can tell you how much your clients owe, not only from you but from other lenders as well. You should leverage reports from credit bureaus as well as other external sources – including banking statements and payment receipts – so you are able to analyze your customers’ finances better.
Enhance existing credit risk evaluation efforts
After the pandemic, you are strongly encouraged to intensify your credit risk evaluation efforts, even with established clients. Gather as much data as you can, and be proactive in studying industry trends and reviewing forecasting reports. This will be of great help, especially when flagging risks that will require you to intervene before a major loss is incurred.
Be flexible in adjusting to customers’ needs
When working with established clients, it is safe to assume that you have already developed a good business relationship with them. Make sure that your decisions are still objective data-driven by separating which among your clients are low-risk, which means that they generally have the capacity to pay back the money you lent them. It may be worth adjusting your payment terms accordingly, if needed, to continue your good business rapport.
Effective Post-Crisis Construction Credit Risk Management
When implementing any strategy, it is important to set the right goals and priorities. You should therefore set short-term and long-term goals that will help you stay on track. Short-term goals are steps or priorities that are executed ideally within the first three to six months, while medium- to long-term goals are actions that must be carried out after six months.
Aside from setting your short-term and long-term priorities, you should also determine the resources necessary to ensure that those priorities are met. Resources may include time, money, and people. You should assign which persons are responsible for carrying out your short-term and long-term goals, and these persons must clearly understand what exactly is expected of them.
Short Term Post-Pandemic Credit Risk Assessment Priorities
Implement new credit policies
Your new trade credit policies must be implemented within the first three months, which means that the trade credit policies should have been studied, crafted, and revised beforehand. This is important to keep in mind. While the pandemic is still ongoing, consider yourself to be in the planning stage. The post-pandemic world will be the time to implement your plan.
It will be ill-advised if you start reviewing and revising your trade credit policies only after the pandemic is over.
Apply early monitoring measures
Within the first three months, you should be able to execute not only your revised trade credit policies but also your credit monitoring measures. Some material suppliers may choose to have a data team dedicated to studying economic trends across relevant sectors, while others may choose to invest in advanced technologies that will conduct risk assessment for them.
Whatever credit monitoring method you choose, it is best to implement them during the first three months of your plan.
Personalize credit risk assessments and intervention plans
Another important short-term priority is to personalize your approach to credit risk assessment and intervention. Having blanket rules that apply to all customers is important, but assessing each of your client’s finances and payment practices in detail is also just as important. In the long run, a personalized approach will help you mitigate risks better.
Medium to Long Term Post-Pandemic Credit Risk Assessment Priorities
Review and evaluate trade credit policies
After the first three months of executing your adjusted trade credit policies, this will be a good time to evaluate them. Ask yourself what works and what doesn’t. You should get a dedicated team to meet for a scheduled assessment, and the team will review and gather feedback to help you improve your credit policies. You should also study the best practices conducted by other lenders and see which of these practices you can apply to your company.
Apply early intervention measures
Since you have already been consistently monitoring your client’s payment performances, you should be ready to apply the necessary intervention measures if needed. For example, you can have an electronic auto-reminder sent through email or a mobile app to remind your client of an upcoming payment deadline.
You can require your customers to send proof that they have served the appropriate preliminary notices to ensure that their lien rights are preserved in case they need to file a mechanics lien in the future. Taking all these proactive approaches will help you ensure that payment recovery goes as smoothly as possible.
Personalize solutions and collection efforts
If your risk assessment processes are personalized to each client, so should your payment collection practices. Coming up with a personalized approach to payment collection is important, especially when you are low on resources. Simple email reminders may be sufficient for low-risk clients, but you will need to exert stronger efforts to recover payment from clients who have a higher risk of non-payment.
By strategically planning your approach to payment collection, you are able to streamline your practices in a way that maximizes your time and resources.
Construction Trade Credit Risk Strategies
Streamlined trade credit policy
Having an effective trade credit policy that aligns with your company’s goals is necessary. The ongoing pandemic has been a wake-up call for many businesses, and you should take this time as an opportunity to revisit your existing practices and improve them. If you do not have a trade credit policy in place, consider crafting one, as it will allow you to standardize and streamline your credit management practices.
Continuous monitoring and forecasting
Credit risk assessment should be done continuously, not only during the approvals stage of the credit life cycle. You should consistently gather data and require documents from your customers, and you should also regularly develop forecasting analyses that will help you make decisions about specific clients. If, for example, a contractor is experiencing major payment delays from their client, be ready to intervene and get them started on the mechanics lien filing process.
Segmented approach to credit management
Credit management has multiple stages, from credit application all the way to payment recovery collection. You should review your processes across all these stages and make sure that they are efficient. No single strategy fits every company. For instance, some companies may choose to hire more people to strengthen their payment collection department, while others may want to augment their credit risk assessment team.
Further reading