Project finance and cash flow remain major challenges in this crisis as construction companies not only in the UAE but around the world question their viability in the coming months.
Lack of financial and accounting discipline from associates generally exacerbates their struggles to go bankrupt in times of economic downturn. The well-known “need for credit,” which is generally structureless, has plunged many contractors into such a difficult cycle.
Due to the Covid-19 pandemic, ongoing projects were put on hold due to disruptions in the supply chain. Productivity is affected because contractors on site follow social distancing guidelines. Operating costs have increased as money has been diverted to reduce the risk of the new coronavirus.
Meanwhile, developments at an early stage have struggled to increase debt as originally envisioned by the project sponsor. As a result, several projects were postponed or canceled entirely.
The communication channels between construction companies and their creditors are becoming more important than ever. This communication needs to be open and focused on the desired end result that will protect the interests of both parties and allow the project to be completed by hand with the best possible outcome.
Restructuring of existing credit lines to accommodate the tidal changes is necessary so that contractors and their projects can survive. Today’s banks are very pragmatic about getting this desired result.
Fence with rings
One of the observations that lenders made during the 2008 financial crisis and the current pandemic crisis is that contractors who limit cash flow from their projects tend to perform better and increase funding for the project more quickly.
This is where the contract finance model appears, the term used by creditor banks. The model depends on the “what”:
The project’s first cash flow
Project implementation plan
A legal contract that describes scope, time, costs and responsibilities
After analyzing the above, the necessary financial instruments or “how” are structured:
Guarantees will be provided by contractors (bank guarantees for performance, prepayments and retention)
Procurement requirements, whether material or equipment (credit note)
Temporary cash flow deficits due to lengthy costs and receipt of payments by the project owner in accordance with the terms of the contract (short-term loan or overdraft)
For ring fencing to work, all payments made or received must be in a specific bank account which will only be used to complete this project. After completing the project, the account will stop functioning.
The communication channels between construction companies and their creditors are becoming more important than ever
Such an agreement requires the contractor to distribute proceeds to the accounts of the lender and the project owner for confirmation and acceptance to ensure that payments are only made to project-specific accounts. However, the refusal of some project owners to assign project assignments made it difficult for contractors to ensure proper cash flow funding from their banks.
Based on the above model, the bank will endeavor to support the completion of the project as much as possible, which will result in a guarantee return and termination of the engagement. The bank offers assistance if the source of payment is clear and unambiguous. They provide more assistance when payments are made and credited to project accounts.
This agreement also helps the contractor and their finance team maintain fencing project discipline and avoid the inconvenience associated with having funds on a specific project to attract other tough projects, ultimately leading to failure of the first project.
When the music stopped, the projects suffered greatly from a lack of new flows to cover previous withdrawals outside the project cash flow.
Hence, it is an ecosystem that must be in place if we are to protect and enhance the performance of this very important industry. All parties need to be aware that nothing can work in isolation and that the failure of either party is the failure of the project.
time for a change
Now is the time to build on this practice and work with regulators to facilitate a mandate to allocate project funds to guarantee banks. It is time for us bankers to rethink the burdens we have placed on contractors: canceled contracts, overdue certificates, and the amount, text and duration of bank guarantees under the project.
These are the real decisions we have to make to solve the real problems that hinder the development of this industry: writing fairer contracts; Promote the use of technology; and build sustainably. Now is always the best time to change.
In the future, any planning after the project should lead to a possible second wave of the Covid-19 pandemic. We all hope we don’t face such calamities again, but when they do we need to be prepared for them. Learning from the current crisis is the most important outcome of our current situation.