Insolvencies remain high in construction

This is the third consecutive year of writing for this publication that we’ve had cause to report on the ongoing economic challenges faced by Australia’s construction industry. Equifax quarterly commercial insights show that this sector continues to grapple with escalating levels of defaults and insolvency, contributing to a risky lending environment.

In the fourth quarter of 2023, construction sector insolvencies surged by 32% compared to the same period in 2022, while Days Beyond Terms increased by 39%.

While overall insolvencies across all sectors in 2023 remained above pre-Covid levels, there is still some way to go for the market to catch up to proportional levels.

In the construction sector, the proportion of insolvencies is double the rest of the market (0.52% vs 0.24%), and the last two years has seen a significant surge in insolvencies of credit-active businesses.

Challenging economic conditions have seen this sector record its first negative net growth since 2019, with lower entry rates (16.4%) and higher exit rates (16.5%). Total building commencements fell to -17.4% over the September quarter 2022 to 2023. Given that every dollar spent in construction generates $3 in economic activity, there is reason for concern, especially when coupled with flat commercial credit demand.

Broader trends in DBT and insolvencies across Australia

At the overall market level, insolvencies spiked by 48% in the December quarter of 2023 compared to the same period in 2022. Throughout the year, insolvencies consistently exceeded pre-Covid levels, driven by workforce shortages, increased cost of goods, inflation, higher operating costs and challenging lending conditions.

These tighter economic conditions have markedly impacted the B2B payment landscape, with commercial credit demand falling by -0.9% in the fourth quarter of 2023. Equifax data analysis has found a noticeable correlation between the commencement of cash rate increases and a material change to underlying business credit demand. In the construction sector, business loan applications decreased by -8% and trade credit applications by -6%.

Also construction was seen to have exhibited the highest credit shopping behaviour across all industry sectors, representing borrowers seeking finance from multiple lenders at the same time.

December 2023 witnessed the highest monthly insolvency volumes in the past five years, with a 90% increase compared to the same month two years ago. Average days beyond terms (DBT) across the market rose to 5 days in Q4, up 44% compared to the same quarter in 2022. Notably, DBT in the construction industry was double the market average, settling payments on average 10 days beyond terms. The trend of elevated construction insolvencies has continued into 2024, with January’s insolvencies being 86% up on last year.

Protecting your bottom line and balance sheet

With this rapidly shifting landscape and the increasing complexity of credit risk management, using holistic data, advanced analytics, and intelligent technology to identify, quantify, manage and mitigate risk has become more critical than ever.

Credit ratings data for the construction sector, for example, reveal an increasing risk among vulnerable constructors facing financial distress. In the nine months leading up to September 2023, over 23% of home builders and commercial construction entities assessed by Equifax had their credit rating downgraded. Many entities in this sector already held a credit rating in the highly speculative ‘B’ range, predisposing them to vulnerability in adverse conditions.

Civil and infrastructure constructors have proven more resilient compared to the commercial construction sector’s ratio of one upgrade for every six to seven downgrades. The above graphs highlight the differences across the construction sub-segments, in particular, the continued financial pressure being experienced across residential and commercial construction.

Indicators of pressure in the construction sector include a substantial decline in profitability for entities experiencing credit rating downgrades, over 30% of medium-major home builders reporting negative net operating cash outflow, and businesses under stress leaning on their supply chains for support.

Building trust in an uncertain market

Despite the challenges, there are still many operators in the construction sector exhibiting the financial capacity, capital, capability and resilience needed to weather the storm. The Independent Construction Industry Rating Tool, iCIRT from Equifax, is a valuable data-driven reference point for regulators, financiers, insurers, and importantly, credit managers seeking to assess a company’s stability and credibility.

iCIRT star-ratings help distinguish trustworthy developers, builders, design practitioners, certifiers, trade contractors and consultants. Those obtaining 3-gold stars and above are classified as trustworthy, allowing reliable players to differentiate themselves and be accountable for the quality of their built assets.

In a market where recent Equifax research identified that only three in ten Australians have a positive perception of the construction industry, this enhanced public trust and market confidence are crucial for the industry’s long-term viability and profitability.

Changing perceptions of the construction sector

Recent research indicates a 76% improvement in the perception of the construction industry among consumers with a negative outlook when they become aware of iCIRT. Of the 45% of Australians intending to purchase, renovate or build in the next five years, three-quarters of this group are willing to pay a premium for the assurance of collaborating with trustworthy property developers or building professionals. .

iCIRT star-ratings operate synergistically with other market-led mechanisms, collectively driving higher standards and offering a clear line of sight to trustworthy construction businesses. This enhanced public trust and increased market confidence serve as critical elements for the long-term viability and profitability of the industry.

In addition, these ratings play a crucial role as an early warning of financial distress. The iCIRT assessment process has identified that nine out of every ten construction collapses exhibit a high-risk rating at least twelve months in advance and, in many cases, even closer to 2+ years.

Armed with expansive data sets, the NSW government is targeting higher-risk sites and developers for increased attention from the newly established Building Commission. In contrast, iCIRT-rated and trustworthy developers are likely to expect a higher level of earned autonomy.

For credit professionals, data is a potent asset when monitoring customers for cash flow stability or undertaking high-stakes contract negotiations. With real-time insights and additional layers of information, such as deteriorating credit quality and sector-specific vulnerabilities, businesses are in a more informed position to understand changes to a customer’s creditworthiness. And with automated alerts and financial vulnerability indicators included in your processes, your ability to anticipate your customer’s risk of defaulting on their credit facilities is considerably enhanced.