Article #135 a How Can Banks and Financial Institutions Use Technology to Address and Manage the Challenges of Managing Construction Projects Credit Risk? Part 1

Credit risk is the potential risk that a bank borrower will fail to make payments by agreed terms. Credit risk management practice aims to mitigate losses by maintaining credit risk exposure within acceptable parameters. In most countries, there are regulatory requirements to demand more transparency when it comes to managing credit risks. They wanted to know that a bank has a thorough knowledge of customers and their associated credit risk.

Nevertheless, banks face many challenges in having successful credit risk management, particularly credit provided to construction projects. Those include the inability to access the right project’s schedule and financial performance data, proper risk management practice, and spreadsheet-based reporting that lacks data accountability and real-time status, among many others.

Implementing an integrated, quantitative credit risk management solution is the key to reducing construction project loan losses. Implementing Project Management Information Systems (PMIS) like PMWeb will provide banks with an integrated solution to manage credit risk across their projects’ portfolios. PMWeb will be used to collect and capture the data from the different processes needed for credit risk management. In addition, PMWeb’s data visualization capabilities and business intelligence capabilities will get important information into the hands of those who need it when they need it.

Assessing the Project Risk Exposure

Like any other loan requirement, banks should have a detailed risk register that will become the basis for assessing the project’s risk exposure. The log should include risks related to the borrower’s organizational capabilities, the project’s technical risks, the borrower’s project management practices, the project owner, and external risks, among others. The PMWeb risk analysis module will be used to create a repository of those risks so the credit risk team can assess the likelihood of those risks, which are needed to determine the project’s risk exposure.

Verifying the Project Cost Estimate

In many countries where unbalanced bids are not prohibited, contractors will front load their bill of quantity to ensure early earning of their project’s profit and contingency. For a bank, this could be a dangerous practice to allow, as the revenue earned on the project will not cover the actual cost of the remaining scope of work. Therefore, banks must verify the project cost estimate, usually using the services of a qualified cost management consultant. PMWeb cost estimate module allows importing the cost estimates prepared by the contractor and the cost management consultant to verify the estimate’s correctness.

Verifying the Project Schedule

The bank needs to review and analyze the project’s integrated project schedule to ensure that schedule-related risks are incorporated into the plan. The PMWeb custom form builder will be used to create a Schedule Review and Analysis checklist to provide a consistent and complete analysis of the project schedule.

Applications like Acumen Risk or Primavera Risk Analysis can be used to run the Monte Carlo simulation. In addition, Monte Carlo simulation can be used to run a stress test on the project’s schedule to identify the likelihood of meeting the project’s completion date. The Monte Carlo simulation will also determine the high-sensitivity activities that control the project’s critical path, for which they need to be subject to further analysis and review.

Establishing the Project Budget

The approved project cost estimate will become the basis for establishing the project’s budget and the proposed spending plan of this budget. The project budget should be aligned with the approved loan given by the bank. Sometimes, the loan provided by the bank could be used to fund only parts of the total project cost estimate, while the balance could be financed from equities to be provided by the borrower. The PMWeb budget module will be used to manage the project budget, which will be generated from the approved cost estimate, and the budget planned spending projection.

Establishing the Project Cashflow

The contractor must submit the cost-loaded schedule in most construction projects, including the performance credit earning rules. This will become the basis for generating the cash flow detailing how the contract’s value will be achieved. The cash flow needs to be adjusted for the contract’s terms and conditions, including advance payment, recovery, retention, and 30 or 60-day payment terms. This will be aligned with the budget-planned spending projection to identify cashflow gaps.

Ensuring Transparency in Subcontract and Purchase Orders Award

Most contractors usually outsource part of their project’s scope of work to qualified subcontractors and suppliers that the project owner must approve. In many projects, the list of those subcontractors and suppliers will be part of the contractor’s bid submission. The bank needs to ensure that competitive bids are received from those subcontractors and suppliers and that those bids are aligned with the approved cost estimate. PMWeb online bid module will be used to capture the details of those bids and for which they will become readily available for financial and technical assessment.

Capturing Changes of Subcontract and Purchase Orders Contracts

The bank must keep track of all potential change orders and changes orders that are related to all awarded subcontract agreements and purchase orders. This will require using two of the PMWeb modules, possible change orders, and change order modules. The potential change order module will be used to capture the change order phase before it gets formally approved by the contractor. When approved, a formal change order will be issued to the subcontractor or supplier using the PMWeb change order module.

Capturing Actual Cost

For each subcontract agreement and purchase order, progress invoices must be submitted to be reviewed and approved before payment. The PMWeb commitment progress invoice module will be used to capture those invoices. Suppose the progress invoice due for a period is linked to a project schedule activity percent (%) complete value. This activity can be connected to the invoice line item to get this value from the updated project schedule. Actual cost also includes the actual payments made against the letter of credit issued by the bank for suppliers on behalf of the contractor.

In addition, for invoices not related to subcontracting agreements or purchase orders, the PMWeb miscellaneous invoices module will capture those details to be reviewed and approved before payment. For site overhead, the PMWeb timesheet module can be used to capture the details of the construction management resources and plants assigned to the project.

All those PMWeb records related to change orders and actual cost invoices could have a pre-determined workflow to ensure the proper review and approval before they are paid. The workflow could have conditions that could escalate the payment request if it exceeds a certain amount.

About the Authorfounder

Bassam Samman, PMP, PSP, EVP, GPM, is a Senior Project Management Consultant with over 35-year service record providing project management and controls services to over 100 projects with a total value of over US $5 Billion. Those projects included Commercial, Residential, Education, and Healthcare Buildings and Infrastructure, Entertainment and Shopping Malls, Oil and Gas Plants and Refineries, and Telecommunication and Information Technology projects. He is thoroughly experienced in project management, including project management control systems, computerized project control software, claims analysis/prevention, risk analysis/management (contingency planning), design, supervision, training, and business development.

Bassam is a frequent speaker on Project Management, Strategic Project Management, and Project Management Personal Skills. Over the past 35 years, he has lectured at more than 350 events and courses at different locations in the Middle East, North Africa, Europe, and South America. He has written over 250 project management and information systems articles featured in international and regional magazines and newspapers. He is a co-founder of the Project Management Institute- Arabian Gulf Chapter (PMI-AGC) and has served on its board of directors for more than six years. He is a certified Project Management Professional (PMP) from the Project Management Institute (PMI), a certified Planning and Scheduling Professional (PSP), an Earned Value Professional (EVP) from the American Association of Cost Engineers (AACE), and a Green Project Management (GPM).

Bassam holds a Master’s in Engineering Administration (Construction Management) with Faculty Commendation, From George Washington University, Washington, DC, USA, Bachelor in Civil Engineering – from Kuwait University, Kuwait, and has attended many executive management programs at Harvard Business School, Boston, USA, and London Business School, London, UK.


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