Australia’s construction industry will face further insolvency challenges over the near term, a leader in commercial credit reporting has warned.

During an interview with Sourceable last week, Patrick Coghlan, chief executive officer of credit reporting bureau CreditorWatch, warned that the building sector is likely to face heightened insolvency risk throughout the remainder of the year.

The comments follow the release of new CreditorWatch data showing that construction is currently the second-highest risk industry across Australia for insolvency (see below).

The comments also come amid the fallout from last month’s collapse of Victorian home building company Porter Davis.

Asked about whether the Porter Davis collapse was the ‘tip of the iceberg’, Coghlan says this was not likely to be the case.

Nevertheless, he added that the industry faces significant pressure.

“I wouldn’t say that this is the tip of the iceberg,” Coghlan said.

“(However,) there have certainly been a lot more construction insolvencies recently than during COVID. We are likely to see that continue for some time.

“There is plenty of pressure on the industry. There are still a lot of headwinds from a labour perspective, a materials perspective and of course these unprofitable fixed contract projects that are in place that have had to wash through. These (fixed price contracts) are either going to be renegotiated, they are going to be walked away from or you are going to see companies fall over as a result.”

“It’s (Porter Davis insolvency) certainly not the end (of construction insolvency stories). I think this is going to continue through to the end of the year.”

(source: CreditorWatch Business Risk Index 20230

Coghlan’s comments come as Victorian home builder Porter Davis collapsed last month.

At the time of its collapse, the firm had about 1,700 unfinished home building contracts.

It also owed more than $20 million to suppliers, $16 million to employees and $32 million to the Commonwealth Bank.

The subcontractors and suppliers are unlikely to see any of the money owed to them as they are unsecured creditors (employees are covered by the Fair Entitlements Guarantee Scheme).

Porter Davis is not the only firm to strike trouble.

Last week, the nation’s 22nd home building company Mahercorp was placed in administration and its home building operations were placed on hold for more than a month.

At a broader level, data from the latest edition of Creditor Watch’s Business Risk Index report released last week shows the construction sector has recorded a monthly rate of external administration appointments of 0.70 percent on a rolling annual basis over the past twelve months.

This makes construction the second highest risk sector for insolvency/external appointments after hospitality during that time.

Whilst construction insolvency rates remain below pre-pandemic levels, the data shows also that these are back on the rise and have increased in each month since January 2022.

According to Coghlan, several factors are driving insolvency risk in construction.

Right now, the sector is suffering from extreme pressures in terms of costs and delays.

Across the overall construction industry (civil/commercial/residential), Producer Price Index data from the Australian Bureau of Statistics indicates that costs surged by 20.2 percent over the two years from December 2020 until December 2022.

Particular impacted has been the detached house sector, which has recorded 30.3 percent cost escalation over that time.

Meanwhile, disruptions on account of weather as well as supply and labour availability have resulted in delayed project completion.

For builders who operate on fixed price contracts, these unanticipated cost increases and delays have pushed many projects into unprofitable territory.

All this is happening at a time when developers and builders are facing greater financing costs as a result of higher interest rates.

Beyond these immediate challenges, Coghlan says the industry has a high-risk profile overall as contractors operate on fixed price contracts with tight margins and significant potential for errors.

Further difficulties arise from other factors.

For suppliers and subcontractors, slow paying practices which are prevalent across the industry can create difficulties in cash-flow management and can result in the build-up of large amounts of receivables that can become difficult to recover in the event of developer or builder insolvency.

Finally, a marked slowdown in new home sales and demand has created profit and cash-flow challenges for developers in terms of closing sales on properties which they have built.

Add these all up and Coghlan says that many issues are driving insolvency risk.

For those firms who supply to the industry, he stresses the need to perform financial due diligence and suitable credit checks.

“I think it’s a combination of issues rather than just a single issue,” Coghlan said, asked about driving factors behind construction insolvencies.

“There is a segment of those who are falling over as a result of those fixed rate contracts (who have needed to absorb unanticipated cost increases and delays).

“Then there are the normal fixed-rate construction businesses that go under as it is a high-risk industry with low margins and high potential for errors. If you get your quoting wrong or there is a blowout, a shutdown or a lack of materials available, a project becomes unprofitable quite quickly.

“It is a traditional high-risk industry.

“I think it’s a challenging industry at the best of times. At the worst of times – at the bottom of the cycle which is what we are in now – it’s even tougher.

“I think anyone that is supplying to that industry needs to perform their due diligence both from a credit reporting point of view and a financial assessment perspective.”

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