Despite the overall rebound in output, construction remains affected by trailing effects of the past recession.
- Many insolvencies in 2015
- Still very long payment terms
- Solar sector-related segment under threat
The UK construction sector accounts for more than 6% of British GDP, and employed 2.1 million people in 2015. The industry suffered heavily after the 2008 credit crisis, but rebounded in 2013 and 2014. However, this recovery lost some steam in 2015, with construction output decreasing 2.2% in Q3 of 2015, and activity increasing again towards the end of the year. Skill shortages often lead to the postponement of construction projects.
Despite the overall rebound in output, construction is still affected by trailing effects of the past recession. This became evident in H1 of 2015, when construction insolvencies increased steeply. Some larger business failures had a knock-on effect causing their suppliers and subcontractors to go bust due to large sums of monies owed.
The on-going problems are particularly noticeable in the tendering process, as during the downturn, construction companies took on contracts at conditions that were no longer sustainable in 2014 and 2015, mainly due to raw material price increases and higher labour costs. As many construction businesses are still working on such low margin legacy contracts, losses on contracts are still relatively frequent despite improving forward order books. Late payments remained a major issue in the industry, especially from Tier 1 contractors, who have issues with legacy contracts themselves. Non-payment notifications showed an increasing trend in 2015, and are expected to remain high in 2016.
At the same time, access to bank finance remains difficult for many smaller businesses or businesses subject to unattractive terms. This lack of funding affects SMEs that may need to resume investment, particularly in capital expenditure to cope with a growing market.
Due to the upward trend in construction output since 2013/2014, builders are now able to be more selective in choosing which contracts to tender, and therefore have more influence on payment terms. However, this is somehow counteracted by increased labour and material costs, which have a negative effect on businesses’ margins. Construction insolvencies are expected to level off in 2016 after the increasing trend in 2015.
After increasing our risk appetite in 2014, we have turned to be more restrictive again in our underwriting stance since early 2015, when construction business failures started to increase again. We will maintain a cautious stance on the industry in the coming months, with risks considered on a case-by-case basis. The speed of deterioration seen with of some of the recently failed construction businesses highlights the need to receive the most updated management accounts from buyers. Regular provision of management accounts enables us to make a more informed decision on credit limit applications and ensures that decisions are as current as possible.
We are currently especially cautious with construction businesses highly dependent on the UK solar sector, which is threatened by a major downturn after the government decided to cut the Feed-In Tariff by more than 80%. Insolvencies have already increased in this segment since the end of 2015.