10-10-2014, 11:32 AM
CREDIT ANALYSIS POLICIES IN CONSTRUCTION
PROJECT FINANCE
CREDIT ANALYSIS.pdf (Size: 184.02 KB / Downloads: 94)
Abstract.
This paper aims to illustrate a revolutionary approach to bank financing of extensive
investment projects developed by major corporations. The new approach pertains to corporate
banking and is applied to corporate projects developed by special purpose vehicles. The
theoretical framework highlights general aspects of project finance and of construction
projects management in general, with special focus on residential constructions. The second
part adds to the theoretical structure the example of a project finance policy implemented by a
Romanian subsidiary of a foreign bank and places the emphasis on the credit analysis in case
of residential construction projects. The final objective of the paper is to bridge the corporate
banking field with project finance, regarded as a banking field of its own, in line with the
vision of the bank subject to this article.
Project evaluation
There are a number of problems in the construction industry caused by bad
management, and the situation seems to be getting worse. Projects are frequently late,
over budget and suffer from poor workmanship and materials. All of these problems
seem to arise mainly from a lack of control, poor planning and risk management, as
well as from overly optimistic or unfunded sales estimations upon project completion.
Consequences of improper planning abound: delayed commissioning, escalation in the
price of resources, excess consumption of resources (delays tend to increase the
consumption of resources, higher financial costs, reduced profitability, and damaged
company reputation).
Such problems could be avoided in case of recurrent projects of the same
Sponsor, if proper project assessment is performed and conclusions drawn. Evaluation
implies not only the mere comparison of actual values to projected values but the
causal identification of project weaknesses. An up-dated SWOT analysis can be
performed, in the light of better information; clients, consultants and other project
stakeholders should also have their contribution in project evaluation.
. Conclusions
Traditionally, lenders have faced credit risk in the form of default by
borrowers. To this date, credit risk remains a major concern for lenders worldwide.
The more they know about the creditworthiness of a potential borrower, the greater the
chance they can maximize profits, increase market share, minimize risk, and reduce
the financial provision that must be set up as buffer against bad debt.
Credit risk is the major challenge for risk managers and market regulators.
Banks, regulators and central banks do not agree on how to measure credit risk and,
more particularly, on how to compute the optimal capital that is necessary for
protecting the different partners that share this risk. Asking banks to keep too much
capital in reserve to cover credit risk can be a source of market distortion in risk
management behaviour (Duffie & Singleton, 2003).
Credit risk measurement has evolved dramatically over the last 20 years in
response to a number of secular forces that have made its measurement more
important than ever before. Among these forces one can count: (i) a worldwide
structural increase in the number of bankruptcies, (ii) a trend towards
disintermediation by the highest quality and largest borrowers, (iii) more competitive
margins on loans, (iv) a declining value of real assets (and thus collateral) in many
markets and (v) a dramatic growth of balance sheet instruments with inherent default
risk exposure, including credit risk derivatives (Altman & Saunders, 1998).
The business reality worldwide increased its complexity along with its
associated risks. As a natural reaction, banks changed the way in which they perceive
businesses and assess the credit worthiness of their borrowers. Credit analysis evolved
and segmentation tools were implemented in order to classify not only borrowers but
also the object of the loans in different risk categories. In this process of evolution, the
notion of project finance emerged and further tends to form a banking business of its
own, similarly to mortgage-based lending or leasing. Effective credit risk
measurement and mitigation stands at the heart of the newly emerged forms of
financing and the latest financial crisis striking the world economies proves that
modern financial intermediation is still far from the ideal standpoint in which risks can
be detected, assessed and mitigated down to a comfortable level for financial
intermediaries, business, governments and communities alike