PMIS 366: PMIS to Manage Construction Project Credit Risk

Credit risk is defined as the potential that a bank borrower will fail to make payments in accordance with agreed terms. The goal of credit risk management practice is to mitigate the 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 thorough knowledge of customers and their associated credit risk.

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

The key to reducing construction project loan losses is to implement an integrated, quantitative credit risk management solution. Implementing Project Management Information Systems (PMIS) like PMWeb will provide banks with an integrated solution to manage credit risk across their complete projects’ portfolio. PMWeb will be used to manage and capture the data from the different processes needed for credit risk management. In addition, PMWeb 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

Similar to any other loan requirement, banks should have a detailed risk register that will become the basis for assessing the project’s risk exposure. The register should include risks that relate to the borrower’s organizational capabilities, project’s technical risks, borrower’s project management practices, project owner, external risks among others. PMWeb risk analysis module will be used to create a repository of those risks so the credit risk team can assess the occurrence 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 very 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 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 correctness. 

Verifying the Project Schedule

The project’s integrated project schedule needs to be reviewed and analyzed by the bank in particular to ensure that schedule related risks are incorporated in the schedule. PMWeb custom form builder will be used to create a Schedule Review and Analysis checklist to ensure consistent and complete analysis of the project schedule.

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

Establishing the Project Budget

The approved project cost estimate will become the basis for establishing the project’s budget as well as 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 funded by equities to be provided by the borrower. 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

In most construction projects, the contractor will be required to submit the cost-loaded schedule that will also include the performance credit earning rules. This will become the basis for generating the cashflow that will detail how the contract’s value will be earned. The cashflow need to be adjusted for the contract’s terms and conditions which could include advance payment, advance payment recovery, retention and 30 or 60-days 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 would usually outsource part of their project’s scope of work to qualified subcontractors and suppliers that must be approved by the project owner. 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 were 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

It is very important that the bank keeps 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 PMWeb modules, potential 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 it is approved, a formal change order will be issued to the subcontractor or supplier using PMWeb change order module.

Capturing Actual Cost

For each subcontract agreements and purchase orders, there will be progress invoices that need to be submitted to be reviewed and approved before it is paid. PMWeb commitment progress invoice module will be used to capture those invoices. If the progress invoice due for a period is linked to a project schedule activity percent (%) complete value, then this activity can be linked to the invoice line item to get this value from the updated project schedule. Actual cost also includes the actual payments made against letter of credits issued by the bank for suppliers on behalf of the contractor.  

In addition, invoices that are not related to subcontract agreements or purchase orders, PMWeb miscellaneous invoices module will be used to capture those details to be reviewed and approved before it is paid. For site overhead, PMWeb timesheet module can be used to capture the details of the construction management resources as well as plants that are assigned to the project.

All those PMWeb records that relate 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 certain amount.

Capturing Project Schedule Status

At the end of each month, the contractor will update the project’s integrated schedule. PMWeb schedule module will be used to import this schedule to maintain a record for the baseline schedule, revised schedules and updated schedules. This will enable the bank to have immediate comparison between the schedule versions to identify if there are any variances.

In addition, all extension of time (EOT) requests need to be captured and reported on. PMWeb custom form builder will be used to capture the details and status of those requests and the impact they will have on the project’s completion date.

Capturing Details of Progress Invoices Made by The Contractor

At the end of each month, the contractor would submit the monthly progress invoice for the project owner to approve. This will be the project revenue for which the bank will use to repay the project’s loan. The percent complete for work in place could be either based on physical assessment of completed works or linked to the project schedule to import the percent complete from the related project schedule activity.

Single Version of the Truth of Project’s Financial Status

The cost data captured in budget, budget adjustments, commitments, change orders, progress invoices, revenue contract, change orders, requisition, payments made and payments received need to be consolidated in a single report to provide single version of the truth of the project’s financial status. PMWeb cost worksheet module will be used to define different spreadsheets to report on the different cost transactions captured by PMWeb modules and stored in PMWeb cost ledger.

Forecasting the Estimated Cost at Completion

The planned budget spending, earned value of actual progress achieved and actual cost incurred in earning this progress will provide the input to assess the estimate to complete the balance of the project’s scope of work. Adding the actual cost to this estimate will provide the estimate cost at completion which will identify if there will be a variance at completion when compared to the original budget at completion. PMWeb forecast module uses the earned value to provide those calculations so they can be reported on.

Maintaining the Project Issues Log

The bank’s authorized representative assigned to the project needs to maintain an updated register of all issues that could impact the project’s performance if they are not resolved within their due action date. Those could be issues that relate to the relation between the bank and contractor, contractor and subcontractors and suppliers among others. PMWeb custom form builder will be used to create the issue form so they can be tracked and resolved.

Capturing the Project Progress Narrative

It is important that for the bank’s authorized representative assigned to the project to provide his/her progress narrative of the current project status. The progress narrative form could include sections that are specific to evaluate the contractor’s quality, safety and project management practices. PMWeb custom form builder will be used to create this progress form for which the captured content will become part of the project’s monthly progress report or dashboard.

Maintain All Important Project Documents

It is very important that all contract documents and revisions to those documents, important project’s communications, supportive documents for the different credit risk management processes among others are properly stored and saved. PMWeb document management repository will be used to upload and store all project documents and records as well as attach those documents and records to the related credit risk management process.

Lessons Learned Repository

Since exposure to credit risk continues to be the leading source of problems in banks world-wide, banks should be able to draw useful lessons from past experiences. The bank’s authorized representative assigned to the project needs to capture and report on those lessons learned. PMWeb custom form builder will be used to create the lessons learned document template to enable sharing this knowledge among the bank’s credit risk management team.

Report, Monitor and Evaluate Project Performance

There should be a standard dashboard that will be use to report, monitor and evaluate each project’s performance. The dashboard will include the key performance indicators that will be extracted from the above credit risk management processes. PMWeb reporting tool will be used to design the dashboard in the form and format required by each bank.

Report, Monitor and Evaluate Projects Portfolio Performance

Having all financed projects on a single repository will enable the bank to have a real-time single version of the truth on the credit risk exposure for the complete projects’ portfolio. This dashboard can be filtered to display the information that is specific to certain contractor or project owner, projects that are in trouble among others. PMWeb reporting tool will be used to design the projects’ portfolio dashboard in the form and format required by each bank.