Financing Sources in the Maltese Construction Industry: An Analysis
The construction industry is considered to be one of the main drivers of the Maltese economy. The core industry employs a substantial amount of the labour force and contributes around 4% towards the local GDP. The wider construction industry contributes approximately 10% towards GDP (NSO,2016). The popular belief that the performance of the construction industry is indicative of the country’s economic well-being may have somewhat lost impetus over the years due to the growth of other economic sectors. But the argument remains relevant when considering that the current economic growth is paralleled by an economic boom in the construction industry.
This article draws upon research findings from semi-structured interviews conducted with six Chief Financial Officers representing large construction companies and five Chief Officers representing local banks, together with an analysis of the financial statements of the construction companies under review.
Sources of finance
Although financial management is usually associated with long-term financing decisions, a substantial part deals also with short-term financing sources. (Pike, R. and Neale, B. 2009). Short-term financing facilitates the consummation of business transactions that need to be effected in a timely manner (Business Finance Guide, 2016). There are several short-term financing methods available, including trade credit, factoring, bank overdrafts, short-term bank loans and revolving credit agreements.
An analysis of the financial statements covering the four years ended 2011 to 2014 revealed that trade credit (31%) was the most popular source of finance amongst the selected companies, underlying the importance of working capital as a source of finance for day to day operations. Finance from related parties (29%) was the second most widely used source of finance during the periods under review, meaning that a significant source of finance is tapped through a group-wide network. Overdrafts (20%) were the most popular form of bank financing. This is consistent with the respondents’ predisposition towards bank overdrafts as opposed to other sources of bank finance, particulary in relation to run of the mill operations.
During the four years under review the average debt ratio for the selected companies stood at 83%. This is a high ratio and goes to show the industry’s exposure to external finance. When analysing each of the four years separately, the debt ratio registered a decreased of 3% and thus remained relatively stable across the years.
An entity can decide to raise long-term funds internally through retained earnings or by channelling funds from companies that have a temporary cash surplus to those that are in deficit. On the other hand, external finance through the capital market directs finance from those individuals or organisations that have a cash surplus to those enterprises that have, or are expecting to have, a cash deficit. Long-term financing instruments include ordinary share capital, preference share capital, accumulated reserves, public share issues, bond issues, debenture issues, bank loans and leasing.
All respondents stated that project financing was the main reason why long-term financing was sought. Long-term financing was also required to replace or upgrade high value plant and equipment. The majority of respondents highlighted that such assets are quite expensive and hence need specific finance.
Respondents claimed that they turn to banks to provide the required finance for projects. As expected, the two main facilities used are overdrafts and short to medium-term loans. Bank officials confirmed that construction companies tend to favour overdrafts, although banks are becoming more stringent and are moving away from providing revolving facilities in order to mitigate credit risk.
Two construction companies had bonds issued publicly through a group-related finance company. One bond issuer emphasised financing through bonds was mainly sought to fund specific projects and not to fund run of the mill operations. Another two construction companies stated that they would not opt for share issues mainly to preserve their family run business. This is symptomatic of most family run businesses in Malta and is perhaps not limited to the construction industry.
The role of banks in the Maltese construction industry
All CFOs emphasised the pivotal role that bank finance plays for their organisation. Respondents considered banks to be a very reliable source of finance and that it is relatively easy to obtain. Contrastingly, bank officers did not share this perception. All bank officers were categorical about their prudent approach when dealing with construction companies, particularly due to the lessons learnt from the financial crisis.
The property market in Malta is going through a period of sustained growth that has led to higher demand for financing solutions provided by banks. Bank officials stated that credit institutions have to be more cautious in times when the economy is thriving. In their view, the banks’ cautious approach in the aftermath of the financial crisis was displayed with all industries and not just the construction industry.
One of the problems pointed out by respondents is related to a credit concentration risk to the construction sector especially in terms of the collateral available to banks. Although this is certainly not to be overlooked, the local scenario cannot be compared to that elsewhere in Europe due to the specifities of the local property market – the value of land in Malta hardly moves downwards due to its scarcity. Not to mention that increased regulatory pressures have obliged banks to set aside additional capital for credit concentation risk.
The problems highlighted by local bank officials are related to the modus operandi of construction companies. One glaring example was the fact that several construction companies do not file financial statements in time. The bank officials’ perception was that construction companies are not investing enough in terms of professional personnel. Bank officials also pointed out that companies, particularly in the construction industry, did not always present a well-thought, documented proposal to substantiate their application for credit. Bank officials have forcefully iterated that they “won’t be a bank for everyone, everywhere doing everything”.
The main source of finance for the selected construction companies is conventional bank finance. Bank overdrafts are predominantly used for mainstream operations whilst short and medium-term loans are used to finance specific projects. Notwithstanding the proliferation of bank finance in the selected companies, the use of bond issues has picked up especially for funding term-specific projects. The capital market may become a more viable and cheaper option over the medium term given the excess liquidity in the local scenario and the prolonged low interest rate environment.