Home Property Australia RBA warns of more insolvencies in the building sector

RBA warns of more insolvencies in the building sector

  • October 11, 2022
  • by Property Australia

The Reserve Bank of Australia (RBA) has cautioned that more insolvencies in the home building industry are inevitable as builders struggle with escalating prices.

Construction cost inflation and rising labour costs have eroded profit margins on existing fixed-price contracts, leading to a number of large residential construction firms entering insolvencies, the RBA said in its latest Financial Stability Review.

Overall, construction firm insolvencies have skyrocketed, surpassing pre-pandemic levels and accounting for about 30 per cent of all company insolvencies.

More recently, the increase in interest rates has begun to raise debt-servicing costs for many firms, adding to financial pressures, with the RBA saying that “further increases in insolvencies are likely”.

The RBA recently raised the cash rate by 25 basis points to 2.60 per cent.

“While the direct implications for the financial system are limited because banks have very small exposures to builders, there is potential for financial stress to spread to other businesses within the broader construction industry and to some households,” the report noted.

Builders often provide contracts to build homes at a set price with significant lead time, which the RBA said left many builders vulnerable to the substantial increase in material and labour prices since the beginning of 2021.

As a result, profit margins for current fixed-price contracts have shrunk significantly, and builders are already losing money on some contracts.

Construction delays for detached homes are presently approximately 12 weeks on average, according to industry contacts in the Bank’s liaison program – and much longer in some cases.

The RBA said builders have responded to these issues by boosting rates on new contracts, decreasing the period before accepting a quotation, and renegotiating some of their current contracts.

However, medium-sized and large builders are recording negative net operating cash flows.

“The likelihood of having persistently weak cash flows over the year has also increased, including for large builders whose size may have given them some advantages in managing the ongoing disruptions,” the report said.

“Over 25 per cent of the largest 200 builders recorded an operating loss in the year to March 2022, up from a little over 15 per cent a year prior.”

The RBA notes some builders are running down cash reserves in the face of operational losses, problematic while the latest available data from June 2022 shows builder’s liquidity buffers were typically equivalent to less than three months of turnover.