Accurate and timely construction draw management is critical to mitigating risk for banks and lenders. Embracing the data available through new technologies will create a paradigm shift.

Construction draws are the disbursement of funds from a bank or a lender for a construction project. The timing of the draws is based on predetermined milestones and progress of the project. The oversight and operational management of construction draw disbursements have traditionally been, and continue to be, a manual and time-consuming process. It’s widely inconsistent in practice, fragmented across lending institutions, and wrought with errors and omissions that have do not have a risk-based reporting structure.

Lending operations generally suffer from outdated operational practices. Further, during turbulent markets, they have been identified by the Federal Reserve as significant underlying contributors to institutional financial failures. The gloomy forecast of housing in the foreseeable future will lead to financial and construction-related project issues, home sales capitulation, and expected fallout in the form of widespread foreclosures. The disruption is inevitable; market indicators clearly show we’re tracking toward a down cycle. However, some will challenge their existing operational practices, assess and redesign their infrastructure to align with available technologies, and ultimately be better prepared and insulated from the fallout their competitors will experience.

Lending Operations and Institutional Financial Failures

In January 2011, the Federal Reserve published a comprehensive investigation of the 2008 financial crisis and its underlying causes. The report is commonly referred to as the “Financial Crisis Inquiry Report.” Examining the role of housing and mortgage markets in the crisis, the report noted key findings and recommendations related to construction lending draw management and its impact on lending institutions.

Some of the report’s key findings related to construction lending include the following:

1. Inadequate oversight. The report found there was inadequate oversight of the construction lending industry in general, including draw management processes, leading to increased risk and potential fraud.
2. Lack of transparency. The report also found the traditional draw management process was often manual and lacked transparency, making it difficult for lenders to accurately assess the progress of construction projects and make informed decisions.

Historically, once a loan funds, there’s limited information available to a lender to track its portfolio of projects. Only borrower interest payments and site inspections are available as measurable reporting metrics. Combining this shallow reserve of information with the inefficient record keeping and standard internal operational practices, there is little known about projects struggling or failing until it’s too late to intervene and change their course.

If you ask any lender about their current practices or controls, all will likely promote the depth of their procedures and diligence. However most, if not all, would be hard-pressed to produce any meaningful information on active construction projects at the portfolio reporting level. Lending oversight tends to rely on problems. “Being in the dark” has become an established and acceptable belief pattern.

Construction project issues have the highest chance of resolution if corrected at their earliest state of failure. Put simply, to “de-risk” a construction portfolio at the highest levels, the lender must implement new systems to create proactive reporting and reduce reactionary processes.

For lenders today, the best option is to adopt and fully utilize one of the several construction risk management software platforms on the market. Companies like Built, Trustpoint.ai, Land Gorilla, and other entrants to the sector have delivered construction management software solutions for construction lenders that replace notepads and spreadsheets. They provide cloud-based solutions that allow lenders, contractors, and project owners to access and share critical information and documentation in real time, improving communication, collaboration, and providing a central place to store documentation. Additionally, cloud-based solutions provide robust security features. Encrypted data storage and secure authentication can protect sensitive information as well as the integrity and liability of companies.

What’s Next?

Loss mitigation. Strategic predictive analysis of key reporting construction metrics, when measured against averages and historical performances, can directionally identify high-risk indicators of seemingly “healthy” and performing projects.

One of the most significant advantages of running an active construction portfolio through predictive analysis is the possibility of recognizing potential liabilities and employing loss mitigation actions early, dimensioning variables of geography, loan amounts, and risk applied attributes. Construction draw management aligned with data sciences can provide a more accurate and comprehensive understanding of project progress and risks, leveraging the inspection process to specifically identify key metrics.

Applied algorithms continue to evolve and present new ways to analyze vast amounts of data (e.g., current and historical project budgets or maturity dates against production timelines). It is now possible to identify patterns and potential problem areas long before a problem becomes the problem! For example, if a project is consistently falling behind schedule, an algorithm measuring historical metrics of similar projects that failed may flag the current project as a potential risk, alerting operations and credit functions to perform a review on the borrower and the project.

Most lenders will not have any information on day-to-day activities once the loan has funded. During the time between the first disbursement and final disbursement, deep-rooted risk and liability gaps may be hidden, producing an unintended lack of transparency. If lenders, however, could take a comprehensive approach to address concerns based on dynamic reporting metrics, they could make better-informed decisions on extension approvals, disbursements, and other loans or contingent liabilities.

The key for predictive analysis becoming an everyday reality for lenders is collecting data at the project level, rolling it up to the portfolio level, and then repeating this across the industry for aggregation. The algorithms and artificial intelligence to do this are in reach; similar technologies are already in use in other industries. The underlying data required to run them accurately remains locked up in the black box of lenders’ processes, however.

Accuracy and reliability of draw disbursement. Another benefit of using predictive analysis in construction draw management is its ability to improve the accuracy and reliability of draw disbursement requests. Draw requests are typically based on the completion of specific milestones (e.g., the installation of certain systems or the completion of certain phases of the project). Predictive analysis algorithms can monitor the progress of these milestones in real time and provide a more accurate assessment of the project’s progress. What has traditionally been an opinion based on an outside party’s manual assessment can now be confirmed through technology assessments, reducing the risk of incorrect disbursements, delays, and human error.

In addition to improving the accuracy of draw requests, predictive analysis can help streamline the overall construction draw management process. By automating many of the manual processes (e.g., data entry and report generation), construction technologies have developed enough to significantly reduce the allocated management time and resources required. This can free up resources for other critical tasks, reduce redundant operational overhead costs, and ultimately refine its most critical and core functions for company sustainability.

One of the latest and most exciting technologies is the integration of blockchain technology, a decentralized ledger that provides a secure, transparent, and tamper-proof record of transactions. In construction draw management, transactions such as invoices, construction draw documentation, and vendor payments are typically recorded in different systems. Blockchain presents a future opportunity to provide a linear perspective with all historical information captured in one location from all parties. Essentially, it provides a secure and tamper-proof record of historical draw requests and disbursements, creating a transparent operating practice for all stakeholders while reducing the risk of fraudulent activity.

The widespread adoption of available construction technologies and future strategic predictive analysis-based metrics in construction risk management will disrupt the industry. The timing of its advancements and potential will force a seismic paradigm-shift, setting the stage to completely change the confines of construction lending ideology.

The combined alignment of process change, technology, and advanced use of data sciences will significantly improve the accuracy and efficiency of lending practices, providing an elevated awareness of portfolio risk tracking and a comprehensive understanding of project-based progress and risk variance. Lenders will be able to proactively recognize and implement risk mitigation actions before a project or loan reaches its failure point. The use of blockchain technology and cloud-based solutions can also help improve security and transparency, reducing fraud and providing all stakeholders with a higher level of dynamic portfolio reporting.

The construction lending industry is on the cusp of evolution as innovative technologies are developed to meet the changing volatilities of the marketplace. Adoption of these technologies combined with an informed predictive analysis approach can reduce risk and liability in construction draw management. Lending institutions will not only benefit from internal operational strengthening but also be able to provide better service and support to their clients, partners, and vendors. The biggest challenge and potential threat to surviving the downward housing market for lenders will be the inability or unwillingness to step out of their comfort zone and confront the flaws inherent in historical practices.

But if we embrace the strategic new approaches that are ready for the call to action, we can create a paradigm shift that disrupts and reshapes the future of construction lending.