Meaning
Collateral valuation adjustments reduce the borrowing value of a contractor’s unpaid project balances that are held back by a client. A retainage haircut accounts for the risk that these withheld funds might not be paid until the project is completed and inspected. This calculation establishes the discount applied to construction receivables before they can be used as loan collateral.
Applying too small a discount before the project is verified can lead to cash shortfalls for the lender.
Calculation Framework
Percentage discounts are applied to the portion of the invoice that has been withheld by the customer. Calculating the retainage haircut depends on the contractor’s track record and the remaining duration of the project. This discount ensures the lender remains protected.
Audit Process
Financial teams inspect active construction contracts to verify the withheld amounts. During these audits, the team checks the retainage haircut to ensure it matches the actual project stage. These checks prevent the overallocation of credit to risky projects.
Capital Security
High reserve margins protect the financial institution from losses if the contractor fails. If a retainage haircut is ignored, the outstanding loan may exceed the recoverable cash. Maintaining strict discount rates secures the credit line.
