Forward Flow in a moving market
01 November 2023
What is a "Forward Flow"?
"Forward Flow" is a term of art, often used rather loosely, occasionally resulting in some confusion. At one end of the spectrum, counterparties referring to a forward flow may simply be referencing an origination arrangement, and at the other, a heavily structured purchase arrangement with material corporate recourse. However, in its true form, a forward flow arrangement involves the ongoing sale of financial assets by an originator to a purchaser. Typically it is beneficial interest that is sold to the purchaser, with legal title remaining with the originator (and the originator or an affiliate company continuing to perform a servicing function).
At the heart of any forward flow are reciprocal obligations in respect of the sale and purchase – be that structured as a purchase volume commitment (provided assets meet set criteria) on the part of the purchaser or minimum allocation commitment on the part of the originator. In return, collections in respect of the sold receivables are paid over to the purchaser via a documented sweep mechanic. Agreeing the parameters of the eligible assets, the mechanics around the cashflows, the corporate interplay and bespoke economic arrangements are some elements that materially differentiate one forward flow to another.
Wet or Dry?
At the point a forward flow arrangement is put in place, there may be a back book of receivables that are sold by the originator to the purchaser. On a go forward basis, the arrangements may provide for purchase on either a wet or dry basis.
Dry funding is the purchase, on sale, of receivables that have already been originated. Wet funding on the other hand is the provision of funding for the origination of receivables which are then originated before being automatically sold.
Wet funding can be helpful for an originator as it minimises the liquidity constraints it may face and adds certainty to its origination processes. For example, the cash flows of real estate backed originators require funds to be advanced to solicitors for completion of a loan before it is actually completed. This can create a capital drag on the originator and may restrict origination.
The structuring of the wet funding element of a forward flow can itself take a number of forms and particular consideration needs to be given to disbursement, repayment, cost of capital and any security.
Considerations
Ashurst works across asset classes and funding structures and we are often asked to walk through why a forward flow may be a useful solution for an originator, or indeed a purchaser, to have in their "armoury". Here we set out a few of those considerations.
Originator considerations
| Diversification | Capital light | Build relationships |
| It is often advantageous for an originator to have a diverse funding structure – the same providing optionality for different assets or sub pools of assets with different features, and greater certainty of funding. A forward flow arrangement may well be a funding structure sitting alongside warehouses and corporate loans. |
A forward flow arrangement can facilitate market growth and recognition for an originator without significant capital investment. A lack of liquidity could operationally hamstring an originator, despite the market offering being competitive and effective. The forward flow model also offers a young originator the opportunity to prove its underwriting capability, provisioning and servicing, despite a lack of balance sheet, reducing the need for dilutive equity raises whilst at the same time building data points for a future debt raise. |
Liquidity is the lifeblood of an originator and the funding relationship is an important and potentially longstanding partnership. The forward flow relationship allows a purchaser to gain an in-depth knowledge of an originator's operations, (and indeed asset class) potentially opening up the possibility of a more diverse range of funding options in the future. |
Purchaser considerations
| Try before you buy | Origination Platform | Yields |
| Challenger banks, boutique banks and alternative lenders, in particular, all have a growing interest in a diverse set of origination platforms. For some, originators with proven track records and strong management is enough. For others, the longer term plan will be to have proprietary platforms, either grown organically from their existing offerings or by taking equity stakes in originators and streamlining back-office functions to leverage synergies and knowledge. Forward flow gives purchasers a granular level of reporting resulting in an informed opinion of the asset class. | Deployment of liquidity has become a pressing need for many purchasers, and indeed with an increase in credit fund participants in the market, a main priority. Partnering with an originator via a forward flow agreement means a purchaser can leverage the benefit of the originators origination and underwriting, bypassing the need for a specialist in-house function, whilst at the same time putting their liquidity to work. The purchaser's own funding lines are however an important consideration here. The adoption of "back leverage" requires securitisation analysis (both on the part of the purchaser, and the originator). |
Bringing the assets onto the purchaser's balance sheet is a different risk proposition to funding an originator via a corporate loan or warehouse. Due to the on balance sheet nature of forward flow arrangements (and therefore a greater asset-risk sitting with purchasers), purchasers will often find that the yields available to them through a forward flow agreement will be greater than if they financed the relevant company through a more conventional arrangement. This in turn can be boosted by the injection of senior funding at the purchaser level. |
Recent developments
Rising interest rates
As interest rates have continued to steadily rise, many originators have found that their margins are squeezed. Many products within the space are offered by originators to underlying borrowers with fixed rates of interest. A relatively expensive conventional speciality finance lend from a funder may be unattractive proposition, particularly where the underlying product has fixed rates, and costs are not easily passed on. A forward flow agreement may remove such risks, facilitating continued origination, and preventing equity dilution (which may arise if such originators were to resort to equity financings in the alternative). That said, purchasers (specifically those with floating rate senior funding lines) may find their own margins come under pressure for the same reason. Purchase price adjustment based on a cost of funds formulation has sought to alleviate some of the issues in this area, seeking to maintain an ability to purchase without having to honour a purchasing obligation that in real terms is economically unpalatable.
Market and regulatory uncertainty/risk allocation
Whether driven by the source of funding available to the purchaser, or the nature of the purchasing entity, we have seen particular focus in recent months on the regulatory and market environment in which it operates. Should the regulatory landscape change, and/or the purchaser's regulatory or capital treatment be altered, should this impact the forward flow arrangement, and ultimately its obligation to purchase? The answer to this question will be one that needs to be keenly considered by both purchaser and originator.
Structured solutions
The ever increasing complexity and requirements for downside mitigation has driven a development in complex structured forward flow arrangements, involving financial collateral analysis and sometimes the deployment of orphan SPVs, normally a feature of warehouse structures. This in turn has meant an increased focus on the tax analysis and should be considered early on.
Points of particular negotiation
Recourse and repurchase
A point of negotiation between parties will centre around the extent to which the originator is to remain responsible for any issues that arise in respect of the receivables. Whether (and how), the beneficial and economic interest of receivables which have been transferred should be repurchased by the originator, and under what circumstances, is at its heart a question of where the risk is to sit.
Typically, the underwriting risk will sit with the originator and the performance risk with the purchaser, however:
- One area of focus for all parties will be scenarios which give rise to the purchased interest in a receivable being put back onto the originator. Often this will be in instances of fraud or misrepresentation in the origination or sale process, where the correct credit checks on the underlying borrower had not been completed, or the underlying documentation was deficient in some respect.
- Should any of the above scenarios occur, is any action open to the purchaser time limited, and if yes, when does that timing run from? The date of origination, transfer or discovery of the issue in question? The answer to these questions will impact the level of constant scrutiny the purchaser must be giving to the loans.
- Another area of focus will be the scenarios which trigger an end to the flow of assets (stop or cease purchase events). These events will often trigger before an obligation to push loans back would arise, and are akin to cease funding or drawstop events under a financing arrangement (and often triggered by a similar set of breaches as well as asset and arrangement specific triggers).
Origination and underwriting
A combination of (i) direct exposure to relevant asset pool risk, in contrast for example, to a conventional debt solution with downside protection via a funding advance rate, and (ii) the permutations of the repurchase mechanics discussed, mean that the diligence and execution of the underwriting process is key to both parties. As a result the underwriting process will be subject to a great deal of scrutiny both before a transaction is entered into, and on an ongoing basis. If the originator has a seed pool which will form part of the forward flow arrangement, examination of historic underwriting procedures and policies will be subject to the same level of scrutiny as those going forward. This is of particular application in the consumer space. In the same vein, an analysis of the standard form documentation on which the loans are written will also likely be undertaken, with parameters agreed around amendments to the same.
Reporting
Originators can expect purchasers in this kind of arrangement to insist of in-depth monthly reporting and have a greater ability to require access and insight to the originators’ origination and underwriting platforms than may be expected in a typical financing arrangement. The extent of which is often a keen point of negotiation, and may in part be driven by any senior funding being taken out by the purchaser.
Representations
As you would expect, the representations under a forward flow arrangement will be given particular focus, particularly those given in relation to the underlying loans. Forward flow purchasers may require a granular, in-depth and extensive set of representations, which in addition to, and as an extension of, the representations commonly found in speciality finance deals will have particular regard to the origination process (including any broker introductions), and the status, type and nature of the underlying borrowers.
Practicalities
A key factor for an originator when considering an arrangement of this nature will be the cost and speed of getting it in place.
Initial and ongoing costs may be lighter on a forward flow arrangement than with a typical loan or warehouse arrangement. There may also be fewer documents to draft and negotiate.
This does not necessarily however have a direct correlation on speed. Whilst such arrangements typically involve fewer parties and require fewer advisors than a warehouse, the speed of putting the arrangement in place will be a function of several factors, including the level of due diligence the purchaser needs to undertake.
Forward flow remains a core option of the structured finance market and Ashurst advises across asset classes and structuring necessities. We would love to discuss your requirements and a link to the Ashurst Speciality Finance Practice Brochure may be found below.
