Funding with
Forward Start Facilities
Ensuring continued financing is top of
the agenda for most companies. Forward start facilities are one of the ways
treasurers can decrease refinancing risk and increase the availability of
funds.
The
main purpose of a firm’s financial policy is to support the execution
of its strategic goals. The goals that are derived from this are:
· To secure the availability of
funds to prevent the firm from having liquidity problems and to enable
execution of the strategic goals.
· To maintain a certain
flexibility to be able to react to unexpected circumstances, to facilitate
changes in the firm’s strategy, and to seize new opportunities.
· To realise competitive financing
costs by maintaining competition between suppliers of finance and by
optimising the capital structure.
For
a long time, the emphasis in finance was on visible costs: margins and fees.
Due to the excessive supply of credit, the availability of finance was not an
issue for managers. Consequently, they were hardly inclined to pay additional
costs in order to increase the availability of funds. However, the world has
changed dramatically and credit has become a scarce, uncertain commodity.
Availability of Finance
As
part of financial policy, the following measures could be taken to ensure the
continued availability of financing:
· Maintaining a sufficient amount
of buffer capital: investments and acquisitions initially have to be financed
with more equity or mezzanine capital. In case of disappointing developments,
measures have to be taken immediately to restore the balance sheet (i.e.
intervene in the operations and/or cut dividends).
· Timely refinancing: existing
finance should be refinanced at least one year before maturity.
· Adjusting finance for future
financing needs: which part of future needs can already be secured with
committed facilities.
· Sufficient headroom in covenants
that also make sense: covenants must not be broken because of incidental or
external factors (i.e. currency effects), but only because of structural
problems within the business.
· Diversification of financing
sources: consider asset (backed) finance or access to the capital markets.
· Maturity: focus predominantly on
long maturities and a balanced redemption schedule.
The
forward start facility (FSF) is an instrument that can help in the
realisation of some of the above-mentioned measures in times of uncertain
availability of financing: timely refinancing, taking future needs into
account and extending maturity.
What is a Forward Start Facility?
Financing
can be provided on an individual basis by banks (bilateral loans), or by a
consortium of banks (a club deal or a syndicated facility).
In
case of a bilateral loan, the company could request the bank to extend the
maturity. If the bank and the company can agree on the terms for this
extension, a simple amendment letter reflecting the extension and other
adjustments will suffice.
In
case of a syndicated facility, the company would need to make the same
request to the consortium of banks. Achieving the same result, will, however,
be more difficult to realise, as the group of banks has to agree on a
unanimous basis. The response from the banks may differ, resulting in a
difficult bargaining position for the company: some banks may agree to the
request, but in return for stricter credit terms; others may not agree at all
and it takes just one bank to frustrate the extension of maturity.
An
FSF offers a solution for this potential stalemate. With an FSF, part of the
consortium of banks will provide a separate facility with the sole purpose of
providing financing to repay the existing facility at maturity. The key
feature of an FSF is that it can only be drawn on maturity of the existing
facility and not earlier.
The
lenders that participate in an FSF will commit to an amount at least equal to
their present exposure/commitment under the existing facility. In return for
this commitment, the FSF lenders receive ‘top-up’ payments
consisting of fees (top-up fees, loyalty fees which are similar to commitment
fees - albeit that they are not called that because the availability of the
FSF facility only occurs in the future - as discussed below). The fee is
expressed as a percentage of their commitment, and is meant to bring the
margin in line with current pricing in the market.
FSFs
are not new. They are the equivalent of back-stop facilities used in bond
financing (i.e. facilities that kick in when the bonds become payable).
However, due to the abundance of liquidity the past few years, there was
little interest in committing in advance or obtaining commitment in advance
to refinancing facilities.
FSFs
in their current form (and purpose) are fairly new. So far FSFs have commonly
been used for unsecured loans to investment grade borrowers. The first Dutch
transaction took place mid-2009. Although the documentation for FSFs does not
deviate substantially from standard loan documentation, there is no standard
wording publicly available yet. However, there is broad agreement on the key
terms and these are discussed below.
Borrower and Lender Benefits
An
FSF is a useful tool to refinance/extend the existing facility in times when
the availability of financing is uncertain at best. Under an FSF, a borrower
can continue to do business with its willing bankers, while ignoring the
banks that are unable to commit against fair terms. In addition to the
extension of the existing facility against market level conditions, a
borrower could also view the negotiation of an FSF as a selection process for
its relationship with the banks.
The
FSF lenders receive additional payments on the amounts of their commitments
(the top-up payments). This allows the FSF to bring the pricing on their
existing commitments in line with market pricing. If properly drafted, the
FSF does not lead to a double exposure for regulated lenders. There are no
extra solvency requirements.
It
also gives FSF lenders the opportunity to increase their share of lending to
the borrower (especially since FSFs are not really attractive to non-bank
lenders such as money market funds (MMFs), collateralised debt obligations
(CDOs) and collateralised loan obligations (CLOs). In addition, banks could
use the FSF to improve their relationship with the borrower in favour of the
lenders that do not participate.
The
FSF need not necessarily be for the full amount of the existing facility. The
borrower may not need to have the full amount refinanced/extended. This may
constitute a risk for the FSF lenders (some residual refinancing risk would
continue to exist), but the FSF can be drafted in a manner so as to allow it
to be increased over time. If not all existing lenders participate from the
outset, they would be allowed to join later (and that may be attractive,
given the top-up payments). The FSF could also be open to other new lenders.
Key Features
No double exposure
If
properly drafted, the FSF lenders should not have double exposure (i.e. for
both the FSF and the existing facility). As capital requirements may differ
per jurisdiction, this needs to be checked by each FSF lender individually
(to prevent additional capital/solvency costs).
Interest
The
FSF lenders receive top-up payments that effectively increase the interest
margin payable under the existing facility. These payments are usually called
top-up payments or loyalty fees. The idea is to bring the margin in line with
current market pricing.
Fees
As
FSF lenders extend their loans or provide new commitments, they will want to
receive an up-front fee (i.e. the regular up-front or participation fee paid
for new money). If the FSF facility is intended to be increased allowing
subsequently lenders to joint the FSF, the borrower may also agree to pay
‘early bird’ fees to the initial FSF lenders. If the FSF lenders
have unfunded commitments under the existing facility, they may also require
that the level of commitment fee for those commitments to be topped-up, in
line with the increased margin they receive through the top-up fees.
Availability
The
FSF is only available on the date the existing facility matures.
Purpose
The
sole purpose of the FSF is to refinance (a specific part or tranche of) the
existing facility (thereby effectively increasing the maturity of the
existing facility).
Cancellation
The
FSF will be reduced to the extent that the existing facility is prepaid or
cancelled. The borrower is should be permitted to voluntarily cancel the FSF
(e.g. if financing becomes cheaper towards the maturity of the existing
facility or if the borrower generates sufficient cash to repay the existing
facility without using the FSF).
Changes
The
FSF will usually include a clause that means that changes the terms of the
existing facility will also require changes in the FSF. This may not always
be achievable in practice, though (see no-conflict below).
The FSF as Part of Total Financing
Non-conflict with existing facility
The
FSF will (as an undrawn facility) coexist side by side with the existing
facility until the latter matures. The documentation of the FSF should be in
line with the documentation of the existing facility, or, at least, the
documentation of the FSF should not conflict with the existing facility. This
limits the possibility of FSF lenders to require additional or deviating
terms as compared to the existing facility (and therefore, the scope of
negotiations, which may be an additional benefit to borrowers).
Security
FSFs
have commonly been used only for unsecured loans to investment grade borrowers.
If the existing facility is secured, partial refinancing through an FSF can
be rather challenging if the FSF needs to share in the (existing) security.
It will probably require that intercreditor agreements and security documents
allow for changes without requiring unanimity. For this reason, FSFs are
difficult to implement to refinance leveraged or secured financings.
Leveraged financing
If
a FSF is applied in leveraged financing, additional complexity arises. The
FSF needs to be integrated in the existing framework (and may require that
the FSF is incorporated in the existing documentation). The leveraged
financing documentation will need to allow for structural amendments (such as
incorporating the FSF) without unanimous consent of the senior lenders - it
would require that the majority of lenders become FSF lender or have no
objection to the FSF being entered into. If the intercreditor arrangements
protect the junior (mezzanine) lenders against additional debt, the FSF can
only be incorporated if the junior lenders consent or the FSF fits within the
headroom for extra senior debt allowed under the intercreditor agreement
(normally 10% of existing debt and therefore not likely to be the case
without junior lenders consent).
Bonds
An
FSF for bonds poses some logistical difficulties because it requires separate
agreements with individual bondholders. Therefore, a bond FSF will most
likely be in the form of an exchange offer on terms equivalent to an FSF. If
this is done well in advance, it will reduce refinancing risks and give the
borrower (the issuer) the opportunity to negotiate better terms than just
prior to the maturity of the existing bonds.
Conclusion
With
the current uncertainty in the financial markets, the emphasis of the
financial policy has moved to the availability of financing in the long run,
instead of on pricing alone. Borrowers are now willing to pay in order to
secure the continued availability of financing in the longer term.
FSFs
can play a role in securing the continued availability of financing by
extending the maturity of the existing facility through a separate facility.
The most important benefit of the FSF is the fact that it enables borrowers
to do business with banks that are willing and able to provide financing. For
the FSF lenders, the most important benefit is that they can receive a margin
that is in line with current market pricing, without a double solvency
requirement.
FSFs
in their current form and purpose have mostly been used for investment grade
borrowers in unsecured facilities. Even though more complex, expectations are
that FSFs will be used in secured facilities and, possibly, even in leveraged
finance.
Article
by Rolf Michon has been a managing partner of Orchard Finance Consultants in
the Netherlands
since 2003. He is responsible for Strategic Finance Consultancy. After his
business administration education at Twente University,
he worked for Rabobank as a corporate banker. Before joining Orchard, Michon
was an independent consultant at Van Den Boom Group and NIBC.
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