Liquidity is currently a rare commodity in the European debtmarkets, and a borrower’s ability to refinance existing debt facilities cannot be taken for granted. Lendersmay be unwilling (or, in some cases, unable) to provide liquidity to even themost robust borrower, and themarket has adjusted to that realitywith the development of a newproduct – the Forward Start Facility (“FSF”).
In today's debtmarket, the terms of any financingwill be bespoke to a borrower and those institutionswhich are to provide debt. The dislocation of credit markets hasmade participants nervous, and “market practice” no longer really applies to operational covenants, pricing or other similar provisions, although a degree of consistency is emerging in some respects. In this context, the terms of FSFs are not yet following a universally applicable pattern, but some interesting trends have developed. This briefing highlights some of those key trends, and addresses some of the pitfallswhich can arise froma borrower's standpoint when negotiating the terms of a FSF financing.
What is a FSF?
A FSF is a debt facility which is committed now, but is only capable of being drawn uponmaturity of a borrower’s existing facility (“Old Facility”). The FSF ismade available for the purpose of refinancing the Old Facility, and is typically entered into up to two years before the statedmaturity of the Old Facility.
The FSF will itself typically last for two years, and thus effectively removes future refinancing risk for the borrower (leaving aside lender default) as it is able to enjoy the balance of the termof the Old Facility (approximately two years) plus the termof the new FSF (approximately two further years).
Who is providing FSF liquidity?
Market dislocation has seen a number of lenders step back fromthe forefront of the loanmarkets. However, FSFs are provided on a “club” basis (ie, a group of banks provide the commitments together, rather than any one ormore lender taking underwriting risk) and themajority ofmainstream balance sheet lenders within the European loanmarkets are able to participate. FSFs are unattractive to secondary lenders (CDOs, CLOs, hedge funds and the like), but mainstreambalance sheet lending banks have generally shown an interest in the product.
Typically, a FSF will be provided by some or all of the lenders under a borrower’s Old Facility, and the nature and composition of that existing syndicate will be important in determining whether or not appetite is likely to exist for a FSF. On rare occasions, a new lender will commit to join an existing group of institutions to provide a FSF (perhaps plugging a funding gap arising due to the unwillingness of one ormore lenders under an Old Facility to provide FSF commitments), but this is unusual and raises an extra layer of complexity which this note does not address in any detail.
Who is borrowing under FSFs?
Corporate borrowers of various types have successfully executed FSFs in the past fewmonths. Those borrowers have ranged fromFTSE 100 companies (or the equivalent) through to privately owned concerns, although themarket is yet to see FSFs deployed in the context of highly leveraged credits or leveraged buy outs.
What are the key terms of a FSF?
The operational terms of a FSF are likely to be based on those of the Old Facility. However, note that lenders are far more focused on the operational terms of facilities than perhaps they were in 2005-2007, andmany are insisting that terms are tightened in banks’ favour as a pre-condition to executing FSF documents. Key areas for negotiation are likely to be:
- financial covenant definitions (to ensure compliance with IFRS and current accounting procedures)
- restriction on indebtedness
- restriction on acquisitions
- restrictions on disposals
The economic terms of a FSF will be set with reference to themarket, but also with reference to the creditworthiness of the borrower. As a result, it is not possible to opine with confidence as to the likely “cost” of a FSF since each financing is priced on a bespoke basis, but in order to incentivise lenders to enter into FSFs, those lenders who commit to provide the FSF will typically receive additional payments fromthe point in time that the FSF is executed. Whilst fee arrangements will be bespoke to any particular deal, a FSF lender may expect to receive:
- FSF arrangement fee: an upfront fee relating to the lender’s FSF commitment
- top-up commitment fees: payable in respect of that lender’s commitments under the Old Facility, and sized so that commitment fees will be effectively raised to the level agreed under the FSF
- top-up margin: payable in respect of drawings under the Old Facility, and sized so that themargin will be effectively raised to the level agreed under the FSF
- new money fee: payable in the event that an existing lender increases its commitment (ie, its commitment under the FSF is greater than that under the Old Facility), or if a new lender joins the FSF club. The newmoney fee will essentially be a commitment fee, and will thus be sized at the level agreed under the FSF (typically, 50%ofmargin)
In contrast, a lender under the Old Facility who declines to commit under the FSF will receive nothing by way of enhanced pricing, and will be obliged to continue to provide the Old Facility at existing pricing levels until termination of that facility. To the extent that an Old Facility was sourced in, for example, 2007, it is quite possible thatmargins will be 1/10th of currentmarket standards (40bps v 400bps, in each case over LIBOR) and therefore declining lenders will suffer significant downside given currentmarket norms.
Are there any barriers to entering into a FSF?
Capital adequacy rulesmean that each lender will take a different view as to the appropriate treatment for a FSF commitment, and we are aware that some institutions are unwilling to enter into FSFs due to “double-counting” concerns. However, since the FSF is incapable of being utilised prior to termination and repayment of the Old Facility, most lenders are prepared to accept that no double-counting exposure exists.
The existence and terms of the FSFmust not breach the terms of the Old Facility, and this will require verification on a deal by deal basis.
Additional (non-default) related implications under the Old Facility may need to be considered. For example, FSFrelated feesmay fall within the financial covenants of the Old Facility and therefore use some existing headroom.
If the FSF is intended only to partially refinance an Old Facility, issues are likely to arise which will need consents and waivers under the Old Facility and/or intercreditor arrangements between the existing and the FSF lenders.
By its nature, a FSF fixes the pricing of the new facility significantly in advance of its drawing. In current times, some lenders are querying whether this is sensible, particularly as it allows no flexibility to re-price risk if the market or the borrower deteriorates further.
Are FSFs here to stay?
FSFs were initially viewed bymany banks as too borrower friendly. The principal criticisms were that they allowed underpricing and discouraged borrowers from deleveraging sufficiently quickly. However, these concerns have abated as FSFs have developed tomeet the requirements of lenders as well as borrowers.
Whilst by nomeans a panacea for all ills within the European loanmarkets, FSFs have provided a degree of liquidity to good corporate credits and have gained significant traction in themarket over recentmonths.
The creation and development of the FSF demonstrates the willingness of the European debtmarkets to adapt to the challenge of the current liquidity crisis in order to continue to service corporate borrower customers.