Only a couple of months ago, many loans bankers could not stand forward start facilities. They were seen as a cushy instrument that allowed borrowers to achieve sub-market pricing while still maintaining long-term maturities. Many also felt that they prevented companies from deleveraging and cleaning up their balance sheets quickly enough.
But those feelings seem to have subsided. Forward starts are now viewed positively by much of the loan market. As one banker recently said: “We have moved from absolutely hating them to finding them useful, as they provide liquidity and are keeping syndicate desks busy.”
A big reason for the initial scepticism towards forward starts was their novelty. They had a precedent in the form of the “commitment to commit”. But these were never used to the extent that forward starts have been. As such, forward starts came in all shapes and sizes, with banks making up the rules as they went along. Some were signed years ahead of their maturity dates (AP Moller Maersk extended debt not due until 2012), some were seen as underpriced (Telefónica’s Eu4bn deal), and some would only pay up when the forward start kicked in, rather than when it was signed (as was the case with ArcelorMittal’s $3.25bn facility).
The confusion and lack of standardisation left banks wary. But the market has now more or less developed a consensus. Borrowers are typically signing their deals between 18 months and two years before they mature. Most also extend their debt for no more than two years.
More importantly, companies are increasing their margins to acceptable levels and realise there is little chance of obtaining a forward start if they do not pay higher pricing immediately in the form of loyalty fees (which act like a margin, being paid quarterly until the forward start is drawn).
There is also more clarity about capital allocations. When forward starts first emerged, many bankers were unsure that double counting (setting aside capital for future commitments) could be avoided. But, although the issue depends on the stance of each lender’s regulator, most banks are now confident that they do not have to set aside fresh capital. As Allen & Overy, which has worked on many forward starts, recently stated: “So long as the commitment of a bank under the forward start is no larger than its commitment under the existing facility, there ought to be no need to allocate capital [to both the existing facility and the forward start].”
Banks may have to set aside more capital due to the increased maturity resulting from a forward start. But this would also be the case if the borrower opted for a straight refinancing or extension.
Of course, there will still be some grumbles. For example, Glencore, which is syndicating a $5bn forward start, has upset some bankers as its loyalty fee does not make up the full difference between its current and future margins. And some bankers still think it is wrong for pricing to be fixed for years to come.
But most of these criticisms are far less prevalent than they were earlier in the year. Bankers recognise how forward starts helped to revive a market that was on its knees at the end of last year. No one believes forward starts are perfect. But the market had to adapt somehow and forward starts were the answer.
The creation and subsequent approval of the forward start shows the loan market is serious about its survival and its challenge to remain relevant to its customers — the world’s most important corporate borrowers.
For other Tuesday View stories please click on the links below
Goldman and institutional investors — is this really the end of the beginning?