Earlier this summer, Doha-based telecommunications firm Qtel announced its intention to take advantage of market conditions and downward pressure on pricing to reduce its borrowing costs. After signing a $2bn forward start loan in 2009, it decided the time was right to seek a more cost-efficient deal and approached banks to refinance it.
The FSF agreement must sit alongside – and be compatible with – the existing loan agreement
Isil Erol, Middle East Technical University
Qtel had used the forward start to raise and price a loan that would not actually be provided by banks for several months. It did this under the expectation that credit conditions would worsen. Forward loans were seen as lifeline just a year ago, but have since failed to live up to their potential.
|Qtel financial performance|
|Net profit (QR millions)|
Forward loans first came to prominence as the global financial crisis took hold. “2009 saw a real hit to the oil producers, primarily because of the oil price drop, not the bank crisis, with Saudi, Kuwait and UAE hit hardest,” says Patrick Clawson, deputy director for research at The Washington Institute for Near East Policy.
Forward start facilities provide lenders with the opportunity to retain or to gain new business
“With the exception of Jordan, the non-oil producers were not affected much by the downturn in the world economy nor the lending crisis.”
|Qtel revenue (QR millions)|
Amid the crisis, funding across the world dried up and companies with loans due to expire grew concerned. The profile of forward loans was raised considerably as firms feared interest rates could keep rising.
“The credit crunch has had a major impact on the availability of loan finance to many corporate borrowers,” says Isil Erol from the department of economics at Middle East Technical University in Turkey.
“Borrowers were concerned about not only the raising of additional loan funds, but also the replacement of existing loan funds on their maturity when they are not in a position to repay the facilities.”
|Qtel’s original forward loan|
|Banks which committed $200m:||Banks which committed smaller amounts:|
|Tokyo-Mitsubishi UFJ||International Bank of Qatar|
|Barclays Capital||JP Morgan Chase|
|BNP Paribas||Arab Bank|
|DBS Bank||Housing Bank for Trade and Finance|
|Royal Bank of Scotland||Doha Bank|
|Qatar National Bank|
Prior to the crisis the trend was for borrowers to look to refinance existing facilities at a date relatively close to the maturity date.
“New facilities would be agreed and become available when required to repay the existing facilities,” says Erol. “But due to the increased uncertainty about the availability of funds, some borrowers sought to reach agreement on replacement loan facilities several months – in some cases up to 24 months – before their existing facilities are due to expire. These replacement facilities are known as forward start facilities [FSFs].”
FSFs are appropriate when a credit-worthy corporate is looking to extend the maturity on existing bank debt. They give the borrower some certainty about the future availability of the loan financing. In exchange for the early extension of the loan, the lenders expect to receive higher fees and increased interest rates – or a combination of both.
“A forward start loan provides borrowers with an agreement to refinance in full or in part an existing loan, signed in advance of the existing facility maturing and available at maturity of the existing facility,” says Erol.
Globally, attention shifted to FSFs in 2009 for companies facing maturing loans as they enabled borrowers to extend the agreement when liquidity was tight.
As more companies looked to secure funding, worldwide FSFs reached $76.8bn in 2009. But companies arranging forward starts fell in the fourth quarter of 2009, with the final quarter accounting for just 14 per cent of the total for the year. This has been attributed to downward pressure on prices meaning FSFs are not necessarily the most cost-efficient option anymore.
|Syndicated lending in EMEA ($trillion)|
|Syndicated lending in EMEA ($trillion)||1.6||0.876||0.648|
|Emea=Europe, the Middle East and Africa. Source: Thompson Reuters|
When a forward loan is taken out various parties have agree. The deal has to be agreed between the borrower and some or all the lenders under the existing facility, in addition to the lenders on the new loan.
There are chances a forward loan may not be the route pursued. It depends on what the existing lenders agree on.
“The providers of the new loan facility will usually be some [but not all] of the existing lenders to the borrower, possibly also with one or more new lenders,” says Erol.
“If all of the existing lenders are willing to continue to provide finance to the borrower then an FSF agreement would not be required. A FSF agreement runs alongside the existing facility agreement and the new loan only becomes available when the existing facility matures.”
FSFs can be a useful solution to the liquidity constraints facing banks and companies. Companies can keep their lenders in place with the promise of upfront fees and higher margins. One of the major benefits is the certainty they provide to borrowers.
“The advantage of certainty for the availability to refinance its existing loan facilities may offset to some extent by the possibility that the agreed price of the new facility may be higher than the market norm at the time when the new facility is required,” says Erol.
“But many borrowers are taking the view that the benefit of certainty [of funding] may outweigh this risk.”
In the post credit-crisis world, certainty counts for a lot. The previous attitude of risk and excess has been quashed. Paying a little extra for this assurance is deemed worthwhile by most firms.
Lenders may also be in the position that, if they do not agree to the FSF, the borrower could sink into financial difficulties, causing problems for them later on.
On top of this, FSFs provide lenders with the opportunity to retain or to gain new business. A further advantage of the FSF agreement for both the borrower and lender is the opportunity to solidify their relationship and potentially ensure ancillary business.
But there are also downsides to FSFs. They can be more complicated agreements than most banks would care to deal with in the current economic climate. At a time when banks are struggling to maintain growth, complex lending is not something they look favourably on.
“FSF agreements introduce complexity into loan arrangements,” says Erol.
“The FSF agreement must sit alongside – and be compatible with – the existing loan agreement. The forward start agreement will usually be based on the existing facility agreement, although terms such as availability, purpose, conditions precedent, maturity and pricing will be particular to the new facility.”
There may also be issues if the existing facility is secured and the FSF is also to be secured. The timing of taking of new security in favour of the new group of lenders requires consideration and planning.
There are dangers to forward loans as Qtel found. Loan pricing fell after its first FSF was arranged, leading the company to embark on another refinancing.
The new loan deal to replace the forward start was undertaken in a way that proves more cost efficient for the company. It is split into a $1.25bn three-year tranche that pays a margin of 125 basis points over London interbank offered rate (Libor). The remaining $750m, a five-year tranche pays a margin of 155 basis points.
The $2bn forward start loan that was signed in 2009 had a margin of 250 basis points over Libor, well above the interest costs more recently achieved, and more than 10 times the pricing of a 2006 loan that the forward start replaced. The three-year, $2bn loan signed in November 2006 (which the forward loan replaced) paid 22.5 basis points over Libor.
The region’s economy is still unsteady. Although uncertainty remains, analysts are predicting a rebound this year, meaning it is possible forward loans could see another surge in popularity. The appeal of securing finance in advance of a loan reaching maturity remains, and, for particularly risk-averse companies, the allure of FSFs may still be tempting.
“Until credit becomes more freely available again, FSF agreements are likely to remain a feature of the loan market,” says Erol.
But if lenders are willing to refinance FSFs now at good prices – and with long-term deals – companies are likely to take this up. As long as prices continue to be pushed down and lenders are offering what firms see as more cost-effective deals, forward start loans may be forced to take a back seat.