Alternative lenders taking UK forward flow market by storm

Forward flow transactions continue to rise in popularity, with the private market serving as both a useful tool for existing participants in the structured finance market and a gateway into securitisation for a growing number of alternative lenders in the UK.

“Over the last few years, we’ve seen this funding product become more and more popular,” says Sarah Caldwell, partner at Reed Smith. “We have received a rapid increase in the amount of requests from both seller/servicer and investor clients to advise on forward flow transactions – and now not only is everyone talking about these types of transactions, but many market participants are finding them their preferred route for investing in asset classes they may not otherwise have exposure to and for sellers/servicers with established origination platforms earning revenue from originations they would not otherwise be able to fund.”

Forward flow transactions have been around for a long time. They fell out of favour for some time, with people opting instead for the likes of securitisation and receivables financing, but their popularity is once again on the rise. 

Despite the opacity of the market due to the private nature of transactions, forward flows are bilaterally negotiated – making for a speedy and efficient method of moving things off balance sheet versus the popularly used securitisation mechanism. Indeed, there is some correlation between the resurgence in forward flow activity and the securitisation market according to another partner at Reed Smith, Nathan Menon.

“We’ve advised on a number of forward flow transactions, and to some extent this stems from a period in time three to four years ago when the securitisation markets were a bit slower,” he explains.

In particular, forward flow transactions have proven to be a very popular choice for smaller, alternative lenders – a space that has seen several newcomers in recent years.

“The ticket size of forward flows hits the sweet spot for these alternative lenders,” Menon says. “Because of the bilateral nature of these deals, you’re not necessarily relying on the same force of will required to get a securitisation over the line from an arranger or joint lead manager.”

He continues: “These smaller specialty providers can use forward flows as a way of driving their transaction volume, either because they want to buy the assets and want greater exposure to them, or because they want to get rid of whatever they’ve got on their balance sheet. There’s a real commercial driver to all this.”

Interestingly, for many of these smaller niche lenders, forward flows serve as an effective gateway into securitisation issuance.

“Some of the newer players who don’t have enough volume may forward flow first, and then flip that into a securitisation later on,” says Caldwell. “We’ve worked on transactions where it’s a forward flow into potentially an SPV financed by an investor – like a warehouse, but on a forward flow basis – and once you’ve built up enough assets, you can then flip that into a securitisation.”

For others active in the forward flow market, these transactions are pursued alongside a securitisation strategy – often as a way to diversify their means of raising capital and liquidity. 

She adds: “There are lots of ways forward flows can be used, depending on the client – whether it’s a stand-alone deal or to later flip into a securitisation. We often see provisions baked into the servicing agreement, and sometimes even the mortgage sale agreement, that if there is a securitisation the originator will get some sort of upside or fee from the securitisation issuance – as they’ve obviously been helpful in originating and completing the initial forward flow.”

Indeed, for some clients, forward flows can be used as a controlled means of gaining exposure to a new asset class of risk. However, forward flows are not only an attractive choice from the sell-side, but the buy-side too.

“You have two parties with a need,” says Caldwell. “One’s got the money, and the other has the platform. We can bring them together to do forward flows, which can be completed fairly easily and quickly. You can match two people up in the market, which ends up with a great outcome for both parties.”

Forward flows can be done with an array of asset classes and in an array of jurisdictions. However, the UK market is reportedly at the forefront in terms of issuance volumes. As the hub of mortgage assets, it is hardly surprising that many forward flows are completed in the residential mortgage space. 

“Certainly, with recent clients, we’ll look at the asset class through the forward flow,” says Menon. “If we think it’s something we can grow into a new business or product line, then we’ll already have some exposure to the book and understand how the business operates. We’ll have seen a lot of the information that comes through via the reporting channels. They can look at that and make much more detailed commercial decisions off the back of that.”

He continues: “Mortgages have long terms, they’re relatively straightforward to model and they have a relatively manageable number of delinquencies compared to other asset classes. That provides a stable cash flow model that is well suited to securitisation. All the hallmarks that make it suitable for securitisation, also make it suitable for forward flows. So, participants familiar with RMBS or CMBS will be familiar with mortgage forward flows – and vice versa.”

The UK has seen a large uptick in the number of niche alternative lenders in the residential mortgage space of late. Some of these lenders have already been active in issuing securitisations and forward flow transactions. However, there remains significant plurality in the UK mortgage lender and originator space versus the rest of Europe – which has remained far narrower post-GFC.

It is not just residential mortgages being used in forward flows. Other popular assets seen in the forward flow world are also those that are prominent in the securitisation space, such as consumer receivables and loans. Yet, despite the connection to the securitisation market, the forward flow market is expected to remain private – mostly as a result of the bespoke nature of the deals. 

“The forward flow market is nascent and doesn’t yet have the same level of sophistication seen in the loan market with, for example, the Loan Market Association” says Menon. “As such, the documents are bespoke, so it would be tricky to develop more standardisation.”

New regulation
The lack of standardisation in the forward flow universe is unlikely to change anytime soon – nor is the market expected to be affected by the new securitisation regulation due to hit the UK later this year.

“Provided a forward flow has a single originator and it’s not tranched in any way, it shouldn’t trigger the securitisation regulation as it stands,” Menon explains. “In some ways that is a positive thing as it makes the analysis quicker, and limits the regulatory burden on the transaction as a whole.”

Of course, if greater divergence from EU regulation is to occur later down the line, this would however have some impact on the market going forward. Indeed, on the whole, parties typically choose to steer clear of falling under the securitisation regulations for forward flow transactions – although mindful structuring is often needed to avoid this.

Caldwell explains: “When you fall into the realms of securitisation regulation, you’ve got risk retention and reporting to consider – so you’re adding in a layer of additional compliance obligations that are costly, and the 5% risk retention will see someone having to put the cash in from an originator perspective.”

As the forward flow market continues to expand, many stress the importance of collaboration between the purchasers and sellers in transactions. Caldwell notes that time-frames for completion vary – she has seen some negotiated in just eight weeks while others have taken six months – but strong collaboration is important.

“It’s a bilateral negotiation – so the quicker you can get a deal done, the cheaper it will be for both parties,” she says. “I always advise my clients to get their heads of terms agreed before they start working on any documentation. Spending time getting heads of terms nailed down, even with lawyers, can be very helpful, as when it comes to negotiations there will be less back and forth. But it will mean having to do lots of turns and redrafts so it ends up being a lot more efficient.”

Menon adds: “Because you don’t have the joint lead manager, arranger type entity that’s really pushing the transaction forward, getting the commercials and the operations side nailed down early really helps smooth out the transaction negotiation timeline.”

Claudia Lewis