Guest blog by Sajan Shah, Director PwC
Forward flow arrangements offer a route to increase profitability without further strain on balance sheets, making them a tempting option for building societies looking to originate more loans. Not just an alternative funding source, these arrangements are also an opportunity to diversify the nature of their lending and make more of their existing origination and servicing infrastructure.
At PwC, our work for building societies, banks and non-bank lenders increasingly involves forward flow arrangements. Under these arrangements, an investor provides funding to a lender, for the origination of loans on the investor’s behalf. The lender receives fees from the investor for the origination and ongoing management of these loans.
Funding, financials and long term partnerships
Forward funding offers access to alternative sources of finance above and beyond your deposit base. These arrangements allow long term partnerships with investors who lack the origination capabilities but want exposure to certain types of lending. These investors sit across different pots of capital, including institutional investors (insurers, pension funds and asset managers), private credit funds and others.
Building societies gain an immediate income statement benefit from origination and servicing fees under the arrangement. By boosting lending volumes in this way, you can get more value from your existing service infrastructure.
Money lent under these arrangements doesn’t sit on your balance sheet as the investor bears the ultimate credit risk. This can help to ease potential capital strains from holding certain types of risk-weighted assets on your books.
Diversifying your customer base
These revenue and capital-efficiency benefits come together in the opportunity to diversify lending outside of existing criteria, be it on current or new asset classes, while still retaining the customer relationship.
A key advantage is being able to offer products that are targeted at particular customer segments, but you may not wish to hold on your own balance sheet. For example, this may be for lending a slightly higher loan-to-value product in an asset class that you are already lending in the market.
Exploring the deal economics
So how could these arrangements be structured for a building society and how would the deal economics work?
As an example, the building society enters into a forward flow arrangement with the investor to originate £100 million of residential mortgages a year for an initial three-year term.
The beneficial or economic interest in the loans would transfer over to the investor on origination, based on criteria that have been pre-agreed between both parties. These criteria can be revised upon mutual agreement during the period of the forward flow arrangement. The investor pays the building society origination and servicing fees. Legal title (i.e. lender of record) and servicing would remain with the building society so that it retains the customer relationship. This arrangement could generate £1-2m additional profit per annum.
Realising the potential
So, forward flow arrangements could be an attractive proposition for a building society. This is an opportunity to boost incomes, expand market share, enter new products or asset classes and develop a mutually beneficial long-term relationship with well-financed investors.
As bespoke agreements, putting them into practice requires care and due diligence, which is why we’ve been working closely with a number of clients to help them get this right. By bringing in experienced advice on both sides, building societies and investors are able to find the right approach for them. And expert advice can also help navigate the increasing levels of regulatory focus and review - which need the same close management that would be applied to your own balance sheet. But on balance, the benefits and advantages these arrangements offer should certainly make them worth your consideration. And if you need advice on how to start, then please get in touch.
About the author: Sajan Shah is a Director in PwC’s Financial Services Lead Advisory team, who has over 10 years’ experience of advising on deals in the financial services sector. He specialises in advising on transactions in the banking and building society sector, with a particular focus on transactions involving credit risk including loan portfolios and forward flow agreements.
The views, opinions and positions expressed within guest blogs are those of the authors and do not necessarily represent those of the BSA.