Forward flow agreement example: What is it and how does it work?
Forward flow agreements, also known as forward purchase agreements, are contracts that allow investors to purchase a set of financial assets from a seller within a specific timeframe. This type of agreement is often used in the financial industry, particularly in the securitization market, where assets such as mortgages, auto loans, and credit card receivables are bundled and sold to investors.
In a forward flow agreement, the seller agrees to sell a predetermined amount of assets at a predetermined price to the buyer. The buyer, on the other hand, agrees to purchase the assets at the agreed price within a specified timeframe. Usually, the assets are sold on an ongoing basis, meaning that the seller will provide a certain amount of assets each month or quarter, and the buyer will purchase them as they become available.
Let`s take a real-world example to better understand how forward flow agreements work. Suppose that ABC Bank originates 1,000 auto loans each month, totaling $10 million in value. Instead of keeping these loans on its books, ABC Bank decides to sell them to a buyer, XYZ Investments, through a forward flow agreement. The agreement states that XYZ Investments will purchase all 1,000 auto loans each month at a set price for a period of one year.
By entering into this agreement, ABC Bank can offload its auto loan portfolio and free up capital, which it can then use to make more loans. Meanwhile, XYZ Investments gains access to a steady stream of auto loans, which it can use to create securitized products and sell to other investors.
Forward flow agreements are beneficial to both parties in that they provide a predictable and reliable source of income. For the seller, they reduce the risk of holding onto assets that could become illiquid or lose value over time. For the buyer, they provide access to a constant flow of high-quality assets that can be used to create investment products with attractive yields.
In summary, forward flow agreements are a useful tool for financial institutions looking to monetize their assets and for investors seeking to acquire a steady stream of income-generating assets. By providing a clear and mutually beneficial framework for buying and selling financial assets, these agreements can help to mitigate risk and generate value for both parties.