A forward commitment is a pledge that a lender will honor a loan obligation in the future if certain conditions are met by the prospective borrower. The forward is typically a fully underwritten loan commitment with predetermined proceeds, term, interest rate, and loan documents. Forwards are a valuable instruments that extends the faith and credit of the lending institution to help borrowers manage financing risk and exposure to variable market conditions. As such, forwards include a premium cost by which the lender can purchase hedging instruments and justify the risk exposure they are required to assume by extending the pledge.
The lender’s obligation to fund the loan may be subject to a variety of negotiable conditions, such as leasing or property cash flow hurdles. The commitment may also be subject to a “Material Adverse Change” provision, by which the lender can refuse to fund in the event of a market dislocation. Refusing to fund under a MAC provision is detrimental to the reputation of the lender, and is not undertaken lightly. The borrower is typically required to pay a fee and post a substantial deposit, which deposit is forfeit if the borrower fails to perform or elects to decline the loan at the planned funding date.
Forward commitments are most frequently used for development projects to secure take-out debt upon project completion. Locking in a loan amount and an interest rate during the construction phase helps the developer reduce the considerable risk exposure involved in any development project.