This article is sponsored by LCM Partners
How does LCM Partners approach special sits?
Our flagship credit opportunities fund is a fund for all seasons or all markets. Twenty-three years ago, we created a market for buying non-performing consumer and SME debt that didn’t really exist at the time. We were able to create this investable asset class by working to make banks more efficient. The driving force was helping banks to increase efficiency by managing their back book of non-performing loans that were taking up a huge amount of resources and not providing the returns they needed.
As that efficiency drive became more integrated into banks’ processes for managing impaired loans, it changed the whole way that they looked after non-performing customers. They were able to redeploy their people to revenue-generating parts of the business without increasing headcount. The reason our fund is for all seasons is because the assets we buy can be non-performing, performing or rescheduled loans; we can help banks solve challenges across their loan book whatever the weather.
On the non-performing side, most of the time it is common life events that create these situations. Consumers experience redundancies, death or divorce and find they cannot make repayments. That means 2-3 percent of all consumer and SME loans can be non-performing at any one time. Then when you add in macroeconomic events like covid or the global financial crisis, and some of the threats we are seeing today, that rate can easily go up to 8-10 percent of loans or higher.
What opportunities are you most excited about?
The breadth of credit opportunities we see today sit across secured and unsecured performing and non-performing loans. We access both those areas not only from a primary perspective but also via secondary purchases from other funds. It may seem odd that a contemporary would want to sell to us the tails of their funds, but because we are not seen as a competitor to the larger funds targeting mega-transactions, and we’re not planning to, it works out well.
In fact, we actually see the secondary market opportunity increasing. When sizeable transactions occur, those large funds are targeting big single ticket pieces of real estate, corporate exposures or hard assets like shipping, while we do the very granular secured or unsecured elements that most people find too complex and fiddly. We are happy to get our hands dirty, but in order to get returns you need dexterity, and you need to be hands-on. We have 1,100 employees, managing approximately €60 billion of assets.
Back in March 2020, everyone thought there was an NPL tsunami coming but in fact the central banks stepped in with huge support packages. Regulators created a synthetic market throughout the height of the pandemic by preventing the banks from enforcing positions, encouraging payment holidays and promoting emergency lending, but once the subsidies stopped, we started to see NPLs going back to where they would normally be.
Now I expect them to track up because consumers are going to be under a lot of pressure. What we are seeing today in terms of interest rates and inflation is setting us up for recession.
We tend to make more money in dislocated markets, and I think things are likely to get worse before they get better. The important thing is that our strategy provides a huge amount of optionality and provides our investors with the ability to invest in good times and also in bad. But, unlike other opportunistic credit strategies, we don’t need an event to occur to make money. We take what would be considered NPLs in any conditions, reschedule them and generate cash over time.
Why aren’t other investors doing these transactions?
The global financial crisis resulted in regulators handing out hundreds of billions of dollars in fines to banks for poor customer treatment and so banks are now hypersensitive about who they do business with. In many countries in Europe, banks are now probably more concerned about what the regulator will think than they are with the commercial aspects of a transaction – particularly in the UK.
Some of the large banks send auditors into our business every six months to do an operational audit and ensure our customer treatment, systems and borrower engagement processes meet the standards that they want. If we bought their portfolio and something went wrong, the regulator would come down hard on us but even harder on them. All of that creates significant barriers to entry for new players.
In our space, we are one of the top two or three purchasers by size in Europe today. We have done hundreds of loan acquisitions from some of the region’s biggest banks over the last 23-plus years, so we know each other well and the process becomes straightforward.
What is the current status of the European consumer and SME non-performing loan market?
The market has gone through a shift in terms of how the banks are overseen by the regulators and how they manage the non-performing loans on their balance sheets. It is now painful for them to hold on to rescheduled loans, so they are jettisoning them, and when you add in the extent of digitisation that has gone on during covid, the renewed focus on efficiency means the market is developing in a way that plays to our strengths.
The banks are really focused on increasing efficiencies, and they see us as a safe pair of hands to whom they can sell loans at various stages of impairment or even fully performing credits that just don’t fit their lending strategy anymore. We have been able to evolve with them as partners to create solutions.
Today, we have two strategies; Credit Opportunities (COPS), which buys performing and non-performing loans, and our asset-backed lending strategy – Strategic Origination and Lending Opportunities (SOLO). SOLO targets direct lending, particularly to SMEs, including asset finance and leasing, which has been an area where we have also seen a large amount of growth.
We encourage the banks we work with to retain every point of contact that they can with a customer, but often we can step in and white label a particular product line where capital charges are excessive. We can provide the infrastructure and the financing to support their origination, so that they can keep the customer.
The customer is happy and our LPs are happy, as we can provide something of a bridge between large-scale institutional capital and the banks. The European SME and consumer loan market is now worth €10 trillion and there are so many product areas to address and issues to solve within it. Because we have the scale in-house to manage large, granular books of loans throughout their lifecycle, we are able to help banks, finance companies, captives and OEMs by providing complete solutions, as well as giving our LPs the benefit of access to that part of the private credit market.