The €2bn snowball effect

It would be easy to assume that LCM Partners group CEO Paul Burdell would be grateful for the rest as he pulls up a chair at the firm’s headquarters near London’s Victoria rail station and prepares to tell the story of how the firm has carved out a place in the market for its distinctive form of credit investing involving the likes of credit cards and auto loans.

After all, it’s been quite a year. The summer months were the busiest in the firm’s 17-year history as it racked up €450 million worth of transactions including: a £200 million deal involving a rescheduled loan portfolio from a large UK consumer finance issuer; a €90 million performing loan book acquired from BBVA in Italy; and the purchase of a loan book and operating business, Everyday Finance, in Ireland.

Following the deal spree, LCM wrapped up capital raising for its Credit Opportunities III strategy on just over €2.0 billion at the end of October, including €865.5 million for a commingled fund plus a number of managed accounts, including one for Arizona State Retirement System worth $350 million according to market sources.

Having set out with a target of €1.0 billion, which was subsequently raised to €1.5 billion, investor interest in the strategy ultimately amounted to around €2.7 billion of potential commitments according to the firm, with acceptance into the strategy restricted to those that were able to meet the stated deadline.

To return to the point made in the opening paragraph, any assumption about Burdell putting up his feet and reflecting on a job well done would appear to be wide of the mark. For one thing, he makes clear that investing the fund successfully is now the number one priority. Moreover, although he cannot comment on fundraising plans, it is clear that a new but complementary strategy has already taken shape in Burdell’s mind, of which more will no doubt be revealed in due course.

That’s the future. But this conversation begins in the past, with Burdell asked to reflect on how it all began for the firm…

PB: Back in the 1990s when we were trading distressed corporate bonds we could see there was a market in the US in distressed consumer debt, with some firms making 40 percent-plus net returns, and we thought there could be an application in the UK and rest of Europe. The credit card companies had never sold debt over here and we told them we were able to pay good money for it. But the likes of Barclays then asked us ‘Who will service the debt?’ and that was a seminal moment because we realised we could be the servicers and transition from being just credit investors to operators as well.

We hired people from the banks to staff our back office and went live in 1999. Known as Link Financial, we were located above Chutney Mary’s curry house with 20 people in total and a desire to prove the concept. The lifeblood of any business like ours is capital but we realised we needed to build a track record of buying and rescheduling debt and making money.

One thing we were cognisant of was that in the US firms called their debtors ‘customers’ and no-one had been doing that in Europe. We saw that as vitally important in terms of attracting and retaining employees and clients – we wanted to be fair and equitable and not take advantage of anyone. That way, people will want to work with you.

What was the next milestone in the company’s development, and how did the core team come together?

PB: We proved the concept from 1999 to 2000 and then we raised private equity capital with 3i and Prudential becoming shareholders this allowed us to grow the UK portfolio, invest in our IT system and develop our operational know how.

The core LCM leadership team has been together for over 12yrs. I founded the business with my wife Selina Burdell who is LCM and Group COO, Adrian Cloake is CIO and joined the business in 2001 having met him when he worked at Arthur Anderson whom was helping us raise our initial equity. We have two Managing Directors: Hitesh Shah, who joined a couple of years after Adrian from Andersen, and our most recent addition Fernando Yanez who used to cover us when he ran specialty finance and FIG M&A at JP Morgan in 2014. The great thing is we complement one another and together with the senior management at Link Financial Group we are a really formidable team.

And then the business eventually moved onto the next stage, with the private equity firms exiting?

PB: Until 2005, we had a good run with 3i and Prudential on board. We opened our first overseas office in Spain in 2004 and, in 2005, we bought what was a large portfolio by our standards for around €300 million from GE that also included a large servicing centre in Wales. The timing was right for 3i and Prudential to exit. They had been with us for around six years and made good returns.

Talk us through the ups and downs of the following period, up to and including the Crisis…

PB: In 2005 we brought in Morgan Stanley, Cheyne Capital and HBOS as shareholders. Our office launches continued, opening in Italy in 2006 and then Germany and Ireland between 2007 and 2008. At that time, we were still a proprietary trader, investing from our balance sheet. And that was fine until the global financial crisis came along and that’s when our ability to access further capital from our partners dried up.

Our assets were still performing and had not lost money – but we no longer had the fire power to continue purchasing portfolios in the greatest NPL bull market. We realised that we needed to do something different. That meant managing third-party capital. We had invested alongside a large European pension fund since 2005, as well as other institutional investors, so we were used to it and to the reporting that was needed.

We approached [investment services firm] Insight Investment to create a fund. In 2009 the danger of systemic failure was still a big talking point and we knew we had to hook up with someone big due to investors’ focus on the security of their money. We used a placement agent and raised our first fund in 2010 with a one-year investment period at a time of great opportunities and then the second fund, which was heavily oversubscribed, in 2012. Between the two funds, we raised €420 million.

But during this period, the idea occurred to create an independent business?

PB: Yes, we came to the view between funds one and two that in the longer term we could go out to market on our own. So, while fund two was being invested, we set up LCM Partners, with LCM as the fund manager and Link Financial as the servicing business. We effectively separated church from state and felt justified in doing that because even in 2013 we had 14 years of experience and a proven infrastructure.

And how did that process go?

PB: We launched LCM Partners in 2013, having spoken to our long-time European pension fund client and said we wanted to set up our own thing and that we didn’t need a big asset management partner anymore because the market had settled down. They came in as a cornerstone investor with an initial €350 million and then subsequently another €150 million. They didn’t ask for an equity stake, all they wanted was a re-up option if we did well. And they were amazingly good to us and we are very grateful; when potential LPs wanted to speak to our cornerstone investor, they took every single call and we’ll never forget it.

We hired Park Hill Group and Citi as placement agents for the fundraise. Citi acted as placement agent to the funds we raised with Insight and we used them again to repeat that success in the Nordics. Park Hill covered the rest of the world, which included the US, Asia and selected European markets. We started the fundraising in earnest in September 2015 and ended up raising over €2.0 billion. LPs conducted thorough due diligence before deciding to invest. We had clients, their advisers and investment consultants kicking all of the tyres more than once, but like all processes, the first time is always the hardest and it gets easier the more times you do it.

How would you describe LCM’s market position and how do you think investors see you? Are there any misunderstandings?

PB: Some LPs told us ‘we already have distressed fund managers in our portfolios’, which meant to us that that they had a relationship with the likes of Cerberus, Apollo or Fortress. But the key difference between us and them is that on the NPL side we typically target smaller deals, worth between €5-75 million, which include individual loans that are €1,000-50,000 in size. We could best be described as concentrating on the retail/consumer/SME sector. This section of the market tends to have a greater servicing need and comes with operational complexity. However, the nice thing about these portfolios is that they have low market correlation (due to the granularity) and they right amount of alpha that our investors require.

How do you view the competitive environment, and how do you create a competitive advantage?

PB: There’s fierce competition everywhere. On the non-performing side, we mostly compete with balance sheet buyers. But many of them are equity-constrained, they have to take a big dilution to raise equity and they’re highly levered whereas we’re debt free.

On the performing side, we have a great origination business in Link Financial which is now independent of LCM. It was a founding fintech servicer and has created lots of innovative business lines, such as a used car loan business from scratch. It has great insights and a fantastic understanding of our customers.

We have a suite of products and we can say to a bank that we can both buy and service. We’re not a hedge fund, we want to partner with the banks. We need to show that we are competent and the best counterparty so that we can get recurring transactions.

And what about regulation? Is that a challenge or something that works to your advantage?

PB: The regulators and central banks make sure that anyone who originates credit is a responsible firm. You mustn’t do anything stupid. The sellers are very worried about being fined, so they have to ensure that whoever they are selling to is a safe pair of hands. The lawyers come in regularly to audit us, and we are fine with that. But this level of regulatory scrutiny reduces the competition because some firms are not well equipped to deal with it and the banks will remove them from their pool of possible buyers. In recent times the watchwords in regulation have come to be “treating customers fairly” but that’s exactly what we’ve been doing since day one.

There is a lot of talk about bank/fund partnerships and collaboration these days. Does that chime with your own experience?

PB: Yes, In Europe, what we do is all about providing a service to the banks. We can buy the non-core assets that they need to dispose of. When we went into Spain, we made the banks more efficient because we enabled their business to be realigned and they could reduce their headcount.

We went from the UK to Spain because clients wanted us to make that move; and then we went from Spain to Italy for the same reason. We had a process that worked, and then it became word of mouth and created a snowball effect.

LCM Partners: Quick facts
Founded: 1999
Targets: Mid-market deals worth €5-75m
Target sectors include: credit cards, mortgages, personal and commercial loans, retail credit, auto loans, leasing and asset finance, utility bills, consumer public sector (including student loans)
Performance: 14.9% gross, unleveraged IRR since inception in 1999
Assets under management: €13.5bn loan receivables across over 2,000 portfolios
Source: LCM Partners website