New update from London Capital & Finance administrators – S&W lays bare the risk of bondholders not being repaid in full

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The administrators of London Capital & Finance, Smith & Williamson, released a further update to LCF investors on Thursday.

After a few initial gaffes which appeared to give far too much credence to the company that appointed them, the latest update is much less forgiving towards the way London Capital & Finance was run until its collapse.

The update is inevitably non-committal on the question on every investor’s lips, whether they will get their money back. It states “It is too early for the Administrators to say how much money they will be able to return to Bondholders and when any payments will be made to them”.

Smith & Williamson does however go on record that the high commissions (up to 25%) paid out by LCF from investors’ money, plus other costs, make an extremely high rate of return necessary to return investors’ capital and interest.

Accordingly, in order for LCF to be able to repay the Bondholders, the Borrowers would need to make very substantial returns on the monies loaned from LCF to them. For instance, in the case of a:

  • 1 year bond, we estimate that the associated Borrowers would need to repay LCF c.144% of the amount loaned to them, and thus requiring them to make a c.44% return in one year on the monies loaned to them.
  • 2 year bond, we estimate that the associated Borrowers would need to repay LCF c.157% of the amount loaned to them over the 2 year period, requiring them to make a c.28.5% annual return on the monies loaned to them.
  • 3 year bond, we estimate that the associated Borrowers would need to repay LCF c.174% of the amount loaned to them over the 3 year period, requiring them to make a c.24.5% annual return on the monies loaned to them.
  • 5 year bond, we estimate that the associated Borrowers would need to repay LCF c.195% of the amount loanedto them over the 5 year period, requiring them to make a c.19% annual return on the monies loaned to them.

The previous management of LCF continue to stress that they believe the level of security available to LCF to cover its lending to the Borrowers will be sufficient to see the Bondholders repaid in full.

However, when both the level of the fundraising agent’s commissions, and the interest rates due to the Bondholders are taken into account, there is a substantial risk to the Bondholders that they will not receive a full repayment, including interest, of the monies due to them.

It is too early to determine the level of that risk to the Bondholders but the Administrators will keep the Bondholders informed of their assessment of that risk as the administration progresses.

For investors not familiar with realistic levels of investment returns: 19% per year over 5 years is an extremely ambitious target return, and any investment offering that level of return inherently has a very high risk of failure. You could diversify over a number of such investments in the hope of a few succeeding, but the ones that failed would bring your average return to well under 19%.

If your aim is to generate a 44% return over 1 year you might as well go into a casino and put half your money on red or black.

The administrators have been told by some of LCF’s underlying borrowers

that they will be unable to generate the very high levels of financial return needed to settle the claims of the Bondholders without engaging in debt for equity swaps. This suggestion was already in contemplation with regard to one of the sub-Borrowers when the Administrators were appointed.

For investors not familiar with corporate finance jargon: even if some of LCF’s borrowers pay their loans back as originally agreed, this will not be sufficient to return all investors’ money. The borrowers are suggesting that the debt is exchanged for shares in the company, in the hope that these shares will grow in value and the administrators will be able to sell them for enough money on the open market to meet investors’ claims.

This is a potentially attractive option for LCF’s borrowers because once the debt has been exchanged for equity, it is entirely the administrators’ problem whether they can sell the shares for enough money on the open market, and the borrower is no longer required to find the money to repay interest or capital.

(The drawback for the borrower is that they have to give up equity in the company. Hypothetically speaking, if the borrower doesn’t have the money to meet its debt obligations, then the equity is potentially worthless anyway.)

Further conerns

The administrators note a number of concerns that have been discussed in the public domain for the last few weeks, and will be no surprise to anyone reading this blog or the other forums following LCF:

There are concerning connections between people currently or previously involved with LCF and people currently or previously involved with the Borrowers and sub-Borrowers.

The fact that c£236m of Bondholder monies has been lent by LCF to a small number of Borrowers and sub-Borrowers shows a lack of the spread of risk that one would expect from a professional portfolio manager. It is especially concerning that c£122m was lent to one Borrower, notwithstanding that Borrower on-lent a large proportion of that money to a number of sub-Borrowers.

The Bondholders believed that their money was being lent to a wide portfolio of UK small and medium sized enterprises (‘SMEs’) but they now find that it has been lent to a small number of complex businesses with substantial risk profiles and which are often dependent on foreign and/or exotic (such as oil & gas) assets.

The Bondholders are very concerned:

– that they have been characterised as sophisticated lenders when, in reality, they are often people who have invested their life savings in LCF financial products for the best possible return. The Bondholders are very upset that the boards of directors of the Borrowers and sub-Borrowers have viewed them as investors with an interest in investments with high risk profiles.

– that LCF was planning to engage in debt for equity swaps with the Borrowers and sub-Borrowers, using the monies lent by the Bondholders. The Bondholders had seen no evidence in any of the Information Memoranda indicating that Bondholder monies might be used in this way.

– that there are corporate transactions involving the Borrowers and sub-Borrowers which involve companies with similar names, frequent name and accountingdate changes, Companies House strike off notices and the same individuals. The Administrators have been investigating and following up on the same matters as those reported by the Bondholders.

However, whilst analysing and interpreting all of the Bondholders concerns, the Administrators’ main focus is to maximise the financial returns to the Bondholders.

The administrators provide some information on measures they have taken regarding LCF’s underlying borrowers, but as none of the borrowers are named, this information is limited in nature. The administrators have previously stated that they do not wish to do anything that threatens confidence in the borrowers or their share prices.

The administrators also reveal that they are in discussions with the FSCS, and also HMRC with regard to the tax status of the ISA bonds (according to the FCA, the ISA status was never valid).

The administrators reveal that they have been in “constant communication” with Nathan Brown, the administrator of the largest Facebook investor group (London Capital & Finance Bondholders), as well as other smaller groups.

They are looking to speak to a cross-section of LCF investors as to how they were persuaded to invest in LCF bonds.

The Administrators have identified a number of Bondholders to assist in this regard through the Bondholder action groups but if any other Bondholder would like to be considered for involvement in this review process can they please email to LondonCapital@smithandwilliamson.com quoting, in the email subject heading, ‘Representations made to Bondholders during their bond application process’, and they will then be considered for inclusion in this process.

The Administrators are particularly interested in any advice given to them, or representations made to them, during the application process from LCF or its agents with regard to the benefits to be obtained from applying for or re-investing in the LCF mini-bonds or ISA-labelled financial products.

The Administrators’ full initial proposals are due to be submitted to investors by 27 March 2019.

The full update can be read here.

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