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Edited Transcript of ARW.L earnings conference call or presentation 9-May-19 8:00am GMT

Q1 2019 Arrow Global Group PLC Earnings Call

Manchester Jul 3, 2019 (Thomson StreetEvents) -- Edited Transcript of Arrow Global Group PLC earnings conference call or presentation Thursday, May 9, 2019 at 8:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Lee Rochford

Arrow Global Group PLC - Group CEO & Executive Director

* Paul David Cooper

Arrow Global Group PLC - Group CFO & Executive Director

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Conference Call Participants

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* Anthony Da-Costa

Peel Hunt LLP, Research Division - Analyst

* Gary Greenwood

Shore Capital Group Ltd., Research Division - Research Analyst

* Gurjit Singh Kambo

JP Morgan Chase & Co, Research Division - Head of Diversified Financials Research

* Martin Williams

Keefe, Bruyette & Woods Limited, Research Division - United Kingdom Analyst

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Presentation

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Operator [1]

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Good day and welcome to the Arrow Global Q1 results conference call. Today's conference is being recorded.

At this time, I would like to turn the conference over to Lee Rochford, Chief Executive Officer. Please go ahead, sir.

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Lee Rochford, Arrow Global Group PLC - Group CEO & Executive Director [2]

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Thank you, and good morning, everyone, and thank you for joining. As ever, in line with our focus on running the business for the long term rather than on a quarterly basis, we're going to try and keep this brief this morning. I'm going to take you through the highlights and then Paul will take you through the financials before we take any questions at the end. We will have time at the end for that.

So if we turn to Slide 4, the first thing to note I guess is new investments for the quarter totaled GBP 56.4 million. And the key point I'd like to make about that is given the backdrop of an improving pricing environment, we have actively managed our investment volume in the first 3 months, effectively rationing capital to take advantage of the greater level of opportunities that we expect to see in the second half of the year.

It is too early a point in the year to project full-year outcomes. But the movements we've seen in both net IRRs and gross money multiples are both really encouraging and built on last year's improving trends. Given the strong visibility we already have in our pipeline for the rest of the year, we remain confident the purchases for the year will be in line with the guidance of GBP 250 million at attractive returns.

And our point we made before is Arrow generates a lot cash and in Q1 free cash generation increased 32% to GBP 57.8 million. And this is the key metric for the business, I believe. You can see that when purchases are slow, as they were in the first quarter, the resulting impact is a significant reduction in leverage by 3 points in Q1 to 3.4x secured net debt to adjusted EBITDA from the 3.7x at the end of 2018.

As purchases increase, leverage will rise modestly from these levels. But the rapid leverage reduction evidences our ability to de-gear quickly and underlines our confidence that the sustainability of our target leverage range of 3 to 3.5x is highly achievable and we do expect to be within this range by the end of the year.

A really important point to note is despite the lower level of portfolio purchases, we have still invested in new portfolios at above our average replacement rate, the notional level of investment required to keep the balance sheet in a steady state. And to be clear, leverage would have fallen from the year-end, even if we had invested at last year's record Q1 levels. So the key takeaway is that we can continue to grow while also de-leveraging at a good pace.

The investment business has again delivered strong collections performance, as we continue to run at 104% of our original underwriting forecast on a cumulative basis. And this is a key contributor to our free cash flow. And then at GBP 32.1 million, gross income from the Asset Management and Servicing business made a significant contribution and was boosted by the acquisitions that we've made in that space over the last 12 months. As a reminder, we noted at the full year that as part of the integration process that we've initiated, that we've been going through a full contract review of all the businesses and some contracts have been canceled that didn't fit with our core areas of expertise or where margins were not as attractive. In addition, it's worth remembering we sold the Belgian business last year as well.

Together, all of that frees up capacity to focus on new business in the most specialist niches that we target that are higher margin and we remain confident we've built the right platform to cater for future growth and opportunities in these areas.

The strong cash result that's been driven by our operational performance has of course filtered into good underlying PBT growth of over 14% to GBP 16.2 million. This is very close to the statutory PBT number, as the high levels of adjusting items seen in 2018 reduced it significantly in line with prior guidance. We again delivered another impressive underlying ROE number at 34.5%, well above our mid-20s target.

And then finally we have announced today, and Paul will talk about this more in a second, that we've completed our first securitization of loan portfolios of GBP 100 million revolving commitment. This does add an important element of diversification to our funding structure at attractive cost and modest scale, but on terms importantly that demonstrate the quality of Arrow's back book. To be clear though, as a post-balance sheet event, this facility is not included in the figures that we've published today.

So if we turn to Slide 5, just before handing over to Paul to talk through the numbers, I just wanted to highlight the key areas that the management team and I are prioritizing on a daily basis. 2019 is a key year for Arrow Global, as we pivot from the rapid acquisition growth through the last few years, and we've built the platform that we want and we're in the process of fully integrating the new businesses. We're growing the client franchise, we're extracting the efficiencies that are there, and reducing the capital intensity of the business. And in that context, we're focused on 4 key areas.

The first is free cash flow generation. And I've said this before that this is a business that's all about cash. And we do make investment decisions based on whether they're attractive from a cash returns perspective. This usually flows into our earnings, which are an output of cash flows after IFRS accounting. However, our approach is very much that we will not pass on an attractive investment opportunity if it's accretive from a cash returns perspective that have timing implications on earnings. And as the business has grown in capability to manage more complex, high return transactions, we are seeing more of these sorts of deals. A really good example might be an SME bankruptcy, for instance, originated by Europa Investimenti, often effectively secured against [cash in corp]. Fantastic from an underlying risk perspective, but with cash flows that might vary from month to month. There are other examples, but they do tend to average out given our small average ticket size. So despite the timing effect, if we're doing everything right, we should be growing our free cash flow is the way we think about the business internally, and I'd encourage the market to do so, too.

And prudent cost efficiency is also key to generating strong cash flow. And we've been clear that we're undertaking a cost review that we will talk about more at the interims by which time they will have advanced. We expect this to contribute to our move towards a 60% cost income target and our commitment to extract operating leverage from the business. As part of our cost efficiency program, we have been talking to you for a while about the potential insourcing of legal collections. The acquisition of Drydens, one of our existing [channel] partners in the U.K., is a modest acquisition by size and price, but represents the final step in that particular journey. As a reminder, litigation forms a very small part of our overall collection strategy, but it has historically proved expensive to outsource. And this acquisition will therefore effectively pay for itself very quickly in the form of a lower cost to collect on that portion of the book.

Secondly, our focus remains on balance sheet discipline. It's absolutely critical for everything that we do. We've spent recent years optimizing the balance sheet while locking in low finance costs and pushing out duration. This does work synergistically with our cash flow. It means that we generate significant amounts of cash before any of our maturities are due. And unlike most financial institutions, our average liability length is longer than our average asset life, which is a fantastic position to be in.

The securitization that we've announced today also demonstrates the importance we've placed on ensuring a diversified funding structure. Our motivation is primarily to create new funding headroom and optionality and we don't expect to either increase the facility or return to the bond markets for new funding before the refinance of our existing bonds.

Thirdly, as a business we're highly focused on cash returns and our approach to capital allocation prioritizes this. Simplistically, depending on our view of market returns, we make capital allocation choices about portfolio purchases, leverage and capital return to shareholders. When it makes sense to do so, we will reduce capital intensity and focus on deleveraging and return to the shareholders. And conversely, we'll dial up capital intensity and leverage if the environment is right, ensuring future strong returns, all of course within our leverage risk appetite.

And then finally increasing the proportion of capital-light earnings the business generates is a high priority. The growth of AMS revenues has been notable in recent years, as we've acquired the right businesses to build an attractive platform that can serve as assets for us and third-party investors. However, I believe this has much further to go from both a volume and a mix perspective.

We've talked in the past about the potential for third-party capital management involving capital partnering, managing and investing capital on behalf of others. We already have a number of managed accounts with recognized capital and industry partners. And we've added another of these managed accounts during the quarter. That growth reflects our differentiated business model, which combines an outstanding 15-year investment track record together with our unique servicing platforms. We believe that that platform is well suited to strong continued expansion and growth to capital partnering. And in particular, our unique platform has the capacity and expertise to service a significantly expanded portfolio of opportunities.

We're making good progress in our work to fully leverage the opportunity and we're very excited about the transformative impact this will have on our business model and I really don't think the potential benefits of this have been fully acknowledged by the market yet.

So that's a quick summary of the key aspects of how we're currently thinking about the business and how we will drive value over the coming years. I'm now going to hand you over to Paul who's going to walk you through the numbers in more detail.

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Paul David Cooper, Arrow Global Group PLC - Group CFO & Executive Director [3]

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Thanks, Lee. Good morning, everyone, so if you could turn to Slide 7 in the presentation. As Lee noted, earnings is an output of our strong cash flows and cashing income in Q1. The total of core cash collections from our Investment Business and the income from our Asset Management and Servicing grew by 22.5% to GBP 128 million. This is the income that we get before we have to represent it under IFRS EIR accounting, where a proportion of the income from the Investment Business is allocated to amortization, et cetera.

We noted at the full year that we were starting to see the benefit of cash flows from the secured asset purchases that we'd been making in the last 2 to 3 years. And this continued into Q1, leading to an increase in income from portfolio investments of over 9% to GBP 63.6 million. Our third-party AMS income grew strongly in the first quarter, increasing by more than 21% to GBP 23 million. The strong Q1 growth mainly reflects the M&A activity undertaken in prior years, and has been partly offset by contracts that we've chosen to cancel, as they were marginal. We expect the third-party AMS growth in the remaining quarters of 2019 to moderate, as both 2019 and the 2018 comparatives will include the revenues from the businesses we have acquired. As a result, 2019's full year growth for the third party AMS business is likely to range from a high single digit to low double digits.

We remain confident in our medium-term revenue targets, with gross AMS business increasing to around half of the total. And as previously guided, this growth will not be in straight line. When combined with the increased capital-light revenues from the AMS business, total income increased by over 12% to GBP 86.6 million.

Collection activity costs saw a small decrease as the total cost to collect ratio also reduced, despite the mix effect of the large servicing business. This is driven by a lower Investment Business cost-to-collect ratio, which continues to trend towards the previously guided longer-term CTC rate.

Conversely, other operating costs increased due to the inclusion of the cost basis of new businesses acquired in last year's M&A activity. Our Q1 cost income ratio is 67%, affected both by the M&A activity and also by investment in our Italian businesses. As a reminder, we previously guided that Italy would not contribute to earnings until the second half of 2019. The impact from these two elements will be most seen in Q2 and Q3, whilst the benefit will be seen mostly in Q4. We continue to expect that the full year 2019 cost income ratio will moderate to around that of 2018, despite the mix shift to more capital-light business and therefore we remain confident we're on the right trajectory to deliver a cost income ratio of towards 60% by 2023.

At the full year, we noted that we thought there was a significant opportunity to cut cost out of the business, after a period where the focus has been on acquiring and integrating new businesses. That cost review is well underway and we will be providing more detail on it at the interim results. The group posted good underlying PBT growth of over 14% to GBP 16.2 million, underlying profit after tax was GBP 11 million, a reduction of 3.5%, mainly due to a higher tax rate, as a greater proportion of profits were generated outside of the U.K. We expect that Q1 underlying effective tax rate of 27% to reduce over the year to a rate for 2019 moderately above that of the 2018 full year of 22%.

Underlying profit after tax was also impacted by GBP 720,000 of earnings allocated to non-controlling interest. This mainly relates to a portfolio consisting of a single SME corporate bankruptcy in which Arrow has a majority share and which it is in the process of realizing. Under IFRS, we consolidate the entire position and allocate the minority holding to the non-controlling interest. Upon realization of the position, this non-controlling interest will cease to exist.

Turning to Slide 8, this graph shows in simple terms the positive momentum in both core collection in the Investment Business and the overall free cash flow resulting from the operating activities at both the Investment Business and Asset Management and Servicing business, which we'll look at in detail on the next slide. An important point to note is that even before the availability of funds from the securitization, this strong cash performance has resulted in over GBP 118 million of RCF headroom going into Q2.

On Slide 9, this slide shows how the operational numbers I've just been talking about translate into a free cash flow number after cash expenses and cash interest costs. The business generated GBP 58 million of free cash, an increase of 32%, meaning that the business effectively self-funded its portfolio purchases in the quarter of GBP 56 million. As Lee noted earlier, this number is our key focus when running the business and what we look at before deciding how much to invest back into portfolio purchases. If it makes sense from a returns perspective, we'll invest a lot. And if it doesn't, we would deploy it in a different way in line with our capital allocation policy.

Turning to Slide 10, which is a familiar slide or should be a familiar slide to you all. Slide 10 shows our liability structure and duration in combination with the 120-month ERC from the Investment Business. It demonstrates the attractive financing structure we have that Lee alluded to earlier, and shows that we estimate we will generate around GBP 1.5 billion of cash, not including the contribution from AMS, by the time our first maturities are due in 2024. Since Q1, we further diversified the liability side of the balance sheet by entering into a GBP 100 million asset-backed facility and remain extremely happy with the shape of the capital structure.

Pleasingly, leverage has fallen in the quarter to 3.4x from 3.7x at year-end. This has been due to strong collections, good cash generation from AMS and moderately lower purchases. The combination of higher collections and lower purchases has meant that ERC has not grown as strongly in Q1. The strength of sterling against the euro has also reduced the sterling equivalent total ERC from year-end. Similarly, the FX movements in Q1 have also contributed to the reduction in both the book value of the portfolio investments and aggregate net debt. If the FX rate remains at Q1 levesl, pretax profits could be negatively impacted in the region of GBP 2 million to GBP 2.5 million.

The book value of portfolio investments was also reduced by GBP 13 million or around 1% due to a portfolio restructure. We previously held a minority position in a co-invest structure which included some leverage. This was the only leveraged portfolio on the balance sheet at year-end. During the quarter, our majority partner drove the sale in the entire position and we used our share of the proceeds to pay down the leverage. Service proceeds from the sale were recognized with collection. This was about GBP 10 million. The portfolio restructure represents the book value associated with the leverage removed due to the sale. We then reinvested the proceeds into a new portfolio with no leverage and a different ERC profile. We remain the servicer on the portfolio. No gain or loss was recognized on the disposal and the reinvestment brings the portfolio into line with the consistent treatment of the rest of the portfolio investments.

Turning to Slide 11, Slide 11 highlights the key terms of our successful securitization completed in April. This is at a good advance rate of 55% of 84 month ERC. This is GBP 100 million non-recourse asset-backed facility with an initial 2-year revolving and 3-year amortizing term. We'll have an option to extend the revolving period by a further year. The attractive cost at LIBOR plus 310 basis points is expected to have little impact on our last reported weighted-average cost of debt at 3.9% at year-end. And the modest scale diversifies our funding and provides an alternative to future high yield bond and RCF refinancing without having a material impact on existing bondholders.

As Lee mentioned earlier, we are seeing an improving pricing environment and expect to take advantage of greater levels of opportunities in the second half of the year. This ABS supplements our existing headroom and provides further financial firepower to invest in this improved pricing environment whilst maintaining our financial discipline in our leverage guidance.

I'll turn back to Lee.

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Lee Rochford, Arrow Global Group PLC - Group CEO & Executive Director [4]

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Thanks, Paul. So I'm just going to finish up by quickly touching on the investment case and why we believe it continues to be attractive, while leaving time at the end for Q&A.

But firstly, we've got a sophisticated investment platform in a growth market with unique origination channels. We focus on high value niches, executing largely off-market where attractive returns are available, despite areas of competition in other parts of the market.

We're confident in our ability to generate returns that are at least in line with our target mid-teens levels.

Secondly, we believe in our ability to generate high quality earnings. We showed at the full year how the capital intensity in the business is reducing quite markedly year-on-year and that our co-investors' capital deployed now far exceeds our own. That underpins our commitment to double gross income from the AMS business and increase AMS revenues towards 50% of gross group income over the next 5 years.

Furthermore, our strong starting point and clear strategy to grow the fund management business will help drive the EBITDA margins of that segment into the mid-20s. All of this contributes to the strong cash flow profile of the business and I hope we've been clear again in our message today that it should be all about cash when you look at us. We turn unpredictable cash flows into predictable ones and we're very good at it.

Thirdly, we've committed to managing the balance sheet at a lower leverage ratio than in the last half of the cycle. Q1 has shown how we can achieve that range very quickly and why we're still growing, albeit at a slightly slower rate than we will for the year as a whole. While leverage will increase modestly from the current level, we remain confident we'll finish the year within our target range and believe we go much further than that in the years thereafter, giving us enormous capital flexibility. When combined with the fact that we fully refinanced our balance and we've no need to return to the bond markets before 2024, it's clear we have a very attractive capital structure that we believe offers us a competitive advantage.

We can do all of this while still delivering high returns to shareholders. Sustaining ROE above mid-20s percent, even at lower leverage levels, is achievable due to the attractive returns from the still growing Investment Business and the earnings generation from AMS. The increased scale of the business offers significant operating leverage benefits and will reduce our cost income ratio towards 60% and support these returns.

And then finally we remain regularly focused on managing the business through the cycle. We've demonstrated our track record of past performance, but also talked a lot at both our Capital Markets Day and the full year results about some of our forward-looking scenarios which also demonstrate the resilience inherent in the business. We will remain cautious and continue to manage the portfolio to diversify the risk and to mitigate the macro environment. We also remain heavily focused on the significant opportunity we see to reduce costs. And as Paul noted, we'll update you on this further on H1.

Altogether, this will help us maintain a progressive dividend at a payout ratio of at least 35% of underlying net income. Overall, we continue to believe we have a compelling business model that will generate sustainable attractive returns through the cycle and that there's significant equity upside from the current levels.

So that's all from us at this stage. I'll now hand back to you, operator, and we can take any questions that people have.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We will now take our first question from Gurjit Kambo from JP Morgan.

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Gurjit Singh Kambo, JP Morgan Chase & Co, Research Division - Head of Diversified Financials Research [2]

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Just one sort of little question is around the purchases you acquired in the first quarter, just by sort of broad geography and maybe sort of type: secured, unsecured, and how that balance looks. And just in term of sort of pipeline, are there particular regions that you're more excited about just where the pricing is more attractive?

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Lee Rochford, Arrow Global Group PLC - Group CEO & Executive Director [3]

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That's a good question. Thank you. I mean it's only a quarter, so I don?t think you should read too much into a quarter. As we've seen in prior years, we tend to rebalance through the year. I do think it's fair to say that in the first quarter we've been very pleased with how acquisitions we got, particularly in Portugal, Italy and the U.K.; a bit less in the Netherlands where the market is a bit quieter. So yes, broadly reflective of what you'll have seen in the past in those jurisdictions and broadly reflected the sort of mix between secured and unsecured that you've seen in the past. We will produce obviously at the half year, a fuller analysis of how the vintage is emerging. But as I said, we're confident at the course of the year we'll hit our target of GBP 250 million with confidence that returns are there. And I'm really pleased with how the pipeline is emerging for the year. It's really apparent, as we've established this Pan European platform, the amount of opportunity coming in is increasing all the time. And so our ability to filter for vintage that we want is really pleasing.

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Operator [4]

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We will now take our next question from Gary Greenwood from Shore Capital.

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Gary Greenwood, Shore Capital Group Ltd., Research Division - Research Analyst [5]

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Hi, sorry if this has already been asked. My call dropped out briefly. But I just wanted a little color really on the divisional profit margins. I know you don't like to give quarterly disclosure on those, but maybe if you could just talk a little bit as to whether there's been any sort of change in trends there or whether it's all sort of as you were.

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Paul David Cooper, Arrow Global Group PLC - Group CFO & Executive Director [6]

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Yes, I mean well Lee just com-- hi, Gary. It's Paul. Lee just commented on sort of the return view for the Investment Business. So certainly from that side of things, we're not seeing any weakening in margins at all. And in fact, the outlook as you're seeing both from the RNS and from what was just said is it's pretty healthy and I'm encouraged by that. I think certainly on the AMS side of things you'll know that we had a 20% EBITDA margin for the full year of 2018. And there hasn't been any change in that at Q1. So the outlook is similar.

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Operator [7]

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We will now take our next question from Anthony Da-Costa from Peel Hunt.

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Anthony Da-Costa, Peel Hunt LLP, Research Division - Analyst [8]

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Three questions from myself, the first is so you've scaled back in purchases because of pricing in Q1, but you can fill in the pipeline. What's some of the assets you're looking at and why do you think pricing is going be positive going forward into these assets? That's the first question.

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Lee Rochford, Arrow Global Group PLC - Group CEO & Executive Director [9]

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Look, it's broadly reflective of what you've seen before. I think it makes sense in this environment which we've been talking about now for at least 12 months. I think it was this time last year that I first started to say we're seeing encouraging signs on pricing. It's not true to say that that's a general single trend, as we sort of talked about a lot at the Capital Markets Day, actually. This is a massive market with a huge variety of returns and assets types being sold. And our job is to filter our way through that, both using the unique origination channels we've got and the servicing platforms insight to that. So I would say on returns it's still a question of getting that filtering right. We don't try to do that quarter by quarter. We try to do that over the period of a vintage. But when we're confident in the underlying trend, particularly given how the business is going up, we do think it's right to be really tough with ourselves in terms of the returns we require to invest. So it wasn't like we targeted a GBP 56 million number for Q1. It was an output from that strict capital discipline driving returns as high as we can in a really large varied market. So the sorts of deals we're doing obviously reflect the strength of the servicing platform. But we are pleased with how the Italian business is starting to contribute to that. Obviously Italy is the largest market in Europe. That's given us a lot of optionality there. There's certainly parts of the market we're just not playing in. We're not participating in large auctions. We're not doing sort of single concentrated risks there in the way you might have seen other players do. The Europa Investimenti business which has a unique skillset, specializing in the SME bankruptcy market in particular which is, we think from a risk perspective, much better on a risk-adjusted basis. Returns are higher, but the risk is much less, because it's often secured on assets already liquidated and in the core process. That's doing really well. I'm very happy with that. We've seen some good diversified business in Portugal, similar to what you will have seen from the Whitestar platform in the past. Although I would say one deal I'm particularly pleased with is a transaction that includes a range of assets that reflect the Whitestar strong point of secured residential, in effect underlying assets, but also a portion of diversified commercial real estate, which begs to the Norfin skillset, so bringing Norfin within the group and having that be the intended effect of us being able to provide a single solution to a selling bank who didn't want to actually divide out the portfolio themselves, but sell it in one go. And we now have the capability to take that on. And then U.K. market, again, picking our way through it, I would say you still see an auction in the U.K. pricing at a level that's not attractive to us. But it's a very large secondary market and with the new combined skillsets now in the U.K. of Capquest, Mars and Focum enabling us to take on more complex assets there we've seen good traction there, particularly with some of the, again, small-ticket secured deals. So it's a really big variation, but all playing to our strengths in the target niches that we have built servicing platforms in where the returns are higher.

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Anthony Da-Costa, Peel Hunt LLP, Research Division - Analyst [10]

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Thanks, Lee. Now I have two technical accounting questions for Paul. So in portfolio investments, there's a GBP 13.2 million portfolio restructure. What is this?

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Paul David Cooper, Arrow Global Group PLC - Group CFO & Executive Director [11]

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Yes, if you go back to what I said earlier, I sort of explained it what I thought was quite comprehensively, but I'll just sort of walk through again. Essentially we had a minority position on a portfolio that we had at year-end. And essentially we were carrying the portfolio on our books and we some leverage attached to it at year-end also. It's the only portfolio on our balance sheet that had that leverage. So during the quarter, the majority co-invest partner basically wanted to get out of the position and sell that position down, which they duly did, and we came along with them and also sold it down. So what you're seeing is the restructure is quite simply the getting out of that position, as we have sold it down, getting the GBP 13 million offset with the leverage on balance sheet associated with that asset. So that leverage is completed cleared as at quarter end, and now all portfolios are on a consistent basis. We just had to treat it is as restructure, because subsequently we basically reinvested into the portfolio with no leverage, getting access to a different ERC profile. That's simply it. The other I added was the cash over and above that was [received] to pay down the leverage. It was about GBP 10 million, and we've recognized that in collections explicitly.

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Lee Rochford, Arrow Global Group PLC - Group CEO & Executive Director [12]

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I think the other thing that's interesting, not the technical accounting answer, but about that portfolio is a trend you'll continue to see with us as we work with a diversified range of capital partners is that that was a portfolio that was on our servicing platform. It remains on our servicing platform. So even though a partner may choose to exit or restructure or think differently about its investment in a portfolio, that doesn't mean that it moves from our servicing platform and we retain those high quality earnings and have an option whether we participate or not in the investment side of it.

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Anthony Da-Costa, Peel Hunt LLP, Research Division - Analyst [13]

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Thanks, and then finally in terms of the portfolio investments classification by amortized cost and fair value, the split as of the end of Q1 was 81%-19%. Can we have the Q1 '18 split?

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Paul David Cooper, Arrow Global Group PLC - Group CFO & Executive Director [14]

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Yes. Anthony, I mean I think what is worth bearing in mind is -- and maybe it is worth recapping and going back to the half year results, where I talked extensively about the accounting treatment for fair value and amortized cost. You know, at that time and what I said is with the transition to IFRS 9, essentially a number of portfolios had to be reclassified from amortized cost to fair value. And that took place throughout 2018. So you've got some reclassification impact on there. But the way to think about it is the portfolios are largely the same or the treatment is very largely the same under either aspect. So for both classifications, we have our modeled estimate of future cash flows with our modeling team that consists of a range of experts based in Manchester who do that. We then take the discounted cash flows back to get to your original purchase price. And that creates either an EIR under amortized cost or a discount rate under fair value. When those cash flows outperform and you'll know from our history that we've got that 104% outperform against original underwrite; you get a write-up and that will form either a gain within the fair value gain line or it will come through in the impairment gain lines for the amortized cost. And I mean I don't want to repeat what I said at half year. But we were very explicit around that and the treatment. So it might just be worth yourself sort of refreshing your memory on that.

Anthony Da-Costa: I think so the split at half year 83%-17%. So we can just sort of draw that down to Q1 '18?

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Paul David Cooper, Arrow Global Group PLC - Group CFO & Executive Director [15]

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I don't think it matters, given the drivers of the income are exactly the same under both classifications. I think it doesn't matter. And you'll see more fully anyway at the half year in a quarter's time the comparative for the half year.

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Operator [16]

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We will now take our next question from Martin Williams from KBW.

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Martin Williams, Keefe, Bruyette & Woods Limited, Research Division - United Kingdom Analyst [17]

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I'll do three questions as well, if I may. Just on your revised AMS guidance of around 10% for the rest of the year, I just wondered if you could share with us the visibility on that. You're obviously investing a lot more third-party capital on behalf of others. And so you've got a good visibility on your debt purchase side. But I'd presume that translates onto a bit on that servicing side now as well. So is the 10% largely down to what you can see or what you need to win? Do you want me to do the questions one at a time or give you all three in a go?

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Lee Rochford, Arrow Global Group PLC - Group CEO & Executive Director [18]

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Why don't you give us all three and then we'll divide them up between us?

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Martin Williams, Keefe, Bruyette & Woods Limited, Research Division - United Kingdom Analyst [19]

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Sure. Okay, so the second question relates to the securitization. My back of the envelope calculations which I'm happy to be corrected on, suggest that you're able to borrow over 80% of the purchase price, based on a rough estimate of your 7-year gross money multiples. That looks like a high figure, but it's obviously attractive to you. Is that because the debt market or the lenders are very confident on the flows or is it because book value is significantly understated as possibly flagged by your Belgian sale last time you reported? And then finally on Drydens, I believe one of our competitors bought a litigation specialist in the past and let it have a look at the whole portfolio, which saw a reasonable uplift in collections as one-off. Do you have the same sort of aspirations for Drydens, appreciating that your litigation element is small at the moment.

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Lee Rochford, Arrow Global Group PLC - Group CEO & Executive Director [20]

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I'll just take that last one. I mean they're a close partner. We've worked with them for years. What I would say is the collection strategies are driven by our central analytics and operations here in the U.K. based on our risk appetite, which is lower than others, as you know, for legal collections, and the value we see in the book for those customers that might be able to pay but once as opposed to those [can't]. So we don't see this changing our risk appetite. What we see is they're being a much more efficient way of managing those legal collections, rather than outsourcing and paying additional margin on that to other third parties, rather than retaining the benefits internally. So I wouldn't expect, if I were you, a significant one-off shift in that. Obviously could we hope through time to have better understanding of the opportunities in the book to get better at our collections as we do in other areas. But our risk appetite is not changing. And as we've said in the past, so that UK book we litigate something like 3% of the book. It's not (inaudible) anyway.

You want to take?

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Paul David Cooper, Arrow Global Group PLC - Group CFO & Executive Director [21]

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Yes, so Martin, why don't I lead off with your first question? So from the AMS perspective, I think it's quite easy to get tempted into looking at the sort of quarter's performance without having a view on the broader strategy. And so if you step back and look at where we are with the AMS business, it's already come a long way from being 0 revenues 5-6 years ago to being around a third of total revenues at the end of last year. And as we've said at the Capital Markets Day that our target for the medium term is to drive that to 50% and drive up the margins from the 20% to the mid-20s. So that's sort of the background and the target of that. Now there's been a lot of activity by Arrow in the recent past, as we built out the platforms and have these niche services in our chosen markets. We also showed at the year-end that we've got and are already deploying capital on behalf of our partners to the tune of around GBP 1.6 billion. And Lee mentioned today that we continue to build out the sort of third-party capital management ability of the business. And that's going pretty well. So the bigger picture that again we explained at the CMD is that we will drive those revenues, A, because we have configured it or are in the process of configuring platforms to, A, help manage their own balance sheet and service their own balance sheet, but also manage the co-invest partner's or the capital of others and service those in which we can drive fees, either for managing that capital or drive fees from a niche perspective for their harder-to-collect assets. So I think the longer term targets reflect that sort of strategic positioning, which I think is very strong, again, against the background where you've got about a trillion euros of assets that are available in our chosen market. So there's a long run of available opportunity. I think what you're seeing at the sort of Q1 is active management on our part where, as both Lee and I have said, we've canceled contracts on businesses that we have acquired both in terms of either they don't fit within the business or if they're just marginal. And we've had a history of doing that, right back to when we acquired Vesting in 2016. So this isn't new news. I think sort of going to your sort of immediate point around guidance, it's quite simply that at Q1 we don't want the market to get ahead of itself at 21% growth and assume that that's going to extend into the full year. And if you're building in the sort of M&A revenues into the comparatives that are featured in both years and add on the sort of canceled contracts that we've spoken about, you will see that growth moderate into that sort of high single, low double-digit territory. In terms of pipeline, both Lee talked about the pipeline of opportunity on the Investment Business side. We also see a pipeline of opportunity on the AMS side that sort of senior management go through and review on a very regular basis. And that will consist of both opportunities coming through from co-invest partners, but also from basically new arrangements.

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Lee Rochford, Arrow Global Group PLC - Group CEO & Executive Director [22]

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[Yes, the next]

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Paul David Cooper, Arrow Global Group PLC - Group CFO & Executive Director [23]

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Yes, and so sorry. And the ABS point, which I think sort of goes to borrowing terms more than anything else, Martin, from what I could see. And I've got to say we were very pleased with this. And I think you've got to put it in the context of the benefits that this gives us in terms of diversified funding and the additional liquidity over that GBP 118 million of headroom that I mentioned. But it is and we did trial this that we said that when we were contemplating the further diversification opportunity, it would be relatively modest. And I think the sort of GBP 100 million size isn't that significant, but it is welcome certainly in terms of the additional liquidity and firepower that that provides. It's at good terms. So the 55% advance rate is, we think, favorable. And the margin at the sort of 310 basis points that I mentioned is also marginal. And this is term money. So we do have the 2-year revolver. It is with an extra year of optionality in extending that revolver with then 3 years amortizing. So we're pleased with the size and the terms in terms of the financial terms that the securitization has provided along with the sort of flexibility that that provides. What I would say though is that out of the total of 7-year ERC of about GBP 1.6 billion and a 10-year of GBP 2 billion, you know the total collateral that we've put into the ABS is literally sort of less than 200 million. So it's pretty modest overall. And I think what you'll see is although there's no change to sort of net debt immediately, as we've used the proceeds from the ABS to pay down the RCF, what you'll see we'll sort of continue to draw around the RCF and use that cash to buy new portfolios at attractive returns which goes to the sort of immediate point of where we're seeing returns going to into the second half of the year.

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Lee Rochford, Arrow Global Group PLC - Group CEO & Executive Director [24]

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I guess I'll just add one thing and you made a point about the quality and conservativeness of the book, which I think is a good point. That's not how the deal is structured around percent of purchase price. But I think what you can take comfort from is this is a new relationship that we have there, a new lender come in. He's taken a look across the book, because this is a non-cherry-picked portfolio. And they're extremely comfortable with where we have the assets marked and the predictability of the cash flows going forward. So it's not structured in the way that you talk about. But then you can run the numbers as well as I can. But it does give you enormous confidence that an independent third party was prepared to lend us that amount of money based on the cash flow profile of the book that we have and where the book is marked.

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Operator [25]

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We have time for one more question and that is from [Simon Jarovski] from Carlyle.

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Unidentified Analyst, [26]

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I have two questions. The first one will be around some color on organic or, let's say, like-for-like performance in Q1. Obviously you've made a number of acquisitions in 2018. Any color on what was the underlying or like-for-like performance in terms of collections or EBITDA would be great. And on the same point, the impact on EBITDA of IFRS 16 in the quarter and on the LTM period, please.

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Paul David Cooper, Arrow Global Group PLC - Group CFO & Executive Director [27]

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So sort of like-for-like, we're seeing good performance as sort of the RNS has stated and as we've mentioned. If you look at collections, collections remain strong. It is underpinned by the metric that continue to state around the 104% of collections being in excess of the original underwrite, as I've mentioned. So that aspect of the business remains positive on a like-for-like basis. The sort of Investment Business remains positive on a like-for-like basis and the AMS I think we've talked about quite extensively under the previous question. In terms of IFRS 16, I'm glad I'm getting a lot of accounting questions today. But the IFRS 16 is that there is a modest benefit to the EBITDA. Essentially what you're seeing is the lease costs that previously would sit in overhead, under IFRS 16 we are forced to reclassify them in essence to finance costs and to depreciation in a very simplistic way. The benefit to cash EBITDA for the first quarter was less than GBP 2 million. And if you roll that forward on an annualized basis, you'll get a sense what that would look like for 2019 full year.

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Unidentified Analyst, [28]

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And on the like-for-like performance, would it be fair to say that your like-for-like organic growth was in excess of 10% or below 10%?

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Lee Rochford, Arrow Global Group PLC - Group CEO & Executive Director [29]

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No, I think you have to be careful on the Investment Business. Obviously it's a combination of strong collections in the back book and the forward purchases that we've said we actually like-for-like versus last year, forward purchases were lower, and we expect them to be high for the year as a whole than that and in line with guidance. So on the Investment Business, I think you just need to be careful about that. And it's not really been impacted by any of the acquisitions. And our guidance there at Capital Market Day was for sort of single-digit growth for the Investment Business going forward with higher growth in the AMS business. And Paul I think has been very clear about underlying expectation for growth in the AMS business.

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Unidentified Analyst, [30]

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Great, and the second question is about securitization facility you spoke about earlier. I'm guessing you will keep it on the balance sheet, so you will not remove the collateral that was put into the subsidiary and you will keep kind of the additional debt on the balance sheet. So I was wondering, would the payments to the subsidiary for which there's non-recourse or from which there's no recourse to the main group, would these payments for collected portfolios be after cost of collection was charged by the main group or are you taking that risk as well I guess on these collections?

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Paul David Cooper, Arrow Global Group PLC - Group CFO & Executive Director [31]

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Yes, you're correct in terms of structure. It does remain on our own balance sheet and there is a -- the cash sort of waterfall does work with after deducting a service fee to Arrow and then it basically pays down to the lender and then ourselves.

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Lee Rochford, Arrow Global Group PLC - Group CEO & Executive Director [32]

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So we retain all the economic risk in the portfolio. I think you just have to look at it as a cheap source of finance and nothing else.

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Unidentified Analyst, [33]

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And is there any limit in terms of ratios, ELC percentage or net debt to EBITDA to increase that facility even further? Are you aware of any ratios or restrictions in the indenture that prohibits you from increasing that sort of funding?

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Lee Rochford, Arrow Global Group PLC - Group CEO & Executive Director [34]

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We do under the bond indenture. This does fit within the limits of there. We've taken a much smaller amount than we could have done under the indenture. But it's not our intention to increase it. As I said in my comments at the opening, this is about creating headroom, creating optionality, reducing reliance on the RCF, and the high yield market should it be necessary. But it's not our expectation that it is. And we think it sort of [makes] things positive to have alternative sources of finance. So I shouldn't read too much into it. It's not our intention to sort of max out on the indenture limits. We're happy with the size of this. And given the other comments we've been making about the business, you have seen in fact in this quarter the net debt actually going down. We're not quite at peak net debt we've set. We're approaching it though over the next couple of years though. So we don't need a lot of new funding to actually meet the guidance we've given the market. this is really all about diversification, headroom and optionality.

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Unidentified Analyst, [35]

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And (inaudible) what would that maximum amount be today more or less, if you were to go for the maximum amount?

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Lee Rochford, Arrow Global Group PLC - Group CEO & Executive Director [36]

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It's around double this level. But as I said, not our intention to go anywhere near that.

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Unidentified Analyst, [37]

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Can you repeat your answer, sorry. I didn't?

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Lee Rochford, Arrow Global Group PLC - Group CEO & Executive Director [38]

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It's around double under the actual terms of the indenture. But as I said, it's not our intention to go anywhere near that.

Good. Thank you everybody for your questions. Operator, I think we may be out of time. So that's really it from us. We'll speak again at the half year results early August. Thank you for listening and thanks for the questions.

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Operator [39]

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This concludes today's call. Thank you for your participation. You may now disconnect.