Real Estate Credit Investments (LON:RECI) is the topic of conversation when Hardman and Co’s Analyst Mark Thomas caught up with DirectorsTalk for an exclusive interview.
Q1: Your recent report on Real Estate Credit Investments sits behind a disclaimer. What can you tell us about that?
A1: It is just the standard disclaimer that many investment companies have. In essence, for regulatory reasons, there are some countries (like the US) where the report should not be read. It is not a simple asset class, and the report should only be looked at by professional/qualified investors.
Q2: Your report was called “Marks taken in uncertainty, released thereafter”. What can you tell us about it?
A2: In this note, we reviewed RECI’s track record of taking MTM hits on its bond portfolio in periods of uncertainty, followed by releases in the subsequent periods. We believe this reflects the market applying a broad-brush approach to risk, and giving insufficient credit to RECI’s superior control assessment, monitoring and restructuring systems, which we summarise again in this note. We have outlined in previous reports why we believe RECI shows resilience against inflation, interest-rate increases and inflation risks.
Q3: So, could you give us a real-life example of when this happened?
A3: In our note, we included a chart of their MTM hits and releases through COVID-19. In March 2020, there was a hit of nearly £10m. In most of the subsequent months that year and into the spring of 2021, there were releases of between £0.5m and £1m, so that within the year the vast majority of the initial hits had been recovered.
Q4: What made you do this analysis now?
A4: In mid-2022, we are once again faced with a period of uncertainty driven by the Ukrainian crisis, inflation and unknown interest rates, and an uncertain growth/recessionary outlook. Corporate loan markets are now priced at similar levels to April/May 2020 when the market was anticipating 18-month default rates in the region of 10%-15% when current default expectations are low-to-mid single-digits levels.
Unlike the COVID-19 period, RECI has not faced a single, sharp month of deterioration, but rather has seen smaller, month-on-month attrition, steadily gnawing away at the NAV with an acceleration in June. We believe the bottom-line driver, though, is the same. The market uncertainty is applying a broad-brush approach to risk, which is not looking to the underlying risk controls and security specific to their proposition.
Q5: The critical issue appears to be that you are saying the market applies a broad-brush approach while Real Estate Credit Investments has superior credit processes. Can you remind us exactly why you believe they have better processes?
A5: That is exactly the nub of the issue. We explored the issue in detail in a number of our notes, but I would particularly point your listeners to p14-19 of our initiation, which although we published in August 2019 is still true today.
Critically, what we said then, was delivered through COVID-19, which is hugely encouraging. In summary, it’s about RECI’s structured and considered approach to lending. The manager’s (Cheyne’s) culture is hugely important to this, and we take considerable comfort in its risk/reward approach. Positions appear to be closely monitored, once committed, and Cheyne endeavours to be actively involved where there are multiple lenders. Early identification of problems is very important to reducing eventual losses, and Cheyne has processes in place to do that. The originator “owns” the loans, and so is highly likely to personally spend the considerable time and effort sorting out any problem accounts.
It is a well secured lender, which we believe reduces both the probability of default and the loss in the event of default. Counterparties are financially strong and experienced professionals. The portfolio is increasingly diversified by counterparty, jurisdiction, economic sector and type of borrower.
Q6: What did their latest quarterly update tell you?
A6: Very much more of the same with the key themes of i) attractive returns from low LTV credit exposure to UK and European commercial real estate assets, ii) quarterly dividends delivering consistently since October 2013, iii) a highly granular book, iv) transparent and conservative leverage, and v) access to strong pipeline.