Real Estate Credit Investments Ltd (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 recent report was called ‘Looking at the current opportunities’. What can you tell us about it?
A2: Our recent notes have, in the main, focused on why RECI should prove resilient in uncertain times, given its credit processes, high-quality security, low exposure to high-risk sectors, diversity and management of problem accounts.
In this note, we explored the upside opportunities such conditions present. In particular, we noted i) improving yields on new business, helped by the relatively short contractual (and even shorter actual) duration of the loan book, and ii) improving covenants.
As competitors with weaker balance sheets, less focused business models, higher capital requirements and worse historical loss experiences withdraw, so RECI can cherry-pick higher risk-return opportunities.
Q3: So, tell us a bit more about the current opportunities?
A3: RECI is benefiting from rising interest rates and spreads – unlevered loan yield up from 7.6% in June 2022 to 9.5% at end-2022. One important factor is that the loan book duration is short – the contractual duration is two years, but, in practice, there are early repayments making the actual duration even shorter. This means new, higher pricing quickly feeds through into book. Additionally covenants are improving with the average LTVs falling sharply, down 6.3%, to 56.3% during 2022.
Q4: I saw from your note that these benefits have arisen because competition has reduced. Can you tell us why it is that competitors have withdrawn, but market can still be attractive for RECI?
A4: The bottom line is that competitors face specific issues, which do not apply to RECI. This applies across the whole range of competitors, critically including mainstream banks but also non-bank finance companies and direct peers.
Our previous reports highlighted why RECI’s model manages credit risk very well and the higher historical losses, especially seen in mainstream banks, affect their appetite to lend, the IFRS9 accounting for new lending and the operational requirements of managing front/back books.
RECI, with a focused business model, can hunt out best opportunities in its chosen market, rather than switching among products to generate income. For the banks, commercial real estate has high capital intensity and non-bank finance companies can have difficulties with their own funding, which does not apply to RECI. So, there are a whole bunch of factors which reduce competitors’ appetite to lend, but which simply do not apply to RECI.
Q5: While your note focused on the upside opportunities, can you remind us of why you see the business as resilient in challenging times?
A5: Yes, there is minimal exposure to shopping centres, secondary offices and logistics. Where RECI has exposure to offices, it is in prime locations with high-quality tenants, where both rental and capital values typically are more sustainable than in non-prime markets. Financing for land development is just 4% of the portfolio, as RECI is not about financing speculative developments where there is material risk.
The bottom line is that, through the COVID-19 pandemic, Real Estate Credit Investments did not suffer capital losses on, say, its exposure to a super-high-risk sector, like hotels, as it managed these exposures, restructuring debt where required, with additional capital provided by its borrowers.
Q6: And a few words on the risks?
A6: The risks of a recession are clear to see, with higher interest rates, lower disposable income, falling property prices (both residential and commercial, compounded by distressed sellers of assets), rising social tensions, governments facing large fiscal deficits and central banks’ inflationary pressures.
