Real Estate Credit Investments Ltd (LON:RECI) is the topic of conversation when Hardman & Co’s Analyst Mark Thomas caught up with DirectorsTalk for an exclusive interview.
Q1: Mark, your recent report on Real Estate Credit Investments sits behind a disclaimer. Can you tell us why that’s there?
A1: It’s a very 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. Private credit is not seen as a simple asset class, and the report should only be looked at by professional and qualified investors. But it’s a very standard disclaimer and absolutely nothing to worry about.
Q2: Now, your report was called ‘The Rise of Private Credit: Threats and Opportunities’, what can you tell me about the report, Mark?
A2: One of the key trends in global financing markets has been the rise of private credit. In this report, we consider the implications for the company.
On the upside, we note that the disintermediation of banks, which is inherent in private credit, reconfirms the drivers of RECI’s business model. This should be positive for sentiment. What we also note is that most of their competitive advantages relative to banks also apply to its advantages over private credit funds.
On the downside, we noted that some competition will increase, especially for higher-end loans and for staff. But their niche position—where the biggest funds are unlikely to be active—does mean the competition is expected to be limited. And secondly, we noted that if there were big credit losses in a large private credit fund, these could be adverse for sentiment as well.
Q3: So private credit is growing strongly, and you say that the factors driving that are also driving RECI. Can you give us some more colour on that?
A3: There are lots of press reports about the rise of private credit. In essence, it’s risen from about $1 trillion in 2020 to $1.6 trillion at the start of 2024 and it’s expected to increase further to $2.8 trillion by 2028. So, that’s a near trebling in less than 10 years and it’s currently 10 times the level it was in 2009.
What’s been driving that is that private credit gives borrowers an alternative and guaranteed source of funding. Investors in private credit get an illiquidity and often an intellectual capital premium so they get a good rate. They get floating rate instruments in the main and a targeted but diversified portfolio with specialist expertise managing risk.
Now, all of those factors apply to credit. Indeed, in our view, many of the competitive advantages that the company has over banks, it also has over most private credit providers. In particular, it has a culture of ownership where the lender, the actual individual, owns the loans they make. That’s very important.
Now, logically, if investor sentiment is increasingly positive towards the whole private credit market, it should be positive towards RECI as well.
Q4: You highlighted two threats; what can you tell us about the competition?
A4: The scale and focus of most private credit funds means that competition will actually only be at the margin. For example, in 2024, five $10 billion-plus funds raised $89 billion, that was two-thirds of all the direct lending fundraising in the year. Those funds will be looking to deploy much larger sums than Cheyne—who manages RECI—does.
We believe they are addressing a very niche market in that it’s not only providing finance for commercial real estate but does so in complex deal structures. Additionally, much of the growth in private credit has come to finance private equity and infrastructure borrowing, and these have no overlap with them.
Now, there may be competition for staff, but Cheyne has a unique culture which we think is very strong in terms of keeping staff who are there. So, yes, there is potential for a little bit more competition, but it’s not going to be material.
Q5: The second threat was sentiment if private credit suffers losses, what can you tell me about that?
A5: The current round of bank disintermediation is just one of many times that markets have tried to take out the spreads that banks earn on lending. Just by way of example, these have included securitisation, peer-to-peer lenders, and supermarket banks, who allegedly, by cutting the customer’s buying habits, would be able to better price risk.
Now, each of these attempts has failed. The first, most obviously, with the global financial crisis, and many peer-to-peer lenders have closed or actually morphed into being banks.
We also note that in the debt investment company space, it has been a bit of a minefield. Of the 32 debt investment companies we covered in our February 2019 report, nearly two-thirds have been put into wind-down or have merged.
Q6: So, what is different about Real Estate Credit Investments?
A6: I mentioned earlier, we believe its culture is key, in particular, the lenders owning the loans and building a relationship model with borrowers, not a transactional one. Additionally, many of the historic new lenders have rushed into the market, compromising asset quality with the need to deploy capital quickly.
Now, the reality is that no matter how well Cheyne controls risk, the share price will also reflect sentiment, and losses elsewhere could thus impact on the company’s discount.
Q7: Can you tell me about the risks?
A7: The risks of a recession are clear to see.
Potentially higher interest rates, low disposable income, and property prices—both residential and commercial—have been falling, although that has stabilised a bit. You’ve got a rise in social tensions, and governments are facing large fiscal deficits, as well as central banks addressing inflationary pressures.
So, credit is the main risk. In previous notes, we’ve detailed why we believe Cheyne, and thus RECI, is good at controlling credit risk.
