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 RECI 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 ‘Positioned for the current crisis’, what can you tell us about it?
A2: In this note, we reviewed how Real Estate Credit Investments is positioned to face the current market challenges, noting i) the track record of superior credit assessment, monitoring and collection reducing the probability of default, ii) the high quality and high level of security limiting the loss in the event of default, iii) the low exposure to high-risk sectors and proven limited loss in ones where they have had exposures in the past, iv) the proven conservative accounting, and v) the benefits to income from rising rates and re-investment opportunities.
There are risks, of course, including investor sentiment and the macroeconomic environment, but the Cheyne team proved, through COVID-19, that it has the skills to deliver consistent returns in challenging times.
Q3: So, can you tell us a bit more about the track record of superior credit assessment, monitoring and collection reducing the probability of default?
A3: The most important issue in positioning RECI for the current crisis is to look not at what it has done over the past few months, or even the last year or two, but at its fundamental approach and its business model.
Investors should understand the credit control processes. We have explored them in detail in a number of our notes, most notably in pages 14-19 of our initiation. In summary, RECI has a 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. The good credit performance also reflects the benefits of being a property-secured lender, which we believe reduces both the probability of default and the loss in the event of default. The portfolio is increasingly diversified by counterparty, jurisdiction, economic sector, and type of borrower.
This and our other note go into a lot more detail covering areas such as new lending, diversification, interest rate exposure, security cover, borrowers and leverage.
Q4: And the secured nature of the portfolio?
A4: The book has been migrating towards a senior loan book, which represents 87% of gross assets, and the pipeline of new loans is entirely senior. All the top 10 exposures are now senior loans. The portfolio section of the note goes into detail but highlights that the average LTV is just 60.4%. We also highlight the importance good execution and the high quality of the security in prime properties too.
Q5: You said there was low exposure to high-risk sectors and proven limited loss in ones where they have had exposures in the past?
A5: Yes, there is minimal exposure to shopping centres (under 2% of gross assets), secondary offices (nil) and logistics (just 3% of gross assets). 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, RECI 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 the accounting points and benefit to rising rates?
A6: You can see, from the COVID-19 experience, that Real Estate Credit Investments takes mark-to market hits upfront and then sees releases in later periods. In terms of rising rates, the loan book average duration is just 1.6 years and the pipeline, which is two thirds of stock, is 100% floating rate. The portfolio yield has risen by a tenth in recent months.
Q7: And the risks?
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.