In this note, we explore Real Estate Credit Investments Ltd (LON:RECI) low sensitivity to a rising rate environment by analysing i) borrower revenue sensitivity, ii) borrower debt sensitivity, iii) RECI’s portfolio risk mitigation techniques, iv) the MTM on the bond portfolio, v) the impact of RECI’s own funding mix, vi) international diversification), vii) previous share price experience, viii) sentiment to the stock, and ix) potential opportunities that may arise. This reinforces the message in our last two notes that RECI’s business has shown limited downside during the COVID-19 crisis. We use a case study of a hotel exposure to illustrate how Cheyne’s management of challenging relationships materially reduces the final loss.
- Why low sensitivity: The key is how RECI manages its book in its selection of less rate-sensitive borrowers and primarily income-generating projects, the structuring of deals, and balance-sheet management and diversification. Credit exposure from rising rates, the critical risk, is tightly controlled. As rates rise, income is likely to increase.
- Historical market reaction: In three of the four periods of sustained rate rises in the past decade, RECI’s share price has risen. Even in the fourth case, the share price rose in the early stages of the interest rate hikes. Prima facie, the market has treated RECI as at least neutral to, if not a beneficiary from, rate increases.
- Valuation: Real Estate Credit Investments trades at a 1.4% premium to a conservative NAV, in line with pre-pandemic average levels. With a 2022E 12p dividend, the 7.8% dividend yield is the highest of its immediate peers and covered by income. RECI’s defensive qualities mean that the dividend has been held throughout the COVID-19 crisis.
- Risks: Any lender is exposed to the credit cycle and individual loans going wrong. Security is currently hard to value and to crystallise. We believe RECI has appropriate policies to reduce the probability of default, and loss in the event of default. Some assets are illiquid, and repo financing has a short duration.
- Investment summary: Real Estate Credit Investments generates an above-average dividend yield from well-managed credit assets. Bond pricing includes a slight discount, reflecting uncertainty, which should unwind when conditions normalise. Market-wide credit risk is currently above-average, but RECI’s strong liquidity and debt restructuring expertise should allow it time to manage problem accounts. Borrowers, to date, have injected further equity into deals.