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: You recently published a report on Real Estate Credit Investments, but it sits behind a disclaimer. What is that about?
A1: RECI is not a simple business, and the disclaimer simply says, “THE MATERIALS CONTAINED HEREIN MAY NOT BE DISTRIBUTED, FORWARDED, TRANSMITTED OR OTHERWISE MADE AVAILABLE, AND THEIR CONTENTS MAY NOT BE DISCLOSED, TO ANY US PERSON OR IN, INTO OR FROM THE UNITED STATES, AUSTRALIA, CANADA, JAPAN, SOUTH AFRICA OR IN, INTO OR FROM ANY OTHER JURISDICTION WHERE TO DO SO WOULD CONSTITUTE A VIOLATION OF THE RELEVANT LAWS OR REGULATIONS OF SUCH JURISDICTION.” The full disclaimer is on our website but, for the man on the Clapham omnibus, it just means it is an investment only for sophisticated, professional investors.
Q2: You called your note Getting a balanced view on outlook. What is your summary of it?
A2: In recent years, RECI has generally traded at a small premium to its net asset value (NAV). It is now trading at a significant discount, which, we believe, reflects a reduction in investors’ confidence, reflecting the uncertain outlook, security values and potential impairments. When considering whether this discount is excessive, we note i) a relatively low-risk profile, ii) strong liquidity means RECI can optimise recovery returns, iii) restructuring is a core competency, iv) realised losses to date are just 2.1p, v) bond valuations are expected by RECI to be repaid at par, but priced at 17% below par, and vi) borrowers have been injecting equity into their deals. The stable 3p 4Q dividend and unchanged policy show confidence and re-investment returns rising.
Q3: What factors make you say it is a low-risk profile?
A3: Like-for-like, senior secured lending (76% NAV), especially when backed by property, should be a lower-risk profile than most lending. Borrowers have injected equity, and governments’ support for borrowers is unprecedented. The company’s liquidity risk is low (net debt just 6% of NAV). Realised losses to date have been just 2.1p. RECI believes that its bonds will be repaid at par over the next couple of years, and their discount is a temporary sentiment issue, unjustified by fundamentals. For loans, having expertise, and working overtime with borrowers, significantly reduces final losses. I cannot emphasise enough how important RECI’s strong balance sheet is in that it will not be a forced seller at distressed prices. Recovery may take time but recovering properly makes a huge difference to ultimate loss.
Q4: What can you tell us about some of RECI’s higher-risk positions?
A4: The Italian exposure (5% of the book) is to Northern Italy, primarily malls and cinemas. This exposure is through listed bonds, which are priced off market prices. The high quality of borrowers and security is reflected in this market price. Student accommodation borrowers (2% assets) have already discussed alternative uses for their apartments for the coming academic year. The largest hotel exposures (9% assets) have rental guarantors from a strongly capitalised operator or strong private equity-backed borrowers. The largest retail exposure is to a prime Paris site with a high-net-worth family backer. Overall ,the quality of backers appears robust, and they have been injecting equity into deals.
Q5: How has Real Estate Credit Investments responded to COVID-19?
A5: The measures taken are what we would expect – a detailed interaction with existing clients to establish their risk profile, and stress-testing their cashflow assumptions, actively managing liquidity and stopping the pipeline, as new lending opportunities are much better priced than existing ones.
Looking at the loan book, there have been four loans seeking forbearance, representing 4% of gross assets, and management is expecting a further six loans (19% GAV) to ask for forbearance in due course. RECI notes that its borrowers could ask for one of three things: i) fewer cash interest/principal repayments; ii) temporary suspension of covenants; or iii) simply an extension to the loan. In its development exposures (where RECI typically has monthly covenant requirements), there have been some delays and cost over-runs, and RECI has typically agreed to a delay in repayments, with more cash being injected into the project by the borrower. Some income-earning assets would have seen breaches of their income covenants and, again, RECI has typically agreed to this – where the discussions with management have indicated clear mitigation action.
There is a huge amount of more detail in the company’s presentation update on its website.