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Q&A with Hardman & Co: Real Estate Credit Investments (LON:RECI)

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 substantial 59-page report on Real Estate Credit Investments Ltd (RECI). What are your headline takeaways?

A1: RECI pays investors a high dividend yield (7.3%), covered by predictable income streams generated by an increasingly diversified portfolio of real-estate-backed debt. Its credit record has been exemplary.

In this report, we detailed the procedures that have delivered this performance, in addition to the benefits from the security taken. Much of the superior revenue yield is generated from service and structuring skills – among the many synergies obtained from having Cheyne Capital (Cheyne) as the manager. Corporate governance appears robust, with a strong board. RECI is exposed to the credit cycle, some of its loan assets may prove illiquid, and the (modest) gearing is short-term.

Q2: At this stage of the cycle, credit appears a critical factor for a lender. What can you tell us about RECI’s approach?

A2: RECI has an exemplary record, with no principal loss since its evolution in 2011. As we detailed in the report, this is the result of 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. We like the fact that credit approach adheres to basic Canons of Lending, known by the acronym CAMPARI (Character, Ability, Means, Purpose, Amount, Repayment, Insurance).

Expected cashflow, rather than the value of the security net, is the key metric. Cheyne adopts risk-adjusted pricing with a range of yields to reflect different risk. Finally, in terms of loan approval, there is clear independence between the risk-sanctioning functions and the marketeers/deal originators.

Q3: The manager is always important, what can you tell us about Cheyne Capital?

A3: The key advantages in having Cheyne as the investment manager are i) economies of scale, ii) specialist credit and structuring skills, iii) access to new deal flow, and iv) market knowledge and relationships. Cheyne also provides more regular disclosure than some of its peers, such as LBOW or SWEF.

In addition to the operational economies of scale from the investment manager, we note that the fixed costs of the fund itself are being spread over an ever-increasing asset pool, creating further efficiency gains. To us, the single most important thing, though, is culture. Cheyne managers are lenders to their fingertips, and this shows through in all they do. Critically, they “own” the exposures and are involved in collecting, as well as lending.

Q4: That all sounds positive and the yield is very attractive, what are the risks though?

A4: There are a number of risks – some more about perception than reality. 

Firstly, RECI’s reported yields range from 5.1% to 13.5% and, while such yields can be generated from a range of sources, including incremental risk, limited competition, structuring skills and expertise, product flexibility, service levels, or illiquidity premia, there may be the perception that this is from increased risk. 

Secondly, non-senior debt positions, including mezzanine finance, account for 19.5% of the portfolio and, like-for-like, these are higher-risk than senior debt.

Thirdly, there is remote lending in different jurisdictions, as Cheyne does not have local offices in each country. Cheyne, however, has a low-risk appetite and approach to lending in new countries.

Fourthly, there is development finance, again noting that Cheyne’s long experience is a mitigating factor.

Finally, it has some high loan to value (LTV) exposures. We explored each of these issues in detail in our note and concluded that the risks were more around sentiment, with Cheyne adopting the right approach to risk management.

Q5: With largely illiquid, unquoted assets, do you see any read-across from the Woodford situation?

A5: The short answer is ‘no’. As a closed-ended vehicle, Real Estate Credit Investments Ltd has permanent capital, and its limited amount of debt is more than covered by assets that should be relatively liquid or be considered as good security by other sources of funding. RECI is extremely unlikely to ever be a forced seller of assets at distressed prices.

Looking at asset valuations, RECI has a range of checks and balances to ensure that the values are independently verified. RECI has never been dependent on retail investor platform sales. Its own shares are liquid, which means it should not be affected by any restrictions on potential investors on the tradability of their positions.

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