Q1: Your recent report 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: You called your piece ‘Improving returns on new opportunities’, what can you tell us about it?
A2: Real Estate Credit Investments released its quarterly investor update on 17 August and factsheet on 8 September. Our note updated investors with the key developments in both these documents.
The key messages are i) robust performance of existing portfolio through COVID-19, ii) full interest and capital repayments expected on bond portfolio, iii) strong volume in investment pipeline, iv) lower-risk business is being added, v) pricing on new business 2%-5% above pre-COVID-19 levels like-for-like, vi) low gearing, and vii) stable dividends. All this appears anomalous with the 17% discount to NAV.
Q3: Can you tell us a bit more about the resilience of the existing portfolio through COVID-19?
A3: Realised losses have been 1% of NAV, reflecting Cheyne’s strong credit assessment and security. Some borrowers have extended facilities (at an appropriate interest cost) but, also, there have been early repayments. We understand that all borrowers are paying in full and on time on their (revised) terms. It is currently trading on a mid-teen percent discount to NAV when, until COVID-19, it had been on a small premium.
We believe investors have been concerned about the real estate and credit outlook, when the actual performance to date clearly illustrates what RECI has done to assess and manage credit risk, and so limit downside. Over time, reality is the key driver.
Q4: And the new business?
A4: New business pricing has widened, and terms have improved. In contrast to the significant reduction in wider fixed income market yields, helped by central banks’ monetary policies and improving sentiment, the returns for European real estate debt markets remain persistently wide.
We believe this is driven by three factors: i) for banks, historical losses mean this is an area treated with extreme caution, and so this area will be the last they return to aggressively; ii) all funders have typically been focused on managing their existing books, devoting more resource to negotiations with borrowers than chasing new business; and iii) non-bank lenders have not been raising equity/have had their own debt financing constrained, and so have not been chasing new business.
We expect these factors to slowly unwind but, for the moment, they present excellent opportunities for those lenders with capacity. The extra value of the wider spread on new business to be added is likely to far exceed credit losses, implying that the overall value of the company should have risen. RECI’s cash balances are high, its gross debt is low, and it has opened up new financing channels –so it has plenty of firepower to fund the new positions. This may be valued by investors, as stable returns reduce uncertainty.
Q5: I can see it is continuing to pay a 3p quarterly dividend. At 12p a year, that is nearly a 10% yield. How safe is it, and what more can you tell us about the dividend policy?
A5: Its dividend yield is the highest of its immediate peers and above wider peer averages too.
Taking the policy first, Real Estate Credit Investments showed its confidence by an accelerated declaration of the dividend, as you say, at 3p – unchanged on the prior quarter. It also intends to pay “stable” dividends going forward. You could not get a much clearer statement of intent. In terms of whether it can meet this ambition and deliver that near 10% return for shareholders, the key issues are how much income is earned and how much credit losses will cost.
On income, as I said, new business is being priced at higher yields, and on better covenants. That is a tick.
On credit costs, it is all about how risk is assessed, monitored, managed and – critically – what the company does when things go wrong. The only way to be absolutely certain of not losing money is not to lend, but then you make no return.
In previous reports, we have highlighted the expertise of the managers (especially in restructuring collections), which is critical at the moment. We also highlighted how the manager, Cheyne, assesses credit and builds ongoing relationships with a borrower in a way in which a bank cannot. We emphasised the importance of a culture where Cheyne managers “own” the debt and are not simply employees of a lender.
Overall, RECI has policies, practices and a culture that should reduce both the probability of customers defaulting and also losses if they do. You cannot ask for more.