Real Estate Credit Investments Ltd (LON:RECI) is the topic of conversation when Hardman & Co’s Analyst Mark Thomas caught up with DirectorsTalk for an exclusive interview.
Q1: Your recent report on the company 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 ‘Why the discount has been closing and its outlook’, what can you tell us about it?
A2: Real Estate Credit Investments’discount has halved over the past six months. We believe this is due to both actions taken by the trust, with an active buyback programme, changing asset mix and enhanced disclosure of highest-risk positions, and more favourable markets.
Interestingly, not all debt investment companies have benefitted from the more favourable markets. By historical standards, the current level of their discount is very high, circa 10% above the 10-year average. The company was at an average 2% premium in 2015-19, and traded at premium again in 2021-22, leaving room for investor concerns to moderate considerably by just reverting to historical average levels.
Q3:Can you outline what the management has been doing to close the discount?
A3: Management actions cover both how it has positioned the portfolio but also capital allocation.
Looking at the portfolio, it has been moving to a lower risk profile with senior secured loans not mezzanine finance, and also shifting into lower risk sectors, most notably what they call living assets, so residential units, student accommodation, assisted housing. It has also announced it will be moving away from development loans and into what they call core/core + or ones where the underlying assets are producing income to make repayments.
They have reduced volatile bonds whose mark downs in challenging times just added to uncertainty, even though they were largely written back later. It is important to understand that a sustained discount to NAV is, in our view, driven by investors believing there are inherent or future losses in the portfolio and so, by reducing the risk of the portfolio, these uncertainties also reduce.
On capital allocation, it has also announced three sequential buyback programmes and, since August 2023, has done the equivalent of nearly a month and half’s normal trading under these programmes.
Q4: And the market conditions have been positive?
A4: In our note, we explore why debt markets have been robust and defaults stayed relatively low, the falling discounts at REITs as their falling valuations appear to have stabilised, and how the market appetite for smaller companies has increased.
We also note that not all debt investment companies, including some of Real Estate Credit Investments’ comparators, have not benefitted from these trends while they have.
Q5: And the outlook?
A5: Our note considers how even just a reversion to historical averages would see:
- the discount reduce,
- the importance of continued return delivery, especially from a lower-risk portfolio in uncertain times,
- how our earnings forecasts were increased after the recent Capital Markets day, which is important in giving dividend cover confidence,
- the recent renewal of the buyback at an elevated level,
- expected disclosures.
Q6: And the risks?
A6: 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.
