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RECI’s current discount to NAV (12%) suggests to us that some investors could be concerned that potential issues with commercial real estate (CRE) will dramatically affect the trust’s assets. In our note, Why CRE equity worries should not apply to RECI, we identified that RECI’s management of its position as a debt provider, and its asset selection, make it very different, noting i) CRE equity holders take first losses (with a 60% LTV, RECI has a big cushion), ii) when accounts have got into difficulties, RECI has typically seen more funds injected by the equity backers, iii) CRE equity holders suffer from rising rates, and iv) RECI has limited high-sector-risk exposure.

  • CRE equity holders vs. RECI: CRE equity holders can suffer losses from falling CRE prices, rents and rising borrowing costs. The risks to a CRE debt provider (like RECI) arise from the probability of a borrower defaulting and loss in the event of default, not CRE prices alone. RECI’s procedures reduce both of these factors.
  • Sep 2023 factsheet: The underlying NAV rose 1.2p, owing to recurring interest income (1.0p). Cash was £15m, and gross leverage £93m. The book has 45 positions (30 loans, gross drawn value £390m, and 15 bonds, fair value £35m – down from 26 and £90m, respectively, at end-March). The weighted average LTV is 60%, and the yield is 10.4%.
  • Valuation: In the five-year, pre-pandemic era, on average, RECI traded at a premium to NAV. In periods of market uncertainty, it has traded at a discount; currently, it trades at a well-above-average 12% discount. RECI is paying an annualised 12p dividend, generating a yield of 9.2%, which we expect to be covered by recurring net interest income.
  • Risks: Any lender is exposed to credit risks. We believe RECI has appropriate policies to reduce the probability of default. As noted, its average LTV is 60%, and most loans are senior-secured, providing a downside cushion. Some assets are illiquid. In the short term, investor sentiment could be an issue.
  • Investment summary: RECI generates an above-average dividend yield from well-managed credit assets. Management has confirmed no change to dividend policy, showing its confidence in its sustainability. Bond pricing includes a 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. An up to £5m share buyback programme was announced on 31 August 2023.
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