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Upcoming Event | Hardman & Co: Bank North management presentation and Q&A

In our note, Why rising rates should not hurt RECI, published on 8 November 2021, we explored RECI’s low sensitivity to rising rates by analysing i) borrower revenue sensitivity, ii) borrower debt sensitivity, iii) RECI’s portfolio risk mitigation techniques, iv) the MTM on the bond portfolio, v) the impact of RECI’s own funding mix, vi) international diversification), vii) previous share price experience, viii) sentiment to the stock, and ix) potential opportunities that could arise. This reinforced previous analyses that RECI’s business has limited downside. We used a case study of a hotel exposure to illustrate how Cheyne’s management of challenging relationships materially reduces the final loss.

  • Why low sensitivity: RECI ensures that it has borrowers that are less rate-sensitive, projects that are primarily income-generating, deals that are carefully structured, strong balance sheet management and diversification. Credit exposure from rising rates, the critical risk, is tightly controlled. As rates rise, income is likely to increase.
  • Historical market reaction: In three of the four periods of sustained rate rises in the past decade, RECI’s share price has risen. Even in the fourth case, the share price rose in the early stages of the interest rate hikes. Prima facie, the market has treated RECI as at least neutral to, if not a beneficiary from, rate increases.
  • Valuation: RECI continues its steady recovery from COVID-19 lows, and now trades at a 0.8% premium to NAV, slightly below the five-year, pre-pandemic average. RECI has continued to pay its annualised 12p dividend, generating a dividend yield of 7.8%, which is expected to be covered by earnings.
  • Risks: Any lender is exposed to credit risks. We believe RECI has appropriate policies to reduce the probability of default. Its average LTV is 65%, 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.
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