CHICAGO ATLANTIC REAL ESTATE FINANCE, INC.
The following discussion and analysis of our financial condition and results of
operations should be read together with the consolidated financial statements
and related notes that are included elsewhere in this annual report on Form
10-K. This discussion contains forward-looking statements that reflect our
current expectations and views of future events, which involve risks and
uncertainties. Our actual results and the timing of selected events could differ
materially from those anticipated in such forward-looking statements. Factors
that could cause or contribute to those differences include, but are not limited
to, those discussed above in "Risk Factors" and those identified below and
elsewhere in this annual report on Form 10-K. See "Forward-Looking Statements."
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Overview
We are a commercial real estate finance company. Our primary investment
objective is to provide attractive, risk-adjusted returns for stockholders over
time primarily through consistent current income dividends and other
distributions and secondarily through capital appreciation. We intend to achieve
this objective by originating, structuring and investing in first mortgage loans
and alternative structured financings secured by commercial real estate
properties. Our current portfolio is comprised primarily of senior loans to
state-licensed operators in the cannabis industry, secured by real estate,
equipment, receivables, licenses or other assets of the borrowers to the extent
permitted by applicable laws and regulations governing such borrowers. We intend
to grow the size of our portfolio by continuing the track record of our business
and the business conducted by our Manager and its affiliates by making loans to
leading operators and property owners in the cannabis industry. There is no
assurance that we will achieve our investment objective.
Our Manager and its affiliates seek to originate real estate loans between $5
million and $200 million , generally with one- to five-year terms and
amortization when terms exceed three years. We generally act as co-lenders in
such transactions and intend to hold up to $50 million of the aggregate loan
amount, with the remainder to be held by affiliates or third party co-investors.
We may revise such concentration limits from time to time as our loan portfolio
grows. Other investment vehicles managed by our Manager or affiliates of our
Manager may co-invest with us or hold positions in a loan where we have also
invested, including by means of splitting commitments, participating in loans or
other means of syndicating loans. We will not engage in a co-investment
transaction with an affiliate where the affiliate has a senior position to the
loan held by us. To the extent that an affiliate provides financing to one of
our borrowers, such loans will be working capital loans or loans that are
subordinate to our loans. We may also serve as co-lenders in loans originated by
third parties and, in the future, we may also acquire loans or loan
participations. Loans that have a one to two year maturity are generally
interest only loans.
Our loans are secured by real estate and, in addition, when lending to
owner-operators in the cannabis industry, other collateral, such as equipment,
receivables, licenses or other assets of the borrowers to the extent permitted
by applicable laws and regulations. In addition, we seek to impose strict loan
covenants and seek personal or corporate guarantees for additional protection.
As of December 31, 2022 , 13.6% of the loans held in our portfolio are backed by
personal or corporate guarantees. We aim to maintain a portfolio diversified
across jurisdictions and across verticals, including cultivators, processors,
dispensaries, as well as ancillary businesses. In addition, we may invest in
borrowers that have equity securities that are publicly traded on the Canadian
Stock Exchange ("CSE") in Canada and/or over-the-counter in the United States .
As of December 31, 2022 , our portfolio is comprised primarily of first mortgages
to established multi-state or single-state cannabis operators or property
owners. We consider cannabis operators to be established if they are
state-licensed and are deemed to be operational by the applicable state
regulator. We do not own any stock, warrants to purchase stock or other forms of
equity in any of our portfolio companies that are involved in the cannabis
industry, and we will not take stock, warrants or equity in such issuers until
permitted by applicable laws and regulations, including U.S. federal laws and
regulations.
We are an externally managedMaryland corporation that elected to be taxed as a REIT under Section 856 of the Code, commencing with our taxable period endedDecember 31, 2021 . We believe that our method of operation will enable us to continue to qualify as a REIT. However, no assurances can be given that our beliefs or expectations will be fulfilled, since qualification as a REIT depends on us continuing to satisfy numerous asset, income and distribution tests, which in turn depend, in part, on our operating results. We also intend to operate our business in a manner that will permit us and our subsidiaries to maintain one or more exclusions or exemptions from registration under the Investment Company Act. Revenues
We operate as one operating segment and are primarily focused on financing
senior secured loans and other types of loans for established state-licensed
operators in the cannabis industry. These loans are generally held for
investment and are secured by real estate, equipment, licenses and other assets
of the borrowers to the extent permitted by the applicable laws and the
regulations governing such borrowers.
67
We generate revenue primarily in the form of interest income on loans. As of
December 31, 2022 and 2021, approximately 83.1% and 53.2%, respectively, of our
portfolio was comprised of floating rate loans, and 16.9% and 46.8% of our
portfolio was comprised of fixed rate loans, respectively. The floating rate
loans described above are variable based upon the Prime Rate plus an applicable
margin, and in many cases, a Prime Rate floor.
The Prime Rate during the year ended
Effective Date Rate(1)December 15, 2022 7.50 %November 3, 2022 7.00 %September 22, 2022 6.25 %July 28, 2022 5.50 %June 16, 2022 4.75 %May 5, 2022 4.00 %March 17, 2022 3.50 %March 15, 2020 3.25 %
(1) Rate obtained from the
Interest on our loans is generally payable monthly. The principal amount of our
loans and any accrued but unpaid interest thereon generally become due at the
applicable maturity date. In some cases, our interest income includes a
paid-in-kind ("PIK") component for a portion of the total interest. The PIK
interest, computed at the contractual rate specified in each applicable loan
agreement, is accrued in accordance with the terms of such loan agreement and
capitalized to the principal balance of the loan and recorded as interest
income. The PIK interest added to the principal balance is typically amortized
and paid in accordance with the applicable loan agreement. In cases where the
loans do not amortize, the PIK interest is collected upon repayment of the
outstanding principal. We also generate revenue from original issue discounts
("OID"), which is also recognized as interest income from loans over the initial
term of the applicable loans. Delayed draw loans may earn interest or unused
fees on the undrawn portion of the loan, which is recognized as interest income
in the period earned. Other fees, including prepayment fees and exit fees, are
also recognized as interest income when received. Any such fees will be
generated in connection with our loans and recognized as earned in accordance
with generally accepted accounting principles ("GAAP").
Expenses
Our primary operating expense is the payment of Base Management Fees and
Incentive Compensation under our Management Agreement with our Manager and the
allocable portion of overhead and other expenses paid or incurred on our behalf,
including reimbursing our Manager for a certain portion of the compensation of
certain personnel of our Manager who assist in the management of our affairs,
excepting only those expenses that are specifically the responsibility of our
Manager pursuant to our Management Agreement. We bear all other costs and
expenses of our operations and transactions, including (without limitation)fees and expenses relating to:
? organizational and offering expenses;
? quarterly valuation expenses;
? fees payable to third parties relating to, or associated with, making loans and
valuing loans (including third-party valuation firms);
? fees and expenses associated with investor relations and marketing efforts
(including attendance at investment conferences and similar events);
? accounting and audit fees and expenses from our independent registered public
accounting firm;
? federal and state registration fees;
? any exchange listing fees;
? federal, state and local taxes;
? independent directors' fees and expenses;
? brokerage commissions;
? costs of proxy statements, stockholders' reports and notices; and
? costs of preparing government filings, including periodic and current reports with theSEC . 68 Income Taxes
We are aMaryland corporation that elected to be taxed as a REIT under the Code, commencing with our taxable period endedDecember 31, 2021 . We believe that our method of operation will enable us to continue to qualify as a REIT. However, no assurances can be given that our beliefs or expectations will be fulfilled, since qualification as a REIT depends on us satisfying numerous asset, income and distribution tests which depends, in part, on our operating results. To qualify as a REIT, we must meet a number of organizational and operational requirements, including a requirement that we distribute annually to our stockholders at least 90% of our REIT taxable income prior to the deduction for dividends paid. To the extent that we distribute less than 100% of our REIT taxable income in any tax year (taking into account any distributions made in a subsequent tax year under Sections 857(b)(9) or 858 of the Code), we will pay tax at regular corporate rates on that undistributed portion. Furthermore, if we distribute less than the sum of 1) 85% of our ordinary income for the calendar year, 2) 95% of its capital gain net income for the calendar year, and 3) any undistributed shortfall from its prior calendar year (the "Required Distribution") to our stockholders during any calendar year (including any distributions declared by the last day of the calendar year but paid in the subsequent year), then we are required to pay a non-deductible excise tax equal to 4% of any shortfall between the Required Distribution and the amount that was actually distributed. The 90% distribution requirement does not require the distribution of net capital gains. However, if we elect to retain any of our net capital gain for any tax year, we must notify our stockholders and pay tax at regular corporate rates on the retained net capital gain. Our stockholders must include their proportionate share of the retained net capital gain in their taxable income for the tax year, and they are deemed to have paid the REIT's tax on their proportionate share of the retained capital gain. Furthermore, such retained capital gain may be subject to the nondeductible 4% excise tax. If it is determined that our estimated current year taxable income will be in excess of estimated dividend distributions (including capital gain dividend) for the current year from such income, we will accrue excise tax on estimated excess taxable income as such taxable income is earned. The annual expense is calculated in accordance with applicable tax regulations. Excise tax expense is included in the line item income tax expense. For the year endedDecember 31, 2022 and the period endedDecember 31, 2021 , we did not incur excise tax expense.Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") Topic 740 - Income Taxes ("ASC 740"), prescribes a recognition threshold and measurement attribute for the consolidated financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. ASC 740 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. We have analyzed our various federal and state filing positions and believe that our income tax filing positions and deductions are well documented and supported as ofDecember 31, 2022 and 2021. Based on our evaluation, there is no reserve for any uncertain income tax positions. Accrued interest and penalties, if any, are included within other liabilities in the consolidated balance sheets.
Factors Impacting our Operating Results
The results of our operations are affected by a number of factors and primarily
depend on, among other things, the level of our net interest income, the market
value of our assets and the supply of, and demand for, commercial real estate
debt and other financial assets in the marketplace. Our net interest income,
which includes the accretion and amortization of OID, is recognized based on the
contractual rate and the outstanding principal balance of the loans we
originate. Interest rates will vary according to the type of loan, conditions in
the financial markets, creditworthiness of our borrowers, competition and other
factors, some of which cannot be predicted with any certainty. Our operating
results may also be impacted by credit losses in excess of initial anticipations
or unanticipated credit events experienced by borrowers.
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Changes in Market Interest Rates and Effect on Net Interest Income
Interest rates are highly sensitive to many factors, including fiscal and monetary policies and domestic and international economic and political considerations, as well as other factors beyond our control. We will be subject to interest rate risk in connection with our assets and our related financing obligations.
Our operating results will depend in large part on differences between the income earned on our assets and our cost of borrowing. The cost of our borrowings generally will be based on prevailing market interest rates. During a period of rising interest rates, our borrowing costs generally will increase (a) while the yields earned on our leveraged fixed-rate loan assets will remain static, and (b) at a faster pace than the yields earned on our leveraged floating-rate loan assets, which could result in a decline in our net interest spread and net interest margin. The severity of any such decline would depend on our asset/liability composition at the time as well as the magnitude and duration of the interest rate increase. Further, an increase in short-term interest rates could also have a negative impact on the market value of our target investments. If any of these events happen, we could experience a decrease in net income or incur a net loss during these periods, which could adversely affect our liquidity and results of operations. Interest Rate Cap Risk
We currently own and intend to acquire in the future floating-rate assets. These are assets in which the loans may be subject to periodic and lifetime interest rate caps and floors, which limit the amount by which the asset's interest yield may change during any given period. However, our borrowing costs pursuant to our financing agreements may not be subject to similar restrictions. Therefore, in a period of increasing interest rates, interest rate costs on our borrowings could increase without limitation by caps, while the interest-rate yields on our floating-rate assets would effectively be limited. In addition, floating-rate assets may be subject to periodic payment caps that result in some portion of the interest being deferred and added to the principal outstanding. This could result in our receipt of cash income from such assets in an amount that is less than the amount that we would need to pay the interest cost on our related borrowings. These factors could lower our net interest income or cause a net loss during periods of rising interest rates, which would harm our financial condition, cash flows and results of operations. As ofDecember 31, 2022 , all of our floating rate loans have interest rate floors, and one loan is subject to an interest rate cap.
Interest Rate Mismatch Risk
We may fund a portion of our origination of loans, or of loans that we may in
the future acquire, with borrowings that are based on the Prime Rate or a
similar measure, while the interest rates on these assets may be fixed or
indexed to the Prime Rate or another index rate. Accordingly, any increase in
the Prime Rate will generally result in an increase in our borrowing costs that
would not be matched by fixed-rate interest earnings and may not be matched by a
corresponding increase in floating-rate interest earnings. Any such interest
rate mismatch could adversely affect our profitability, which may negatively
impact distributions to our stockholders.
Our analysis of risks is based on our Manager's experience, estimates, models
and assumptions. These analyses rely on models which utilize estimates of fair
value and interest rate sensitivity. Actual economic conditions or
implementation of decisions by our Manager and our management may produce
results that differ significantly from the estimates and assumptions used in our
models and the projected results.
Market Conditions
We believe that favorable market conditions, including an imbalance in supply
and demand of credit to cannabis operating companies, have provided attractive
opportunities for non-bank lenders, such as us, to finance commercial real
estate loans and other loans that exhibit strong fundamentals but also require
more customized financing structures and loan products than regulated financial
institutions can presently provide. Additionally, to the extent that additional
states legalize cannabis, our addressable market will increase. We intend to
continue our track record of capitalizing on these opportunities and growing the
size of our portfolio.
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Risk Management
To the extent consistent with maintaining our REIT qualification and our
exemption from registration under the Investment Company Act, we seek to manage
risk exposure by closely monitoring our portfolio and actively managing the
financing, interest rate, credit, prepayment and convexity (a measure of the
sensitivity of the duration of a loan to changes in interest rates) risks
associated with holding our portfolio of loans. Generally, with the guidance and
experience of our Manager:
? we manage our portfolio through an interactive process with our Manager and
generally service our self-originated loans through our Manager's servicer;
? we invest in a mix of floating-and fixed-rate loans to mitigate the interest
rate risk associated with the financing of our portfolio;
? we actively employ portfolio-wide and asset-specific risk measurement and
management processes in our daily operations, including utilizing our Manager's
risk management tools such as software and services licensed or purchased from
third-parties and proprietary analytical methods developed by our Manager; and
? we seek to manage credit risk through our due diligence process prior to
origination or acquisition and through the use of non-recourse financing, when
and where available and appropriate. In addition, with respect to any
particular target investment, prior to origination or acquisition our Manager's
investment team evaluates, among other things, relative valuation, comparable
company analysis, supply and demand trends, shape-of-yield curves, delinquency
and default rates, recovery of various sectors and vintage of collateral.
Recent Developments
Updates to Our Loan Portfolio during Fiscal Year 2022
For the period
For the periodApril 1, 2022 throughJune 30, 2022 , we closed a credit facility with one new borrower, which included an aggregate commitment of$17.0 million , all of which was advanced at closing. Additionally, we advanced$34.2 million in aggregate principal on existing credit facilities to seven different borrowers. 71 For the periodJuly 1, 2022 throughSeptember 30, 2022 , we closed one credit facility with a new borrower, which had an aggregate commitment of$9.0 million ,$5.0 million of which was advanced at closing. Additionally, we sold a senior secured loan to an affiliate under common control. The selling price of approximately$6.7 million was approved by the Audit Committee of the Board. The fair value approximated the carrying value of the loan plus accrued and unpaid interest through the selling date. Further, we assigned$10.0 million of unfunded commitment of a senior secured loan to an affiliate and we advanced approximately$680 thousand in aggregate principal on an existing credit facility to one borrower. For the periodOctober 1, 2022 throughDecember 31, 2022 , we refinanced and closed two credit facilities with two existing borrowers, which had an aggregate commitment of$43.1 million , both of which were fully funded at closing. Additionally, we advanced approximately$3.4 million in aggregate principal on existing credit facilities to three borrowers.
Subsequent Updates to Our Loan Portfolio
OnJanuary 12, 2023 , we advanced approximately$0.2 million in aggregate principal on an existing credit facility to one borrower. OnJanuary 24, 2023 , we refinanced and closed one credit facility with an existing borrower, which resulted in a paydown of$18.3 million in aggregate principal. OnJanuary 24, 2023 , we also purchased a senior secured loan from an affiliate under common control. The purchase price of approximately$19.0 million was approved by the Audit Committee of the Board. The fair value approximated the carrying value of the loan plus accrued and unpaid interest throughJanuary 24, 2023 . OnJanuary 24, 2023 , we also closed one credit facility with a new borrower, which had an aggregate commitment of$11.3 million , which was fully funded at closing. OnMarch 6, 2023 , we advanced approximately$0.7 million in aggregate principal on an existing credit facility to one borrower. Dividends Declared Per Share For the period fromJanuary 1, 2022 throughMarch 31, 2022 , we declared a cash dividend of$0.40 per share of our common stock, relating to the first quarter of 2022, which was paid onApril 14, 2022 to stockholders of record as of the close of business onMarch 31, 2022 . The total amount of the cash dividend payment was$7.1 million . For the period fromApril 1, 2022 throughJune 30, 2022 , we declared a cash dividend of$0.47 per share of our common stock, relating to the second quarter of 2022, which was paid onJuly 15, 2022 to stockholders of record as of the close of business onJune 30, 2022 . The total amount of the cash dividend payment was approximately$8.3 million . For the period fromJuly 1, 2022 throughSeptember 30, 2022 , we declared a cash dividend of$0.47 per share of our common stock, relating to the third quarter of 2022, which was paid onOctober 14, 2022 to stockholders of record as of the close of business onSeptember 30, 2022 . The total amount of the cash dividend payment was approximately$8.3 million . For the period fromOctober 1, 2022 throughDecember 31, 2022 , we declared a cash dividend of$0.47 per share of our common stock, relating to the fourth quarter of 2022, which was paid onJanuary 13, 2023 to stockholders of record as of the close of business onDecember 30, 2022 . The total amount of the cash dividend payment was approximately$8.3 million . In addition, we declared a special cash dividend of$0.29 per share of our common stock, which was paid onJanuary 13, 2023 to stockholders of record as of the close of business onDecember 30, 2022 . The total amount of the special cash dividend payment was approximately$5.1 million .
The payment of these dividends is not indicative of our ability to pay such dividends in the future.
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Results of Operations
Comparison of the Year Ended
Increase /
Year Ended Period Ended (Decrease)
December 31, December 31, 2022 vs.
2022 2021 2021
Revenue
Interest income $ 51,471,766 $ 11,075,116 $ 40,396,650
Interest expense (2,614,138 ) (75,861 ) (2,538,277 )
Net interest income 48,857,628 10,999,255 37,858,373
Expenses:Management and incentive fees, net 6,562,087 802,294 5,759,793 Provision for current expected credit losses 3,887,405 147,949 3,739,456 General and administrative expense 3,528,322 297,916 3,230,406 Professional fees 2,151,714 57,458 2,094,256 Stock based compensation 435,623
29,611 406,012
Organizational expense - 167,591 (167,591 )
Total expenses $ 16,565,151 1,502,819 15,062,332
Net Income before income taxes 32,292,477
9,496,436 22,796,041
Income tax expense - - -
Net Income $ 32,292,477 $ 9,496,436 $ 22,796,041
We commenced operations on March 30, 2021 and, therefore, the comparative period
for the year ended December 31, 2022 is from March 30, 2021 (inception) to
December 31, 2021 (the "Prior Period" or "period ended December 31, 2021 ").
Differences in the results of operations compared to the Prior Period are mainly
due to the Prior Period only including approximately nine months of operations
compared to the year ended December 31, 2022 . Results for the initial periods of
our operations are not indicative of the results we expect when our investment
strategy has been fully implemented and proceeds from our IPO are fully
deployed.
? Interest income increased as we deployed approximately
capital subsequent to
offering. Further driving the increase was an increase in the Prime Rate
from 3.25% as of
impacting the Company's loans which bear a floating rate as well as new
fundings of approximately
the Company's portfolio was 19.7% and 18.6%, respectively.
? The increase in interest income was offset by a corresponding increase in
interest expense. During the year ended
additional
bears interest at the Prime Rate plus an applicable margin and was subject
to the Prime Rate increases throughout the year. During the year ended
the Third Amendment, which were capitalized and are subsequently amortized
through maturity. The amortized debt issuance costs included in interest
expense was $563,464 for the year ended December 31, 2022 . Interest
expense previously included only amortization of deferred financing costs
for the period ended December 31, 2021 .
? We incurred base management and incentive fees payable to our Manager of
approximately
compared to approximately
2021. The increase in base management and incentive fees payable to our
Manager was primarily attributable to greater assets under management as
well as greater origination fee offsets in the year ended
2022 of approximately
the period ended
average equity as defined by the Management Agreement for the comparable
period. In addition, pursuant to Fee Waiver Letter Agreements executed by
our Manager, dated
management fees that would have been payable to our Manager for the period
from
subject to recoupment at a later date.
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? Pursuant to a Fee Waiver Letter Agreement executed by our Manager, dated
to our Manager for the period from
as well as a portion of reimbursable expenses incurred during the period
from
not subject to recoupment at a later date.
? Provision for current expected credit losses increased in the year ended
December 31, 2022 as compared to the period ended December 31, 2021 primarily due to declines in risk ratings (discussed below) from December
31, 2021 to
credit issues, but rather, are primarily due to our quarterly
re-evaluations of overall current macroeconomic conditions affecting our
borrowers. As interest rates have risen over the year ended
2022, the ability of our borrowers to service their debt and fund
operations has been reduced. The current expected credit loss reserve
represents 115 basis points of our aggregate loan commitments held at
carrying value of approximately
(i) the current expected credit loss reserve (contra-asset) related to
outstanding balances on loans held at carrying value of approximately
million and (ii) a liability for unfunded commitments of $94,413 . The
liability is based on the unfunded portion of loan commitments over thefull contractual period over which we are exposed to credit risk through a
current obligation to extend credit. Management considered the likelihood
that funding will occur, and if funded, the expected credit loss on the
funded portion. We continuously evaluate the credit quality of each loan
by assessing the risk factors of each loan.
? Our Manager has incurred general administrative expenses on our behalf and
was reimbursed approximately
2022. For the period ended December 31, 2021 , all reimbursements to our
Manager from May 1, 2021 to September 30, 2021 for general and
administrative expenses were voluntarily waived by our Manager and not
subject to recoupment at a later date.
? The increase in professional fees was primarily due to an increase in
audit, legal, investor relations and third-party consulting fees in the
normal course of business as we continued to increase our assets under
management.
? The increase in stock based compensation expense was due to having a fullyear of restricted stock grants outstanding for the year ended December
31, 2022 as opposed to less than a month for the year ended
2021.
Loan Portfolio
As of December 31, 2022 and 2021, our portfolio included 22 and 21 loans held
for investment of approximately $339.3 million and $197.0 million of loans
receivable, respectively. The aggregate originated commitment under these loans
was approximately $351.4 million and $235.1 million and outstanding principal
was approximately $343.0 million and $200.6 million as of December 31, 2022 and
2021, respectively. As of December 31, 2022 and 2021, our loan portfolio had a
weighted-average yield-to-maturity internal rate of return ("YTM IRR") of 19.7%
and 18.6%, respectively, and was substantially secured by real estate and, with
respect to certain of our loans, substantially all assets of the borrowers and
certain of their subsidiaries, including equipment, receivables, and licenses.
YTM IRR is calculated using various inputs, including (i) cash and paid-in-kind
("PIK") interest, which is capitalized and added to the outstanding principal
balance of the applicable loan, (ii) original issue discount ("OID"), (iii)
amortization, (iv) unused fees, and (v) exit fees. Certain of our loans have
extension fees, which are not included in our YTM IRR calculations, but may
increase YTM IRR if such extension options are exercised by borrowers.
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As of December 31, 2022 and 2021, approximately 83.1% and 53.2%, respectively,
of our portfolio was comprised of floating rate loans that pay interest at the
Prime Rate plus an applicable margin and were subject to a Prime Rate floor. The
Prime Rate was 3.25% for the period from January 1, 2022 through March 16, 2022 ,
increased to 3.50% effective March 17, 2022 , increased to 4.00% effective May 5,
2022 , increased again to 4.75% effective June 16, 2022 , increased to 5.50%
effective July 28, 2022 , increased to 6.25% effective September 22, 2022 ,
increased to 7.00% effective November 3, 2022 , and increased again to 7.50%
effective December 15, 2022 . The below summarizes our portfolio as of December
31, 2022 :
Initial
Funding Maturity Total Principal Carrying Percent of Our Future Periodic YTM Loan Date (1) Date (2) Commitment (3) Balance Value Loan Portfolio Fundings Interest Rate (4) Payment(5) IRR (6)
1
8.6 % - P + 6.50%(7) I/O 16.3 %
2
10.9 % - P + 6.65%(7)(8) Cash, 4.25% PIK P&I 18.0 %
3(11)
6.0 % - 13.91% Cash(7), 2.59% PIK P&I 21.3 %
4(9)
3.8 % - 18.72%(7)(8) P&I 24.2 %
5 4/19/2021 4/30/2025 3,500,000 1,856,000 1,856,000 0.5 % 1,644,000 P + 12.25%(7) P&I 24.3 %
6
3.9 % - P + 10.75%(7) Cash, 4% PIK(10) P&I 22.6 %
7 8/20/2021 2/20/2024 6,000,000 4,359,375 4,354,824 1.3 % 1,500,000 P + 9.00%(7) P&I 17.1 %
8
7.4 % - P + 6.00%(7) Cash, 2.5% PIK P&I 17.8 %
9 9/1/2021 9/1/2024 9,500,000 10,086,382 9,980,730 2.9 % - 18.75% PIK P&I 25.9 %
10
4.6 % - P + 10.75%(7) Cash, 6% PIK P&I 23.6 %
11 9/20/2021 9/30/2024 470,411 274,406 274,406 0.1 % - 11.00% P&I 21.4 %
12
9.4 % - P + 8.75%(7) Cash, 2% PIK I/O 21.4 %
13 11/8/2021 10/31/2024 20,000,000 20,000,000 19,815,257 5.8 % - 13.00% P&I 18.4 %
14 11/22/2021 11/1/2024 13,100,000 13,118,014 12,993,155 3.8 % - P + 6.00%(7) Cash, 1.5% PIK I/O 18.0 %
15 12/27/2021 12/27/2026 5,000,000 5,194,167 5,194,167 1.5 % - P + 12.25%(7) Cash, 2.5% PIK P&I 22.8 %
16 12/29/2021 12/29/2023 6,000,000 3,787,852 3,743,099 1.1 % 2,400,000 P + 7.50%(7) Cash, 5% PIK I/O 20.9 %
17 12/30/2021 12/31/2024 13,000,000 7,387,500 7,337,523 2.2 % 5,500,000 P + 9.25%(7) I/O 19.9 %
18 1/18/2022 1/31/2025 15,000,000 15,000,000 14,737,682 4.3 % - P + 4.75%(7) P&I 14.2 %
19 2/3/2022 2/28/2025 30,000,000 30,837,950 30,415,113 9.0 % - P + 8.25%(7) Cash, 3% PIK P&I 24.4 %
20 3/11/2022 8/29/2025 20,000,000 20,483,947 20,406,737 6.0 % - 11% Cash, 3% PIK P&I 15.3 %
21 5/9/2022 5/30/2025 17,000,000 17,337,220 17,203,138 5.1 % - 11% Cash, 3% PIK P&I 15.5 %
22 7/1/2022 7/29/2026 9,000,000 5,076,736 4,997,797 1.5 % 4,000,000 P + 8.50%(7) Cash, 3% PIK P&I 24.3 %
Subtotal $ 351,367,706 $ 343,029,334 $ 339,273,538 100.0 % $ 15,044,000 16.9% Wtd Average 19.7 %
(1) All loans originated prior to
entities at fair value plus accrued interest on or subsequent to
2021.
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(2) Certain loans are subject to contractual extension options and may besubject to performance based on other conditions as stipulated in the loan
agreement. Actual maturities may differ from contractual maturities stated
herein as certain borrowers may have the right to prepay with or without a
contractual prepayment penalty. The Company may also extend contractual
maturities and amend other terms of the loans in connection with loan
modifications.
(3) Total Commitment excludes future amounts to be advanced at sole discretion
of the lender.
(4) "P" = Prime Rate and depicts floating rate loans that pay interest at the
Prime Rate plus a specific percentage; "PIK" = paid-in-kind interest;
subtotal represents weighted average interest rate.
(5) P&I = principal and interest. I/O = interest only. P&I loans may include
interest only periods for a portion of the loan term.
(6) Estimated YTM includes a variety of fees and features that affect the
total yield, which may include, but is not limited to, OID, exit fees,prepayment fees, unused fees and contingent features. OID is recognized as
a discount to the funded loan principal and is accreted to income over the
term of the loan.
The estimated YTM calculations require management to make estimates andassumptions, including, but not limited to, the timing and amounts of loan
draws on delayed draw loans, the timing and collectability of exit fees,
the probability and timing of prepayments and the probability of
contingent features occurring. For example, certain credit agreements
contain provisions pursuant to which certain PIK interest rates and fees
earned by us under such credit agreements will decrease upon the
satisfaction of certain specified criteria which we believe may improve
the risk profile of the applicable borrower. To be conservative, we have
not assumed any prepayment penalties or early payoffs in our estimated YTM
calculation. Estimated YTM is based on current management estimates and
assumptions, which may change. Actual results could differ from those
estimates and assumptions.
(7) This Loan is subject to Prime Rate floor.
(8) This Loan is subject to an interest rate cap.
(9) The aggregate loan commitment to Loan #4 includes a
commitment which has a base interest rate of 15.00% and a second
commitment of $2.0 million which has an interest rate of 39%. The
statistics presented reflect the weighted average of the terms under all
advances for the total aggregate loan commitment.
(10) Subject to adjustment not below 2% if borrower receives at least two
consecutive quarters of positive cash flow after the closing date.
(11) The aggregate loan commitment to Loan #3 includes a
commitment which has a base interest rate of 13.625%, 2.75% PIK and a
second commitment of
2.00% PIK. The statistics presented reflect the weighted average of the
terms under all advances for the total aggregate loan commitment.
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The following tables summarize our loans held for investment as of December 31,
2022 and 2021:
As of December 31, 2022
Weighted
Average
Original Remaining
Outstanding Issue Carrying Life
Principal (1) Discount Value (1) (Years) (2)
Senior Term Loans $ 343,029,334 $ (3,755,796 ) $ 339,273,538 2.2Current expected credit loss reserve - - (3,940,939 ) Total loans held at carrying value, net$ 343,029,334 $ (3,755,796 ) $ 335,332,599 As of December 31, 2021 Weighted Average Original Remaining Outstanding Issue Carrying Life Principal (1) Discount Value (1) (Years) (2) Senior Term Loans$ 200,632,056 $ (3,647,490 ) $ 196,984,566 2.2
Current expected credit loss reserve - -
(134,542 )
Total loans held at carrying value, net
(1) The difference between the Carrying Value and the Outstanding Principal
amount of the loans consists of unaccreted original issue discount, deferred
loan fees and other upfront fees. Outstanding principal balance includes
capitalized PIK interest, if applicable.
(2) Weighted average remaining life is calculated based on the carrying value of
the loans as of December 31, 2022 and December 31, 2021 , respectively.
The following tables present changes in loans held for investment at carrying
value as of and for the year ended December 31, 2022 and the period ended
December 31, 2021 :
Current
Original Issue Expected Credit
Principal Discount Loss Reserve Carrying ValueBalance at December 31, 2021$ 200,632,056 $ (3,647,490 ) $ (134,542 ) $ 196,850,024 New fundings 160,163,120 (3,243,735 ) - 156,919,385 Principal repayment of loans (17,728,730 ) - - (17,728,730 ) Accretion of original issue discount - 2,874,706 - 2,874,706 Proceeds from sale of loans (6,957,500 ) 260,723 - (6,696,777 ) PIK Interest 6,920,388 - - 6,920,388 Current expected credit loss reserve - - (3,806,397 ) (3,806,397 ) Balance at December 31, 2022$ 343,029,334 $ (3,755,796
)$ (3,940,939 ) $ 335,332,599
(1) The difference between the Carrying Value and the Outstanding Principal
amount of the loans consists of unaccreted original issue discount, deferred
loan fees and other upfront fees. Outstanding principal balance includes
capitalized PIK interest, if applicable.
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Current
Expected
Original Issue Credit Loss
Principal Discount Reserve Carrying ValueBalance at March 30, 2021 (inception) $ - $ -
$ - $ -
Loans contributed 40,191,921 (846,724 ) - 39,345,197
New fundings 174,445,480 (3,529,406 ) - 170,916,074Principal repayment of loans (9,798,364 ) - - (9,798,364 ) Accretion of original issue discount - 595,872 - 595,872 Proceeds from sale of loans (5,005,000 ) 132,768 - (4,872,232 ) PIK Interest 798,019 - - 798,019 Provision for credit losses - - (134,542 ) (134,542 ) Balance at December 31, 2021$ 200,632,056 $ (3,647,490
)$ (134,542 ) $ 196,850,024
(1) The difference between the Carrying Value and the Outstanding Principal
amount of the loans consists of unaccreted original issue discount, deferred
loan fees and other upfront fees. Outstanding principal balance includes
capitalized PIK interest, if applicable.
We may make modifications to loans, including loans that are in default. Loan
terms that may be modified include interest rates, required prepayments,
maturity dates, covenants, principal amounts and other loan terms. The terms and
conditions of each modification vary based on individual circumstances and will
be determined on a case by case basis. Our Manager monitors and evaluates each
of our loans held for investment and has maintained regular communications with
borrowers regarding the potential impacts on our loans.
Non-GAAP Measures and Key Financial Measures and Indicators
As a commercial real estate finance company, we believe the key financial measures and indicators for our business are Distributable Earnings, Adjusted Distributable Earnings, book value per share and dividends declared per share.
Distributable Earnings and Adjusted Distributable Earnings
In addition to using certain financial metrics prepared in accordance with GAAP
to evaluate our performance, we also use Distributable Earnings and Adjusted
Distributable Earnings to evaluate our performance. Each of Distributable
Earnings and Adjusted Distributable Earnings is a measure that is not prepared
in accordance with GAAP. We define Distributable Earnings as, for a specified
period, the net income (loss) computed in accordance with GAAP, excluding (i)
non-cash equity compensation expense, (ii) depreciation and amortization, (iii)
any unrealized gains, losses or other non-cash items recorded in net income
(loss) for the period; provided that Distributable Earnings does not exclude, in
the case of investments with a deferred interest feature (such as OID, debt
instruments with PIK interest and zero coupon securities), accrued income that
we have not yet received in cash, (iv) provision for current expected credit
losses and (v) one-time events pursuant to changes in GAAP and certain non-cash
charges, in each case after discussions between our Manager and our independent
directors and after approval by a majority of such independent directors. We
define Adjusted Distributable Earnings, for a specified period, as Distributable
Earnings excluding certain non-recurring organizational expenses (such as
one-time expenses related to our formation and start-up).
78
We believe providing Distributable Earnings and Adjusted Distributable Earnings
on a supplemental basis to our net income as determined in accordance with GAAP
is helpful to stockholders in assessing the overall performance of our business.
As a REIT, we are required to distribute at least 90% of our annual REIT taxable
income and to pay tax at regular corporate rates to the extent that we annually
distribute less than 100% of such taxable income. Given these requirements and
our belief that dividends are generally one of the principal reasons that
stockholders invest in our common stock, we generally intend to attempt to pay
dividends to our stockholders in an amount equal to our net taxable income, if
and to the extent authorized by our Board. Distributable Earnings is one of many
factors considered by our Board in authorizing dividends and, while not a direct
measure of net taxable income, over time, the measure can be considered a useful
indicator of our dividends.
Distributable Earnings and Adjusted Distributable Earnings should not be
considered as substitutes for GAAP net income. We caution readers that our
methodology for calculating Distributable Earnings and Adjusted Distributable
Earnings may differ from the methodologies employed by other REITs to calculate
the same or similar supplemental performance measures, and as a result, our
reported Distributable Earnings and Adjusted Distributable Earnings may not be
comparable to similar measures presented by other REITs.
The following table provides a reconciliation of GAAP net income to
Distributable Earnings and Adjusted Distributable Earnings (in thousands, except
per share data):
Period from
March 30,
For 2021
the year (inception)
ended to
December 31, December 30,
2022 2021
Net Income $ 32,292,477 $ 9,496,436
Adjustments to net income
Non-cash equity compensation expense 435,623 29,611
Amortization 563,464 75,861
Provision for current expected credit losses 3,887,405 147,949
Distributable Earnings $ 37,178,969 $ 9,749,857
Adjustments to Distributable Earnings
Adjusted Distributable Earnings 37,178,969 9,917,448 Basic weighted average shares of common stock outstanding (in shares)
17,653,765 6,442,865
Adjusted Distributable Earnings per Weighted Average Share $ 2.11 $ 1.54
Diluted weighted average shares of common stock outstanding
(in shares)
17,746,214 6,450,383
Adjusted Distributable Earnings per Weighted Average Share
Book Value Per Share
The book value per share of our common stock as of
79
Liquidity and Capital Resources
Liquidity is a measure of our ability to meet potential cash requirements, including ongoing commitments to repay borrowings, fund and maintain our assets and operations, make distributions to our stockholders, and meet other general business needs. We use significant cash to invest in loans, repay principal and interest on our borrowings, make distributions to our stockholders, and fund our operations.
Our primary sources of cash generally consist of unused borrowing capacity under our financing sources, the net proceeds of future offerings of equity or debt securities, payments of principal and interest we receive on our portfolio of assets and cash generated from our operating results. On a long-term basis, we expect that our primary sources of financing will be, to the extent available to us, through (a) credit facilities and (b) public and private offerings of our equity and debt securities. We may utilize other sources of financing to the extent available to us. As the cannabis industry continues to evolve and to the extent that additional states legalize cannabis, the demand for capital continues to increase as operators seek to enter and build out new markets. In the short-term, we expect the principal amount of the loans we originate to increase and that we will need to raise additional equity and/or debt financing to increase our liquidity. We expect to achieve this through recycling capital from loan paydowns, repayments, and sales of common stock related to our shelf registration statement. As ofDecember 31, 2022 and 2021, all of our cash was unrestricted and totaled approximately$5.7 million and$80.2 million , respectively. We believe that our cash on hand, capacity available under our Revolving Loan, and cash flows from operations for the next twelve months will be sufficient to satisfy the operating requirements of our business through at least the next twelve months. The sources of financing for our target investments are described below. Credit Facilities InMay 2021 , in connection with the Company's acquisition of its wholly-owned financing subsidiary, CAL, the Company was assigned a secured revolving credit facility (the "Revolving Loan"). The Revolving Loan had an original aggregate borrowing base of up to$10,000,000 and bore interest, payable in cash in arrears, at a per annum rate equal to the greater of (x) Prime Rate plus 1.00% and (y) 4.75%. The Company incurred debt issuance costs of$100,000 related to the origination of the Revolving Loan, which were capitalized and are subsequently being amortized through maturity. The maturity date of the Revolving Loan was the earlier of (i)February 12, 2023 and (ii) the date on which the Revolving Loan is terminated pursuant to terms in the Revolving Loan Agreement. OnDecember 16, 2021 , CAL entered into an amended and restated Revolving Loan agreement (the "First Amendment and Restatement"). The First Amendment and Restatement increased the loan commitment from$10,000,000 to$45,000,000 and decreased the interest rate, from the greater of the (1) Prime Rate plus 1.00% and (2) 4.75% to the greater of (1) the Prime Rate plus the applicable margin and (2) 3.25%. The applicable margin is derived from a floating rate grid based upon the ratio of debt to equity of CAL and increases from 0% at a ratio of 0.25 to 1 to 1.25% at a ratio of 1.5 to 1. The First Amendment and Restatement also extended the maturity date fromFebruary 12, 2023 to the earlier of (i)December 16, 2023 and (ii) the date on which the Revolving Loan is terminated pursuant to the terms of the Revolving Loan agreement. The Company has the option to extend the initial term for an additional one-year term, provided no events of default exist and the Company provides the required notice of the extension pursuant to the First Amendment and Restatement. The Company incurred debt issuance costs of$859,500 related to the First Amendment and Restatement, which were capitalized and are subsequently being amortized through maturity. OnMay 12, 2022 , CAL entered into a second amended and restated Revolving Loan agreement (the "Second Amendment and Restatement"). The Second Amendment and Restatement increased the loan commitment from$45,000,000 to$65,000,000 . No other material terms of the Revolving Loan were modified as a result of the execution of the Second Amendment and Restatement. The Company incurred debt issuance costs of$177,261 related to the Second Amendment and Restatement, which were capitalized and are subsequently amortized through maturity. OnNovember 7, 2022 , CAL entered into a third amended and restated Revolving Loan agreement (the "Third Amendment and Restatement"). The Third Amendment and Restatement increased the loan commitment from$65,000,000 to$92,500,000 . No other material terms of the Revolving Loan were modified as a result of the execution of the Third Amendment and Restatement. The Company incurred debt issuance costs of$323,779 related to the Third Amendment and Restatement, which were capitalized and are subsequently amortized through maturity. As ofDecember 31, 2022 and 2021, unamortized debt issuance costs related to the Revolving Loan and the First, Second and Third Amendments and Restatements of$805,596 and$868,022 , respectively, are recorded in other receivables and assets, net on the consolidated balance sheets. The Revolving Loan incurs unused fees at a rate of 0.25% per annum which began onJuly 1, 2022 pursuant to the Second Amendment and Restatement. Additionally, during the year endedDecember 31, 2022 , the Company borrowed$58.0 million against the Revolving Loan, which incurred an effective interest rate of 7.75% including the unused fee rate of 0.25%, and$34.5 million available under the Revolving Loan. The Third Amendment and Restatement provides for certain affirmative covenants, including requiring us to deliver financial information and any notices of default, and conducting business in the normal course. Additionally, the Company must comply with certain financial covenants including: (1) maximum capital expenditures of$150,000 , (2) maintaining a debt service coverage ratio greater than 1.35 to 1, and (3) maintaining a leverage ratio less than 1.50 to 1. As ofDecember 31, 2022 , we were in compliance with all financial covenants with respect to the Revolving Loan. 80 During the year endedDecember 31, 2022 , we borrowed$58.0 million , had$58.0 million outstanding, and$34.5 million available under the Revolving Loan as of such date. For the period endedDecember 31, 2021 we did not borrow against the Revolving Loan and therefore had$0 outstanding and$45 million available under the Revolving Loan as of such date. OnFebruary 27, 2023 , CAL entered into the First Amendment to the Third Amended and Restated Loan and Security Agreement. This amendment extended the contractual maturity date of the Revolving Loan untilDecember 16, 2024 . The Company retained its option to extend the initial term for an additional one-year period, provided no events of default exist and the Company provides 365 days' notice of the extension pursuant to this amendment. Capital Markets
We may seek to raise further equity capital and issue debt securities in order to fund our future investments in loans.
Cash Flows The following table sets forth changes in cash for the year endedDecember 31, 2022 and the period ofMarch 30, 2021 (inception) throughDecember 31, 2021 : Period fromMarch 30, 2021 For the
year ended (inception) to
December 31 ,December 30, 2022 2021 Net income $
32,292,477
(15,287,322 ) (2,826,999 )
Net cash provided by operating activities 17,005,155 6,669,437
Net cash used in investing activities (125,244,044 ) (145,221,676 )
Net cash provided by financing activities 33,706,190 218,800,765
Change in cash $ (74,532,699 ) $ 80,248,526 Net Cash Provided by Operating Activities
For the years endedDecember 31, 2022 and 2021, we reported "Net cash provided by operating activities" of$17.0 million and$6.7 million , respectively. Net cash flows provided by operating activities increased$10.3 million , primarily attributable to an increase in net income of$22.8 million , partially offset by an increase in accretion of OID of approximately$2.3 million , increase in PIK interest of approximately$6.1 million , increase in provision for current expected credit losses of approximately$3.7 million , increase in amortization of deferred debt issuance costs of approximately$0.5 million , increase in stock based compensation of approximately$0.4 million , increase in interest receivable of approximately$0.8 million , increase interest reserve of approximately$11.2 million , increase in management and incentive fees payable of approximately$1.6 million , and increase in accounts payable and other accrued expenses and related party payables of$1.7 million . 81
For the years ended
The year endedDecember 31, 2022 was impacted by cash outflows primarily related to$149.7 million used for the origination and funding of loans held for investment, partially offset by$6.7 million received from the sales of loans and$17.7 million of cash received from the principal repayment of loans held for investment.
The period endedDecember 31, 2021 was impacted by cash outflows primarily related to$159.9 million used for the origination and funding of loans held for investment, partially offset by$4.9 million received from the sales of loans and$9.8 million cash received from the principal repayment of loans held for investment.
Net Cash Provided by Financing Activities
For the years ended
The year endedDecember 31, 2022 was impacted by cash inflows of approximately$58.0 million related to draw downs on our Revolving Loan and approximately$4.5 million received from the underwriters' partial exercise of their over-allotment option, partially offset by approximately$28.2 million in dividends paid, approximately$0.5 million in debt issuance costs paid, and approximately$0.1 million related to offering costs associated with our initial public offering. The period endedDecember 31, 2021 was impacted by cash inflows of approximately$226.0 million related to proceeds from the issuance of our common stock, partially offset by approximately$5.1 million in dividends paid, approximately$1.2 million of offering costs relate to our initial public offering, and approximately$0.9 million related to debt issuance costs paid. Leverage Policies
Although we are not required to maintain any particular leverage ratio, we expect to employ prudent amounts of leverage and, when appropriate, to use debt as a means of providing additional funds for the acquisition of loans, to refinance existing debt or for general corporate purposes. Leverage is primarily used to provide capital for forward commitments until additional equity is raised or additional medium- to long-term financing is arranged. This policy is subject to change by management and our Board. Dividends
We have elected to be taxed as a REIT forUnited States federal income tax purposes and, as such, anticipate annually distributing to our stockholders at least 90% of our REIT taxable income, prior to the deduction for dividends paid and our net capital gain. If we distribute less than 100% of our REIT taxable income in any tax year (taking into account any distributions made in a subsequent tax year under Sections 857(b)(9) or 858 of the Code), we will pay tax at regular corporate rates on that undistributed portion. Furthermore, if we distribute less than the sum of (i) 85% of our ordinary income for the calendar year, (ii) 95% of our capital gain net income for the calendar year and (iii) any Required Distribution to our stockholders during any calendar year (including any distributions declared by the last day of the calendar year but paid in the subsequent year), then we are required to pay non-deductible excise tax equal to 4% of any shortfall between the Required Distribution and the amount that was actually distributed. Any of these taxes would decrease cash available for distribution to our stockholders. The 90% distribution requirement does not require the distribution of net capital gains. However, if we elect to retain any of our net capital gain for any tax year, we must notify our stockholders and pay tax at regular corporate rates on the retained net capital gain. The stockholders must include their proportionate share of the retained net capital gain in their taxable income for the tax year, and they are deemed to have paid the REIT's tax on their proportionate share of the retained capital gain. Furthermore, such retained capital gain may be subject to the nondeductible 4% excise tax. If we determine that our estimated current year taxable income (including net capital gain) will be in excess of estimated dividend distributions (including capital gains dividends) for the current year from such income, we accrue excise tax on a portion of the estimated excess taxable income as such taxable income is earned. To the extent that our cash available for distribution is less than the amount required to be distributed under the REIT provisions of the Code, we may be required to fund distributions from working capital or through equity, equity-related or debt financings or, in certain circumstances, asset sales, as to which our ability to consummate transactions in a timely manner on favorable terms, or at all, cannot be assured, or we may make a portion of the Required Distribution in the form of a taxable stock distribution or distribution of
debt
securities.
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The following table summarizes the Company's dividends declared during the year
ended December 31, 2022 .
Common
Share Taxable Section
Record Payment Distribution Ordinary Return of 199A
Date Date Amount Income Capital Dividends
Regular cash dividend 3/31/2022 4/14/2022 $ 0.40 $ 0.40 $ - $ 0.40
Regular cash dividend 6/30/2022 7/15/2022 $ 0.47 $ 0.47 $ - $ 0.47
Regular cash dividend 9/30/2022 10/14/2022 $ 0.47 $ 0.47 $ - $ 0.47
Regular cash dividend 12/30/2022 1/13/2023 $ 0.47 $ 0.47 $ - $ 0.47
Special cash dividend 12/30/2022 1/13/2023 $ 0.29 $ 0.29 $ - $ 0.29
Total cash dividend $ 2.10 $ 2.10 $ - $ 2.10
Critical Accounting Estimates
Our consolidated financial statements are prepared in accordance with GAAP which
requires the use of estimates and assumptions that involve the exercise of
judgment as to future uncertainties. In accordance with SEC guidance, the
following discussion addresses the accounting estimates that we believe apply to
us based on the nature of our operations. Our most critical accounting estimates
involve a significant level of estimation uncertainty that have had or are
reasonably likely to have a material impact on our financial conditions and
results of operations. We believe that all of the decisions and assessments used
to prepare our consolidated financial statements are based upon reasonable
assumptions given the information available to us at that time. Our critical
accounting estimates will be expanded over time as we fully implement our
strategy. Those accounting estimates that we believe are most critical to an
investor's understanding of our financial results and condition and require
complex management judgment are discussed below.
CECL Reserve
In accordance with ASC 326, we record allowances for our loans held for
investment. The allowances are deducted from the gross carrying amount of the
assets to present the net carrying value of the amounts expected to be collected
on such assets. The Company estimates its CECL Reserve using among other inputs,
third-party valuations, and a third-party probability-weighted model that
considers the likelihood of default and expected loss given default for each
individual loan based on the risk profile for approximately three years after
which we immediately revert to use of historical loss data.
ASC 326 requires an entity to consider historical loss experience, current
conditions, and a reasonable and supportable forecast of the macroeconomic
environment. We consider multiple datapoints and methodologies that may include
likelihood of default and expected loss given default for each individual loans,
valuations derived from discount cash flows ("DCF"), and other inputs including
the risk rating of the loan, how recently the loan was originated compared to
the measurement date, and expected prepayment, if applicable. The measurement of
expected credit losses under CECL is applicable to financial assets measured at
amortized cost, and off-balance sheet credit exposures such as unfunded loan
commitments.
We evaluate our loans on a collective (pool) basis by aggregating on the basis
of similar risk characteristics as explained below. We make the judgment that
loans to cannabis-related borrowers that are fully collateralized by real estate
exhibit similar risk characteristics and are evaluated as a pool. Further, loans
that have no real estate collateral, but are secured by other forms of
collateral, including equity pledges of the borrower, and otherwise have similar
characteristics as those collateralized by real estate are evaluated as a pool.
All other loans are analyzed individually, either because they operate in a
different industry, may have a different risk profile, or have maturities that
extend beyond the forecast horizon for which we are able to derive reasonable
and supportable forecasts.
83
Estimating the CECL Reserve also requires significant judgment with respect to various factors, including (i) the appropriate historical loan loss reference data, (ii) the expected timing of loan repayments, (iii) calibration of the likelihood of default to reflect the risk characteristics of our loan portfolio, and (iv) our current and future view of the macroeconomic environment. From time to time, we may consider loan-specific qualitative factors on certain loans to estimate our CECL Reserve, which may include (i) whether cash from the borrower's operations is sufficient to cover the debt service requirements currently and into the future, (ii) the ability of the borrower to refinance the loan and (iii) the liquidation value of collateral. For loans where we have deemed the borrower/sponsor to be experiencing financial difficulty, we may elect to apply a practical expedient, in which the fair value of the underlying collateral is compared to the amortized cost of the loan in determining a CECL Reserve.
To estimate the historic loan losses relevant to our portfolio, we evaluate our historical loan performance, which includes zero realized loan losses since our inception of operations. Additionally, we analyzed our repayment history, noting we have limited "true" operating history, since the incorporation date ofMarch 30, 2021 . However, our Sponsor has had operations for the past two fiscal years and has made investments in similar loans that have similar characteristics, including interest rate, collateral coverage, guarantees, and prepayment/make whole provisions, which fall into the pools identified above. Given the similarity of the structuring of the credit agreements for the loans in our portfolio, management considered it appropriate to consider the past repayment history of loans originated by the Sponsor in determining the extent to which we should record a CECL Reserve. In addition, we review each loan on a quarterly basis and evaluate the borrower's ability to pay the monthly interest and principal, if required, as well as the loan-to-value (LTV) ratio. In considering the potential current expected credit loss, the Manager primarily considers significant inputs to our forecasting methods, which include (i) key loan-specific inputs such as the value of the real estate collateral, liens on equity (including the equity in the entity that holds the state-issued license to cultivate, process, distribute, or retail cannabis), presence of personal or corporate guarantees, among other credit enhancements, LTV ratio, ratio type (fixed or floating) and IRR, loan-term, geographic location, and expected timing and amount of future loan fundings, (ii) performance against the underwritten business plan and our internal loan risk rating and (iii) a macro-economic forecast. Estimating the enterprise value of our borrowers in order to calculate LTV ratios is often a significant estimate. We rely primarily on comparable transactions to estimate enterprise value of our portfolio companies and supplement such analysis with a multiple-based approach to enterprise value to revenue multiples of publicly-traded comparable companies obtained fromS&P Capital IQ as of the quarter end, to which we apply a private company discount based on our current borrower profile. These estimates may change in future periods based on available future macro-economic data and might result in a material change in our future estimates of expected credit losses for our loan portfolio. Regarding real estate collateral, we generally cannot take the position of mortgagee-in-possession as long as the property is used by a cannabis operator, but we can request that the court appoint a receiver to manage and operate the subject real property until the foreclosure proceedings are completed. Additionally, while we cannot foreclose under state Uniform Commercial Code ("UCC") and take title or sell equity in a licensed cannabis business, a potential purchaser of a delinquent or defaulted loan could. In order to estimate the future expected loan losses relevant to our portfolio, we utilize historical market loan loss data obtained from a third-party database for commercial real estate loans, which we believe is a reasonably comparable and available data set to use as an input for our type of loans. We expect this dataset to be representative for future credit losses whilst considering that the cannabis industry is maturing, and consumer adoption, demand for production, and retail capacity are increasing akin to commercial real estate over time. For periods beyond the reasonable and supportable forecast period, we revert back to historical loss data. All of the above assumptions, although made with the most available information at the time of the estimate, are subjective and actual activity may not follow the estimated schedule. These assumptions impact the future balances that the loss rate will be applied to and as such impact our CECL Reserve. As we acquire new loans and our Manager monitors loan and borrower performance, these estimates will be revised each period. 84 Risk Ratings
We assess the risk factors of each loan, and assign a risk rating based on a variety of factors, including, without limitation, payment history, real estate collateral coverage, property type, geographic and local market dynamics, financial performance, enterprise value of the portfolio company, loan structure and exit strategy, and project sponsorship. This review is performed quarterly. Based on a 5-point scale, our loans are rated "1" through "5," from less risk to greater risk, which ratings are defined as follows: Rating Definition 1 Very low risk 2 Low risk 3 Moderate/average risk 4 High risk/potential for loss: a loan that has a risk of realizing a
principal loss 5 Impaired/loss likely: a loan that has a high risk of realizing principal
loss, has incurred principal loss or an impairment has been recorded
The risk ratings are primarily based on historical data and current conditions specific to each portfolio company, as well as consideration of future economic conditions and each borrower's estimated ability to meet debt service requirements. The declines in risk ratings shown in the following table fromDecember 31, 2021 toDecember 31, 2022 consider borrower specific credit history and performance and quarterly re-evaluation of overall current macroeconomic conditions affecting its borrowers. As interest rates have increased due to rising rates from theFederal Reserve Board , it has impacted borrowers' ability to service their debt obligations on a global scale. This decline in risk ratings had an effect on the level of the current expected credit loss reserve, though the loans continued to perform as expected. For approximately 82% of the portfolio, the fair value of the underlying real estate collateral exceeded the amounts outstanding under the loans as ofDecember 31, 2022 . The remaining approximately 18% of the portfolio, while not fully collateralized by real estate, was secured by other forms of collateral including equipment, receivables, licenses and/or other assets of the borrowers to the extent permitted by applicable laws and regulations governing such borrowers. As ofDecember 31, 2022 and 2021, the carrying value, excluding the CECL Reserve, of the Company's loans within each risk rating by year of origination is as follows: As of December 31, 2022 As of December 31, 2021 Risk Rating 2022 2021 2020 2019 Total 2021 2020 2019 Total 1 $ -$ 274,406 $
- $ -$ 274,406 $ 135,076,307 $ 32,242,114 $ 590,384 $ 167,908,805 2 94,467,449 88,444,868 29,140,546 - 212,052,863 29,075,761 - - 29,075,761 3 30,415,113 83,131,444 - - 113,546,557 - - - - 4 - 13,399,712 - - 13,399,712 - - - - 5 - - - - - - - - - Total$ 124,882,562 $ 185,250,430 $ 29,140,546 $ -$ 339,273,538 $ 164,152,068 $ 32,242,114 $ 590,384 $ 196,984,566
(1) Amounts are presented by loan origination year with subsequent advances shown
in the original year of origination. Originations prior to
were acquired in connection with our formation.
Credit Risk
We are subject to varying degrees of credit risk in connection with our loans
and interest receivable. Our Manager seeks to mitigate this risk by seeking to
originate loans, and may in the future acquire loans, of higher quality at
appropriate prices given anticipated and unanticipated losses, by employing a
comprehensive review and selection process and by proactively monitoring
originated and acquired loans. Nevertheless, unanticipated credit losses could
occur that could adversely impact our operating results. None of our borrowers
are now, or have previously been in payment or otherwise material default under
their respective loan agreements with us.
We expect to be subject to varying degrees of credit risk in connection with
holding our portfolio of loans. We will have exposure to credit risk on our
commercial real estate loans and other targeted types of loans. Our Manager will
seek to manage credit risk by performing deep credit fundamental analysis of
potential assets and through the use of non-recourse financing, when and where
available and appropriate.
85
Credit risk will also be addressed through our Manager's on-going review, and loans will be monitored for variance from expected prepayments, defaults, severities, losses and cash flow on a quarterly basis.
Our Manager or affiliates of our Manager have originated all of our loans and intend to continue to originate our loans, but we may in the future also acquire loans from time to time. Our Investment Guidelines are not subject to any limits or proportions with respect to the mix of target investments that we make or that we may in the future acquire other than as necessary to maintain our exemption from registration under the Investment Company Act and our qualification as a REIT. Our investment decisions will depend on prevailing market conditions and may change over time in response to opportunities available in different interest rate, economic and credit environments. As a result, we cannot predict the percentage of our capital that will be invested in any individual target investment at any given time. Our loan portfolio as ofDecember 31, 2022 and 2021 was concentrated with the top three borrowers representing approximately 29.4% and 34.6% of the funded principal and approximately 27.9% and 9.7% of the total commitments to borrowers, respectively. As ofDecember 31, 2022 and 2021, the top three borrowers represented approximately 29.3% and 15.3% of interest income, respectively. The largest loan represented approximately 10.9% and 15.0% of the funded principal and approximately 10.2% and 12.8% of the total commitments as ofDecember 31, 2022 and 2021, respectively.
As of
As of December 31, 2022 As of
Outstanding Outstanding
Jurisdiction Principal Our Loan Portfolio Jurisdiction Principal Our Loan Portfolio
Michigan $ 58,823,506 17 % Michigan $ 31,724,877 16 %
Maryland 53,394,180 16 % Maryland 38,267,872 19 %
Florida 51,421,128 15 % Florida 16,800,000 8 %
Ohio 45,116,990 13 % Ohio 14,150,000 7 %
Pennsylvania 34,606,585 10 % Pennsylvania 31,210,457 16 %
Illinois 30,302,490 9 % Illinois 27,312,315 14 %
Arizona 19,266,104 6 % Arizona 18,214,035 9 %
Missouri 17,337,220 5 % Missouri - 0 %
Massachusetts 15,031,751 4 % Massachusetts 4,284,605 2 %
West Virginia 11,640,004 3 % West Virginia 11,017,895 5 %
Nevada 6,089,376 2 % Nevada
1,800,000 1 %
New Jersey - 0 % New Jersey 5,700,000 3 %
Arkansas - 0 % Arkansas 150,000 0 %Total$ 343,029,334 100 % Total
$ 200,632,056 100 %
The Company measures current expected credit losses ("CECL") for loans held for
investment based on Accounting Standards Codification ("ASC") Topic 326,
Financial Instruments - Credit Losses ("ASC 326"). The Company early adopted ASU
326 at formation, which introduces a new credit loss methodology which requires
earlier recognition of credit losses, while also providing additional
transparency about credit risk. The CECL methodology utilizes a lifetime
"expected credit loss" methodology for the recognition of credit losses for
loans and other receivables at the time the financial asset is originated or
acquired. CECL amended the previous credit loss model to reflect a reporting
entity's current estimate of all expected credit losses, not only based on
historical experience and current conditions, but also by including reasonable
and supportable forecasts incorporating forward-looking information. The
allowance for credit losses (the "CECL Reserve") required under ASU 326 is
deducted from the respective loans' amortized cost basis on the Company's
Consolidated Balance Sheets. The allowance for credit losses attributed to
unfunded loan commitments is included in Accounts payable and accrued expenses
on the Consolidated Balance Sheets. The expected credit losses are adjusted each
period for changes in expected lifetime credit losses.
Refer to footnote 3 to our consolidated financial statements for the year ended
December 31, 2022 , titled "Loans Held for Investment, net" for more information
on CECL.
Income Taxes
We are aMaryland corporation that elected to be taxed as a REIT under the Code, commencing with our taxable period endedDecember 31, 2021 . We believe that our method of operation will enable us to continue to qualify as a REIT. However, no assurances can be given that our beliefs or expectations will be fulfilled, since qualification as a REIT depends on us satisfying numerous asset, income and distribution tests which depend, in part, on our operating results. 86 To qualify as a REIT, we must meet a number of organizational and operational requirements, including a requirement that we distribute annually to our stockholders at least 90% of our REIT taxable income prior to the deduction for dividends paid and our net capital gain. To the extent that we distribute less than 100% of our REIT taxable income in any tax year (taking into account any distributions made in a subsequent tax year under Sections 857(b)(9) or 858 of the Code), we will pay tax at regular corporate rates on that undistributed portion. Furthermore, if we distribute less than the sum of 1) 85% of our ordinary income for the calendar year, 2) 95% of our capital gain net income for the calendar year, and 3) any Required Distributions to our stockholders during any calendar year (including any distributions declared by the last day of the calendar year but paid in the subsequent year), then we are required to pay a non-deductible excise tax equal to 4% of any shortfall between the Required Distribution and the amount that was actually distributed. The 90% distribution requirement does not require the distribution of net capital gains. However, if we elect to retain any of our net capital gain for any tax year, we must notify our stockholders and pay tax at regular corporate rates on the retained net capital gain. The stockholders must include their proportionate share of the retained net capital gain in their taxable income for the tax year, and they are deemed to have paid the REIT's tax on their proportionate share of the retained capital gain. Furthermore, such retained capital gain may be subject to the nondeductible 4% excise tax. If it is determined that our estimated current year taxable income will be in excess of estimated dividend distributions (including capital gain dividend) for the current year from such income, we accrue excise tax on estimated excess taxable income as such taxable income is earned. The annual expense is calculated in accordance with applicable tax regulations. Excise tax expense is included in the line item income tax expense. FASB ASC Topic 740, Income Taxes ("ASC 740"), prescribes a recognition threshold and measurement attribute for the consolidated financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. ASC 740 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. We have analyzed our various federal and state filing positions and believe that our income tax filing positions and deductions are well documented and supported as ofDecember 31, 2022 . Based on our evaluation, there is no reserve for any uncertain income tax positions. Accrued interest and penalties, if any, are included within other liabilities in the balance sheets.
Recent Accounting Pronouncements
Refer to footnote 2 to our consolidated financial statements for the year endedDecember 31, 2022 , titled "Significant Accounting Policies" for information on recent accounting pronouncements. 87
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