Chicago Atlantic Real Estate Finance, Inc.

Thank you for standing by, and welcome to Chicago Atlantic Real Estate Finance fourth quarter 2021 earnings call. At this time, all participants are in a listen-only mode. After the presentation, there will be a question and answer session. To participate during the session, simply press star 1 on your telephone. If you require any further assistance, please press star 0. I would now like to hand the conference over to Tripp Sullivan of Investor Relations. The floor is yours.

Thank you. Good morning. Welcome to the Chicago Atlantic Real Estate Finance Conference call to review the company's results for the fourth quarter of 2021. On the call today will be John Mazarrakis, Executive Chairman, Tony Kappel, Chief Executive Officer, Andreas Bodmeier, Co-President and Chief Investment Officer, and Lindsey Minns, Chief Financial Officer. Our results were released this morning in our earnings press release, which can be found on the investor relations section of our website, along with our supplemental filed with the SEC. A replay of this call will be available shortly after the conclusion of the call through March 29, 2022. The numbers to access the replay are provided in the earnings press release. For those who listened to the replay of this call, We remind you that the remarks made herein are as of today, March 22, 2022, and will not be updated subsequent to this call. During this call, certain comments and statements we make may be deemed forward-looking statements within the meaning prescribed by the securities laws, including statements related to the future performance of our portfolio, our pipeline of potential loans and other investments, future dividends, and financing activities. All forward-looking statements represent Chicago Atlantic's judgment as of the date of this conference call and are subject to risk and uncertainties that can cause actual results to differ materially from our current expectations. Investors are urged to carefully review various disclosures made by the company, including the risk and other information disclosed in the company's filings with the SEC. We will also discuss certain non-GAAP measures, including but not limited to distributable earnings, and adjusted distributable earnings. Definitions of these non-GAAP measures and reconciliations to the most comparable GAAP measures are included in our filings with SEC. And now I'll turn the call over to John Masarykas. Please go ahead.

Thanks, Tripp. Good morning, everyone, and thank you for joining us today. As this is our first earning call since completing the IPO in early December, I would like to welcome all of our new shareholders and analysts. We have worked hard to get to this point, and we're excited about the opportunities ahead of us. With less than a month between our IPO and the end of the fourth quarter, the real measure of how strong a start we have built is in the growth of our portfolio, the attractive yields we're generating, and the robust pipeline of new loan originations. We will focus much of our time this morning on each of these topics as well as the state of the industry and the plans for our capital structure. Before we do that, I want to call out some of our financial highlights for the quarter and to date in March. We have been growing our loan commitments at inception of the REIT Q2 2021. We had $72 million in commitments. That number of loan commitments grew to $192 million at IPO and 235 million at the end of 2021. As of March 17, we have 324 million commitments. Since the IPO and through March 17, we have funded 115 million of new and existing commitments. With that, we have deployed all IPO proceeds, which puts us ahead of schedule in deploying the IPO proceeds and beginning to draw on our revolving credit facility. With this portfolio growth, We were able to report 57 cents of earnings and 61 cents of adjustable distributable earnings for Q4. The fourth quarter results and active start of the year also enabled the board to declare a 26 cent dividend in Q4 and to subsequently increase it in Q1 by 54% to 40 cents per share. Now, let's talk about what initially attracted us to the cannabis market. Four years ago, we recognized that there was an opportunity to bring an institutional lending approach to an industry that had previously struggled to access capital. By institutional approach, I mean introducing to the nascent cannabis industry the disciplines that are taken for granted in all of direct lending, such as rigorous credit reviews, strict underwriting guidelines, deep operator evaluations, enterprise value analysis, as well as other methods of perfecting collateral. We were not looking to create a new model of lending. Instead, we just focused on applying what has been a tried and true approach to an industry that desperately needed it. With a little over a billion dollars in closed facilities, most of which have been in cannabis, we've established a good track record and capitalized on being a first mover in this space. The fact is, you can't create a track record like this without a good team. And we have one of the best teams in the industry. Tony has been in banking for over 15 years and has completed over $5 billion in loans during his career at Wells Fargo and StokeGate Capital. Andreas has underwritten over $500 million in cannabis credit transactions and heads up our investment efforts. He has a strong research and consulting background that helps us with risk management. Peter led the cannabis lending practice at BC Partners Credit before joining us and has a strong underwriting background as well. I come from an operating background having built businesses from the ground up and as a real estate developer and owner. We have a diverse yet complementary background backed by a team of over 30 investment and management professionals who have helped establish the Chicago Atlantic brand in the cannabis industry. That's something I'm focused on every day, ensuring we have the right people in place, the right culture, the full integration of the REIT with the Chicago Atlantic Originations platform, and my goal is to continue building on our well-earned reputation as a capital provider that can be trusted and to grow together with the leading operators in the industry. Another feature that attracted us to the cannabis industry is that it's by no means mature. I've described it before as being in maybe the second inning in terms of its development. In an industry like this, sometimes it's hard to accurately estimate how big the addressable market really is. We and others in the industry have pegged the current size of the legal state regulated markets as $25 billion in top line retail revenue and a multiple of that across the entire value chain. I think we all know it is much larger when you factor in the illicit market, which will eventually become legal over time. When you adjust for that inevitable transition, We believe it's really a $100 billion industry just on the retail side. We have stats in our presentation that highlight the industry could rival beer, spirit, and wine by 2030, leading to substantial growth opportunity and demand for capital. This industry is not the Wild West anymore. The real winners in this space will be the operators that have a proven and disciplined approach. the operators that understand unit economics, scale of manufacturing, and multi-unit retail operations. As Andreas will explain later, when we look at the opportunities in our pipeline, we're able to quickly sort out the operators who meet our stringent criteria and those that likely never will. We believe that good operators will be rewarded long-term, and they will continue to be a shakeout. As you look across, Across our portfolio, it's clear where we are focused on providing capital. We have primarily targeted the limited licensed states with operators that are vertically integrated. While we're open to opportunities west of the Mississippi, we prefer to start with states that are medically licensed and then grow within them as many of those states transition to adult use. The regulatory environment is one of the biggest hurdles to this industry. and we are very familiar with the dynamics within each state and what's being proposed. While federal legalization, passage of the Safe Banking Act, and a change in the Internal Revenue Code to Section 280E will ultimately unlock the true potential of this market, our opportunity set is not built on any of these events occurring in the near term. After the Biden-Harris administration took office, there was speculation about full legalization, quick passage of the Safe Banking Act. When that didn't happen, we saw the public market valuations of the cannabis operators decline significantly, and their access to equity capital was either cut off or suddenly became much more expensive than debt. This environment of uncertainty was exacerbated by all sorts of inflationary pressures like COVID, Ukraine, and the global supply disruption as well as the Federal Reserve moves. What's important to remember is that these operators are in growth mode. The demand for their products has shown no sign of letting up, not even through the pandemic when it actually accelerated, and they need to invest in production, cultivation, and retail. That demand for capital can best be met by working with us. We don't thrive on the disruption in the public equity market, but it is clearly a net positive for us both near and long term. Tony, why don't you take it from here?

Thanks, John. Good morning, everyone. We've done exactly what we said we would do on our IPO roadshow last December. We focused on growing our pipeline, putting the IPO proceeds to work at yields and collateral coverage consistent with our existing portfolio, executing on that pipeline as expeditiously as possible, and building on the first mover advantage that John described earlier. Before I get into details on our execution during Q4 and to date in Q1, I'd like to spend a few moments on the key differentiators for us that are responsible for these results. It all starts with how we drive new loan originations. Across the Chicago Atlantic platform, we have seven investment professionals dedicated to new loan originations. We like to think that we are responsible for bringing the normal structure of credit lending to the cannabis world. Most of our cannabis-focused competition sources their deals syndicated by investment banks or in some cases participates in facilities we lead. Other lenders or community banks might have a local relationship with an operator, but typically they won't have the cannabis experience to truly understand what their underwriting or what their borrower needs. In addition to inbounds from brand recognition we've established, we also get referrals from borrowers, brokers, and banking relationships. When we're looking at new borrowers and loan opportunities, we focus on four criteria. The first is the state. As John noted earlier, our focus is primarily east of the Mississippi. This will continue to be our focus, but that does not preclude us from making loans to the best-in-class operators in the more efficient markets. Second, we look for a medical state versus an adult-use state as the transition to adult use creates revenue growth and consequently EBITDA growth, improving the creditworthiness of our borrower and improving the value of the underlying license and business. Third, we focus on cash flows. While all but a small number of our loans have underlying coverage through real estate, we underwrite our borrowers on their ability to drive the bottom line and operate profitably. And lastly, we look for strong collateral coverage, which includes real estate, AR, equipment, personal guarantees, and other assets that may be more intangible in nature. We don't want to share too much of our secret sauce, but we have proprietary methods of perfecting collateral and liens in an industry where there are limitations when having to exercise your rights and remedies in a workout. Fortunately, we have not had that experience to date as all loans are performing, and we have yet to have a payment default across the platform. But we do regularly underwrite that risk and have strong real estate coverage, equity pledges, and all asset liens back in our loans. A great example of one of the closings in Q1 is our credit facility to Sanctuary Medicinals. which is a vertically integrated operator in Florida. This is a $25 million senior secured delay draw term loan that was used to build additional canopy and continue their dispensary expansion. As of close, they had six dispensaries open and expect to open additional 10 through the first year of the term. This is a great loan because, first, they are based in Florida, a limited licensed state, which has one of the most robust medical programs in the country. There are over 675,000 registered patients, and that continues to grow. Also, Florida is expected to turn adult use within the next few years, which will create one of the largest markets in the U.S. because of the growing population and robust tourism market. Second, we have over two times real estate coverage today. If you include all the collateral, our estimate for an LTV would be under 35%. Number three, Sanctuary Medicinals has a great management team, with a proven track record operating cannabis businesses. Lastly, all of their capital is used for accretive reasons, which adds to our collateral and future cash flows of the borrower and mitigates risk throughout the term. Another key differentiator is that we structure our loans so that we are a borrower's only source of debt, and the REIT is the lead or the co-lead on the credit facility. That not only protects our collateral, but also allows us to maintain a great relationship with our borrowers and grow with them. We also don't retrade, which is unique in an industry where that is common practice. The term sheets we provide are what we deliver. We believe that reputation, combined with our large dedicated presence in the space, and the ability to grow with our borrowers, makes us the lender of choice for leading cannabis operators. One of the best measures of our reputation is the fact that our loan origination pipeline remains robust. Today, our pipeline is approximately $979 million in size, that's comprised of opportunities with both existing and potential borrowers in the limited licensed states. And these opportunities have commensurate risk profiles and yields that comprise the existing portfolio. Through last week, we have completed nearly $115 million in loan fundings in the REIT since the IPO. That's quite a start to our new life as a public company, and we look to build on that momentum. Looking ahead to the balance of the year, While we're not providing specific loan origination target for 2022 at this time, I would note that that is largely a function of our access to attractive sources of capital. $115 million in the REIT in a little over three months is a strong pace, but we are sensitive to fueling that pace with capital that would dilute our existing investors. Andreas will walk through our capital plan shortly, but we expect to adhere to the plan we described in our IPO of utilizing the credit facility, and possibly a debt offering before we come back to the public equity markets. Another promise we made during the IPO that we've delivered on is providing dividend growth to our investors. We declared our first dividend at year end for Q4 of 26 cents per share, which was covered by adjusted distributable earnings and even adjusting for the fully loaded share count of 17.5 million. And as noted in our earnings release this morning, the board has declared a Q1 dividend of $0.40 per share, a 54% increase from Q4. And based on Friday's closing price, that would equate to an annualized yield of 9.4%. And while we have not stated a specific payout target, we expect it would be at least 85%. Now, Andreas will walk us through our investments and capital plan. Thanks, Tony. Good morning.

We did a good job of outlining our investment activity in the earnings release and supplementals. I'll reference both documents and provide some additional commentary. At our IPO, we disclosed a portfolio of 17 loans totaling $192 million in commitments, both funded and unfunded, producing a weighted average yield of 17.1%. By December 31, that portfolio had grown to total loan commitments of $235 million across 21 portfolio companies with a weighted average yield of 18.6%. That IRR was a little higher than expected due to a high-yielding bridge loan that preceded a larger facility in January 2021. As of March 17, our total loan commitments had grown to $324 million across 23 portfolio companies with a weighted average yield of 17.3%. That figure is more consistent with our expectations going forward. Recapping what we've done since the IPO, that equates to $115 million of total loan fundings from both new and existing commitments. Quite a start, but we have much more we want to accomplish. Our portfolio continues to be strong. All loans are current and performing. And as we know, the Fed is raising rates 25 basis points last week is a hot topic. I would highlight that our portfolio is currently 57% floating rate, so we've been able to manage the impact of rising rates. As John noted earlier, the current environment hasn't diminished the demand for debt capital. In fact, it has increased it. And we feel comfortable that we will continue to source new opportunities that provide the yields that we've been targeting. We've also considered how inflation and rising interest rates could impact our borrowers. We've witnessed through our borrowers a 10% to 30% increase in construction costs and ongoing delivery delays. We have an experienced real estate and cannabis development team that evaluates our borrowers' construction efforts and underwrites such that our capital is insulated from construction execution risks. We believe that rising construction costs increase the value of our existing real estate collaterals. And for the industry as a whole, a rising interest rate environment demands a focus on underwriting to cash flow generation and ultimately benefits conservatively levered and established operators. Lastly, I'd like to talk about our capital plan for the year. Now that we've fully deployed our IPO proceeds, our next step is consistent with what we've described at our IPO. We plan to utilize our senior bank credit facility. In mid-December, we upsize our facility from $10 to $45 million with another bank joining the facility. And although we currently have full availability on the existing line, we're in active negotiations to upsize it again over the next few weeks. The upcoming and future upsizes to the credit facility should give us more runway to continue capturing new opportunities from our pipeline. Our goal all along has been to use this facility and possibly a bond or net debt offering to reach our target of only half a turn of leverage by year end. We're conservative by nature, and therefore we intend to run with lower leverage than is common in the mortgage rate industry while remaining sensitive to the dilution of our current shareholders. And with that, I'll turn it over to Lindsay to discuss the financials.

Thanks, Andreas, and good morning, everyone. First, I would call your attention to the supplemental information filed earlier today, which provides more detailed disclosures in addition to those referenced in these prepared remarks. With less than one month of actual operations as a public entity, the Q4 results aren't yet indicative of our potential performance, but were consistent with what we anticipated in our S11. The activity since the closing of our IPO has set us up well to deliver even better results over the course of the year. Rather than reading out all of the financial results this morning, I want to call out a few moving parts in our Q4 print. As I noted earlier, we experienced significant growth in our loan portfolio during the quarter, but especially in December as we began deploying the IPO proceeds. As such, our total interest income of $5.8 million doesn't yet reflect full deployment. We're well ahead of schedule on deployment of the IPO proceeds with an increasing benefit in Q1 and the full effect expected to show in Q2. Total expenses for the quarter were nearly equivalent to what we incurred for the year as we recorded management fees for the first time as well as approximately $63,000 of organizational expenses and $148,000 for a CECL reserve, both of which were added back in our calculation of adjusted distributable earnings. Organizational expenses were lower than anticipated. Going forward, we expect G&A to be in the range of $2.5 to $3 million as we are growing faster than expected. Given that our 10-K won't be filed until the 31st with the footnotes to describe it, I'll provide some detail on the CECL reserve. Pursuant to ASC 326, we recorded a $148,000 provision for current expected credit losses in Q4. In determining this reserve, we noted that 92% of the portfolio is fully secured by real estate and 8% has limited or no real estate collateral. Our portfolio on average had real estate collateral coverage of 2.2x as of December 31, 2021. All of our loans are secured by equity pledges of the borrower and all asset liens. After factoring in these items, as well as other adjustments defined in our S-11, our adjusted distributable earnings per share was 61 cents for Q4. Our weighted average share count for Q4 reflected only 21 days of the impact from the IPO shares. During Q1, we will see most of the impact of the 17.8 million shares outstanding post-offering and post-Greenshoe exercise in January 2022. Our book value as of December 31st was $15.13 per common share. Operator, we are now ready to take questions.

Thank you. And as a reminder, to ask a question, please press star 1 on your telephone to get in the queue. Our first question is from Aaron Heck with JMP Securities.

Good morning, everyone. Congrats on the first earnings call. Thanks for taking my questions. Tony, You said the payout ratio for the first quarter, the 40-cent dividend, would be at least 85 percent. What metric are you using for the denominator? Are we talking gap earnings, distributable? And is that including or excluding incentives if you're using distributable?

Aaron, the 85 percent or higher is relative to distributable earnings, and that's the outlook for the year. Q1, we paid out essentially 100%, but you would expect that number to be lower going forward.

Okay. And the distributable, is that before or after incentive fees? Andres, can you hear me?

It's before incentive fees.

Okay. And then secondly, on the leverage, talked about going to one-half turn, and obviously you guys are putting capital to work really quickly. If you get past that one-half turn mark, what would you look at first after that? Would you prefer to look at the equity markets? Would you be willing to go to a higher leverage market? How would you think about your capital options at that time?

We're seeing a lot of interest in our bank credit facilities. So if we're able to grow that over $100 million and then opportunistically consider a bond offering, we may be above that half a turn of leverage temporarily before we come back to the equity markets, which would then bring it back down to our target ratio.

Okay. And then last one, if I may, yields on the signed term sheets, what does that profile look like?

So yield, we haven't seen any yield compression. Basically, there are, just like we said during the IPO, there are sort of two buckets of loans that we're dealing with. The one bucket sort of reflects the heavily brokered deals, the top five, 10 MSOs. And then where we focus our bread and butter is mostly in the single state, dual state operators that have been doing a great job with plenty of collateral and cash flow. So we're continuing to focus in those operators, and we haven't really seen any compression in rates currently. Great.

Appreciate that, John. Great job so far, guys. We'll jump back in the queue.

Thank you. And as a reminder, to ask a question, simply press star 1 on your telephone. Next question is from Mark Smith with Lake Street Capital.

Hi, guys. I wanted to talk first just a little bit about the industry. You guys talked about limited license states and primarily focused east of the Mississippi. Can you just talk about industry trends that you're seeing primarily in the markets that you operate in?

So one anticipated event that we're all looking forward is the New Jersey going REC. So that has been something we've been looking forward to. Other trends are reflected in Massachusetts and Michigan, where we see slight compression. I would say that those are sort of markets that don't reflect the limited nature other eastern states so in those markets where we're focusing on the top tier operators that have have targeted their cost per pound and that has been our strategy okay then you guys were talking about it here just a minute ago but just talk about yield to maturity as we look through the through the year you know the seventeen point three

Would you expect some compression over time or in a rising rate environment? Will that move higher? Maybe talk just big picture how you view that this year.

Yeah, no, I would say that right now they're going to be consistent for quite some time. Obviously, with the fact that the majority or over half of our loans are floating rate, you'll see a pickup there. Now, in the medium term and longer term, I would expect that there would be compression, but at least for the foreseeable future in the existing pipeline, it's commensurate with what we have in the portfolio.

Perfect. And then the last one for me, just as we think about growth in the portfolio through the rest of the year, Can you talk about your mix or maybe expected mix of new borrowers versus kind of existing relationships?

So we have about $40 million in future funding through existing facilities, and we have about $115 million in our underwriting pipeline with signed term sheets and deposits. We expect those ratios to sort of remain the same.

Great. Thank you, guys. Thank you.

Thank you. And I'm not showing any further questions in the queue, sir. I will turn the call back to John Masarakis for his final thoughts.

Thank you. And thank you all for joining us this morning. We're available for follow-up questions. Thanks again.

And with that, ladies and gentlemen, we conclude today's conference. Thank you for your participation, and you may now disconnect.