Chicago Atlantic Real Estate Finance, Inc.

Welcome to the Chicago Atlantic Real Estate Finance Inc. First Quarter 2022 Earnings Conference Call. My name is John, and I'll be your operator for today's call. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. During the question-and-answer session, if you do have a question, press 01 on your touchtone phone. And now I'll turn the call over to Tripp Sullivan of SCR Partners.

Thank you. Good morning. Welcome to the Chicago Atlantic Real Estate Finance Conference call to review the company's results for the first quarter of 2022. On the call today will be John Matsourakis, Executive Chairman, Tony Kappel, Chief Executive Officer, and Andreas Bodmeier, Co-President and Chief Investment Officer. Our results for release this morning and our earnings press release, which can be found on the Invest Relations section of our website, along with our supplemental filed with the SEC. A live audio webcast of this call is being made available today. For those who listen to the replay of this webcast, we remind you that the remarks made herein are as of today, May 12, 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 also will 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 the SEC. I'll now turn the call over to John Masarakis. Please go ahead.

Thanks, Tripp. Good morning, everyone, and thank you for joining us today. This has been a quick turnaround since our Q4 reporting in mid-March, so I want to address some of the macroeconomic issues that are grabbing everyone's attention before we briefly summarize our activity since the last call. Let's start with the issues of the day. While there are real concerns in the broader market with rising rates, the war in Ukraine, and whether the Federal Reserve will push the economy into a recession, We believe all perspective has been lost on the growth potential in the cannabis lending. I think the market may have also lost sight of the reasons why we have been so bullish on this sector the past four years. There is no disputing that rates are rising and that there has been substantial disruption in the equity markets for cannabis operators. What's been lost is that this business is incredibly resilient, counter-cyclical, and uncorrelated to the broader market. It acts much like the pharmaceutical industry, as well as the alcohol and tobacco. Those sectors continue to demonstrate very inelastic demand, and cannabis is much of the same. Cannabis is growing by close to 20% per year, and this growth is not contingent upon the broader economy. This growth is tied to regulatory matters and to expansion of licensing within an existing state. This is one of the few industries that exist that you can directly correlate new regulations and new licensing with demand for capital. New Jersey is a great example. Previously, a $300 million medical market, now with the move to adult use, it is easily a $1 billion retail market. Recession or no recession, it will remain so. This is why we're so busy. States like Georgia, Ohio, Illinois, Arizona, Maryland, and Alabama are adding new licenses And Florida has a new license as well. These are states that are driving our growth. Approximately 63% of our loans are tied to prime. We do not have any LIBOR-based loans. These floating rate loans allow us to adjust with the market. You'll note that as of May 10th, our weighted average yield to maturity increased to 17.5%. I would also highlight that our portfolio today has $337 million in commitments and a market cap in excess of $290 million as of Monday. We have incurred no leverages of March 31st and have since borrowed $30 million against our credit facility. We're trading at an unlevered yield to book of approximately 10.6%. That's why I think we need to bring back a little more perspective to what's going on in our markets and in our business. Our operators are in great shape as well. They usually have no leverage other than our loans. you would have operators carry four to six times debt to EBITDA ratio of leverage, and then a mortgage rate would carry a couple turns of leverage on top of that. That's not the case in our portfolio. One of our newest loans is with a borrower who currently has 11 million of EBITDA, and our loan is only $17 million. This borrower has no other debt on its capital structure. My goal all along has been to continue building on our reputation as a capital provider that can be trusted, and to grow together with the leading operators in the industry. We primarily target the limited license states with operators that are vertically integrated, and we have been able to pick and choose the borrowers we want to back. Our disciplined approach produces a higher yielding and very well-collateralized portfolio. With this, I will turn to Tony. And Tony, why don't you take it from here?

Thanks, John. Good morning, everyone. We continue to execute on growing our pipeline, putting capital to work at yields and with collateral coverage exceeding our targeted ranges. We are also building momentum with our platform based on strong relationships, a targeted originations effort, and a well-earned reputation within the industry as the lender of choice for leading cannabis operators. Since our Q4 earnings call was only six weeks ago, I don't want to repeat much of what we said and did then. What I would prefer to highlight is what we've accomplished during Q1, and to date in Q2 within the portfolio and with our originations team as well as reinforce how we are achieving these results. Let's start with the how first. Recall that some of the key differentiators for us are that we have our own originations team that sources our loans and that we structure these loans so that we are our borrowers only source of debt with the REIT as the lead or the co-lead on the facility. The common theme with both approaches is that we build and maintain a relationship with our borrowers. That relationship is crucial in terms of being able to grow with them and also getting the monthly compliance reporting and detail that enables us to keep our finger on the pulse of operations and market conditions. I can't stress enough the importance of creating the relationships directly the way we do at Chicago Atlantic. We know what our borrowers need, when they need it, and how they are managing through the challenges of meeting the accelerated demand for their product. During Q1, we funded a total of $86.7 million in gross principal, represented from new and existing loan commitments. To date, in Q2, we have funded an additional $25 million, $17 million of which was to a new borrower and $8 million was to an existing borrower. Year-to-date, we have had two payoffs totaling $3.6 million, resulting in a total of $337 million of commitments, and a weighted average yield to maturity of 17.5 percent as of May 10th. Lastly, our pipeline feels endless with over 900 million of near-term opportunities. Looking ahead to the balance of the year, we will continue to keep a measured pace. It's clear to us there is no shortage of demand for capital from operators, but we will continue to balance this demand with the need to fuel it with attractive sources of capital, and we will only cherry-pick the best of the best deals. Lastly, I'd like to highlight this quarter's increase in the dividend. For Q1, we paid out a dividend of $0.40 per share, representing a 54% increase from the Q4 dividend. That's an annualized rate of $1.60 per share, resulting in a yield of 9.73% on the May 9th closing stock price and a 10.6% yield to book value. Also, we expect steady dividend growth in the quarters to come. Now, Andreas will walk us through our investments, capital plan, and financial results.

Thanks, Tony. Good morning. We did a good job of outlining our investment activity in the earnings release and supplemental, so I'll reference both documents and provide some additional commentary. At March 31st, our loan portfolio has grown to total loan commitments of $321 million across 22 portfolio companies. It has a weighted average yield to maturity of 17.2%. And as Tony noted a moment ago, as of May 10, the portfolio has grown to $337 million with a yield of 17.5%. All loans are current and performing. During the quarter, we had only one loan totaling $3.1 million payoff at maturity. I would highlight that our portfolio is currently 63% floating rate based off of the prime rate, so we have been able to manage the impact of rising rates to this point. The demand for debt capital is as strong as ever, and the opportunities we have sourced in our pipeline continue to meet our yield targets. Sourcing capital is our greatest challenge and opportunity right now. We have utilized our IPO proceeds this quarter and borrowed $30 million to date in Q2 on the credit facility. We're actively working to increase that facility with additional banks to meet the growing demand shown in our pipeline and in our signed term sheets. Our goal all along has been to use this facility and possibly a bond or debt offering to to reach our target of only half a turn of leverage by year-end. Should those options not provide enough capital quickly or accretively, then we will look to the equity markets in the second half of the year to help us grow. Turning now to our financial results of our first full quarter as a public entity, there are a few points to highlight from our Q1 print. Our total interest income is beginning to reflect the deployment of our IPO proceeds. While the interest income of $9.8 million increased sequentially from $5.8 million in Q4, we expect to see the full effect of the deployment of IPO proceeds and the use of the credit facility in Q2. Total expenses for the quarter were $2 million, which includes management and incentives fees of $671,000. Recall that the incentive fees had been waived in Q4. We had G&A of $556,000 and professional fees of $557,000. Our plan to charge the incentive fees for the first time in Q1 was noted on last quarter's earnings call. G&A is consistent with the guidance we gave last quarter of $2.5 to $3 million for the year, and the sequential increase in the professional fees was almost entirely related to accounting and audit fees. Pursuant to ASC 326, we increased our provision for expected credit losses by $51,000 in Q1. In determining this reserve, we noted that 93% of the portfolio is fully secured by real estate and 7% has limited or no real estate collateral. Our portfolio on average has real estate collateral coverage of 1.9 times as of March 31, 2022. All of our loans are secured by equity pledges of the borrower and all asset liens. And while the CECL reserve was added back to our calculation of distributable earnings consistent with Q4, we've elected not to add back the incentive fees to our calculation of distributable earnings and adjusted distributable earnings. This is a slight definitional change to the calculation from what we had originally intended, but we believe it is the right decision to make and provides a clear indication of our ability to pay dividends to shareholders. After factoring in these items, our adjusted distributable earnings per share was 45 cents per diluted share for Q1. And as noted last quarter, Weighted average share count for Q1 reflected most of the impact of the 17.8 million shares outstanding post-offering and post-Greenshoe exercise in January 22. Our book value as of March 31 was $15.17 per common share. Operator, we're now ready to take questions.

Thank you. We will now begin the question and answer session. If you do have a question, press 0 then 1 on your touchtone phone. If you wish to be removed from the queue, add zero, then two. Once again, if you do have a question, add zero, then one on your touchtone phone. And we'll take our first question from Aaron Hecht of JMP Securities.

Hey, everyone. Thanks for taking my questions. Obviously, you guys have put capital to work quickly and yields are really strong. Sounded like you started working into the credit facility during the second quarter. You discussed some options for capital, but given your pipeline, it seems like you could be running tight pretty quickly here on availability. How quickly do you expect to be able to access some new capital on the debt side? What are the actions you're taking? Just any sort of updates so we can think about how to build out deployment in our models?

So we have the flexibility to increase our credit facility, are upsizing it imminently, and have indication of interest from other banks in participating as well. We are heavily focused on pursuing debt this and next quarter, including a debt offering. Now, we're all aware that both rates and spreads have increased since we did the IPO. We will pursue a debt offering only if it's accretive. and otherwise look to the equity markets for the second half of the year.

Great. And then on that note, with obviously rates being up, valuations being down across the cannabis space, are you seeing more opportunities with larger MSOs? Are they becoming a bigger priority in your pipeline? How has the yield profile changed? Any sort of updates? on your pipeline and borrower preference.

Hi, Aaron. This is John. We haven't really focused on MSOs as of recent. Our main focus remains the middle market. We're interested definitely in multi-state operators that are operating in two, three states, but the middle market is our bread and butter, and we will continue to focus on that. Great.

Appreciate the time, guys.

Thank you.

And our next question is from Guav Mehta from EF Hutton. Please go ahead with your question, Guav. Your line may be on mute. We'll go to our next question. It's from Mark Smith from Lake Street Capital Markets.

Hi, guys. First off, can you just discuss during the quarter the mix of new borrowers versus existing?

Is this a question for Q1 or year-to-date?

No, for Q1. I think, you know, and even if you want to give us kind of the full year-to-date would be okay. That would be great.

The majority of the fundings were to new businesses. We did upsize one that was in the existing portfolio. And then one of the fundings, as we said in the script, was an upsize. So two of them were upsizes. The rest were new borrowers. Okay.

And of those upsizes, one was post Q1, correct?

That's right. Perfect.

Perfect. And then two questions that are just kind of big picture questions. You know, any thoughts that you guys have right now on kind of changing legislation, new legalization, any states that you're really looking at or anything at the federal level as you guys look at your crystal ball that you're kind of maybe anticipating or looking forward to?

We're hoping for more transitions from medical to rec, similar to the one we saw in New Jersey. Those tend to be very accretive for our space. As a whole, we don't expect any sort of regulatory relief at the federal level. So that's kind of like our overall view, state versus federal.

And to add to that, we've seen, obviously, to John's point on New Jersey, it usually has an effect on the contiguous states. So we're keeping an eye on Pennsylvania. Obviously, there's positive momentum in Delaware and then, of course, Maryland. So those are some of the states we're watching out for that do create significant opportunity, as well as just creating a much more robust environment to lend money into.

Okay. And then last one for me, I know you guys focus on kind of limited license states. Any states to call out that are seeing, you know, some of this industry weakness that's kind of bleeding over from the West Coast? Any states to call out that maybe have seen a change in kind of the weakness?

So east of the Mississippi, we have two states that are closely monitoring, and that is Michigan and Massachusetts. Those two states have seen a major compression both on wholesale and retail prices. So we're very focused on understanding those states in a granular manner, and we're technically staying away from them for the time being.

And also, these are things that we knew early on. They were not limited license states from a state perspective. So the focus has always been on the scale producers, at least from a wholesale perspective. And those are the players that are going to end up obviously weathering the storm and then thriving as they become more of like an efficient market similar to Colorado. So we spent a lot of time looking at Colorado and their ultimate slope of

compression and that's really how we played that space in those particular states okay and then just remind us as we think about you know probably Michigan out of those two having a bigger impact in current portfolio am I thinking about that right yes yeah anything to call out on those loans you know you know, just as we think about, you know, CECL reserves, is there anything that we should be nervous about or investors should be watching, you know, as far as anticipation in those states?

Not at all, Mark. Actually, the investment we've made in Michigan is to one of the largest operators with probably the lowest cost per pound in the state. So we targeted early on in Michigan the spread rather than you know, the higher prices. And there is consolidation in Michigan, which helps some of the leading operators in the space. So we're arguably invested in one of the best Michigan companies.

Okay. Perfect. Thank you, guys.

Thank you. Our next question is from from EF Hutton.

Yeah, thanks. Good morning. Going back to your comments about sources of funding and potential upsizing of your credit line. So you have $30 million outstanding on the credit line. The total capacity is 45. So if you guys were to upsize that, how much capacity should we think about? And then you also talked about potential debt offering. If you were to issue debt, what kind of rates are you looking at?

So on the credit facility, what we expect is to see a sequential upsizes as we bring in new banks. We have a number of banks in the data room that will happen incrementally, and we're on track to exceed $100 million throughout the rest of and middle of the year. Regarding debt, we have not gone out to market. We are aware of the market environment of both rates going up and spreads widening. I think in our position, after this quarter, we will be heavily focused on pursuing a debt offering. But to reiterate, it has to be accretive, and we will not do a debt offering at all costs.

Okay, great. Second question on your yield, 17.5% as of May. As you look in the marketplace and look at the new loans, should we expect the yields to stay at 17, 18 percent level? How do you expect yields to evolve over the next 12 to 18 months?

Yes, we actually don't expect any yield compression. I think rates are positioned well to stay where they are currently.

Okay. Great. That's all I have. Thanks for taking my questions.

Thank you.

And it appears we have no further questions in queue. I will now turn the call back over to John Masarekis for final remarks.

Well, I want to thank all the analysts for their wonderful questions, and we're looking forward to answering more questions in the future as we're growing our platform. Thank you, everyone, for your time today.

Thank you, ladies and gentlemen. That concludes today's call. Thank you for participating, and you may now disconnect.