Chicago Atlantic Real Estate Finance, Inc.

Standing by, welcome to the Chicago Atlantic Real Estate Finance, Inc. Second Quarter 2023 earnings conference call. At this time, all participants are in listening mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you'll need to press star 1-1 on your telephone. If your question has been answered and you'd like to remove yourself from the queue, simply press star 1-1 again. As a reminder, today's program is being recorded. And now I'd like to introduce your host for today's program, Tripp Sullivan. Please go ahead.

Good morning. Welcome to the Chicago Atlantic Real Estate Finance conference call to review the company's results for the second quarter of 2023. On the call today will be John Matsarakos, Executive Chairman, Tony Cappell, Chief Executive Officer, Andreas Bodmeier, Co-President and Chief Investment Officer,

Peter

Sack, Co-President, and Phil Silverman, Interim Chief Financial Officer. Our results were released this morning in our earnings press release, which can be found in the best relations section of our website along with our supplemental file with the SEC. A live audio webcast of this call is being made available today. For those who listened to the replay of this webcast, we remind you that the remarks made here and or as of today, August 8, 2023, 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 the 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-GAP measures, including but not limited to distributable earnings and adjusted distributable earnings. Definitions of these non-GAP measures and reconciliations to the most comparable GAP measures are included in our filings with the SEC. I'll now turn the call over to John Masarek. Please go ahead.

Thanks, Tripp. Good morning, everyone. After another quarter of volatility in the broader financial sector, and cannabis in particular, we can now add the fact that small cap equity risk premiums are at the lowest level in a couple of decades. Things like yield will soon be king again. If you add in worries about a recession or not, that's a lot of ways to get distracted. I want to address some of these topics to stress how we've approached the creation, management, and execution of our platform against Chicago Atlantic. Over the past 25-plus years, I've been through three recessions and several economic cycles. I've seen cycles where there's catastrophic collapse or cycles where competition is fierce. Our job as fund managers is to smooth out the peaks and troughs evident within the strategy that we're managing. No deal does that better than the partnership we've created with the state of New York that Peter will discuss in a moment. With the largest platform, our own Originations team, experience in direct lending, a well-capitalized and conservative balance sheet, and a diversified loan portfolio, I believe we can make a stronger case than ever before that we're the leading capital provider in this space. The pipeline remains robust with actionable deals in excess of 400 million. There are a lot of good things happening in states such as Maryland and Missouri, and we're starting to see more transaction activity within the industry with the new states coming online that's leading to improved optimism among investors in different forms of capital allocation. There's also a growing recognition that the high-rate environment isn't going away quickly, which is leading to decisions about whether to grow or not to grow, as well as increased M&A funded by debt financing. We're in front of several trends in limited license states that are moving from medical to adult use, and states that have seen the greatest price compression show improvements in wholesale pricing. We have been cautious for some time now, but it could be time to change that to cautiously optimistic. We're picking our spots and remaining incredibly disciplined in the pursuit of new opportunities. Our partnership with New York is a great example of picking the right opportunity backed by strong credit and an appropriate return that could potentially lead to other partnerships. I will now turn it over to Peter.

Thank you, John. On June 30th, Governor Hockel announced our partnership with New York and the New York State Cannabis Social Equity Investment Fund. The Chicago Atlantic platform has committed $150 million to this partnership with the REIT accounting for up to $50 million of that total commitment. Our investment is subject to the identification and due diligence of dispensary locations. We have a highly skilled real estate team that has lent our expertise to picking and building the right locations, and they have been working on these sites for several months. Last week, we advanced our first capital, nearly $19 million, to fund the opening of 17 dispensaries, at least 15 of which should be operational in the fall. This partnership with New York is a whole new ballgame and perhaps the largest commitment to social equity initiatives in the history of the industry. We are fortunate to be the capital provider in the cannabis industry that has the operational, financial, legal, and underwriting expertise, not to mention the capital, to come alongside the state of New York and make this happen. If this works the way we all envision, there could be future opportunities to replicate this partnership in other states. Tony, why don't you take it from here?

Good morning. At June 30th, our loan portfolio had total loan commitments of $329 million across 25 portfolio companies with a weighted average yield to maturity of 19.2 percent, compared with 19.4 percent at March 31st and 17.7 percent a year ago. As expected, we kept new originations limited with total gross originations of only $1.9 million to existing borrowers. That was offset by $6.9 million of principal repayments, $5 million of which was related to unscheduled early repayments. Our portfolio remains 88 percent floating rate based off the prime rate, consistent with last quarter, and up from 60 percent from June of 2022. With the Federal Reserve raising their target rate again last week and the increase in the prime rate to 8.5 percent, we continue to see a positive impact on portfolio yield. I'll now turn it over to Andreas.

For the first time in our life as a platform, we experienced a default this quarter and moved loan number nine to non-accrual. The decision to place this loan on non-accrual is borrower specific and not representative of the performance across the rest of the portfolio. The borrower did not make contractual payments due under our loan since May. As a result, we accelerated the obligations due under the loan and are in the process of exercising our rights and remedies in pursuit of full repayment of outstanding obligations. Due to our stringent underwriting, we are confident that we will be made whole on this loan. The current outstanding principal balance is approximately $16.1 million and no past due interest has been accrued or recognized to income. On the capital structure side, we were able to increase our revolving credit facility to $100 million within the quarter with the addition of another bank to the syndicate. With that up size in the revolver, we are comfortable where we are with that size. As of quarter end, we had $43 million outstanding on the line. With the advance on the $18.8 million New York loan subsequent to quarter end that Peter mentioned earlier, we drew an additional $15 million on the revolver and have $58 million outstanding on the line as of today, which provides the company with a total of $46 million in liquidity. Our balance sheet is still under levered at 16% of book equity at quarter end compared with 22% at year end. Our debt service coverage ratio on a consolidated basis was 11.5 to 1 as of quarter end, compared with the requirement of 1.35 to 1. Given that leverage among other mortgage rates remains elevated, we believe we offer a very compelling dividend yield backed by strong portfolio yields and coverage without the level of risk that these other rates have taken on. In addition, we also benefit from strong underwriting and collateral coverage that extends well beyond the real estate. I'll now turn it over to Phil to review your financial results.

Thank you, Andreas. Net interest income for the quarter decreased 1.2 million or .4% from Q1. In Q2, we recognized approximately 0.6 million in nonrecurring interest income from early principal repayments as compared to 1 million during the first quarter. The decrease was further driven by the impact of one loan placed on non-accrual status in May, which accounted for 0.6 million of the sequential decline as well as a decrease in the average principal outstanding of 332 million during Q1 as compared to 319 million in Q2. These decreases were partially offset by lower average borrowings on our revolving credit facility and the positive impact of the 25 basis point increase in the prime rate in May. Total operating expenses for the quarter before our Cecil provision were down 5.8%, primarily due to decrease in net management and incentive fees. Adjusted distributable earnings was 55 cents per weighted average diluted share for Q2 compared with 62 cents during Q1. We distributed a dividend of 47 cents during the second quarter, which resulted in a dividend payout ratio of approximately 85%. Here to date, we have distributed approximately 80% of taxable income. The Q2 diluted earnings per weighted average common share was 47 cents compared to 60 cents in Q1. The decrease is primarily due to a higher provision for expected credit losses and stock-based compensation partially offset by the lower management and incentive fees. We increased our quarterly Cecil reserve by 1.1 million as of June 30th. The Cecil determination for the quarter considered reserved reversals attributable to the principal repayment during Q2 as well as the downgrade of one loan with an outstanding principal balance of 11 million to a risk rating of 4. Our reserve estimate further contemplates benchmark third-party loan loss data, which during Q2 reflected an increase in expected loss and probability of default rates as compared to Q1. The increase in these benchmark loss rates are the result of the continued rising rate environment and other macroenvironmental factors and contributed to the overall increase in the provision during Q2. On a relative size basis, we increased the total reserve to approximately .6% of outstanding principal as compared to .3% as of March 31st. Approximately 74% of the portfolio based on outstanding principal is fully secured by real estate collateral. 24% is partially secured with the remaining 2% having no real estate collateral. Our portfolio on a weighted average basis had real estate collateral coverage of 1.5 times as of June 30th, 2023. Our book value as of June 30th increased to $15.06 per common share compared with $15.04 as of March 31st. Lastly, I would note that based on our results through the first half of the year, we have affirmed our previously issued 2023 outlook. Operator, we're now ready to take questions.

Certainly. And as a reminder, if you have a question at this time, simply press star 1-1 on your telephone. One moment for our first question. And our first question comes from the line of Mark Smith from Lake Street. Your question, please. Hi,

guys. Just curious if you can give us any additional details on this New York deal, on kind of potential timing of additional capital put into this, rates, any additional details. I think this would be great.

Good morning. Unfortunately, we will stick to what we've published so far. I think it's detailed enough to kind of provide a guidance as to the risk return associated with the transaction. In line with what we've done in the past, we can discuss our borrowers in detail.

That's fair. And then any additional thoughts on new states? I know we've talked recently on Minnesota. You know, the thoughts on states that maybe have recently gone forward with new legalization or, you know, any that's just you in the pipeline that maybe gets you excited.

Ohio is probably the next state. As you know, they've gathered enough signatures to have the initiative on the ballot in November. That was expected. So we should be looking at Ohio turning red sometime next year. I would also say that we're a little bit cautiously optimistic with the P.A., although it's a harder way to get through the legislator. But those two states are rather big. And of course, the biggest state that has collected the signatures is the state of Florida. We're not holding our breath, but, you know, we have capable operators representing our portfolio in Florida. And we also feel strongly that at some point in the next 24 months, probably Florida will turn red.

OK, and I assume your outlook on anything changing at the federal level is probably unchanged.

Yeah, that's that requires a crystal ball. We're not quite there yet, but, you know. We can we can speculate.

The last question for me is just as we look at industry headwinds, others in the industry that are reported, you know, pretty tough results in outlook here. Are you seeing anywhere to call out, you know, from pockets of continued or maybe quickly?

I haven't been seeing weakness and I'm kind of constantly boots on the ground. What I have seen is a plateau as a result of, you know, turning off the capex faucet. So I suspect as what we're seeing is prices are kind of leveling off and in some cases taking upwards. So, you know, this is a Darwinian process. Whoever knows what they're doing, they're going to excel and there's going to be consolidation, which we were prepared for since day one. OK, thank you.

Thank you once again. If you have a question at this time, please press star one one. One moment for our next question. And our next question comes from the line of Mitchell Penn from Oppenheimer. Your question, please.

Yeah, hi, guys. Hey, can you provide more details on the non-acrol and give us an idea of the process and the timing in terms of how this is the first time we've seen a non-acrol? So more color around that.

Mitch, Chicago Atlantic is known for being very efficient. So I'm happy to report that we have a scheduled sale taking place tomorrow. But of course, the borrower has also filed a counterclaim and we're going to try to go over it today. As of right now, the sale is scheduled for tomorrow and we have a few buyers in line waiting to purchase the assets. So we're very much ahead of the game.

Terrific. And that's 16.2 million on your books.

I'm sorry, Mitch, can you repeat that?

That the value, the carrying value, 16.2 million. That low? Yes.

Plus 600 of interest. That's correct, Mitchell. The carrying value on the balance sheet 16.2. We had about 600,000 of income that would have been recognized on this loan had it not been placed on non-acrol status. And at this point, we're very comfortable that any reserves on the balance sheet are sufficient if there were to be any losses related to this loan. Got it.

OK, thanks, guys.

Thank you. This does conclude the question and answer session as well as today's program. Thank you, ladies and gentlemen, for your participation. You may now disconnect. Good day.