Chicago Atlantic Real Estate Finance, Inc. — Q3 2022 Form 10-Q
Reporting period: Three and nine months ended September 30, 2022. Chicago Atlantic is an externally managed commercial mortgage REIT focused mainly on senior loans to state-licensed cannabis businesses, generally secured by real estate and other borrower assets. It elected REIT tax treatment beginning in 2021.
Financial results and position
| Metric | Q3 2022 | Comparison / period-end |
|---|---|---|
| Interest income | $13.80 million | Up 16% from Q2 2022 |
| Net interest income | $12.93 million | Up 13% from Q2 2022 |
| Net income | $9.77 million | $7.46 million in Q2 2022; $4.07 million in Q3 2021 |
| EPS | $0.55 basic and diluted | $0.83 in Q3 2021; share counts differed substantially |
| Adjusted distributable earnings | $10.30 million; $0.58 per diluted share | Non-GAAP measure |
| Cash / debt | $9.33 million / $53.0 million revolving loan | At September 30, 2022; cash was $80.25 million and debt was zero at December 31, 2021 |
| Net loans at carrying value | $329.58 million | Up from $196.85 million at December 31, 2021 |
| Equity / book value per share | $270.15 million / approximately $15.23 | Book value per share was approximately $15.13 at year-end 2021 |
| Dividends | $0.47 per share for Q3 | $1.34 per share declared in the first nine months of 2022 |
For the nine months, net income was $25.04 million and net cash provided by operations was $12.38 million. Investing activities used $120.72 million, mainly to fund loans; financing activities provided $37.43 million, including $53.0 million of revolver borrowings and offset by $19.87 million of dividends paid. Cash declined by $70.92 million during the period.
Portfolio, changes, and liquidity
- The portfolio comprised 22 loans to portfolio companies, with $348.9 million of total commitments and $334.5 million of outstanding principal. Net carrying value rose about 67% from December 31, 2021, reflecting loan fundings and capitalized PIK interest.
- Floating-rate loans represented 59.7% of principal, up from 53.2% at year-end; the remainder was fixed-rate. Weighted-average estimated yield-to-maturity IRR was 18.3%, versus 18.6% at year-end. These yield estimates depend on assumptions and are not guaranteed returns.
- All loans were reported current, with none on non-accrual or more than 30 days past due. The CECL reserve for funded loans was $1.50 million, compared with $0.13 million at year-end; the total reserve including unfunded commitments was $1.55 million. Management attributed weaker portfolio risk ratings primarily to macroeconomic reassessment, not borrower-specific issues.
- Unfunded loan commitments were $18.48 million, down from $34.70 million at year-end. The revolving facility commitment was $65 million at quarter-end. On November 7, 2022, it was increased to $92.5 million; the company reported approximately $34.5 million available on November 9.
- Management said cash, available revolver capacity, and operating cash flows were expected to meet requirements for at least the next 12 months. It also expected to need additional equity and/or debt financing as the portfolio grows.
Management commentary, outlook, and risks
- Q3 interest income benefited from prime-rate increases and approximately $5.7 million of new loan principal fundings. Higher rates also increased revolver interest expense; management noted that borrowing costs could rise faster than yields on some assets.
- No numerical earnings or dividend guidance was provided. The company stated that future dividends are not assured. Its REIT status generally requires annual distributions of at least 90% of REIT taxable income, subject to applicable rules.
- On October 27, a borrower refinanced and consolidated $30 million of debt, extending maturity from 2023 to October 2026.
- Key exposures include cannabis remaining illegal under U.S. federal law, potential changes in state laws or enforcement, borrower licensing and operating risks, loan concentration, credit and real-estate valuation risk, and interest-rate mismatch. The company noted that legal restrictions may impede direct possession of cannabis-related collateral following default and could result in losses.
- Two previously reported material weaknesses remained: IT general controls, including access and segregation-of-duties controls, and controls over estimating expected credit losses. Remediation was ongoing; management concluded disclosure controls were not effective at the reasonable-assurance level as of September 30, 2022, while stating the financial statements fairly presented the company’s position and results.
- The revolver had financial covenants, including a debt-service coverage ratio above 1.35 to 1 and leverage below 1.50 to 1; the company reported compliance at quarter-end. No material pending legal proceedings were reported.
Important facts for investors to verify
- Whether loan performance, collateral coverage, risk ratings, and the CECL reserve remain adequate as economic conditions and borrower valuations change.
- Actual revolver availability, borrowing costs, covenant compliance, and financing needs following the November 2022 commitment increase.
- Cash generation relative to dividends, including the role of PIK interest and other income not yet received in cash.
- Progress in remediating the two material weaknesses and whether controls are operating effectively.
- Developments in cannabis laws and enforcement, borrower licensing, and the company’s ability to recover collateral following default.
Comparability note: The company commenced operations in March 2021, and its 2021 nine-month comparison covers only the period from inception through September 30. The Q3 2021 comparison also reflects a much smaller share base following the company’s subsequent public offering.