Chicago Atlantic Real Estate Finance, Inc. — Q1 2022 Form 10-Q
Reporting period: Three months ended March 31, 2022. The company is an externally managed commercial mortgage REIT focused primarily on senior loans to state-licensed cannabis businesses, secured by real estate and other borrower assets. It began operations in 2021; the comparable 2021 period was essentially pre-operational, so year-over-year comparisons are not meaningful.
Financial performance and position
| Metric | Q1 2022 / March 31, 2022 | Comparison |
|---|---|---|
| Interest income / total revenue | $9.83 million | Prior comparable period: $0 |
| Net income | $7.80 million; $0.44 per basic and diluted share | Prior comparable period: $0 |
| Total expenses | $2.03 million | Prior comparable period: $0 |
| Operating cash flow | $3.04 million | Prior comparable period: $0 |
| Investing cash flow | $(77.18) million | Primarily loan fundings, net of principal repayments |
| Financing cash flow | $(0.03) million | Includes $4.51 million of dividends paid and $4.51 million of net stock proceeds |
| Cash | $6.08 million | Down from $80.25 million at December 31, 2021 |
| Loans held for investment, net | $278.64 million | Up from $196.85 million at December 31, 2021 |
| Total assets / stockholders’ equity | $285.91 million / $269.38 million | At March 31, 2022 |
| Debt outstanding | $0 under revolving facility | No borrowings at March 31; $30 million drawn after quarter-end |
The filing does not provide a conventional net interest margin. Interest income includes $0.97 million of payment-in-kind (PIK) interest, which was added to loan principal rather than received in cash. The non-GAAP measure adjusted distributable earnings was $8.05 million, or $0.46 per basic weighted-average share and $0.45 per diluted share. Book value was $15.17 per share, versus $15.13 at year-end 2021.
Portfolio, dividends, and material changes
- The portfolio increased to 22 loans from 21 at year-end. Outstanding principal was $282.71 million; aggregate commitments were $321.11 million, including $39.57 million undrawn. The company funded approximately $86.7 million of new loan principal during the quarter.
- Floating-rate loans rose to 63.4% of portfolio principal from 53.2%; the remainder was fixed-rate. Floating loans reference prime and generally have floors. Weighted-average portfolio yield-to-maturity IRR was 17.2%, down from 18.6% at year-end; this is a portfolio measure, not a reported margin.
- All loans were current, none were on non-accrual, and none were more than 30 days past due. Loan balances were rated either low risk or very low risk. The total CECL allowance, including unfunded commitments, was $199,292; the quarter’s provision was $51,343.
- The company declared a $0.40-per-share Q1 cash dividend, totaling approximately $7.1 million, paid April 14, 2022. Management cautions that this payment does not indicate future dividend capacity.
- In May 2022, the revolving facility commitment increased from $45 million to $65 million. The company had drawn $30 million after quarter-end, leaving approximately $35 million available as of May 12.
Outlook, risks, and unusual items
- Management stated that cash on hand, available revolving capacity, and operating cash flows were expected to meet business requirements for at least 12 months. It also anticipated needing additional equity and/or debt financing as the loan portfolio grows. No numerical earnings or dividend guidance was provided.
- Key risks include borrower credit deterioration, cannabis-sector volatility and competition, and changes to state cannabis laws. Cannabis remains illegal under U.S. federal law; legal restrictions could impair borrowers or limit the company’s ability to take possession of or realize value from collateral. Management may need to sell a defaulted loan rather than take control of cannabis-related collateral.
- Interest-rate exposure is material: management estimated that a 100-basis-point increase in prime would add approximately $1.25 million to annual interest income; a 100-basis-point decrease was not expected to reduce income because of loan floors. Rising rates could nevertheless increase borrowing costs and pressure spreads if debt is used to fund assets.
- Portfolio concentration: the top three borrowers represented 31.6% of funded principal at quarter-end. Loan fair values are Level 3 estimates using discounted cash flows and market assumptions; realized proceeds could differ, particularly in a forced sale.
- The company reported two material weaknesses in internal control over financial reporting: information-technology general controls and controls over CECL allowance development. Remediation is ongoing; management said the controls were not effective at the reasonable-assurance level as of March 31, 2022, while concluding the financial statements were fairly stated in all material respects.
- The manager and its affiliates are related parties. Q1 management and incentive fees totaled $671,505, after a $717,750 offset from origination fees; the manager was also owed approximately $411,521 for reimbursable expenses. Ten loans were co-invested by affiliates.
- The company elected REIT tax treatment and generally must distribute at least 90% of REIT taxable income to maintain qualification. Accrued PIK income may create distributions that are not matched by cash collections.
Important facts for investors to verify
- Whether the $30 million post-quarter-end revolver borrowing, subsequent loan originations, and $35 million remaining availability adequately cover undrawn loan commitments and operating needs.
- Cash collection and sustainability of reported interest income, particularly the PIK component, alongside the $0.40 dividend and REIT distribution requirements.
- Borrower performance, collateral values, concentration exposures, and the assumptions supporting the CECL reserve and Level 3 fair values.
- Progress and independent validation of remediation for both reported material weaknesses.
- Compliance with revolving-credit covenants and the cost and availability of future financing as the portfolio expands.