Chicago Atlantic Real Estate Finance, Inc. — Q2 2023 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2023. The company is an externally managed mortgage REIT focused primarily on senior loans to state-licensed cannabis businesses, generally secured by real estate and other borrower assets.
Financial performance and position
| Metric | Q2 2023 | Q2 2022 | Six months 2023 | Six months 2022 |
|---|---|---|---|---|
| Interest income | $14.66 million | $11.85 million | $31.19 million | $21.68 million |
| Interest expense | $0.99 million | $0.45 million | $2.61 million | $0.52 million |
| Net interest income | $13.66 million | $11.40 million | $28.57 million | $21.16 million |
| Net income | $8.64 million | $7.46 million | $19.34 million | $15.27 million |
| Diluted EPS | $0.47 | $0.42 | $1.07 | $0.86 |
- Q2 net interest income rose 20% and net income rose 16% year over year. For the first half, net interest income increased 35% and net income increased 27%.
- Management attributed higher interest income chiefly to rising Prime Rate and the floating-rate portfolio; Q2 and first-half results also included approximately $0.6 million and $1.7 million, respectively, of prepayment-fee interest income.
- Operating cash flow was $11.9 million for the first half, versus $7.4 million a year earlier. Net income included $4.35 million of paid-in-kind interest, which was accrued rather than received as cash.
- Investing activities provided $30.5 million, reflecting $51.9 million of loan principal repayments and $13.4 million of loan-sale proceeds, partly offset by $34.8 million of loan fundings. Financing activities used $30.1 million, including $22.0 million of dividends and net revolving-loan repayments.
- At June 30, cash was $18.0 million; total assets were $330.6 million; stockholders’ equity was $273.7 million. Loans at carrying value were $314.5 million before a $5.1 million expected-credit-loss reserve, or $309.4 million net.
- Revolving-loan borrowings were $43.0 million, with $57.0 million available under the $100 million facility. The facility matures December 16, 2024, subject to terms and a possible extension. The company reported compliance with its financial covenants.
- The portfolio comprised 25 borrowers, with $318.0 million of principal outstanding and a 19.2% weighted-average estimated yield-to-maturity IRR. Floating-rate loans were 87.9% of the portfolio. Fair value was $309.9 million, with $4.7 million of gross unrecognized holding losses.
Material developments, outlook and risks
- Credit deterioration: Loan #9, with approximately $16.2 million principal outstanding, was placed on non-accrual May 1 after payment and covenant defaults. The administrative agent issued an acceleration notice June 20 seeking immediate repayment. The company ceased accruing interest; the loan was reported 60 days past due at quarter end. One other loan was 31–60 days past due, with $16.2 million total in that aging category. No loans were more than 90 days past due.
- The allowance for expected credit losses on outstanding loans increased to $5.1 million from $3.9 million at year-end; including unfunded commitments, the reserve totaled $5.27 million. Management cited weaker risk ratings, borrower-specific conditions and the macroeconomic environment, including higher rates. Approximately 74% of the portfolio’s outstanding loans had underlying real-estate collateral value above the loan amount; the remainder relied partly on other collateral.
- Loan amendments during the quarter included changes to pricing, payment timing and covenants. A borrower on Loan #7 paid down $5.0 million; Loan #18 was amended to address non-monetary covenant breaches. Loan #4’s amendment included a one-quarter covenant waiver subject to conditions.
- After quarter end, the company advanced $18.7 million toward a discretionary $50 million commitment to Loan #25. It also borrowed $15.0 million under its revolver; by August 9, borrowings were $58.0 million and availability was $42.0 million.
- The company declared a $0.47-per-share Q2 dividend, paid July 14, bringing first-half declared dividends to $0.94 per share. Management cautioned that the dividend does not indicate future dividend capacity. The REIT generally must distribute at least 90% of taxable income, and future distributions may depend on available cash and financing.
- Management said cash on hand, revolver availability and operating cash flow were expected to meet requirements for at least the next 12 months. It also expects to need additional equity and/or debt financing as it grows. No specific earnings or dividend guidance was provided.
- Key risks include cannabis remaining illegal under U.S. federal law, changes to state cannabis laws or licensing, borrowers’ ability to service debt amid elevated rates, interest-rate mismatch and caps, collateral recovery limitations, and borrower and geographic concentration. The top three borrowers represented 31.8% of principal outstanding.
- The $75 million at-the-market equity program was established in June; 79,862 shares generated approximately $1.2 million net proceeds during Q2. A February registered direct offering raised approximately $6.0 million net in the first half. Related-party matters include external-manager fees and reimbursements and co-investments; the company disclosed a loan sale to a syndicate that included manager affiliates, approved by the board audit committee.
Most important facts for investors to verify
- Loan #9’s recovery prospects, enforcement actions, collateral value and potential impact on earnings and reserves.
- Subsequent funding and performance of Loan #25, and the updated revolver balance, availability, maturity and covenant headroom.
- Whether portfolio credit quality, risk ratings and the $5.27 million total expected-credit-loss reserve remain appropriate as rates and borrower conditions evolve.
- Cash income versus reported earnings, particularly the level and collectability of paid-in-kind interest and the sustainability of the $0.47 quarterly dividend.
- Portfolio concentration and collateral coverage, including the effects of cannabis-related legal restrictions on the ability to enforce or realize collateral.