Chicago Atlantic Real Estate Finance, Inc. — Q2 2022 Form 10-Q
Reporting period: Three and six months ended June 30, 2022. The company is an externally managed commercial mortgage REIT focused primarily on senior loans to state-licensed cannabis businesses, generally secured by real estate and other borrower assets. It began operations in 2021, so comparisons with the 2021 inception-period results are not like-for-like.
Financial and operating performance
| Metric | Q2 2022 / June 30, 2022 | Comparison / context |
|---|---|---|
| Interest income | $11.85 million | $21.68 million for the first half of 2022 |
| Interest expense | $0.45 million | $0.52 million for the first half; increased with revolver borrowings |
| Net interest income | $11.40 million | $21.16 million for the first half |
| Total expenses | $3.94 million | Includes $1.05 million credit-loss provision and $1.25 million net management and incentive fees |
| Net income / EPS | $7.46 million / $0.42 diluted | First-half net income was $15.27 million and diluted EPS was $0.86. Q2 net income was down from $7.80 million in Q1. |
| Adjusted distributable earnings | $8.80 million, or $0.50 per weighted-average share | Non-GAAP measure; includes adjustments for non-cash equity compensation, amortization and credit-loss provision |
| Loans held for investment, net | $329.0 million | Up from $196.9 million at December 31, 2021; 22 loans versus 21 |
| Cash and debt | $6.6 million cash; $45.0 million revolver outstanding | Cash was $80.2 million at year-end 2021. Revolver commitment is $65 million. |
| Stockholders’ equity / book value | $268.6 million / approximately $15.13 per share | Book value per share was also approximately $15.13 at December 31, 2021. |
| Dividends | $0.47 per share for Q2 | Paid July 15, 2022; first-half declared dividends totaled $0.87 per share. |
For the six months, operating cash flow was $7.4 million, investing cash flow was negative $118.7 million and financing cash flow was $37.7 million. Cash declined by $73.6 million. Loan originations and fundings were the main use of investing cash. The portfolio’s weighted-average yield-to-maturity IRR was 17.7%, down from 18.6% at year-end; this is a company-defined portfolio measure, not a GAAP margin.
Material changes and portfolio credit
- The company funded approximately $137.9 million of new loan principal in the first half. In Q2, it closed one new $17.0 million facility and advanced $34.2 million on existing facilities.
- Floating-rate loans increased to 59.8% of portfolio principal from 53.2% at year-end; the remainder was fixed-rate. Floating loans reference prime, and the filing estimates that a 100-basis-point prime-rate move would change annual interest income by approximately $1.0 million.
- The CECL reserve for outstanding loans rose to $1.20 million from $0.13 million at year-end; the total reserve, including unfunded commitments, was $1.24 million. Management attributed the increase primarily to its macroeconomic reassessment, rather than borrower-specific credit issues.
- All loans were current, none were on non-accrual, and none had principal or interest more than 30 days past due. The filing reports no realized loan losses since inception. Risk ratings weakened in management’s assessment primarily because of broader macroeconomic conditions; $5.0 million of loans carried risk rating 4, with none rated 5.
- The top three borrowers represented 29.6% of funded principal. The largest borrower represented 10.9%. Management reported average real-estate collateral coverage of 1.9x and stated that 94% of the portfolio was fully secured by real estate.
Liquidity, outlook, risks and unusual items
- The revolver commitment was increased to $65 million in May 2022; $45 million was drawn by quarter-end, leaving nominal unused capacity of $20 million. The facility matures no later than December 16, 2023, subject to its terms. The company reported compliance with its financial covenants.
- Management said cash on hand, available revolver capacity and operating cash flows should meet requirements for at least the next 12 months, while also stating it expects to need additional equity or debt financing as the portfolio grows. No specific earnings or dividend guidance was provided. Management cautioned that declared dividends do not assure future dividends.
- Key risks include cannabis remaining illegal under U.S. federal law, potential changes to state cannabis laws or enforcement, borrowers’ ability to maintain licenses, concentrated borrower exposure, collateral valuation and loan liquidity, and rising inflation and interest rates. Cannabis-related legal restrictions may also limit the company’s ability to take possession of certain collateral after a default.
- Rising rates may increase borrowing costs faster than income from fixed-rate or capped assets. The company reported no interest-rate caps on its floating-rate loans; its loans generally have prime-rate floors.
- Disclosure controls were not effective as of June 30, 2022 because of previously reported material weaknesses in IT general controls and controls over the CECL allowance. Remediation was ongoing; management nevertheless stated that the financial statements fairly present the company’s position and results in all material respects.
- After quarter-end, the company sold an approximately $6.7 million senior secured loan to an affiliate on July 8 at a price approximating carrying value plus accrued interest, and assigned $10.0 million of an unfunded commitment to an affiliate on August 4.
Most important facts for investors to verify
- Whether portfolio growth, interest collections and funding of the $25.2 million in undrawn loan commitments can be supported by liquidity and financing availability.
- How the CECL reserve and loan risk ratings change as macroeconomic conditions and borrower performance evolve, including the assumptions used in collateral and enterprise-value estimates.
- Borrower concentration, collateral coverage and the practical recoverability of collateral given cannabis-related legal restrictions.
- Interest-rate sensitivity of asset yields versus revolver and future borrowing costs, and compliance with debt covenants and the revolver’s maturity terms.
- Progress in remediating the disclosed material weaknesses, and the effect of management fees, incentive compensation and affiliate transactions on shareholder returns.
- Whether future dividends are supported by cash earnings and REIT distribution requirements; adjusted distributable earnings is non-GAAP and includes accrued PIK income that may not be received in cash during the period.