Q3 2022 Chicago Atlantic Real Estate Finance Inc Earnings Call
The conference will begin shortly to raise your hand during Q&A you can dial star one one.
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Yeah.
Good day, ladies and gentlemen, and thank you for standing by welcome to the Chicago Atlanta Real estate Finance incorporated third quarter 2022 earnings Conference call. At this time all participants are in a listen only mode. After the speaker's presentation. There will be a question and answer session to ask a question during.
The session you will need to press star one one on your telephone keypad at this time I would like to turn the conference over to Mr. Tripp Sullivan of SCR partners. Mr. Sullivan you may begin.
Thank you and good morning, welcome to the Chicago, Atlanta Real estate Finance Conference call to review the company's results for the third quarter of 2022.
On the call today will be John <unk> Executive Chairman, Tony Campbell, Chief Executive Officer, Andreas both admire co President and Chief Investment Officer, and Phil Silverman interim Chief Financial Officer.
Our results were released this morning in our earnings press release, which can be found on the Investor Relations section of our website along with our supplemental filed with the SEC.
A live audio webcast of this call is being made available today.
Those who listen to the replay of this webcast.
Mind, you that the remarks made herein are as of today November nine 2022, it 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.
Pipeline of potential loans and other investments future.
Future dividends and financing activities all.
All forward looking statements represent Chicago Atlantic judgment as of the date of this call and are subject to risks and uncertainties that can cause actual results to differ materially from our current expectations.
Investors are urged to carefully review various disclosures made by the company, including the risks and other information disclosed in the company's filings with the SEC.
We will also discuss certain non-GAAP measures, including but not limited to distributable earnings and adjusted distributable earnings definitions of these non-GAAP measures and reconciliations to the most comparable GAAP measures are included in our filings with the SEC.
I'll now turn the call over to John <unk>. Please go ahead.
Good morning, everyone and thank you for joining us today.
Throughout this year, we have stressed the importance of maintaining discipline in underwriting loan documentation and loan monitoring. We have also continued to assess asset values in every state as state markets evolve monthly.
Given the continued disruption in the capital markets. It is critical that we continue to rely on these aspects of our strategy that have made us successful so far being methodical analytical and pragmatic.
I want to remind again, everyone the investment potential of this industry.
Let's compare the performance of the cannabis market in the last three years to beer wine tobacco and pharmaceuticals.
The revenue growth of these other industries from 2019 to 2021 was in the low single digits, along with high single digits to low double digit profit growth at best.
The cannabis market on the other hand generated annual revenue growth in the mid 30% to low 50% range, along with mid 30% to 50% annual profit growth in the same period.
Cannabis is an industry that has only just began to grow and will continue to need significant growth capital.
I would also highlight that U S retail sales estimate from back book.
Canada sales to increase from $30 billion in 2000 $22 billion to $53 billion by 2026, with Rhode Island, proving adult use cannabis in may and its first retail store opening in early December and with Maryland being expected to move to adult use with a referendum. This month. These estimates named fact the concern.
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I don't think we've seen the full impact of New Jersey, or New York and those sales estimates either.
I also think it is worth mentioning the safe banking Act here briefly.
There has been an increasing amount of speculation that something could get done before next January while this piece of legislation may ultimately pass we believe that there is still a lot of work and compromise on both sides of the Io for that to happen overall, we believe that this legislation will be a net positive for Chicago Atlanta.
Several local banks are already providing smaller loans to smaller operators if the safe banking act results in larger regional banks entering the space. We believe that they will want to put sizable capital to work quickly with platforms, such as Chicago Atlantic rather than to build up the expertise with their own underwriting and lending groups.
Ultimately this legislation is expected to help us increase our leverage and to result in an overall lower cost of capital for the REIT.
I noted last quarter that it was our number one goal to increase our syndicated credit facility because of how accretive this lower cost of capital is for our investors.
And I am pleased to announce that we have successfully done. So we increased our credit facility by $27 5 million to a total of $92 $5 million and we added four new banks to our lending group.
Actively working to close another $7 5 million to get us to $100 million in total we're also working to ultimately increase the overall size of our revolver as the credit facility will remain the most accretive source of capital for us in the foreseeable future.
As we disclosed in our earnings release, we increased our outlook for the full year. We are now expecting adjusted distributable earnings to be in the range of 201 to 205 per share.
This outlook assumes the use of our expanded credit facility over the balance of the fourth the fourth quarter with leverage by year end in the range of 25% to 35%.
Having declared a <unk> 47 regular quarterly dividend for Q3 as planned in December we expect to declare at least 47 for the fourth quarter. We also intend to distribute up to 99% of distributable earnings for 2022 that would imply a special dividend to be declared before year end.
To true up our taxable income.
We have combined a very bullish outlook on the cannabis industry with a measured and disciplined approach to underwriting our conservativism has been even more evident in our projections, our leverage and our dividend payouts. We believe that these decisions have been the right ones for our shareholders and have led to our outperformance.
On a relative basis to our peers and our comparable indexes.
Tony why don't you take it from here.
Good morning, everyone.
I wanted to follow up on a point John made earlier about investment potential as you might expect we track pricing data and trends in every state in which we're invested along with those where we are not invested well.
While we keep seeing and that data is there a lot of headlines about pricing compression, but not much context beyond the headlines.
Without the context and analysis, all you might come away with is misguided impression of general operator distress.
There have been some well documented cases in the industry, but for the most part we are seeing continued growth from our operators.
The way we see it success is defined differently in every state and not all prices are created equal here's a good example.
More competitive states, such as Arizona, California, Colorado, Oregon, Washington, and Michigan has seen their average wholesale price per pound decreased from an average of 250 per pound in January to roughly 800 per pound in September .
Other states, such as Illinois, Maryland, Pennsylvania, and Massachusetts have seen declines as well in the same period, but they've all stayed between $22 50, and $37 50 per pound and a percentage declines haven't been as steep as the western states.
This is where the underwriting discipline and first mover experience in the industry count.
When we look at underwriting cultivation, if an operator can produce at 400 per pound than they are viable at even a wholesale price of $1 per pound.
The same goes for a producer who is costs are 200 per pound in a market where wholesale pricing is between 2500 $3 per pound.
For our retail operations, we focus on sales per square foot. The current average across our portfolio is $3000 per square foot.
That's comparable to what an Apple store or other high end retail stores with produce an operator with $400 per pound cost structure and $3000 per square foot in retail sales is viable even in a market like California.
Turning to our origination pipeline, we have remained very active in the second half of the year.
As planned the Chicago Atlantic platform has been able to fulfill demand from new and existing operators until the REIT could increase the size of its credit facility.
Just last month, we were pleased to lead and serve as the agent for a new four year $350 million facility for our largest multistate operator.
The REIT retained its $30 million in that facility.
We believe there will be additional opportunities for the REIT to participate in future financing needs with this operator in the not too distant future.
While we have stayed active with originations. We have also held the line on a robust structuring upfront intense loan monitoring strict financial covenants and all asset leans from borrowers that improve our collateral well beyond the one nine times real estate coverage that we have in our portfolio.
In addition, we expect to continue to increase the amount of great loans to well above 60% of our portfolio.
Loan demand is strong and with the REIT now having additional capital to put to work and plans to potentially increase the facility again to REIT can once again reap the benefits of the leading origination platform. We have created now Andreas will walk us through our investments.
Thanks, Tony at September 30, our loan portfolio had grown to total loan commitments of 349 million across 22 portfolio company.
It has a weighted average yield to maturity of 18, 3% up from 17, 7% at June 30.
Originations during the quarter were $5 7 million comprised of $5 million create new borrower with $4 million commitment remaining and 680000 incremental advance to an existing borrower.
As discussed on the Q2 earnings call originations were expected to be low in Q3 due to the capital constraints. However, the Chicago Atlantic pipeline remains strong and with the increase of the credit facility. We expect the rate to be able to increase its loan originations in Q4.
Sequential quarter, and we have the origination Tony mentioned earlier, which extended the maturity of a $30 million loan that the REIT holds until 2026.
All loans are current and performing our portfolio is currently about 60% floating rate based off of the prime rate. So we have been able to effectively manage the impact of rising rates last weeks decision by the federal reserve to raise the fed funds rate by another 75 basis points should result in another increase in portfolio yield in Q4.
With our leverage expected to increase from 20% to 25% to 35% by year end the higher interest on the credit facility could potentially offset some of that yield and distributable earnings.
I'll now turn it over to Phil to review our financial results.
Thank you Andreas turning now to our financial results for the third quarter.
As expected net interest income continued to increase sequentially up $1 5 million or 13, 4% from Q2.
The increase was primarily due to the 150 basis point increase in the prime rate during Q3, which impacted the 60% of our portfolio, which bears a floating rate.
Additionally, the company benefited from a full quarter of interest recognition on our Q2 loan originations.
Total operating expenses for the quarter were consistent with Q2 at approximately $2 9 million, which includes management and incentive fees of $1 3 million aggregate G&A and professional fees of $1 4 million in stock based compensation of approximately 100000 <unk>.
The incentive and management fees were up sequentially in line with higher net interest income while the other G&A and professional fee expenses were down nearly 100000 as compared to prior quarter.
We anticipate full year G&A will be approximately $3 5 million, which includes costs associated with our upsized credit facility, which were not capitalized under GAAP.
The incentive fees paid to our manager are calculated on a rolling 12 month basis. These incentive fees for the last 12 months as of Q3 less the fees paid and waived in the previous three quarters was approximately 519000 in Q3 compared to approximately 599000 in Q2.
In Q4 2021, the manager granted an incentive fee waiver of approximately $1 1 million in connection with our IPO. This fee waiver from Q4 2021 will be excluded from the rolling 12 month calculation in Q4 2022.
As a result, we expect an increase in incentive fee for Q4, and a corresponding decrease to distributable earnings for the same period.
As of quarter end, we increased our provision for expected credit losses by 300000 or nearly <unk> <unk> per weighted average diluted common share similar to last quarter. Our reserve was increased based on our quarterly reevaluation of overall current macroeconomic conditions, including for example, the rising rate environment as opposed to.
Any company specific factors impacting the credit quality of our borrowers.
Nearly 96% of the portfolio continue to be fully secured by real estate and 4% is limited or no real estate collateral our portfolio on average had real estate collateral coverage of one nine times as of September 32022.
So reserve was added back to the calculation of distributable earnings consistent with prior quarters.
The other adjustments to distributable earnings include stock based compensation, and depreciation and amortization, which amounted to 223000 in Q3 compared to approximately 291000 in Q2.
Our adjusted distributable earnings per share was <unk> 58 per diluted share for Q3 up sequentially from 50 in Q2.
Our book value as of September 30 was $15 23 per common share compared with $15 13 as of June 30th Operator, we're now ready to take questions.
Ladies and gentlemen, if you have a question or comment at this time. Please press star one one on your telephone keypad.
Again, if you have a question or comment at this time. Please press star one one on your telephone keypad.
First question or comment comes from the line of Aaron Hecht from JMP Securities. Mr. Hill. Your line is open.
Hey, guys. Thanks for taking my questions and congrats on.
Getting that extra liquidity on the credit facility I know you don't work on that for a while.
Okay.
When you look at your pipeline today.
How is the.
Investment yield changes across the landscape I mean, obviously.
There's been significant capital market volatility interest rates are up.
Our investment yields keeping up with the cost of capital increase that you guys are seeing.
For you anything in the market.
Good morning, Erin and thanks for the question good morning.
Everyone.
Yes. The answer the quick answer is absolutely we are seeing yields like going up proportionately to the fed increases we.
We don't have any.
Expectations for those to subside anytime soon keeping.
Keep in mind that for the broader market for increasing rates.
Highlights at 300% to 400% increase.
From zero to four and a quarter.
In our case.
The increase it's much smaller relative to the initial rate that the borrowers were paying before so that is that is a key metric.
To kind of define stress in cannabis versus the broader market.
Okay, and then you guys got.
Graves Mehta from EF Hutton Mr. Mehta. Your line is now open.
Mr. <unk> your line is open.
Hey, good morning, Thanks for taking my question.
Wanted to ask.
On some expense items.
Talked about G&A expectations of $3 5 million.
Which is at the higher end of your prior expectation of three five to $3 five.
I think you mentioned.
Awesome Upsized credit facility.
Outside of that are there.
Or any other items.
The G&A to the higher end and then I guess you guys would think about the run rate.
G&A, how should we think about that.
Hi.
Yeah. Thanks for the question.
Yeah as you correctly pointed out we increased our G&A guidance slightly to about $3 5 million.
And as you also correctly pointed out we dedicated a substantial internal resources of our manager rather than an investment bank. Our third party during Q3 to pursue and source the increased commitments on the Upsized credit facility and.
So that's really the significant driver of the increase in Q3, and therefore the run rate for the year. Those presumably are one time costs, although we continue to.
Pursue further increases to the total commitments on that facility as we've noted I think.
The Q2.
Expense numbers are indicative of our run rate.
Going forward.
Okay.
Maybe on your guidance of distributable earnings.
I was curious if you could.
So from that standpoint, maybe the variance between the <unk>.
Earnings as implied by the guidance versus <unk>. It seems like <unk> will be lower than <unk>.
And then earlier, you said higher incentive fee, but I guess outside of that other items that were bringing <unk> earnings lower than <unk>.
Okay.
No it's really predominantly the incentive fee. It is a fairly substantial difference in.
And the nature of the way it's calculated.
We explained that in our prepared remarks.
That will drive distributable earnings down slightly we have not forecasted any additional rate hikes from the fed beyond what's occurred through today. So.
That is not contemplated in our calculations, we expect expenses in other.
The operations of the company to remain relatively consistent through the fourth quarter.
Okay.
Thank you that's all I had.
Thank you again, ladies and gentlemen, if you have a question or comment at this time. Please press star one one on your telephone keypad. Our next question or comment comes from the line of Mark Smith from Lake Street Capital markets. Mr. Schmidt Your line is open.
Hey, good morning, guys.
A couple for me.
First any outlook really into repayments or anything that we should have on our radar that could be coming up that changes portfolio a little bit.
Yes, we just have one deal that is set to mature in Q4.
And again, it's not that big and our expectation is.
We will be able to roll that into a new deal at a at a higher return now if if that does pay down we are very confident that that can be put to work in short order other than that there really are no expectations of payoffs.
Perfect.
We look at kind of structuring of new deals any pushback any issues. As you guys look at continued move to floating rates as well as kind of getting the real estate collateral that you that you look for a need.
So yes, we're trying to to pick the best of the best deals.
We've been able to increase our floating percentage the floating percentage of the portfolio from 60% to the low seventies.
So we're very mindful of not committing to any fixed loans.
And we're actively pursuing converting any fixed loans to floating loans.
Collateral, obviously has become top of mind.
And credit worthiness in general.
<unk> has been what we have been citing after.
In the last.
Couple of quarters since the rates started to increase.
We have not I mean, obviously.
Lee borrowers will always pushed back regarding of the conditions.
Regardless of the conditions, so nothing nothing new to report on that front.
Okay.
And then last one for me you mentioned it a little bit on your comments, John but as we look at Missouri, and Maryland looking positive here for <unk>.
Legalization.
There are those that you really think maybe change.
Your outlook that are good growth opportunities and then.
Maybe not looking at a full lame duck session here does that reduce the risks or reduce the odds maybe of getting safe.
<unk> factor anything else past year over the next few months.
The truth is that we were expecting those two states to slip because of the overwhelming support by voters.
So we were actively pursuing deals in those states and we've actually made we're in the process of.
Closing deals in those states so yeah.
Yes, net net positive great great story for both states.
It's a win win for everyone.
Okay, great. Thank you.
Thank you Sir.
Appears to be no additional questions in the queue I'd like to turn the conference back over to Mr. <unk> for any closing remarks.
Well. Thank you very much I wanted to thank everyone.
Feel that we've put another good quarter.
For scrutiny by the group.
And where we're going to continue to do what we do and hopefully deliver more quarters like this one.
Wonderful day.
Ladies and gentlemen, thank you for participating in today's conference. This concludes the program you may now disconnect everyone have a wonderful day.
The conference will begin shortly to raise your hand during Q&A you can dial star one one.
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