Chicago Atlantic Real Estate Finance, Inc.: Form 10-Q for the period ended Jun 30, 2024

FORWARD-LOOKING STATEMENTS

Some of the statements contained in this quarterly report constitute forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995 and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and we intend such statements to be covered by the safe harbor provisions contained therein. Forward-looking statements relate to future events or the future performance or financial condition of Chicago Atlantic Real Estate Finance, Inc. (the “Company,” “we,” “us,” and “our”). The information contained in this section should be read in conjunction with our consolidated financial statements and notes thereto appearing elsewhere in this quarterly report on Form 10-Q. This description contains forward-looking statements that involve risks and uncertainties. Actual results could differ significantly from the results discussed in the forward-looking statements due to the factors set forth in this quarterly report and in “Risk Factors” in our annual report on Form 10-K filed with the Securities and Exchange Commission (the “SEC”) and in Part II, Item 1A of this quarterly report on Form 10-Q, as such risks may by updated, amended, or superseded from time to time by subsequent reports we file with the SEC. The forward-looking statements contained in this report involve a number of risks and uncertainties, including statements concerning:

• our future operating results and projected operating results;
• the ability of our Manager to locate suitable loan opportunities for us, monitor and actively manage our loan portfolio, and implement our investment strategy;
• the allocation of loan opportunities to us by our Manager;
• the impact of inflation on our operating results;
• actions and initiatives of the federal or state governments and changes to government policies related to cannabis and the execution and impact of these actions, initiatives, and policies, including the fact that cannabis remains illegal under federal law;
• the estimated growth in and evolving market dynamics of the cannabis market;
• the demand for cannabis cultivation and processing facilities;
• shifts in public opinion regarding cannabis;
• the state of the U.S. economy generally or in specific geographic regions;
• economic trends and economic recoveries;
• the amount and timing of our cash flows, if any, from our loans;
• our ability to obtain and maintain financing arrangements;
• our expected leverage;
• changes in the value of our loans;
• our expected investment and underwriting process;
• rates of default or decreased recovery rates on our loans;
• the degree to which any interest rate or other hedging strategies may or may not protect us from interest rate volatility;
• changes in interest rates and impacts of such changes on our results of operations, cash flows, and the market value of our loans;
• interest rate mismatches between our loans and our borrowings used to fund such loans;
• the departure of any of the executive officers or key personnel supporting and assisting us from our Manager or its affiliates;
• impact of and changes in governmental regulations, tax law and rates, accounting guidance, and similar matters;
• our ability to maintain our exclusion or exemption from registration under the Investment Company Act;
• our ability to qualify and maintain our qualification as a real estate investment trust (“REIT”) for U.S. federal income tax purposes;
• estimates relating to our ability to make distributions to our stockholders in the future;
• our understanding of our competition;
• market trends in our industry, interest rates, real estate values, the securities markets or the general economy; and
• any of the other risks, uncertainties and other factors we identify in our annual report on Form 10-K or this quarterly report on Form 10-Q.

Available Information

We routinely post important information for investors on our website, www.chicagoatlantic.com (http://www.chicagoatlantic.com). We intend to use this webpage as a means of disclosing material information, for complying with our disclosure obligations under Regulation FD and to post and update investor presentations and similar materials on a regular basis. We encourage investors, analysts, the media, and others interested in us to monitor the Investments section of our website, in addition to following our press releases, SEC filings, public conference calls, presentations, webcasts and other information we post from time to time on our website. To sign-up for email-notifications, please visit “Contact” section of our website under “Join Our Mailing List” and enter the required information to enable notifications.

Overview

We are a commercial mortgage real estate investment trust. Our primary investment objective is to provide attractive, risk-adjusted returns for stockholders over time primarily through consistent current income dividends and other distributions and secondarily through capital appreciation. We intend to achieve this objective by originating, structuring and investing in first mortgage loans and alternative structured financings secured by commercial real estate properties. Our current portfolio is comprised primarily of senior loans to state-licensed operators in the cannabis industry, secured by real estate, equipment, receivables, licenses or other assets of the borrowers to the extent permitted by applicable laws and regulations governing such borrowers. We also invest in companies or properties that are not related to the cannabis industry that provide return characteristics consistent with our investment objective. We intend to grow the size of our portfolio by continuing the track record of our business and the business conducted by our Manager and its affiliates by making loans to leading operators and property owners in the cannabis industry. There is no assurance that we will achieve our investment objective.

Our Manager and its affiliates seek to originate real estate loans between $5 million and $200 million, generally with one- to five-year terms and amortization when terms exceed three years. We generally act as co-lenders in such transactions and intend to hold up to $50 million of the aggregate loan amount, with the remainder to be held by affiliates or third party co-investors. We may revise such concentration limits from time to time as our loan portfolio grows. Other investment vehicles managed by our Manager or affiliates of our Manager may co-invest with us or hold positions in a loan where we have also invested, including by means of splitting commitments, participating in loans or other means of syndicating loans. We will not engage in a co-investment transaction with an affiliate where the affiliate has a senior position to the loan held by us. To the extent that an affiliate provides financing to one of our borrowers, such loans will be working capital loans or loans that are subordinate to our loans. We may also serve as co-lenders in loans originated by third parties and, in the future, we may also acquire loans or loan participations. Loans that have one to two year maturities are generally interest only loans.

Our loans are secured by real estate and, in addition, when lending to owner-operators in the cannabis industry, other collateral, such as equipment, receivables, licenses or other assets of the borrowers to the extent permitted by applicable laws and regulations. In addition, we seek to impose strict loan covenants and seek personal or corporate guarantees for additional protection. As of June 30, 2024 and December 31, 2023, 24.0% and 27.1%, respectively, of the principal of loans held in our portfolio are backed by personal or corporate guarantees. We aim to maintain a portfolio diversified across jurisdictions and across verticals, including cultivators, processors, dispensaries, as well as ancillary businesses. In addition, we may invest in borrowers that have equity securities that are publicly traded on the Canadian Stock Exchange (“CSE”) in Canada and/or over-the-counter in the United States.

As of June 30, 2024, our portfolio is comprised primarily of first mortgages to established multi-state or single-state cannabis operators or property owners. We consider cannabis operators to be established if they are state-licensed and are deemed to be operational and in good standing by the applicable state regulator. We do not own any stock, warrants to purchase stock or other forms of equity in any of our portfolio companies that are involved in the cannabis industry, and we will not take stock, warrants or equity in such issuers until permitted by applicable laws and regulations, including U.S. federal laws and regulations.

We are an externally managed Maryland corporation that elected to be taxed as a REIT under Section 856 of the Code, commencing with our taxable year ended December 31, 2021. We believe that our method of operation will enable us to continue to qualify as a REIT. However, no assurances can be given that our beliefs or expectations will be fulfilled, since qualification as a REIT depends on us continuing to satisfy numerous asset, income, and distribution tests, which in turn depend, in part, on our operating results. We also intend to operate our business in a manner that will permit us and our subsidiaries to maintain one or more exclusions or exemptions from registration under the Investment Company Act.

Revenues

We operate as one operating segment and are primarily focused on financing senior secured loans and other types of loans for established state-licensed operators in the cannabis industry. These loans are generally held for investment and are substantially secured by real estate, equipment, licenses and other assets of the borrowers to the extent permitted by the applicable laws and the regulations governing such borrowers.

We generate revenue primarily in the form of interest income on loans. As of June 30, 2024 and December 31, 2023, approximately 76.4% and 80.5%, respectively, of our portfolio was comprised of floating rate loans, and 23.6% and 19.5% of our portfolio was comprised of fixed rate loans, respectively. The floating rate loans described above are variable based upon the Prime Rate plus an applicable margin, and in many cases, a Prime Rate floor.

The below table reflects the changes in the Prime Rate since January 1, 2023:

(1) Rate obtained from the Wall Street Journal’s “Bonds, Rates & Yields” table.

Interest on our loans is generally payable monthly. The principal amount of our loans and any accrued but unpaid interest thereon generally become due at the applicable maturity date. In some cases, our interest income includes a paid-in-kind (“PIK”) component for a portion of the total interest. The PIK interest, computed at the contractual rate specified in each applicable loan agreement, is accrued in accordance with the terms of such loan agreement and capitalized to the principal balance of the loan and recorded as interest income. The PIK interest added to the principal balance is typically amortized and paid in accordance with the applicable loan agreement. In cases where the loans do not amortize, the PIK interest is collected upon repayment of the outstanding principal. We also generate revenue from original issue discounts (“OID”), which is also recognized as interest income from loans over the initial term of the applicable loans. Delayed draw loans may earn interest or unused fees on the undrawn portion of the loan, which is recognized as interest income in the period earned. Other fees, including prepayment fees and exit fees, are also recognized as interest income when received. Any such fees will be generated in connection with our loans and recognized as earned in accordance with generally accepted accounting principles (“GAAP”).

Expenses

Our primary operating expense is the payment of Base Management Fees and Incentive Compensation under our Management Agreement with our Manager and the allocable portion of overhead and other expenses paid or incurred on our behalf, including reimbursing our Manager for a certain portion of the compensation of certain personnel of our Manager who assist in the management of our affairs, excepting only those expenses that are specifically the responsibility of our Manager pursuant to our Management Agreement. We bear all other costs and expenses of our operations and transactions, including (without limitation) fees and expenses relating to:

• organizational and offering expenses;
• quarterly valuation expenses;
• fees payable to third parties relating to, or associated with, making loans and valuing loans (including third-party valuation firms);
• fees and expenses associated with investor relations and marketing efforts (including attendance at investment conferences and similar events);
• accounting and audit fees and expenses from our independent registered public accounting firm;
• federal and state registration fees;
• any exchange listing fees;
• federal, state and local taxes;
• independent directors’ fees and expenses;
• brokerage commissions;
• costs of proxy statements, stockholders’ reports and notices; and
• costs of preparing government filings, including periodic and current reports with the SEC.

Income Taxes

We are a Maryland corporation that elected to be taxed as a REIT under the Code, commencing with the taxable period ended December 31, 2021. We believe that we qualify as a REIT and that our method of operation will enable us to continue to qualify as a REIT. However, no assurances can be given that our beliefs or expectations will be fulfilled, since qualification as a REIT depends on us satisfying numerous asset, income and distribution tests which depends, in part, on our operating results.

To qualify as a REIT, we must meet a number of organizational and operational requirements, including a requirement that we distribute annually to our stockholders at least 90% of our REIT taxable income prior to the deduction for dividends paid. To the extent that we distribute less than 100% of our REIT taxable income in any tax year (taking into account any distributions made in a subsequent tax year under Sections 857(b)(9) or 858 of the Code), we will pay tax at regular corporate rates on that undistributed portion. Furthermore, if we distribute less than the sum of 1) 85% of our ordinary income for the calendar year, 2) 95% of our capital gain net income for the calendar year, and 3) any undistributed shortfall from our prior calendar year (the “Required Distribution”) to our stockholders during any calendar year (including any distributions declared by the last day of the calendar year but paid in the subsequent year), then we are required to pay a non-deductible excise tax equal to 4% of any shortfall between the Required Distribution and the amount that was actually distributed. The 90% distribution requirement does not require the distribution of net capital gains. However, if we elect to retain any of our net capital gain for any tax year, we must notify our stockholders and pay tax at regular corporate rates on the retained net capital gain. Our stockholders must include their proportionate share of the retained net capital gain in their taxable income for the tax year, and they are deemed to have paid the REIT’s tax on their proportionate share of the retained capital gain. Furthermore, such retained capital gain may be subject to the nondeductible 4% excise tax. If it is determined that our estimated current year taxable income will be in excess of estimated dividend distributions (including capital gain dividend) for the current year from such income, we will accrue excise tax on estimated excess taxable income as such taxable income is earned. The annual expense is calculated in accordance with applicable tax regulations. Excise tax expense, if any, is included in the line item, income tax expense. For the six months ended June 30, 2024, we did not incur excise tax expense.

Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 740 - Income Taxes (“ASC 740”), prescribes a recognition threshold and measurement attribute for the consolidated financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. ASC 740 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. We have analyzed our various federal and state filing positions and believe that our income tax filing positions and deductions are documented and supported as of June 30, 2024. Based on our evaluation, there is no reserve for any uncertain income tax positions. Accrued interest and penalties, if any, are included within other liabilities in the consolidated balance sheets.

Factors Impacting our Operating Results

The results of our operations are affected by a number of factors and primarily depend on, among other things, the level of our net interest income, the market value of our assets and the supply of, and demand for, commercial real estate debt and other financial assets in the marketplace. Our net interest income, which includes the accretion and amortization of OID, is recognized based on the contractual rate and the outstanding principal balance of the loans we originate. Interest rates will vary according to the type of loan, conditions in the financial markets, creditworthiness of our borrowers, competition and other factors, some of which cannot be predicted with any certainty. Our operating results may also be impacted by credit losses in excess of initial anticipations or unanticipated credit events experienced by borrowers.

Changes in Market Interest Rates and Effect on Net Interest Income

Interest rates are highly sensitive to many factors, including fiscal and monetary policies and domestic and international economic and political considerations, as well as other factors beyond our control. We will be subject to interest rate risk in connection with our assets and our related financing obligations.

Our operating results will depend in large part on differences between the income earned on our assets and our cost of borrowing. The cost of our borrowings generally will be based on prevailing market interest rates. Periods of rising interest rates may, over time, cause:

• the interest expense associated with our borrowings to increase, subject to any applicable ceilings, which could result in a decline in our net interest spread and net interest margin;
• the value of our mortgage loans to decline; and
• coupons on our floating rate loans to reset to higher interest rates.

Conversely, periods of declining interest rates, in general, may over time cause:

• the interest expense associated with our borrowings to decrease, subject to any applicable floors;
• the value of our loan portfolio to increase, for such mortgages with applicable floors; and
• coupons on our floating rate mortgage loans to reset to lower interest rates, subject to any applicable floors.

The severity of any such increase or decrease to our net interest spread and net interest margin would depend on our asset/liability composition at the time as well as the magnitude and duration of the interest rate increase. If any of these events happen, we could experience a decrease in net income or incur a net loss during these periods, which could adversely affect our liquidity and results of operations.

Interest Rate Cap Risk

We currently own and intend to acquire in the future floating-rate assets. These are assets in which the loans may be subject to periodic and lifetime interest rate caps and floors, which limit the amount by which the asset’s interest yield may change during any given period. However, our borrowing costs pursuant to our financing agreements may not be subject to similar restrictions. Therefore, in a period of increasing interest rates, interest rate costs on our borrowings could increase without limitation by caps, while the interest-rate yields on our floating-rate assets would effectively be limited. In addition, floating-rate assets may be subject to periodic payment caps that result in some portion of the interest being deferred and added to the principal outstanding. This could result in our receipt of cash income from such assets in an amount that is less than the amount that we would need to pay the interest cost on our related borrowings.

These factors could lower our net interest income or cause a net loss during periods of rising interest rates, which would harm our financial condition, cash flows and results of operations. As of June 30, 2024, 82.0% of our floating rate loans, based on principal outstanding have interest rate floors, and one loan is subject to an interest rate cap (Note 3).

Interest Rate Mismatch Risk

We may fund a portion of our origination of loans, or of loans that we may in the future acquire, with borrowings that are based on the Prime Rate or a similar measure, while the interest rates on these assets may be fixed or indexed to the Prime Rate or another index rate. Accordingly, any increase in the Prime Rate will generally result in an increase in our borrowing costs that would not be matched by fixed-rate interest earnings and may not be matched by a corresponding increase in floating-rate interest earnings. Any such interest rate mismatch could adversely affect our profitability, which may negatively impact distributions to our stockholders.

Our analysis of risks is based on our Manager’s experience, estimates, models and assumptions. These analyses rely on models which utilize estimates of fair value and interest rate sensitivity. Actual economic conditions or implementation of decisions by our Manager and our management may produce results that differ significantly from the estimates and assumptions used in our models and the projected results.

Market Conditions

We believe that favorable market conditions, including an imbalance in supply and demand of credit to cannabis operating companies, have provided attractive opportunities for non-bank lenders, such as us, to finance commercial real estate loans and other loans that exhibit strong fundamentals but also require more customized financing structures and loan products than regulated financial institutions can presently provide. Additionally, to the extent that additional states legalize cannabis, our addressable market will increase. We intend to continue to capitalize on these opportunities and grow the size of our portfolio.

Developments During the Second Quarter of 2024

Updates to Our Loan Portfolio during the Second Quarter of 2024

In June 2024, we entered into an amendment to Loan #3, which extended the maturity date to July 31, 2024 of two of the three tranches held. No other terms of the loan were modified in connection with this amendment.

In the second quarter, we entered into an amendment to Loan #4, which extended the maturity date from May 17, 2024 to June 17, 2026, and decreased the PIK rate from 15% to 0%. The cash interest is fixed at $65,765 per month until May 31, 2025, and $67,738 per month thereafter to maturity.

In the second quarter, we entered into an amendment to Loan #6, which extended the maturity date from May 31, 2024 to January 30, 2026 and increased the PIK interest rate to the greater of Prime plus 6.5% or 15.0%. Additionally, amortization payments will start on October 31, 2024.

In June 2024, we entered into an amendment to Loan #8 which waived amortization from May 1, 2024 to June 30, 2024 and capitalized unpaid accrued interest to PIK interest during the second quarter of 2024. The PIK rate also increased from 2% to 10%.

In June 2024, we entered into an amendment to Loan #12, which extended the maturity date to April 30, 2025. Amortization payments are to begin again on July 31, 2024 at $60,000 per month. No other terms of the loan were modified in connection with this amendment.

As described in Note 3, Loan #9 remains on non-accrual status and the Company will continue to cease further recognition of income until such events of default are cured or obligations are repaid. As of June 30, 2024, Loan #9 is held on the consolidated balance sheet as a loan held for investment – related party with a carrying value of approximately $16.4 million and a reserve for current expected credit losses of approximately $1.7 million.

Subsequent Updates to Our Loan Portfolio

During the period from July 1, 2024 to August 7, 2024, we funded approximately $0.7 million to the borrower of Loan #18 and $0.1 million to the borrower of Loan #21. Loan #14 was fully paid off on July 15, 2024.

Dividends Declared Per Share

During the three months ended June 30, 2024, we declared an ordinary cash dividend of $0.47 per share of our common stock, relating to the second quarter of 2024, which was paid on July 15, 2024 to stockholders of record as of the close of business on June 28, 2024. The total amount of the cash dividend payment was approximately $9.3 million.

The payment of this dividend is not indicative of our ability to pay such dividends in the future.

Results of Operations

Comparison of the three months ended June 30, 2024 and 2023

• Interest income increased by approximately $0.4 million, or 2%, during the quarter ended June 30, 2024, compared to the quarter ended June 30, 2023. The increase in interest income was driven primarily from the increase in the average outstanding principal balance of loans during the comparable period which increased from $319.0 million for the three months ended June 30, 2023 to $380.4 million for the three months ended June 30, 2024. Additionally, the Prime Rate increased from 8.25% as of June 30, 2023 to 8.50% as of June 30, 2024, increasing the yield on the portion of the portfolio that bears a floating rate. The increase was offset by a decrease in the weighted average portfolio yield from 19.2% to 18.7% during the comparable periods.
• Net interest income decreased approximately $0.5 million, or 4%, over the comparative period. The decrease was attributable to the increase in interest expense driven by the timing of borrowings and an increase in the outstanding balance on the Revolving Loan, which bears interest at the Prime Rate plus an Applicable Margin. The outstanding balance on the Revolving Loan was approximately $76.8 million and $43.0 million, as of June 30, 2024 and 2023, respectively. The impact of the increase in interest expense was partially offset by the increase in interest income as explained above.
• Management and incentive fees to our Manager decreased by approximately $25 thousand, or 1%, over the comparative period. Incentive fees of $192 thousand during the June 30, 2024, as compared to June 30, 2023, primarily as a result in the decrease in Core Earnings over the comparable trailing twelve month period. This was offset by an increase in management fees of approximately $167 thousand, which was primarily attributable to lower origination fee offsets in the three months ended June 30, 2024 of approximately $16 thousand, compared to approximately $125 thousand for the three months ended June 30, 2023, as well as an increase in weighted average equity as defined by the Management Agreement for the comparable period.
• General and administrative expenses and professional fees decreased by approximately $155 thousand for the three months ended June 30, 2024, as compared to the three months ended June 30, 2023. The decrease was primarily due to a decrease in professional fees in the second quarter of 2024. Overhead reimbursements for costs incurred by the Manager on behalf of the Company decreased by at approximately $105 thousand over the comparative period.
• Stock based compensation expense increased by approximately $0.6 million for the three months ended June 30, 2024, as compared to the three months ended June 30, 2023. The increase over the comparable period is driven by the incremental expense recognized on the 187,335 restricted stock awards granted to employees of our Manager on April 1, 2024.
• Reversal for current expected credit losses was $275 thousand in the three months ended June 30, 2024, as compared to a provision for current expected credit losses of $1.1 million in the three months ended June 30, 2023. Our provision for current expected credit losses decreased due to both borrower specific credit factors and regular re-evaluations of overall current macroeconomic conditions affecting our borrowers and the industry. Additionally, the original portfolio has matured since June 30, 2023, though the weighted average remaining life of the total loan portfolio has remained consistent at 1.8 years as of June 30, 2023 and 2024. Our reserves for performing loans generally decrease as they approach maturity.
• The current expected credit loss reserve represents approximately 133 basis points of our aggregate loan commitments held at carrying value of approximately $5.1 million as of June 30, 2024, compared with 163 basis points as of June 30, 2023. As of June 30, 2024, we anticipate a softened interest rate environment in our forecast period compared to June 30, 2023, when interest rates were continuing to rise. The prime rate during the three months ended June 30, 2024 was stable at 8.50%, compared to an increase of 25 basis points from 8.00% to 8.25% during the three months ended June 30, 2023. Accordingly, estimates and metrics regarding our borrower's ability to meet debt service obligations, have improved given the expectations of declining interest rates subsequent to June 30, 2024, leading to expected additional free cash flow generation by our portfolio companies. These factors contributed to a decline in the reserve as a percentage of our portfolio principal.
• We record a reserve liability based on the unfunded portion of loan commitments over the full contractual period over which we are exposed to credit risk through a current obligation to extend credit. Management considered the likelihood that funding will occur, and if funded, the expected credit loss on the funded portion. We continuously evaluate the credit quality of each loan by assessing the risk factors of each loan. There is $6.0 million of unfunded commitments as of June 30, 2024 relating to one borrower, and this unfunded commitment carries a $0 CECL reserve.

Comparison of the six months ended June 30, 2024 and 2023

• Interest income decreased by approximately $0.8 million, or 3%, during the year ended June 30, 2024, compared to the quarter ended June 30, 2023. The decrease was driven primarily of gross interest income during the six months ended June 30, 2024 and 2023. Additionally, the outstanding principal of the Company's loans which bear a floating rate decreased from 87.9% at June 30, 2023 to 76.4% at June 30, 2024, contributing to the sequential decline. Furthermore, as of June 30, 2024, the weighted average yield to maturity of the loan portfolio was 18.7% compared with 19.2% as of June 30, 2023. The decrease results from certain repricing amendments during the six months ended June 30, 2024. Lastly, interest income from prepayment fees were approximately $0.8 million for the six months ended June 30, 2023 compared to $0.1 million for the six months ended June 30, 2024, further contributing to this decrease.
• Net interest income decreased approximately $2.2 million, or 8%, over the comparative period. The decrease was attributable to the decrease in interest income described above, and by a corresponding increase in interest expense driven by the timing of borrowings and an increase in the outstanding balance on the Revolving Loan, which bears interest at the Prime Rate plus an Applicable Margin. The outstanding balance on the Revolving Loan was approximately $76.8 million and $43.0 million, as of June 30, 2024 and 2023, respectively.
• Management and incentive fees to our Manager was approximately $3.5 million for the six months ended June 30, 2024, as compared to approximately $3.9 million for the six months ended June 30, 2023. Management fees were approximately $2.2 million for the six months ended June 30, 2024, as compared to approximately $2.1 million for the six months ended June 30, 2023. The slight increase in management fees was primarily attributable to fewer origination fee offsets in the six months ended June 30, 2024 of approximately $32 thousand, compared to approximately $130 thousand for the six months ended June 30, 2023, as well as an increase in weighted average equity as defined by the Management Agreement for the comparable period. Incentive fees were approximately $1.4 million for the six months ended June 30, 2024, as compared to approximately $2.0 million for the six months ended June 30, 2023, primarily driven by higher trailing twelve month Core Earnings in the first half of 2023.
• General and administrative expenses and professional fees decreased by approximately $159 thousand for the six months ended June 30, 2024, as compared to the six months ended June 30, 2023. The decrease was primarily due to a decrease in professional fees in 2024 compared to the first half of 2023. Overhead reimbursements for costs incurred by the Manager on behalf of the Company were approximately $2.3 million for the six months ended June 30, 2024, as compared to $2.4 million for the six months ended June 30, 2023.
• Stock based compensation expense increased by approximately $1.0 million for the six months ended June 30, 2024, as compared to the six months ended June 30, 2023. The increase over the comparable period is driven by the incremental expense recognized on the 187,335 restricted stock awards granted to employees of our Manager on April 1, 2024.
• Our provision for current expected credit losses decreased due to both borrower specific credit factors and regular re-evaluations of overall current macroeconomic conditions affecting our borrowers and the industry.
• Provision for current expected credit losses was $105 thousand in the six months ended June 30, 2024, as compared to $1.2 million in the six months ended June 30, 2023.
• Changes in portfolio risk composition resulting from principal paydowns and new fundings also contributed to the decrease, with reserves on new 2024 originations representing a larger portion of the reserve than loans originated as of June 30, 2023. As of June 30, 2024 approximately 61.2% of our loans carry a risk rating of "1" or "2". During the six month period ended June 30, 2024, we originated loans with a principal balance of approximately $19.3 million which are secured by strong collateral in forms other than real estate. This contributed to the increase in loans that are less than 1.0x secured by real estate collateral as compared to December 31, 2023. However; due to the strength of the other collateral securing these loans, there was not a material increase in the CECL reserve. Additionally, loans risk rated "3" increased to approximately 26.9% of the portfolio at June 30, 2024 from 18.8% of the portfolio at December 31, 2023, as a result of new originations, while loans risk rated "2" decreased to approximately 50.0% from 58.0% during the same period. Despite these fluctuations, loans risk rated "2" and "3" both generally are expected to result in a full repayment of principal and may not carry materially different CECL reserves based on risk ratings alone.
• The current expected credit loss reserve represents approximately 133 basis points of our aggregate loan commitments held at carrying value of approximately $5.1 million as of June 30, 2024, compared with 163 basis points as of June 30, 2023. As of June 30, 2024, we anticipate a softened interest rate environment in our forecast period compared to June 30, 2023, when interest rates were continuing to rise. The prime rate during the six months ended June 30, 2024 was stable at 8.50%, compared to an increase of 75 basis points from 7.50% to 8.25% during the six months ended June 30, 2023.Accordingly, estimates and metrics regarding our borrower's ability to meet debt service obligations, have improved given the expectations of declining interest rates and additional free cash flow generation by our portfolio companies. These factors contributed to a decline in the reserve as a percentage of our portfolio principal to 133 basis points from 163 basis points as of June 30, 2024 and 2023, respectively.
• We record a reserve liability based on the unfunded portion of loan commitments over the full contractual period over which we are exposed to credit risk through a current obligation to extend credit. Management considered the likelihood that funding will occur, and if funded, the expected credit loss on the funded portion. We continuously evaluate the credit quality of each loan by assessing the risk factors of each loan. There is $6.0 million of unfunded

commitments as of June 30, 2024 relating to one borrower, and this unfunded commitment carries a $0 CECL reserve.

Loan Portfolio

As of June 30, 2024 and December 31, 2023, our portfolio included 31 and 27 loans held for investment, of approximately $381.9 million and $353.6 million at carrying value, respectively, prior to the reserve for current expected credit losses. The aggregate originated commitment under these loans was approximately $409.3 million and $378.8 million and outstanding principal was approximately $383.3 million and $355.7 million as of June 30, 2024 and December 31, 2023, respectively. As of June 30, 2024 and December 31, 2023, our loan portfolio had a weighted-average yield-to-maturity internal rate of return (“YTM IRR”) of 18.7% and 19.4%, and was substantially secured by real estate and, with respect to certain of our loans, substantially all assets of the borrowers and certain of their subsidiaries, including equipment, receivables, and licenses. YTM IRR is calculated using various inputs, including (i) cash and paid-in-kind (“PIK”) interest, which is capitalized and added to the outstanding principal balance of the applicable loan, (ii) original issue discount (“OID”), (iii) amortization, (iv) unused fees, and (v) exit fees. Certain of our loans have extension fees, which are not included in our YTM IRR calculations, but may increase YTM IRR if such extension options are exercised by borrowers.

As of June 30, 2024 and December 31, 2023, approximately 76.4% and 80.5%, respectively, of our portfolio was comprised of floating rate loans that pay interest at the Prime Rate plus an applicable margin and were subject to a Prime Rate floor. The Prime Rate was 7.50% on January 1, 2023, increased to 7.75% effective February 2, 2023, increased to 8.00% effective March 23, 2023, increased to 8.25% effective May 4, 2023 and increased again to 8.50% as of December 31, 2023. The below summarizes our portfolio as of June 30, 2024:

(1) All loans originated prior to April 1, 2021 were purchased from affiliated entities at fair value plus accrued interest on or subsequent to April 1, 2021. Loan numbering in the table above is maintained from origination for purposes of comparability and may not be sequential due to maturities, payoffs, or refinancings.

(2) Certain loans are subject to contractual extension options and may be subject to performance based on other conditions as stipulated in the loan agreement. Actual maturities may differ from contractual maturities stated herein and certain borrowers may have the right to prepay with or without a contractual prepayment penalty. The Company may also extend contractual maturities and amend other terms of the loans in connection with loan modifications.

(3) "P" = prime rate and depicts floating rate loans that pay interest at the prime rate plus a specific percentage; "PIK" = paid-in-kind interest.

(4) P&I = principal and interest. I/O = interest only. P&I loans may include interest only periods for a portion of the loan term.

(5) Estimated YTM, calculated on a weighted average principal basis, includes a variety of fees and features that affect the total yield, which may include, but is not limited to, OID, exit fees, prepayment fees, unused fees and contingent features. OID is recognized as a discount to the funded loan principal and is accreted to income over the term of the loan. The estimated YTM calculations require management to make estimates and assumptions, including, but not limited to, the timing and amounts of loan draws on delayed draw loans, the timing and collectability of exit fees, the probability and timing of prepayments and the probability of contingent features occurring. For example, certain credit agreements contain provisions pursuant to which certain PIK interest rates and fees earned by us under such credit agreements will decrease upon the satisfaction of certain specified criteria which we believe may improve the risk profile of the applicable borrower. To be conservative, we have not assumed any prepayment penalties or early payoffs in our estimated YTM calculation. Estimated YTM is based on current management estimates and assumptions, which may change. Actual results could differ from those estimates and assumptions.

(6) This Loan is subject to a prime rate floor of 3.25%

(7) This Loan is subject to a prime rate floor of 4.00%

(8) This Loan is subject to a prime rate floor of 4.75%

(9) This Loan is subject to a prime rate floor of 5.50%

(10) This Loan is subject to a prime rate floor of 6.25%

(11) This Loan is subject to a prime rate floor of 7.00%

(12) This Loan is subject to a prime rate floor of 7.50%

(13) This Loan is subject to a prime rate floor of 8.00%

(14) This Loan is subject to a prime rate floor of 8.25%

(15) This Loan is subject to a prime rate floor of 8.50%

(16) This Loan is subject to a prime rate cap of 5.85%

(17) The aggregate principal balance outstanding of Loan #3 is comprised of two tranches. The first tranche has a principal balance $16.6 million, a base interest rate of 13.625% and 2.75% PIK and an original maturity date of July 31, 2024. In July 2024, we entered into an amendment which extended the maturity date of the July 31, 2024 tranche to January 29, 2027. The second tranche has a principal balance of $4.3 million, which has an interest rate of 15.00% and 2.00% PIK, and a maturity date of November 29, 2024. The statistics presented reflect the weighted average of the terms under all advances for the total aggregate loan commitment.

(18) As of May 1, 2023, Loan #9 was placed on non-accrual status and continues to be on non-accrual as of June 30, 2024. Loan #9 is included on the consolidated balance sheet as a loan held for investment – related party (Note 7).

(19) This Loan was paid off on July 15, 2024 and carried a zero CECL reserve as of June 30, 2024.The maturity date presented reflects the original contractual date.

(20) An affiliate under common control holds a controlling equity investment in this portfolio company.

(21) This loan has floating grid pricing based on the Prime Rate plus a spread of 5.00% to 8.75% based on monthly annualized EBITDA performance. As of June 30, 2024, applied interest rate is Prime Rate + 5.00%.

(22) This loan earns an unused fee on the unfunded commitment at an annual rate of 1.2%.

The following tables summarize our loans held for investment as of June 30, 2024 and December 31, 2023:

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(1) The difference between the Carrying Value and the Outstanding Principal amount of the loans consists of unaccreted original issue discount, deferred loan fees and other upfront fees. Outstanding principal balance includes capitalized PIK interest, if applicable.

(2) Weighted average remaining life is calculated based on the carrying value of the loans as of June 30, 2024 and December 31, 2023, respectively.

The following tables present changes in loans held for investment at carrying value as of and for the six months ended June 30, 2024 and 2023:

(1) The difference between the Carrying Value and the Outstanding Principal amount of the loans consists of unaccreted original issue discount, deferred loan fees and other upfront fees. Outstanding principal balance includes capitalized PIK interest, if applicable.

(1) The difference between the Carrying Value and the Outstanding Principal amount of the loans consists of unaccreted original issue discount, deferred loan fees and loan origination costs. Outstanding principal balance includes capitalized PIK interest, if applicable.

(2) One loan was reclassified as held for sale from loans held for investment as the decision was made to sell the loan during the six months ended June 30, 2023 to a syndicate of co-lenders which includes a third party and two affiliates under common control with our Manager. The sale was executed on March 31, 2023.

We may make modifications to loans, including loans that are in default. Loan terms that may be modified include interest rates, required prepayments, maturity dates, covenants, principal amounts and other loan terms. The terms and conditions of each modification vary based on individual circumstances and will be determined on a case by case basis. Our Manager monitors and evaluates each of our loans held for investment and has maintained regular communications with borrowers regarding potential impacts on our loans.

Non-GAAP Measures and Key Financial Measures and Indicators

As a commercial mortgage real estate investment trust, we believe the key financial measures and indicators for our business are Distributable Earnings, Adjusted Distributable Earnings, book value per share, and dividends declared per share.

Distributable Earnings and Adjusted Distributable Earnings

In addition to using certain financial metrics prepared in accordance with GAAP to evaluate our performance, we also use Distributable Earnings and Adjusted Distributable Earnings to evaluate our performance. Each of Distributable Earnings and Adjusted Distributable Earnings is a measure that is not prepared in accordance with GAAP. We define Distributable Earnings as, for a specified period, the net income (loss) computed in accordance with GAAP, excluding (i) non-cash equity compensation expense, (ii) depreciation and amortization, (iii) any unrealized gains, losses or other non-cash items recorded in net income (loss) for the period; provided that Distributable Earnings does not exclude, in the case of investments with a deferred interest feature (such as OID, debt instruments with PIK interest and zero coupon securities), accrued income that we have not yet received in cash, (iv) provision for current expected credit losses and (v) one-time events pursuant to changes in GAAP and certain non-cash charges, in each case after discussions between our Manager and our independent directors and after approval by a majority of such independent directors. We define Adjusted Distributable Earnings, for a specified period, as Distributable Earnings excluding certain non-recurring organizational expenses (such as one-time expenses related to our formation and start-up).

We believe providing Distributable Earnings and Adjusted Distributable Earnings on a supplemental basis to our net income as determined in accordance with GAAP is helpful to stockholders in assessing the overall performance of our business. As a REIT, we are required to distribute at least 90% of our annual REIT taxable income and to pay tax at regular corporate rates to the extent that we annually distribute less than 100% of such taxable income. Given these requirements and our belief that dividends are generally one of the principal reasons that stockholders invest in our common stock, we generally intend to attempt to pay dividends to our stockholders in an amount equal to our net taxable income, if and to the extent authorized by our Board. Distributable Earnings is one of many factors considered by our Board in authorizing dividends and, while not a direct measure of net taxable income, over time, the measure can be considered a useful indicator of our dividends.

Distributable Earnings and Adjusted Distributable Earnings should not be considered as substitutes for GAAP net income. We caution readers that our methodology for calculating Distributable Earnings and Adjusted Distributable Earnings may differ from the methodologies employed by other REITs to calculate the same or similar supplemental performance measures, and as a result, our reported Distributable Earnings and Adjusted Distributable Earnings may not be comparable to similar measures presented by other REITs.

The following table provides a reconciliation of GAAP net income to Distributable Earnings and Adjusted Distributable Earnings (in thousands, except per share data):

Book Value Per Share

The book value per share of our common stock as of June 30, 2024 and December 31, 2023 was approximately $14.92 and $14.94, respectively.

Liquidity and Capital Resources

Liquidity is a measure of our ability to meet potential cash requirements, including ongoing commitments to repay borrowings, fund and maintain our assets and operations, make distributions to our stockholders, and meet other general business needs. We use significant cash to invest in loans, repay principal and interest on our borrowings, make distributions to our stockholders, and fund our operations.

Our primary sources of cash generally consist of unused borrowing capacity under our financing sources, the net proceeds of future offerings of equity or debt securities, payments of principal and interest we receive on our portfolio of assets and cash generated from our operating results. On a long-term basis, we expect that our primary sources of financing will be, to the extent available to us, through (a) credit facilities and (b) public and private offerings of our equity and debt securities. We may utilize other sources of financing to the extent available to us. As the cannabis industry continues to evolve and to the extent that additional states legalize cannabis, the demand for capital continues to increase as operators seek to enter and build out new markets. In the short-term, we expect the principal amount of the loans we originate to increase and that we will need to raise additional equity and/or debt financing to increase our liquidity. We expect to achieve this through recycling capital from loan paydowns, repayments, and sales of common stock related to our shelf registration statement.

As of June 30, 2024 and December 31, 2023, all of our cash was unrestricted and totaled approximately $7.1 million and $7.9 million, respectively. We believe that our cash on hand, capacity available under our Revolving Loan, and cash flows from operations for the next twelve months will be sufficient to satisfy the operating requirements of our business through at least the next twelve months. The sources of financing for our target investments are described below.

Credit Facility

As of June 30, 2024 and December 31, 2023, unamortized debt issuance costs related to the Revolving Loan, including all amendments and amendments and restatements thereto, as applicable, of $301,037 and $366,592, respectively, are recorded in other receivables and assets, net on the consolidated balance sheets.

For the six months ended June 30, 2024, the Company had net borrowings of $10.8 million against the Revolving Loan. As of June 30, 2024, the Company had $28.3 million available and $76.8 million outstanding under the Revolving Loan (Note 6).

Capital Markets

We may seek to raise further equity capital and issue debt securities in order to fund our future investments in loans. Our Shelf Registration Statement became effective on January 19, 2023, allowing us to sell, from time to time in one or more offerings, up to $500 million of our securities, including common stock, preferred stock, debt securities, warrants and rights (including as part of a unit) to purchase shares of our common stock, preferred stock, or debt securities. The specifics of any future offerings, along with the use of proceeds of any securities offered, will be described in detail in a prospectus supplement, or other offering materials, at the time of any offering. We may also access liquidity through our ATM Program, which was established in June 2023, pursuant to which we may sell, from time to time, up to $75.0 million of our common stock.

For the six months ended June 30, 2024, the Company sold an aggregate of 1,306,803 shares of the Company’s common stock under the Sales Agreement at a weighted average price of $15.88 per share, generating net proceeds of approximately $20.2 million.

Cash Flows

The following table sets forth changes in cash and cash equivalents for the six months ended June 30, 2024 and 2023, respectively:

Net Cash Provided by Operating Activities

For the six months ended June 30, 2024 and 2023, we reported “Net cash provided by operating activities” of approximately $13.1 million and $11.9 million, respectively. Net cash provided by operating activities increased approximately $1.2 million, primarily attributable to a change in the interest reserve for applied interest payments of approximately $2.9 million, proceeds from the sale of $0.8 million of debt securities, at fair value, an increase in management and incentive fees payable of approximately $27 thousand and an increase in accounts payable and accrued expenses of approximately $0.1 million. These changes were offset by a decrease in net income over the comparable period of approximately $1.4 million, a decrease in interest receivable of approximately $375 thousand, a decrease in related party net payable of approximately $0.8 million, and an increase in stock based compensation of approximately $1.0 million, over the comparable period.

Net Cash (Used in)/Provided by Investing Activities

For the six months ended June 30, 2024 and 2023, we reported “Net cash (used in)/provided by investing activities” of approximately $21.6 million and $30.5 million, respectively.

For the six months ended June 30, 2024, cash outflows primarily related to $43.2 million used for the origination and funding of loans held for investment, partially offset by $21.6 million of cash received from the principal repayment of loans held for investment.

For the six months ended June 30, 2023, cash outflows primarily related to $34.8 million used for the origination and funding of loans held for investment, partially offset by $13.4 million received from the sales of loans and $51.9 million of cash received from the principal repayment of loans held for investment.

Net Cash Provided by/(Used in) Financing Activities

For the six months ended June 30, 2024 and 2023, we reported “Net cash provided by/(used in) financing activities” of approximately $7.6 million and $30.1 million, respectively.

For the six months ended June 30, 2024, cash inflows of approximately $20.8 million related to proceeds received from sales of our common stock through the ATM offering and $44.0 million related to draw downs on our Revolving Loan, which were offset by approximately $33.3 million in repayments on our Revolving Loan, $23.1 million in dividends paid, approximately $113 thousand in debt issuance costs paid, and approximately $667 thousand in offering costs associated with the registered at-the-market offering.

For the six months ended June 30, 2023, cash inflows of approximately $7.2 million related to proceeds received from sales of our common stock through the registered direct offering and ATM offering of $6.0 million and $1.2 million, respectively. Additionally, we had cash inflows related to draw downs on our Revolving Loan of $34.0 million, which were offset by approximately $49.0 million in repayments on our Revolving Loan, $22.0 million in dividends paid, approximately $0.1 million in debt issuance costs paid, and approximately $0.3 million in offering costs paid associated with the registered direct offering and ATM offering.

Leverage Policies

Although we are not required to maintain any particular leverage ratio, we expect to employ prudent amounts of leverage and, when appropriate, to use debt as a means of providing additional funds for the acquisition of loans, to refinance existing debt or for general corporate purposes. Leverage is primarily used to provide capital for forward commitments until additional equity is raised or additional medium- to long-term financing is arranged. This policy is subject to change by management and our Board.

Dividends

We have elected to be taxed as a REIT for United States federal income tax purposes and, as such, anticipate annually distributing to our stockholders at least 90% of our REIT taxable income, prior to the deduction for dividends paid and our net capital gain. If we distribute less than 100% of our REIT taxable income in any tax year (taking into account any distributions made in a subsequent tax year under Sections 857(b)(9) or 858 of the Code), we will pay tax at regular corporate rates on that undistributed portion. Furthermore, if we distribute less than the sum of (i) 85% of our ordinary income for the calendar year, (ii) 95% of our capital gain net income for the calendar year and (iii) any Required Distribution to our stockholders during any calendar year (including any distributions declared by the last day of the calendar year but paid in the subsequent year), then we are required to pay non-deductible excise tax equal to 4% of any shortfall between the Required Distribution and the amount that was actually distributed. Any of these taxes would decrease cash available for distribution to our stockholders. The 90% distribution requirement does not require the distribution of net capital gains. However, if we elect to retain any of our net capital gain for any tax year, we must notify our stockholders and pay tax at regular corporate rates on the retained net capital gain. The stockholders must include their proportionate share of the retained net capital gain in their taxable income for the tax year, and they are deemed to have paid the REIT’s tax on their proportionate share of the retained capital gain. Furthermore, such retained capital gain may be subject to the nondeductible 4% excise tax. If we determine that our estimated current year taxable income (including net capital gain) will be in excess of estimated dividend distributions (including capital gains dividends) for the current year from such income, we accrue excise tax on a portion of the estimated excess taxable income as such taxable income is earned.

To the extent that our cash available for distribution is less than the amount required to be distributed under the REIT provisions of the Code, we may be required to fund distributions from working capital or through equity, equity-related or debt financings or, in certain circumstances, asset sales, as to which our ability to consummate transactions in a timely manner on favorable terms, or at all, cannot be assured, or we may make a portion of the Required Distribution in the form of a taxable stock distribution or distribution of debt securities.

The following table summarizes the Company’s dividends declared during the six months ended June 30, 2024 and 2023, respectively.

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CECL Reserve

In accordance with ASC 326, we record allowances for our loans held for investment. The allowances are deducted from the gross carrying amount of the assets to present the net carrying value of the amounts expected to be collected on such assets. The Company estimates its CECL Reserve using among other inputs, third-party valuations, and a third-party probability-weighted model that considers the likelihood of default and expected loss given default for each individual loan based on the risk profile for approximately three years after which we immediately revert to use of historical loss data.

ASC 326 requires an entity to consider historical loss experience, current conditions, and a reasonable and supportable forecast of the macroeconomic environment. We consider multiple datapoints and methodologies that may include likelihood of default and expected loss given default for each individual loans, valuations derived from discounted cash flows (“DCF”), and other inputs including the risk rating of the loan, how recently the loan was originated compared to the measurement date, and expected prepayment, if applicable. The measurement of expected credit losses under CECL is applicable to financial assets measured at amortized cost, and off-balance sheet credit exposures such as unfunded loan commitments.

We evaluate our loans on a collective (pool) basis by aggregating on the basis of similar risk characteristics as explained above. We make the judgment that loans to cannabis-related borrowers that are fully collateralized by real estate exhibit similar risk characteristics and are evaluated as a pool. Further, loans that have no real estate collateral, but are secured by other forms of collateral, including equity pledges of the borrower, and otherwise have similar characteristics as those collateralized by real estate are evaluated as a pool. All other loans are analyzed individually, either because they operate in a different industry, may have a different risk profile, or have maturities that extend beyond the forecast horizon for which we are able to derive reasonable and supportable forecasts.

Estimating the CECL Reserve also requires significant judgment with respect to various factors, including (i) the appropriate historical loan loss reference data, (ii) the expected timing of loan repayments, (iii) calibration of the likelihood of default to reflect the risk characteristics of our loan portfolio, and (iv) our current and future view of the macroeconomic environment. From time to time, we may consider loan-specific qualitative factors on certain loans to estimate our CECL Reserve, which may include (i) whether cash from the borrower’s operations is sufficient to cover the debt service requirements currently and into the future, (ii) the ability of the borrower to refinance the loan and (iii) the liquidation value of collateral. For loans where we have deemed the borrower/sponsor to be experiencing financial difficulty, we may elect to apply a practical expedient, in which the fair value of the underlying collateral is compared to the amortized cost of the loan in determining a CECL Reserve.

To estimate the historic loan losses relevant to our portfolio, we evaluate our historical loan performance, which includes zero realized loan losses since our inception of operations. Additionally, we analyzed our repayment history, noting we have limited “true” operating history, since the incorporation date of March 30, 2021. However, our Sponsor has had operations for the past three fiscal years and has made investments in similar loans that have similar characteristics, including interest rate, collateral coverage, guarantees, and prepayment/make whole provisions, which fall into the pools identified above. Given the similarity of the structuring of the credit agreements for the loans in our portfolio, management considered it appropriate to consider the past repayment history of loans originated by the Sponsor in determining the extent to which we should record a CECL Reserve.

In addition, we review each loan on a quarterly basis and evaluate the borrower’s ability to pay the monthly interest and principal, if required, as well as the loan-to-value (LTV) ratio. In considering the potential current expected credit loss, the Manager primarily considers significant inputs to our forecasting methods, which include (i) key loan-specific inputs such as the value of the real estate collateral, liens on equity (including the equity in the entity that holds the state-issued license to cultivate, process, distribute, or retail cannabis), presence of personal or corporate guarantees, among other credit enhancements, LTV ratio, ratio type (fixed or floating) and IRR, loan-term, geographic location, and expected timing and amount of future loan fundings, (ii) performance against the underwritten business plan and our internal loan risk rating and (iii) a macro-economic forecast. Estimating the enterprise value of our borrowers in order to calculate LTV ratios is often a significant estimate. We rely primarily on comparable transactions to estimate enterprise value of our portfolio companies and supplement such analysis with a multiple-based approach to enterprise value to revenue multiples of publicly-traded comparable companies obtained from S&P Capital IQ as of the quarter end, to which we apply a private company discount based on our current borrower profile. These estimates may change in future periods based on available future macro-economic data and might result in a material change in our future estimates of expected credit losses for our loan portfolio.

Regarding real estate collateral, we generally cannot take the position of mortgagee-in-possession as long as the property is used by a cannabis operator, but we can request that the court appoint a receiver to manage and operate the subject real property until the foreclosure proceedings are completed. Additionally, while we cannot foreclose under state Uniform Commercial Code (“UCC”) and take title or sell equity in a licensed cannabis business, a potential purchaser of a delinquent or defaulted loan could.

In order to estimate the future expected loan losses relevant to our portfolio, we utilize historical market loan loss data obtained from a third-party database for commercial real estate loans, which we believe is a reasonably comparable and available data set to use as an input for our type of loans. We expect this dataset to be representative for future credit losses whilst considering that the cannabis industry is maturing, and consumer adoption, demand for production, and retail capacity are increasing akin to commercial real estate over time. For periods beyond the reasonable and supportable forecast period, we revert back to historical loss data.

All of the above assumptions, although made with the most available information at the time of the estimate, are subjective and actual activity may not follow the estimated schedule. These assumptions impact the future balances that the loss rate will be applied to and as such impact our CECL Reserve. As we acquire new loans and our Manager monitors loan and borrower performance, these estimates will be revised each period.

Risk Ratings

We assess the risk factors of each loan, and assign a risk rating based on a variety of factors, including, without limitation, payment history, real estate collateral coverage, property type, geographic and local market dynamics, financial performance, enterprise value of the portfolio company, loan structure and exit strategy, and project sponsorship. This review is performed quarterly. Based on a 5-point scale, our loans are rated “1” through “5,” from less risk to greater risk, which ratings are defined as follows:

The risk ratings are primarily based on historical data and current conditions specific to each portfolio company, as well as consideration of future economic conditions and each borrower’s estimated ability to meet debt service requirements. The risk ratings shown in the following table as of June 30, 2024 and December 31, 2023 consider borrower specific credit history and performance and quarterly re-evaluation of overall current macroeconomic conditions affecting the borrowers. As interest rates have increased due to rising rates from the Federal Reserve Board, it has impacted borrowers’ ability to service their debt obligations on a global scale. Changes in risk ratings had an effect on the level of the current expected credit loss reserve though, other than the one loan placed on non-accrual status, the loans continued to perform as expected. For approximately 66.0% of the portfolio, the fair value of the underlying real estate collateral exceeded the amounts outstanding under the loans as of June 30, 2024. The remaining approximately 34.0% of the portfolio, while not fully collateralized by real estate, may be partially collateralized by real estate and was secured by other forms of collateral including equipment, receivables, licenses and/or other assets of the borrowers to the extent permitted by applicable laws and regulations governing such borrowers.

As of June 30, 2024 and December 31, 2023, the carrying value, excluding the CECL Reserve, of the Company’s loans within each risk rating by year of origination is as follows:

(1) Amounts are presented by loan origination year with subsequent advances shown in the original year of origination.

(2) Loan #9 placed on non-accrual status is included in risk rating category “4” as of June 30, 2024 and December 31, 2023.

Accounting Policies and Estimates

As of June 30, 2024, there were no significant changes in the application of our accounting policies or estimates from those presented in our annual report on Form 10-K. Refer to Note 2 to our consolidated financial statements for the six months ended June 30, 2024, titled “Significant Accounting Policies” for information on recent accounting pronouncements.

We are exposed to market risks in the ordinary course of our business. These risks primarily relate to fluctuations in interest rates. Our loans are typically valued using a yield analysis, which is typically performed for performing loans to borrowers. Changes in market yields may change the fair value of certain of our loans. Generally, an increase in market yields may result in a decrease in the fair value of certain of our loans, however this is mitigated to the extent our loans bear interest at a floating rate. As of June 30, 2024, we had 22 floating-rate loans, representing approximately 76.4% of our loan portfolio based on aggregate outstanding principal balances, subject to a Prime Rate floor. We estimate that a hypothetical 100 basis points increase in the Prime Rate would result in an increase in annual cash interest income, excluding the effects of PIK interest, of approximately $2.9 million and a 100 basis points decrease in the Prime Rate would result in a decrease in annual interest income of approximately $2.9 million. Our loans generally have a Prime Rate floor established at the prevailing Prime Rate at the time of origination. Refer to Note 3 for Prime Rate floor by loan.

In addition, our Revolving Loan is exposed to similar market risks. Changes in market rates may change the fair value of our Revolving Loan as our loan bears interest at the greater of (1) the Prime Rate plus the applicable margin and (2) 3.25%. As of June 30, 2024, we had an outstanding balance of $76.8 million under the Revolving Loan. Based on our outstanding balance as of June 30, 2024, we estimate that a hypothetical 100 basis points increase in the Prime Rate would result in an increase in annual cash interest expense, excluding unused fees, of approximately $0.8 million and a 100 basis points decrease in the Prime Rate would result in a decrease in annual interest expense of approximately $0.8 million. As of December 31, 2023, we had an outstanding balance of $66.0 million under the Revolving Loan. Based on our outstanding balance as of December 31, 2023, we estimate that a hypothetical 100 basis points increase in the Prime Rate would result in an increase in annual cash interest expense, excluding unused fees, of approximately $0.7 million and a 100 basis points decrease in the Prime Rate would result in a decrease in annual interest expense of approximately $0.7 million.

Changes in Market Interest Rates and Effect on Net Interest Income

Interest rates are highly sensitive to many factors, including fiscal and monetary policies and domestic and international economic and political considerations, as well as other factors beyond our control. We will be subject to interest rate risk in connection with our assets and our related financing obligations.

Our operating results will depend in large part on differences between the income earned on our assets and our cost of borrowing. The cost of our borrowings generally will be based on prevailing market interest rates. Periods of rising interest rates may, over time' cause:

• the interest expense associated with our borrowings to increase, subject to any applicable ceilings, which could result in a decline in our net interest spread and net interest margin.
• the value of our mortgage loans to decline; and
• coupons on our floating rate loans to reset to higher interest rates.

Conversely, periods of declining interest rates, in general, may over time cause:

• the interest expense associated with our borrowings to decrease, subject to any applicable floors;
• the value of our loan portfolio to increase, for such mortgages with applicable floors; and
• coupons on our floating rate mortgage loans to reset to lower interest rates, subject to any applicable floors.

The severity of any such increase or decrease to our net interest spread and net interest margin would depend on our asset/liability composition at the time as well as the magnitude and duration of the interest rate increase. If any of these events happen, we could experience a decrease in net income or incur a net loss during these periods, which could adversely affect our liquidity and results of operations.

Risk Management

To the extent consistent with maintaining our REIT qualification and our exemption from registration under the Investment Company Act, we seek to manage risk exposure by closely monitoring our portfolio and actively managing the financing, interest rate, credit, prepayment and convexity (a measure of the sensitivity of the duration of a loan to changes in interest rates) risks associated with holding our portfolio of loans. Generally, with the guidance and experience of our Manager:

• we manage our portfolio through an interactive process with our Manager and service our self-originated loans through our Manager’s servicer;
• we invest in a mix of floating-rate and fixed-rate loans to mitigate the interest rate risk associated with the financing of our portfolio;
• we actively employ portfolio-wide and asset-specific risk measurement and management processes in our daily operations, including utilizing our Manager’s risk management tools such as software and services licensed or purchased from third-parties and proprietary analytical methods developed by our Manager; and
• we seek to manage credit risk through our due diligence process prior to origination or acquisition and through the use of non-recourse financing, when and where available and appropriate. In addition, with respect to any particular target investment, prior to origination or acquisition our Manager’s investment team evaluates, among other things, relative valuation, comparable company analysis, supply and demand trends, shape-of-yield curves, delinquency and default rates, recovery of various sectors and vintage of collateral.

Market Conditions

We provide loans to established companies operating in the cannabis industry which involves significant risks, including the risk of strict enforcement against our borrowers of the federal illegality of cannabis, our borrowers’ inability to renew or otherwise maintain their licenses or other requisite authorizations for their cannabis operations, and such loans lack of liquidity, and we could lose all or part of any of our loans.

We believe that favorable market conditions, including an imbalance in supply and demand of credit to cannabis operating companies, have provided attractive opportunities for non-bank lenders, such as us, to finance commercial real estate loans and other loans that exhibit strong fundamentals but also require more customized financing structures and loan products than regulated financial institutions can presently provide. Additionally, to the extent that additional states legalize cannabis, our addressable market will increase. While we intend to continue capitalizing on these opportunities and growing the size of our portfolio, we are aware that the competition for the capital we provide is increasing.

Our ability to grow or maintain our business depends on state laws pertaining to the cannabis industry. New laws that are adverse to our borrowers may be enacted, and current favorable state or national laws or enforcement guidelines relating to cultivation, production and distribution of cannabis may be modified or eliminated in the future, which would impede our ability to grow and could materially adversely affect our business.

Management’s plan to mitigate risks include monitoring the legal landscape as deemed appropriate. Also, should a loan default or otherwise be seized, we may be prohibited from owning cannabis assets and thus could not take possession of collateral, in which case we would look to sell the loan, which could result in us realizing a loss on the transaction.

While we believe the principal amounts of our loans are generally adequately protected by underlying collateral value, there is a risk that we will not realize the entire principal value of certain loans, particularly those not fully collateralized by real estate. In order to mitigate that risk, our loans are generally collateralized by other assets, such as equipment, receivables, licenses or other assets of the borrowers to the extent permitted by applicable laws and regulations. In addition, we seek to impose strict loan covenants and seek personal or corporate guarantees for additional protection. As of June 30, 2024, 66% of our portfolio is fully secured by real estate. Our portfolio on average had real estate collateral coverage of 1.3x as of June 30, 2024, and all of our loans are secured by equity pledges of the borrower and all asset liens. As of June 30, 2023, 74% of our portfolio was fully secured by real estate and 26% had limited or no real estate collateral. Our portfolio on average had real estate collateral coverage of 1.5x as of June 30, 2023 and all of our loans were secured by equity pledges of the borrower and all asset liens.

Credit Risk

We are subject to varying degrees of credit risk in connection with our loans and interest receivable. Our Manager seeks to mitigate this risk by seeking to originate loans, and may in the future acquire loans, of higher quality at appropriate prices given anticipated and unanticipated losses, by employing a comprehensive review and selection process and by proactively monitoring originated and acquired loans. Nevertheless, unanticipated credit losses could occur that could adversely impact our operating results. For additional information regarding the credit risk associated with our loans and interest receivables, see “Risk Factors- Loans to relatively new and/or small companies and companies operating in the cannabis industry generally involve significant risks” in our Annual Report on Form 10-K for the year ended December 31, 2023.

Our Manager or affiliates of our Manager have originated all of our loans and intend to continue to originate our loans, but we may in the future also acquire loans from time to time. Our Investment Guidelines are not subject to any limits or proportions with respect to the mix of target investments that we make or that we may in the future acquire other than as necessary to maintain our exemption from registration under the Investment Company Act and our qualification as a REIT. Our investment decisions will depend on prevailing market conditions and may change over time in response to opportunities available in different interest rate, economic and credit environments. As a result, we cannot predict the percentage of our capital that will be invested in any individual target investment at any given time.

Our loan portfolio as of June 30, 2024 and December 31, 2023, was concentrated with the top three borrowers representing approximately 25.7% and 28.7% of principal outstanding and approximately 23.9% and 26.4% of the total commitments, respectively. As of and for the three months ended June 30, 2024 and 2023, the top three borrowers represented approximately 30.0% and 30.3% of the total interest income, respectively. The largest loan represented approximately 10.3% and 10.9% of principal outstanding and approximately 8.8% and 9.7% of the total commitments as of June 30, 2024 and December 31, 2023, respectively.

As of June 30, 2024 and December 31, 2023, our borrowers have operations in the jurisdiction noted within the table below based on real estate collateral location or principal place of business:

(1) The principal balance of the loans not secured by real estate collateral are included in the jurisdiction representing the principal place of business.

Real Estate Risk

Commercial real estate loans are subject to volatility and may be affected adversely by a number of factors, including, but not limited to, national, regional and local economic conditions (which may be adversely affected by industry slowdowns and other factors); local real estate conditions; changes or continued weakness in specific industry segments; construction quality, age and design; demographic factors; and retroactive changes to building or similar codes. In addition, decreases in property values reduce the value of the collateral and the potential proceeds available to a borrower to repay the underlying loan or loans, as the case may be, which could also cause us to suffer losses.

Evaluation of Disclosure Controls and Procedures

Disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) are designed to provide reasonable assurance that information required to be disclosed in reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the forms and rules of the SEC and that such information is accumulated and communicated to management, including the Principal Executive Officer and Principal Financial Officer, to allow timely decisions regarding required disclosures. Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives.

In connection with the preparation of this quarterly report on Form 10-Q, our management, including the Principal Executive Officer and Principal Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of June 30, 2024. Based on that evaluation, our Principal Executive Officer and Principal Financial Officer have concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of June 30, 2024 to ensure that (a) information required to be disclosed in reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the forms and rules of the SEC and (b) such information is accumulated and communicated to management, including the Principal Executive Officer and Principal Financial Officer, to allow timely decisions regarding required disclosures.

Changes in Internal Control over Financial Reporting

During the six months ended June 30, 2024, we launched and adopted a new integrated ERP system, which replaced our existing core financial system. The system enhances efficiencies and simplifies our accounting and reporting processes. In conjunction with the implementation of the ERP system, our internal processes, procedures and controls have been updated accordingly.

Except as discussed in the preceding paragraph, there were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended June 30, 2024 that have materially affected, or that are reasonably likely to materially affect, our internal control over financial reporting.

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2023, which could materially affect our business, financial condition and/or results of operations. Except to the extent updated below or to the extent additional factual information disclosed elsewhere in this Quarterly Report on Form 10-Q relates to such risk factors, there have been no material changes to the risk factors described in the “Risk Factors” sections in our Annual Report on Form 10-K for the year ended December 31, 2023. The risks described in our Annual Report on Form 10-K and subsequent Quarterly Reports on Form 10-Q are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or results of operations.

Recent macroeconomic trends, including inflation and rising interest rates, may adversely affect our business, financial condition and results of operations.

During the six months ended June 30, 2024, inflation in the United States has remained at an elevated level and may remain at an elevated level in the near-term. Rising inflation could have an adverse impact on any variable rate debt we may incur in the future, and our general and administrative expenses, as these costs could increase at a rate higher than our interest income and other revenue. The Federal Reserve raised interest rates multiple times since January 2023 to combat inflation and restore price stability and rates may remain stable. To the extent our borrowing costs increase faster than the interest income earned from our floating-rate loans, such increases may adversely affect our cash flows.