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Item 3. Quantitative and Qualitative Disclosures About Market Risk

2022-05-10 compared with 2021-11-04 · 121 added, 118 removed, 44 unchanged (84% of the section changed)

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These risks primarily relate to fluctuations in interest rates.

Our loans are typically valued using a

yield analysis, which is typically performed for non-credit impaired loans to borrowers.

Our loans are typically valued using a yield analysis, which

is typically performed for non-credit impaired 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 September 30, 2021, a decrease of 50 bps or increase of 50 bps of the market yield would have resulted in a change in unrealized gain

/ (loss) of approximately $0.4 million and $(0.4) million, respectively.

As of September 30, 2021, we had six floating-rate loans, representing approximately 45.7% of our loan portfolio based on aggregate outstanding principal balances, subject to

a weighted average LIBOR floor of approximately 1% with LIBOR quoted as 0.080%.

We estimate that a hypothetical 100 basis points increase in LIBOR would result in an increase in annual interest income of approximately $0.1 million and a decrease in

LIBOR would not affect our interest income due to the LIBOR floor on 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 March 31, 2022, a decrease of 50 bps or increase of 50 bps of the market yield would have resulted change in unrealized gain (loss) of approximately

$0.5 million and $(0.5) million, respectively.

As of March 31, 2022, we had five floating-rate loans, representing approximately 31% of our portfolio based on aggregate outstanding principal balances, subject to a weighted average LIBOR floor of

approximately 1.0% with LIBOR quoted as 0.452%.

We estimate that a hypothetical 100 basis points increase in LIBOR would result in an increase in annual interest income of approximately $0.5 million and a decrease in LIBOR would not affect our

interest income due to the LIBOR floor on our loans.

This assumes that the weighted average LIBOR floor of our floating-rate loans remains at approximately 1.0%.

Potential Impact of LIBOR Transition

The Chief Executive of the U.K.

Financial Conduct Authority (the “FCA”), which regulates the London Interbank Offered Rate, or LIBOR, has announced that the FCA will no longer

persuade or compel banks to submit rates for the calculation of LIBOR after 2021.

However, for U.S dollar LIBOR, the relevant date has been deferred to at least June 30, 2023 for certain tenors (including overnight and one, three, six and 12

months), at which time the LIBOR administrator has indicated that it intends to cease publication of U.S.

dollar LIBOR.

Despite this deferral, the LIBOR administrator has advised that no new contracts using U.S.

dollar LIBOR should be entered into

after December 31, 2021.

These actions indicate that the continuation of U.S.

LIBOR on the current basis cannot and will not be guaranteed after June 30, 2023.

Moreover, it is possible that U.S.

LIBOR will be discontinued or modified prior to June

As of September 30, 2021, six of our loans, representing approximately 45.7% of our loan portfolio based on total loan commitments, paid interest at a variable rate tied to

If LIBOR is no longer available, our applicable loan documents generally allow us to choose a new index based upon comparable information.

However, if LIBOR is no longer available, we may need to renegotiate some of our agreements to

determine a replacement index or rate of interest.

As of March 31, 2022, five of our loans, representing approximately 31% of our portfolio based on aggregate outstanding principal balances, paid interest at a variable rate tied to LIBOR.

LIBOR is no longer available, our applicable loan documents generally allow us to choose a new index based upon comparable information.

However, if LIBOR is no longer available, we may need to renegotiate some of our agreements to determine a

replacement index or rate of interest.

There is currently no definitive information regarding the future utilization of LIBOR or of any particular replacement rate.

As such, the potential effect of any such event on our cost of capital

and net investment income cannot yet be determined and any changes to benchmark interest rates could increase our financing costs, which could impact our results of operations, cash flows and the market value of our loans.

In addition, the

elimination of LIBOR and/or changes to another index could result in mismatches with the interest rate of loans that we are financing.

As such, the potential effect of any such event on our cost of capital and net

investment income cannot yet be determined and any changes to benchmark interest rates could increase our financing costs, which could impact our results of operations, cash flows and the market value of our loans.

In addition, the elimination of

LIBOR and/or changes to another index could result in mismatches with the interest rate of loans that we are financing.

Changes in Fair Value of Our Assets

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however, we may occasionally classify some of our loans as held for sale.

We may carry our loans at fair value or

carrying value in our balance sheet.

As of September 30, 2021 and December 31, 2020, three and four of our loans held for investment, respectively, were carried at fair value within loans held at fair value in our balance sheets, with changes in

fair value recorded through earnings.

We may carry our loans at fair value or carrying value in

our consolidated balance sheet.

As of March 31, 2022 and December 31, 2021, three of our loans held for investment were carried at fair value within loans held at fair value in our consolidated balance sheets, with changes in fair value recorded

through earnings.

We evaluate our loans on a quarterly basis and fair value is determined by our Board through its independent Audit and Valuation Committee.

We use an independent third-party

valuation firm to provide input in the valuation of all of our unquoted investments, which we consider along with other various subjective and objective factors in making our evaluations.

We use an independent third-party valuation firm to

provide input in the valuation of all of our unquoted investments, which we consider along with other various subjective and objective factors in making our evaluations.

Our loans are typically valued using a yield analysis, which is typically performed for non-credit impaired loans to borrowers.

To determine fair value using a yield analysis, a

current price is imputed for the loan based upon an assessment of the expected market yield for a similarly structured loan with a similar level of risk.

In the yield analysis, we consider the current contractual interest rate, the maturity and

other terms of the loan relative to risk of the borrower and the specific loan.

To determine fair value using a yield analysis, a current price is

imputed for the loan based upon an assessment of the expected market yield for a similarly structured loan with a similar level of risk.

In the yield analysis, we consider the current contractual interest rate, the maturity and other terms of the

loan relative to risk of the borrower and the specific loan.

A key determinant of risk, among other things, is the leverage through the loan relative to the enterprise value of the borrower.

As loans held by us are substantially

illiquid with no active transaction market, we depend on primary market data, including newly funded loans, as well as secondary market data with respect to high-yield debt instruments and syndicated loans, as inputs in determining the appropriate

market yield, as applicable.

As loans held by us are substantially illiquid with no

active transaction market, we depend on primary market data, including newly funded loans, as well as secondary market data with respect to high-yield debt instruments and syndicated loans, as inputs in determining the appropriate market yield, as

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.

Due to the inherent uncertainty of determining the fair value of loans that do not have a readily available market value, the fair value of our loans may fluctuate from period to

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.

Due to the inherent uncertainty of determining the fair value of loans that do not have a readily available market value, the fair value of our loans may fluctuate from period to period.

Additionally, the fair value of our loans may differ significantly from the values that would have been used had a ready market existed for such loans and may differ materially from the values that we may ultimately realize.

Further, such

loans are generally subject to legal and other restrictions on resale or otherwise are less liquid than publicly traded securities.

If we were required to liquidate our investment in a loan in a forced or liquidation sale, we could realize

significantly less than the value at which we had recorded such loan investment.

Further, such loans are

generally subject to legal and other restrictions on resale or otherwise are less liquid than publicly traded securities.

If we were required to liquidate our investment in a loan in a forced or liquidation sale, we could realize significantly less

than the value at which we had recorded such loan investment.

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.

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

We are subject to interest rate risk in connection with our assets and our related financing obligations.

Our operating results 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.

During a period of rising interest rates, our borrowing costs generally will increase (a) while the yields earned on our leveraged fixed-rate loan assets will remain static, and (b) at a faster pace than the yields

earned on our leveraged floating-rate loan assets, which could result in a decline in our net interest spread and net interest margin.

The severity of any such decline would depend on our asset/liability composition at the time as well as the

magnitude and duration of the interest rate increase.

The cost of our borrowings generally will be based on prevailing

market interest rates.

our leveraged floating-rate loan assets, which could result in a decline in our net interest spread and net interest margin.

The severity of any such decline would depend on our asset/liability composition at the time as well as the magnitude and

duration of the interest rate increase.

Further, an increase in short-term interest rates could also have a negative impact on the market value of our target investments.

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.

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

Through our Manager, we originate both fixed and floating-rate loans and going forward, we intend to have the majority of our loans by aggregate commitments accrue at floating

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.

Through our Manager, we originate both fixed and floating rate loans and going forward, we intend to have the majority of our loans by aggregate commitments accrue at floating rates.

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.

In July 2017, the Financial Conduct Authority announced its intention to phase out LIBOR by the end of 2021 and the IBA recently announced that it will be consulting on plans to

extend the cessation date for certain tenors of U.S.-dollar LIBOR until 2023.

It is not possible to predict the effect of any changes in the methods by which LIBOR is determined or regulatory activity related to LIBOR’s phase out.

If LIBOR is no

longer available, our applicable loan documents generally allow us to choose a new index based upon comparable information.

Any of these proposals or consequences could have a material adverse effect on our interest expenses.

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.

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 LIBOR, while the interest rates on these

assets may be fixed or indexed to LIBOR or another index rate.

Accordingly, any increase in LIBOR 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.

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 LIBOR, while the interest rates on these assets may be fixed or

indexed to LIBOR or another index rate.

Accordingly, any increase in LIBOR 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.

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

Additionally, to the extent that additional states legalize cannabis, our addressable market will increase.

While we intend to continue our track record of capitalizing on these opportunities and growing the size of our portfolio, we are

aware that the competition for the capital we provide is increasing.

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 our track record of capitalizing on these opportunities and growing the size of our portfolio, we are aware that the

competition for the capital we provide is increasing.

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.

In June 2016, the Financial Accounting Standards Board issued Accounting Standards Update (“ASU”) No.

2016-13, which replaced the incurred loss impairment methodology pursuant to

GAAP with a methodology that reflects current expected credit losses (“CECL”) on both the outstanding balances and unfunded commitments on loans held for investment and requires consideration of a broader range of historical experience adjusted for

current conditions and reasonable and supportable forecast information to inform credit loss estimates (the “CECL Reserve”).

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.

We expect to be subject to varying degrees of credit risk in connection with holding our portfolio of loans.

We will have exposure to credit risk on our commercial real estate loans and other targeted types of loans.

Our Manager will seek to manage credit risk by performing deep credit fundamental analysis of potential assets and through the use of non-recourse financing, when and where available and appropriate.

Credit risk will also be addressed through our Manager’s on-going review, and loans will be monitored for variance from expected prepayments, defaults, severities, losses and cash flow on a quarterly basis.

Other than the acquisition of our initial portfolio of loans and certain loan commitments relating to Private Company A, we, through our Manager, have originated substantially all of our loans and intend to continue

to originate our loans, but we have previously and may in the future 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 March 31, 2022 was concentrated with the top four borrowers representing approximately 69.4% of the aggregate outstanding principal balances and approximately 69.0% of the total loan

Additionally, the industry is experiencing significant consolidation, which we expect to continue, among cannabis operations and certain of our borrowers may combine, increasing the concentration of our borrower portfolio with those

consolidated operators.

Our largest credit facility represented approximately 20.6% of our total loan commitments and approximately 23.2% of the aggregate outstanding principal balances of our portfolio as of March 31, 2022 and the borrower under

this credit facility is Public Company F, a multi-state operator with real estate assets in several states, certain of which have been included as collateral in connection with the senior term loan.

Our portion of the senior term loan provided to

such borrower had an aggregate principal amount of $86.6 million outstanding as of March 31, 2022.

This senior term loan accrues interest at a blended rate of 8.6% per annum, payable in cash, across the three tranches of the senior term loan

The Public Company F senior term loan is managed by a third-party agent, acting as sole lead arranger, administrative agent and collateral agent, which is an affiliate of one of the other lender parties.

In June 2016, the FASB issued Accounting Standards Update (“ASU”) No.

2016-13, which replaced the incurred loss impairment methodology pursuant to GAAP with a methodology that reflects current expected credit losses

(“CECL”) on both the outstanding balances and unfunded commitments on loans held for investment and requires consideration of a broader range of historical experience adjusted for current conditions and reasonable and supportable forecast

information to inform credit loss estimates (the “CECL Reserve”).

We adopted ASU No.

2016-13 as of July 31, 2020, the date of our commencement of operations.

Subsequent period increases and

decreases to expected credit losses impact earnings and are recorded within provision for current expected credit losses in our statement of operations.

The CECL Reserve related to outstanding balances on loans held for investment required under

2016-13 is a valuation account that is deducted from the amortized cost basis of our loans held at carrying value and loans receivable at carrying value in our balance sheet.

The CECL Reserve related to unfunded commitments on loans held at

carrying value is recorded within accounts payable and other liabilities in our balance sheet.

Refer to Note 6 to our unaudited consolidated financial statements included elsewhere in this quarterly report for more information on CECL.

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

Subsequent period increases and decreases to expected credit losses impact earnings and

are recorded within provision for current expected credit losses in our consolidated statement of operations.

The CECL Reserve related to outstanding balances on loans held for investment required under ASU No.

2016-13 is a valuation account that

is deducted from the amortized cost basis of our loans held at carrying value and loans receivable at carrying value in our consolidated balance sheet.

The CECL Reserve related to unfunded commitments on loans held at carrying value is recorded

within accounts payable and other liabilities in our consolidated balance sheet.

Refer to Note 6 to our unaudited interim consolidated financial statements titled “Current Expected Credit Losses” for more

information on CECL.

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.

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.

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.

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.

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);

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;

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demographic factors;

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.

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.

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

Generally, with the guidance and experience of our Manager:

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 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.

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 invest in a mix of floating- 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

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 3. Quantitative and Qualitative Disclosures About Market Risk