Chicago Atlantic Real Estate Finance, Inc. (REFI) FY 2023 MD&A

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read together with the consolidated financial statements and related notes that are included elsewhere in this annual report on Form 10-K. This discussion contains forward-looking statements that reflect our current expectations and views of future events, which involve risks and uncertainties. Our actual results and the timing of selected events could differ materially from those anticipated in such forward-looking statements. Factors that could cause or contribute to those differences include, but are not limited to, those discussed above in “Risk Factors” and those identified below and elsewhere in this annual report on Form 10-K. See “Forward-Looking Statements.”

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 may 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 December 31, 2023 and 2022, 27.1% and 13.6%, respectively, of the loan principal 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 December 31, 2023, our portfolio is comprised primarily of first mortgages to established multi-state or single-state cannabis operators or property owners. In addition, we own approximately $0.8 million, at fair value, of publicly-traded corporate bonds issued by a cannabis operator. 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 we have qualified 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 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.

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We generate revenue primarily in the form of interest income on loans. As of December 31, 2023 and 2022, approximately 80.5% and 83.1%, respectively, of our portfolio was comprised of floating rate loans, and 19.5% and 16.9% 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 Prime Rate during the years ended December 31, 2023 and 2022 was as follows:

(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:

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organizational and offering expenses;

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quarterly valuation expenses;

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fees payable to third parties relating to, or associated with, making loans and valuing loans (including third-party valuation firms);

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fees and expenses associated with investor relations and marketing efforts (including attendance at investment conferences and similar events);

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accounting and loan servicing fees from our third-party fund administrator;

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audit fees and expenses from our independent registered public accounting firm;

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federal and state registration fees;

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any exchange listing fees;

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federal, state and local taxes;

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independent directors’ fees and expenses;

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brokerage commissions;

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costs of proxy statements, stockholders’ reports and notices; and

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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 have qualified 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 years ended December 31, 2023 and 2022, 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 December 31, 2023 and 2022. 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.

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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. 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. 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.

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 December 31, 2023, we had $286.4 million of floating rate loans of which 81.9%, based on principal outstanding, have interest rate floors, and one loan is subject to an interest rate cap (Note 3) as summarized below:

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

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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.

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:

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we manage our portfolio through an interactive process with our Manager and generally service our self-originated loans through our Manager’s servicer;

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we invest in a mix of floating-and fixed-rate loans to mitigate the interest rate risk associated with the financing of our portfolio;

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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

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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.

Recent Developments

Revolving Loan

On February 28, 2024, Chicago Atlantic Lincoln, LLC ("CAL") entered into a Fifth Amended and Restated Loan and Security Agreement (the “Fifth Amendment and Restatement”). The Fifth Amendment and Restatement extended the contractual maturity date of the Revolving Loan until June 30, 2026, and expanded the existing accordion feature to permit aggregate loan commitments of up to $150.0 million. No other material terms of the Revolving Loan were modified as a result of the execution of the Fifth Amendment and Restatement. The Company incurred debt issuance costs of approximately $0.1 million related to the Fifth Amendment and Restatement, which were capitalized and will subsequently be amortized through maturity.

Updates to Our Loan Portfolio during Fiscal Year 2023

For the year ended December 31, 2023, our cash loan fundings, net of original issue discounts and other upfront fees were approximately $92.2 million. We received approximately $90.3 million of total proceeds from sales and principal amortization of loans of $13.4 million and $76.9 million, respectively.

In total, our loans held for investment, at carrying value, increased by $14.3 million, from $339.3 million at December 31, 2022 to $353.6 million as of December 31, 2023. Total loan commitments and contingencies as of December 31, 2023 is approximately $371.3 million, of which $7.5 million is unfunded.

In January 2023, we refinanced the syndicated credit facility with the borrower of Loan #18, which resulted in a net paydown of $18.3 million in aggregate principal. There were no monetary terms that were amended in connection with the refinancing.

In January 2023, we purchased a senior secured loan from an affiliate under common control. The purchase price of approximately $19.0 million was approved by the Audit Committee of the Board. The fair value approximated the carrying value of the loan plus accrued and unpaid interest through January 24, 2023. We received an early repayment of this loan in full during March 2023.

In January 2023, we closed one credit facility with the borrower of prior Loan #22, which had an aggregate commitment of $11.3 million, which was fully funded at closing. We received an early repayment of this loan in full during November 2023. The loan had an original maturity date of January 2026 and the outstanding principal on the date of repayment was approximately $10.8 million. We received a prepayment fee of approximately $1.4 million upon repayment which is included in interest income.

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In March 2023, we closed the credit facilities for Loan #23 and Loan #24, which have aggregate commitment of approximately $2.0 million and $1.0 million, respectively.

In March 2023, we completed the sale of a secured loan to an affiliate under common control. The selling price of approximately $13.7 million was approved by the Audit Committee of the Board and the fair value approximated the carrying value of the loan plus accrued and unpaid interest through March 31, 2023.

In May 2023, we entered into an amendment to Loan #4, which extended the make-whole period through maturity and re-priced the second tranche to the prime rate plus a spread of 11.75%. In connection with the amendment, we also agreed to waive compliance with certain covenants for one fiscal quarter, subject to certain terms and conditions.

In May 2023, Loan #9 was placed on non-accrual status for borrower's breach of certain non-financial covenants and obligations under the loan agreement. The borrower subsequently failed to make contractual principal and interest payments due for the months of May and June 2023. On June 20, 2023, the Administrative Agent to Loan #9 (the “Agent”, a related party) issued an acceleration notice notifying the borrower of the Agent’s intention to exercise all rights and remedies under the credit documents and requested immediate payment of all amounts outstanding thereunder on behalf of the lenders. The Agent subsequently pursued a Uniform Commercial Code (“UCC”) sale of the membership interests of the borrower’s subsidiaries which were pledged as collateral. On August 10, 2023, the Agent was the highest bidder in a public auction of the membership interests and took ownership of the membership interests. The Agent intends to sell the assets in satisfaction of the loan for the benefit of the lenders. As described in Note 3, Loan #9 remains on non-accrual status and we will continue to cease further recognition of income until such events of default are cured or obligations are repaid. As of December 31, 2023, 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 $1.5 million.

In June 2023, we entered into an amendment to Loan #7, which resulted in a pay down of $5.0 million, along with applicable make-whole fees under the credit facility. Among other things, the amendment decreased the PIK rate from 2.5% to 2.0% and deferred scheduled amortization payments until September 30, 2023.

In June 2023, we entered into an amendment to Loan #18, to cure certain non-monetary covenant breaches which resulted in a re-pricing of the cash interest rate to the Prime Rate plus 1.75%.

In September 2023, we closed Loan #28 with a new borrower in Ohio. The credit facility has an aggregate commitment of approximately $2.5 million, all of which was funded at closing.

In October 2023, we closed Loan #29 with a new borrower in Illinois. The credit facility has an aggregate commitment of approximately $1.1 million, all of which was funded at closing.

In November 2023, we executed an amendment to Loan #12 in connection with the early repayments received during fiscal year 2023 of approximately $10.1 million. The amendment converted the interest rate to a floating pricing grid based on the aggregate principal balance outstanding. As of the amendment date, the pricing was set at the Prime rate plus 7.00%.

In December 2023, $2.6 million of corporate bonds were redeemed prior to contractual maturity by the issuer at 100% of the face value. The redemption resulted in a realized gain of approximately $0.1 million. This investment was classified as debt securities, at fair value as of September 30, 2023.

In December 2023, Loan #6 was placed on non-accrual status. As of December 31, 2023, Loan #6 is held on the consolidated balance sheet with a carrying value of approximately $4.3 million and a reserve for current expected credit losses of approximately $0.1 million.

In December 2023, we closed Loan #30 with a new borrower in Missouri. The credit facility has an aggregate commitment of $15.0 million, of which $7.5 million was funded at closing and $7.5 million remains unfunded as of December 31, 2023.

In December 2023, we entered into an amendment to Loan #8, which waived principal amortization payment for the period from October 31, 2023 to December 31, 2023. Among other things, the amendment increased the PIK rate from 2.0% to 13.0% and waived cash interest for the fourth quarter of 2023. Additionally, previously accrued cash interest of approximately $0.6 million was paid in kind and capitalized to the principal balance of the loan outstanding.

In December 2023, we entered into an amendment to Loan #4, which extended the maturity date to February 14, 2024. The amendment increased the PIK rate from 2.0% to Prime plus 11.75% and cash interest is 0% from December 1, 2023 to maturity.

Subsequent Updates to Our Loan Portfolio in 2024

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During the period from January 1, 2024 through March 11, 2024, the Company advanced approximately $16.5 million of gross loan principal, of which $6.7 million and $9.8 million were funded to a new borrowers and existing borrowers, respectively.

In February 2024, we entered into an amendment to Loan #16, which modified certain financial covenants. No monetary terms of the loan were modified in connection with the amendment.

In February 2024, we entered into an amendment to Loan #6, which extended the maturity date to March 20, 2024.

In February 2024, we entered into an amendment to Loan #4, to extend the maturity date to April 16, 2024 and modified the interest rate for the period from February 14, 2024 through maturity to 15.0% PIK.

In February 2024, we entered into an amendment to Loan #19, which extended the maturity date from August 29, 2025 to December 31, 2025. Additionally, make-whole interest protections were extended through June 30, 2025 and the PIK rate was increased from 3.0% to 5.0%.

In March 2024, we entered into an amendment to Loan #6, which extended the maturity date to April 15, 2024, and waived amortization payments until such date. Additionally, previously accrued interest of approximately $0.3 million was paid in kind and capitalized to the principal balance. From the amendment date through maturity all interest at the prevailing interest rate will be paid in kind. In connection with this amendment, Loan #6 was restored to accrual status.

Dividends Declared Per Share

For the period from January 1, 2023 through March 31, 2023, we declared an ordinary cash dividend of $0.47 per share of our common stock, relating to the first quarter of 2023, which was paid on April 14, 2023 to stockholders of record as of the close of business on March 31, 2023. The total amount of the cash dividend payment was approximately $8.5 million.

For the period from April 1, 2023 through June 30, 2023, we declared an ordinary cash dividend of $0.47 per share of our common stock, relating to the second quarter of 2023, which was paid on July 14, 2023 to stockholders of record as of the close of business on June 30, 2023. The total amount of the cash dividend payment was approximately $8.5 million.

For the period from July 1, 2023 through September 30, 2023, we declared an ordinary cash dividend of $0.47 per share of our common stock, relating to the third quarter of 2023, which was paid on October 13, 2023 to stockholders of record as of the close of business on September 29, 2023. The total amount of the cash dividend payment was approximately $8.5 million.

For the period from October 1, 2023 through December 31, 2023, we declared an ordinary cash dividend of $0.47 per share of our common stock, relating to the fourth quarter of 2023, which was paid on January 12, 2024 to stockholders of record as of the close of business on December 29, 2023. The total amount of the cash dividend payment was approximately $8.5 million. In addition, we declared a special cash dividend of $0.29 per share of our common stock, which was paid on January 12, 2024 to stockholders of record as of the close of business on December 29, 2023. The total amount of the special cash dividend payment was approximately $5.2 million.

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

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Results of Operations

Comparison of the years ended December 31, 2023 and 2022

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The increase in interest income was driven by the $12.7 million increase in principal outstanding, as well as the increase in the Prime rate of 100 basis points during the year. The Prime rate increase impacted approximately 80.5% of the Company’s loans, which bear a floating rate as of December 31, 2023. Additionally, we recognized approximately $3.5 million of interest income from prepayment fees and acceleration of original issue discounts and other upfront fees during the year ended December 31, 2023, as compared to $1.2 million for the year ended December 31, 2022.

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Interest expense increased as a result of the series of Prime Rate increases discussed above as well as timing of borrowings and amounts outstanding under the Revolving Loan. Additionally, the Company increased the availability under the Revolving Loan from $92.5 million as of December 31, 2022 to $100.0 million as of December 31, 2023, resulting in an increase to unused fee interest expense (25 basis points of amounts outstanding) over the comparative period.

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The increase in base management and incentive fees, net was primarily attributable to the year over year increases in Equity and Core Earnings of $7.9 million and $4.3 million, respectively, on which the fees are earned. These increases were partially offset by fewer Outside Fees applied during the year ended December 31, 2023 of approximately $0.2 million, compared to approximately $1.3 million for the year ended December 31, 2022.

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The increase in general and administrative expenses and professional fees was primarily due to an increase in overhead reimbursements for costs incurred by the Manager of $4.8 million for the year ended December 31, 2023 compared to $3.1 million for the same period in 2022.

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Stock based compensation increased as a result of the grant of 323,452 restricted stock awards to employees of our Manager during the year ended December 31, 2023, for which expense is recognized ratably over the vesting period.

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During 2023, the Company recognized approximately $0.2 million of realized and unrealized gains on corporate bonds, held at fair value, which were not held by the Company as of or during the year ended December 31, 2022.

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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.

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As of December 31, 2023 and 2022, greater than 80% of the portfolio bears a floating rate based on the Prime Rate. The Prime rate increased 100 basis points in 2023, as compared to 425 basis points in 2022, indicating a more stabilized credit market in 2023 compared to 2022. The significant upward movement in benchmark interest rates during 2022 contributed to a greater change in the probability of default when compared to 2023, and contributed to the decrease in the provision year over year.

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Changes in portfolio risk composition resulting from principal paydowns and new fundings also contributed to the decrease, with reserves on new 2023 originations representing a smaller portion of the reserve than loans originated in prior years. As of December 31, 2023 approximately 68.9% of our loans carry a risk rating of "1" or 2", an increase when compared to 62.6% as of December 31, 2022.

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Additionally, improvement in enterprise valuations of our borrowers, driven by valuation multiples of comparable companies remaining more stable or increasing during the year ended December 31, 2023 as compared to December 31, 2022.

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The current expected credit loss reserve represents approximately 140 basis points of our aggregate loan commitments held at carrying value of approximately $5.0 million. The liability is 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.

Loan Portfolio

As of December 31, 2023 and 2022, our portfolio included 27 and 22 loans held for investment of approximately $353.6 million and $339.3 million at carrying value, respectively, prior to the reserve for current expected credit losses. The aggregate originated commitment under these loans was approximately $378.8 million and $351.4 million and outstanding principal was approximately $355.7 million and $343.0 million as of December 31, 2023 and 2022, respectively. As of December 31, 2023 and 2022, our loan portfolio had a weighted-average yield-to-maturity internal rate of return (“YTM IRR”) of 19.4% and 19.7%, respectively, 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 December 31, 2023 and 2022, approximately 80.5% and 83.1%, 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% as of December 31, 2022, and increased to 8.50% as of December 31, 2023. The table below summarizes our portfolio as of December 31, 2023:

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(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)
Total Commitment excludes future amounts to be advanced at sole discretion of the lender and reflects receipt of scheduled amortization payments as of December 31, 2023.

(4)
"P" = prime rate and depicts floating rate loans that pay interest at the prime rate plus a specific percentage; "PIK" = paid-in-kind interest; subtotal represents weighted average interest rate.

(5)
P&I = principal and interest. I/O = interest only. P&I loans may include interest only periods for a portion of the loan term.

(6)
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.

(7)
This Loan is subject to a prime rate floor of 3.25%

(8)
This Loan is subject to a prime rate floor of 4.00%

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(9)
This Loan is subject to a prime rate floor of 4.75%

(10)
This Loan is subject to a prime rate floor of 5.50%

(11)
This Loan is subject to a prime rate floor of 6.25%

(12)
This Loan is subject to a prime rate floor of 7.00%

(13)
This Loan is subject to a prime rate floor of 7.50%

(14)
This Loan is subject to a prime rate floor of 8.00%

(15)
This Loan is subject to a prime rate floor of 8.25%

(16)
This Loan is subject to a prime rate floor of 8.50%

(17)
This Loan is subject to a prime rate cap of 5.85%

(18)
The aggregate loan commitment to Loan #3 includes a $15.9 million initial commitment which has a base interest rate of 13.625%, 2.75% PIK and a second commitment of $4.2 million which has an interest rate of 15.00%, 2.00% PIK. The statistics presented reflect the weighted average of the terms under all advances for the total aggregate loan commitment.

(19)
As of December 1, 2023, this loan was placed on non-accrual status. In March 2024, we entered into an amendment to Loan #6, which extended the maturity date to April 15, 2024. In connection with this amendment, Loan #6 was restored to accrual status (Note 14).

(20)
As of May 1, 2023, Loan #9 was placed on non-accrual status and continues to be on non-accrual as of December 31, 2023. Loan #9 is included on the consolidated balance sheet as a loan held for investment – related party (Note 7).

The following tables summarize our loans held for investment as of December 31, 2023 and 2022:

(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 December 31, 2023 and 2022, respectively.

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The following tables present changes in loans held for investment at carrying value as of and for the years ended December 31, 2023 and 2022:

(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)
One loan was reclassified as held for sale from loans held for investment as the decision was made to sell the loan during the year ended December 31, 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.

(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.

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)

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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 December 31, 2023 and 2022 was approximately $14.94 and $14.86, 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

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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 December 31, 2023 and 2022, all of our cash was unrestricted and totaled approximately $7.9 million and $5.7 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.

Revolving Credit Facility

In May 2021, in connection with our acquisition of CAL, we were assigned a secured revolving credit facility (the “Revolving Loan”). The Revolving Loan had an original aggregate borrowing base of up to $10,000,000 and bore interest, payable in cash in arrears, at a per annum rate equal to the greater of (x) Prime Rate plus 1.00% and (y) 4.75%. We incurred debt issuance costs of $100,000 related to the origination of the Revolving Loan, which were capitalized and are subsequently being amortized through maturity. The maturity date of the Revolving Loan was the earlier of (i) February 12, 2023 and (ii) the date on which the Revolving Loan is terminated pursuant to terms in the Revolving Loan Agreement.

On December 16, 2021, CAL entered into an amended and restated Revolving Loan agreement (the “First Amendment and Restatement”). The First Amendment and Restatement increased the loan commitment from $10,000,000 to $45,000,000 and decreased the interest rate, from the greater of the (1) Prime Rate plus 1.00% and (2) 4.75% to the greater of (1) the Prime Rate plus the applicable margin and (2) 3.25%. The applicable margin is derived from a floating rate grid based upon the ratio of debt to equity of CAL and increases from 0% at a ratio of 0.25 to 1 to 1.25% at a ratio of 1.5 to 1. The First Amendment and Restatement also extended the maturity date from February 12, 2023 to the earlier of (i) December 16, 2023 and (ii) the date on which the Revolving Loan is terminated pursuant to the terms of the Revolving Loan agreement. We have the option to extend the initial term for an additional one-year term, provided no events of default exist and we provide the required notice of the extension pursuant to the First Amendment and Restatement. We incurred debt issuance costs of $859,500 related to the First Amendment and Restatement, which were capitalized and are subsequently being amortized through maturity.

On May 12, 2022, CAL entered into a second amended and restated Revolving Loan agreement (the “Second Amendment and Restatement”). The Second Amendment and Restatement increased the loan commitment from $45,000,000 to $65,000,000. No other material terms of the Revolving Loan were modified as a result of the execution of the Second Amendment and Restatement. We incurred debt issuance costs of $177,261 related to the Second Amendment and Restatement, which were capitalized and are subsequently amortized through maturity. The Revolving Loan incurs unused fees at a rate of 0.25% per annum which began on July 1, 2022 pursuant to the Second Amendment and Restatement.

On November 7, 2022, CAL entered into a third amended and restated Revolving Loan agreement (the “Third Amendment and Restatement”). The Third Amendment and Restatement increased the loan commitment from $65,000,000 to $92,500,000. No other material terms of the Revolving Loan were modified as a result of the execution of the Third Amendment and Restatement. We incurred debt issuance costs of $323,779 related to the Third Amendment and Restatement, which were capitalized and are subsequently amortized through maturity.

On February 27, 2023, CAL entered into an amendment to the Third Amendment and Restatement (the “Amendment”). The Amendment extended the contractual maturity date of the Revolving Loan until December 16, 2024 and we retained the option to extend the initial term for an additional one-year period, provided no events of default exist and we provide 365 days’ notice of the extension pursuant to the Amendment. No other material terms of the Revolving Loan were modified as a result of the execution of the Amendment. We incurred debt issuance costs of $2,988 related to the Amendment, which were capitalized and are subsequently amortized through maturity.

On June 30, 2023, CAL entered into a Fourth Amended and Restated Loan and Security Agreement (the “Fourth Amendment and Restatement”). The Fourth Amendment and Restatement increased the loan commitment from $92.5 million to $100.0 million. No other material terms of the Revolving Loan were modified as a result of the execution of the Fourth Amendment and Restatement. We incurred debt issuance costs of $109,291 related to the Fourth Amendment and Restatement, which were capitalized and are subsequently amortized through maturity.

On February 28, 2024, CAL entered into a Fifth Amended and Restated Loan and Security Agreement (the “Fifth Amendment and Restatement”). The Fifth Amendment and Restatement extended the contractual maturity date of the Revolving Loan until June 30, 2026, and expanded the existing accordion feature to permit aggregate loan commitments of up to $150.0 million. No other material terms of the Revolving Loan were modified as a result of the execution of the Fifth Amendment and Restatement. The

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Company incurred debt issuance costs of approximately $0.1 million related to the Fifth Amendment and Restatement, which were capitalized and will subsequently be amortized through maturity.

The Revolving Loan provides for certain affirmative covenants, including requiring us to deliver financial information and any notices of default, and conducting business in the normal course. Additionally, we must comply with certain financial covenants including: (1) maximum capital expenditures of $150,000, (2) maintaining a debt service coverage ratio greater than 1.35 to 1, and (3) maintaining a leverage ratio less than 1.50 to 1. As of December 31, 2023, we were in compliance with all financial covenants with respect to the Revolving Loan.

As of December 31, 2023 and 2022, unamortized debt issuance costs related to the Revolving Loan, including all amendments and amendments and restatements thereto, as applicable, of $366,592 and $516,261, respectively, are recorded in other receivables and assets, net on the consolidated balance sheets.

For the year ended December 31, 2023, we had net borrowings of $8.0 million against the Revolving Loan. As of December 31, 2023, we had $34.0 million available and $66.0 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 on Form S-3 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.

On February 15, 2023, the Company completed a registered direct offering of 395,779 shares of common stock at a price of $15.16 per share, raising net proceeds of approximately $6.0 million. The Company sold shares of common stock directly, without the use of underwriters or placement agents, to institutional investors registered pursuant to its effective shelf registration statement.

On June 20, 2023, the Company entered into an At-the-Market Sales Agreement (the “Sales Agreement”) with BTIG, LLC, Compass Point Research & Trading, LLC and Oppenheimer & Co. Inc. (each a “Sales Agent” and together the “Sales Agents”) under which we may, from time to time, offer and sell shares of common stock, having an aggregate offering price of up to $75.0 million. Under the terms of the Sales Agreement, we have agreed to pay the Sales Agents a commission of up to 3.0% of the gross proceeds from each sale of common stock sold through the Sales Agents. Sales of common stock, if any, may be made in transactions that are deemed to be “at-the-market” offerings, as defined in Rule 415(a)(4) promulgated under the Securities Act of 1933, as amended (the “Securities Act”).

During the year ended December 31, 2023, we sold an aggregate of 79,862 shares of our common stock under the Sales Agreement at an average price of $15.78 per share, generating net proceeds of approximately $1.2 million.

Cash Flows

The following table sets forth changes in cash and cash equivalents for the years ended December 31, 2023 and 2022, respectively:

Net Cash Provided by Operating Activities

For the years ended December 31, 2023 and 2022, we reported “Net cash provided by operating activities” of approximately $28.4 million and $17.0 million, respectively. Net cash provided by operating activities increased approximately $11.4 million,

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primarily attributable to an increase in net income over the comparable period of approximately $6.4 million, a change in the interest reserve for applied interest payments of approximately $13.0 million, redemption of debt securities of $2.5 million and an increase in interest receivable of approximately $1.2 million. These changes were offset by the purchase of $3.2 million of debt securities at fair value, an increase in PIK interest of approximately $2.5 million, a decrease in management and incentive fees payable of approximately $2.5 million, a decrease in current expected credit losses of approximately $2.9 million, an increase in stock based compensation of approximately $1.0 million, a decrease in related party net payable of approximately $0.7 million, $0.1 million in unrealized gain relating to the purchase of debt securities at fair value, and $0.1 million in realized gain relating to the purchase of debt securities over the comparable period.

Net Cash Used in Investing Activities

For the years ended December 31, 2023 and 2022, we reported “Net cash provided used in investing activities” of $1.9 million and $125.2 million, respectively.

For the year ended December 31, 2023, cash outflows primarily related to $92.2 million used for the origination and funding of loans held for investment, partially offset by $13.4 million of cash received from the sale of loans and $76.9 million of cash received from the principal repayment of loans held for investment.

For the year ended December 31, 2022, cash outflows primarily related to $149.6 million used for the origination and funding of loans held for investment, partially offset by $6.7 million of cash received from the sales of loans and $17.7 million of cash received from the principal repayment of loans held for investment.

Net Cash (Used in)/Provided by Financing Activities

For the years ended December 31, 2023 and 2022, we reported “Net cash (used in)/provided by financing activities” of $(24.3) million and $33.7 million, respectively.

For the year ended December 31, 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 $82.0 million, which were offset by $74.0 million in repayments on our Revolving Loan, approximately $39.1 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.

For the year ended December 31, 2022, cash inflows of approximately $4.5 million related to proceeds received from the underwriters’ partial exercise of their over-allotment option in connection with our initial public offering and $58.0 million related to draw downs on our Revolving Loan, partially offset by approximately $28.2 million in dividends paid, approximately $0.5 million in debt issuance costs paid, and approximately $0.1 million related to offering costs associated with our initial public 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

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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 years ended December 31, 2023 and 2022.

Critical Accounting Estimates

Our consolidated financial statements are prepared in accordance with GAAP which requires the use of estimates and assumptions that involve the exercise of judgment as to future uncertainties. The following discussion addresses the accounting estimates that we believe apply to us based on the nature of our operations. Our most critical accounting estimates involve a significant level of estimation uncertainty that have had or are reasonably likely to have a material impact on our financial conditions and results of operations. We believe that all of the decisions and assessments used to prepare our consolidated financial statements are based upon reasonable assumptions given the information available to us at that time. Our critical accounting estimates will be expanded over time as we fully implement our strategy. Those accounting estimates that we believe are most critical to an investor’s understanding of our financial results and condition and require complex management judgment are discussed below.

CECL Reserve

In accordance with Accounting Standards Codification ("ASC") Topic ASC 326, Financial Instruments - Credit Losses ("ASC 326") we record a current expected credit loss reserve ("CECL Reserve") for our loans held for investment. The CECL Reserve is 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.

We 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

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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.

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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 December 31, 2023 and 2022 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 two loans placed on non-accrual status, the portfolio continued to perform as expected. For approximately 70% and 82% of the portfolio, the fair value of the underlying real estate collateral exceeded the amounts outstanding under the loans as of December 31, 2023 and 2022, respectively. The remaining approximately 30% and 18% of the portfolio, respectively, while not fully collateralized by real estate, may be partially collateralized by real estate and is 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 December 31, 2023 and 2022, 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 #6 and Loan #9 placed on non-accrual status and are included in risk rating category "3" and “4”, respectively.

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. None of our borrowers are now, or have previously been in payment or otherwise material default under their respective loan agreements with us.

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.

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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 December 31, 2023 and 2022 was concentrated with the top three borrowers representing approximately 28.7% and 29.4% of the funded principal and approximately 26.4% and 27.9% of the total commitments to borrowers, respectively.

As of December 31, 2023 and 2022, the top three borrowers represented approximately 28.4% and 29.3% of interest income, respectively. The largest loan represented approximately 10.9% and 10.9% of the funded principal and approximately 9.7% and 10.2% of the total commitments as of December 31, 2023 and 2022, respectively.

As of December 31, 2023 and December 31, 2022, our borrowers have operations in the jurisdictions in the table below:

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

Refer to footnote 3 to our consolidated financial statements for the year ended December 31, 2023 titled “Loans Held for Investment, net” for more information on CECL.

Income Taxes

We are a Maryland corporation that elected to be taxed as a REIT under the Code, commencing with our taxable period 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 satisfying numerous asset, income and distribution tests which depend, 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 and our net capital gain. 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 Required Distributions 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

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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 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 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 is included in the line item income tax expense.

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 well documented and supported as of December 31, 2023. 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 balance sheets.

Recent Accounting Pronouncements

Refer to footnote 2 to our consolidated financial statements for the year ended December 31, 2023, titled “Significant Accounting Policies” for information on recent accounting pronouncements.

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