Cannabis Musings - October 17, 2024

The Great Wall of Debt

Friends, we talked last week about investment firm FiSai’s letter to The Cannabist Company (née Columbia Care) asking for an airing of their grievances.  In that post, I quipped:

FiSai apparently owns $50 million of those February 2026 Notes, and is fardeiget (“worried”) about the pending “maturity wall” (a finance term for “a shmear of debt coming due all at once”). 

FiSai also mentioned a “maturity wall” in said letter:

Equally concerning is the fact that the largest public MSOs anticipate a maturity wall exceeding $3 billion in 2026, which will necessitate substantial refinancing efforts in 2025. This presents a formidable competitive landscape for Cannabist, likely affecting both the availability and cost of capital associated with any potential refinancing.

Talking with Jerry Derevyanny, friend of Cannabis Musings, Partner at Bengal Capital, and fellow ex-lawyer, about the concept, I thought it would be worth spending a little more time looking at what it means for a mass of cannabis debt to be coming due around the same time.

“Maturity wall” is a common term in finance.  The Financial Times calls it “a near-mythical beast conjured up to scare small children, skittish investors[,] and chief financial officers into pulling the trigger on bond sales.”  There’s other terms thrown around for this – “Debt Cliff,” “Titanic Tower of Terminations,” “Raging River of Refinancings and Remittances,” “Payback Time: Terror.” Okay, I made most of those up, but you get the idea. Lots of loans are all coming due around the same time, and they’ll need to be paid back or, more likely, refinanced, and there’s only so much capital available to do that. 

This is a huge problem right now in the commercial real estate market.  There’s $1.5 trillion of debt coming due by the end of 2026 on commercial properties that had previously borrowed money at low(er) interest rates, and that are suffering from higher vacancy rates (pandemic and work-from-home).  Cannabis has a similar problem.  Last year, The Dales Report put together a nice summary of major cannabis debt maturities coming due through 2026, and Green Market Report recently offered up its own summary of the impending “tsunami of debt.”  The latter’s math comes to $1.83 billion – less than the $3 billion quoted by FiSai in its letter, but still a lot of gelt. 

If we were still in the geshmack days of 2017-2019, when sweet, sweet money flowed into cannabis like Manischewitz Concord Grape Wine, and when prevailing interest rates were so low, you couldn’t afford not to borrow money, the maturity wall wouldn’t be a concern.  Az a glick ahf mir! (“I should have such luck!”).  Large cannabis companies were issuing bonds at rates that didn’t at all reflect the underlying credit and industry risk, and investors were eagerly snarfing them up, oblivious to, or actively ignoring, the warning signs. 

These days, there aren’t that many investors with the collective ability to lend freely that much capital to this industry.  That’s not to denigrate the primary lending sources working in our space – there the specialty finance companies and a handful of FDIC-insured banks that are able to lend, there’s some real estate investment trusts still standing, and there are always going to be some intrepid hedge funds willing to buy bonds.  But the pool isn’t that deep – although the private credit (generally, loans made through investment funds, rather than by banks or bonds) market is something like $2-$3 trillion right now, almost none of that can/will invest in cannabis.

The other problem is interest rates.  Although prevailing rates have been coming down over the past few months, particularly since the Federal Reserve cut its benchmark rate by 50 basis points (0.50%, but “basis points” sounds cooler) in September, they’re still high.  Consider Green Thumb’s recently-announced refinancing – they borrowed $150 million at SOFR + 500 (the Secured Overnight Financing Rate (a benchmark interest rate used by lenders) plus 5.00%) to repay their $225 million 7% Notes due April 2025.  SOFR currently sits at 4.86% (it’s a floating rate, meaning that it changes), so that’s a 9.86% rate on the loan today (you can read the Credit Agreement, although these aren’t drafted for casual perusal, and they blanked out the juicy bits like the fees they paid and the financial covenants).

Consider that Green Thumb is arguably the strongest credit (meaning it’s the least likely to default on its loans) of any of the major MSOs in US cannabis.  Don’t just take my word – Viridian Capital Advisors notes the same in its weekly Credit Tracker (actually, don’t take my word for it – this isn’t financial advice).  If GTI is borrowing at a rate that’s currently about 3% higher than the average high yield bond rate (corporate bonds that are below investment grade, meaning they’re considered by investors to have a higher risk of default), then what kinds of rates are other MSOs going to attract when they go to market to refinance their debt?

Now, if we actually see cannabis rescheduled to Schedule III, so that operators are no longer subject to 280E, that’ll certainly improve MSO balance sheets, making their credits more attractive (because they’ll have more cash to pay interest).  But that doesn’t solve the fundamental concern raised by FiSai and others in the space that there’s going to be a lot of demand and potentially not enough supply, and even if the supply does arrive, it’s going to be expensive debt.

What does this mean?  We can be certain that it’ll be a fruitful period for lawyers, accountants, and investment bankers.  I expect we’ll see some refinancings at rates higher than what companies have enjoyed, but it wouldn’t surprise me to see more extend-and-pretend maneuvers like we saw last year with Ayr, and what FiSai seems to be hinting at in its letter to The Cannabist Company (née Columbia Care) – the borrower negotiating with the lender to extend out the looming maturity in exchange for a large chunk of equity and fees. These lenders don’t want to actually foreclose on the assets, so they’ll opt for a loan-to-own light (an investor strategy where debt is converted into ownership of the company in bankruptcy, but since that isn’t feasible in cannabis (no bankruptcies allowed), you make do).

Az m'iz hungrig, esst men breit. (“If you're hungry enough, you can eat dry bread.”)

Be seeing you.

© 2024 Marc Hauser.  None of the foregoing is legal, investment, or any other sort of advice, and it may not be relied upon in any manner, shape, or form.  The foregoing represents my own views and not those of Jardín.