Cannabis Musings - April 27, 2023

Friends, if I’m counting correctly, an iteration of the SAFE Banking Act was filed in Congress for the ninth time earlier this week. This comes right on the heels of the Senate failing to advance legislation to bolster research into therapeutic cannabis use by veterans, in a cloture vote blocked by a group of senators that, in a Kafka-esque turn, included co-sponsors of the new SAFE Banking Act. You want me to try to explain that? Freg mich becherim! (translated: “Even if you excommunicate me, I can’t give you an answer!”)

More remarkably, the Bureau of Alcohol, Tobacco, Firearms and Explosives (ATF), a division of the same Department of Justice that also houses the Drug Enforcement Agency (which maintains the schedule of controlled substances), and potential candidate to oversee federal regulation of cannabis (if we ever see legalization), has reportedly slightly softened its stance on cannabis for new employees. Their policy went from this:

"Individuals applying for ATF employment who are currently involved in illegal drug activities or substance abuse are ineligible for hiring. In addition, past involvement in illegal drug activities or misuse or abuse of substances also may disqualify an applicant from consideration for hiring. … Minimal and limited previous drug activity or substance misuse or abuse that does not initially disqualify an applicant from consideration for hiring under the ATF drug policy guidelines may still be considered as unfavorable information for purposes of favorably adjudicating the applicant’s background investigation."

to this:

"Use within a state/locality that has legalized marijuana use or use for legal medical purposes, is still considered illegal by federal law. The following activities are automatically disqualifying:

• Distribution, sale, or transport for profit, cultivation, or manufacturing of marijuana without state/local legal authorization while in a position of public responsibility."

That’s a bisel tsetumlt, but what it seems to say is that a candidate who’s currently, shall we say, partaking in certain cannabis-related activities in accordance with state law, won’t automatically be disqualified from a job with the ATF.

In other words, one of the major agencies of the federal government tasked with enforcing federal drug laws that say that cannabis is completely and totally illegal might nonetheless potentially allow its employees to break that very same federal law (by complying with state law) and still keep their job enforcing said federal law.

Ironic, right?

As we’ve talked about before, I’m not an optimist on SAFE Banking or any other federal legislation benefiting the cannabis industry happening any time soon. I hope to be proven wrong, but to date my cynicism reigns supreme (follow me on Twitter @_Marc_Hauser_ if you want to watch me telling people on the internet that they’re wrong about things like SAFE Banking and uplisting).

On the other hand, I think that these more subtle, under-the-radar changes like this easing of the ATF’s hiring policy are much more promising than waiting on members of Congress who are subject to the passions of their base that shows up to vote in primary elections. There’s been a subtle, yet profound shift in attitude and acceptance on a federal bureaucratic level, the same bureaucracy that maintains the list of controlled substances, interprets and enforces IRS Code 280E, and regulates stock exchanges.

These paradoxes (two in one week!) highlight the challenge of navigating, let alone predicting, cannabis policy. Perhaps someday federal and state law will come into alignment and provide the industry with some stability. Until then, these Cannabis Musings remain observant.

Be seeing you!

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Hauser Advisory provides advice and strategy on business lifecycle events and cannabis

industry navigation, tapping into a deep, national network

and twenty-five years of dealmaking and capital markets experience.

© 2023 Marc Hauser and Hauser Advisory. 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. Subscribe to Cannabis Musings at hauseradvisory.com.

Cannabis Musings - April 11, 2023

Friends, I was listening this morning to one of my favorite podcasts, Odd Lots, which we’ve talked about before. Today’s drop considered the upcoming maturities of mortgage loans on commercial (non-residential) real estate in the U.S., and what that means for landlords, lenders, investors, and the U.S. economy. TL;DR – it’s almost certainly not going to be pretty.

This got me thinking again about upcoming debt maturities in the cannabis industry. We’ve talked here before about handling financial distress, but I thought it’d be worth considering in more depth some of the dynamics at play.

For background, The Dales Report recently summarized the maturity dates of loans to many of the largest MSOs – there are a number of loans coming due in 2024, while the vast majority come due in 2026. Three years is an eternity in cannabis, let alone financial markets, and it’s pointless to even try to make predictions for next year. However, the public MSOs are not the only borrowers out there, and there are plenty of other companies navigating creditor demands.

The podcast guest, Jim Costello, Chief Economist of the Real Estate assets team at MSCI, a financial analytics company, pointed out an interesting distinction between having a bank as your real estate lender and having a fund as your lender:

“…[I]f I'm a big bank, what do I know about running an apartment building? What do I know about managing an office building? I'd rather, you know, have the experts take care of that and I just collect a nice stable yield. So I want to underwrite to avoid that. ... So I make sure that I'm whole. …

The debt funds, they didn't do any of that because the debt funds, a lot of them started as equity shops that had their own investments and own management in place. And you know, they viewed it as an opportunity. It might be a situation where I have either a nice stable yield and I can help my investors that way. But if I had the tail situation where there's a foreclosure, I have this equity management shop on the side, I can just take the property at a lower basis than before and I know how to run a property and I could probably do it better than those people who were coming to me for a loan. So I'll put it into that shop and raise some capital to stabilize it and I'll be good.”

Translated, this means that banks don’t want to own the real estate, so they tend to be more conservative in their mortgage lending – the returns may be lower, but the likelihood of default (and therefore foreclosure) is also lower. On the other hand, non-bank lenders like debt funds (also sort-of-paradoxically referred to as “credit funds”) are typically less afraid of owning the real estate if they have to, so they’re usually more willing to lend money on aggressive terms such as a higher loan-to-value ratio (more proceeds relative to the actual appraised value of the property) and looser financial covenants (performance metrics that gauge the financial health of the borrower). Commercial real estate investments are very much driven by the leverage provided by mortgage loans, so why have kishke when you can eat halvah?

What’s interesting about cannabis is that there are virtually no banks making loans– nearly all of the lending (including sale-leasebacks, which is kinda like a loan) is done by non-bank lenders. Notably, recent exceptions are a $71.5mm mortgage loan arranged by Valley National Bank to Trulieve and FVCbank’s $20mm mortgage loan to Jushi, but those are very much not the norm. Most of the lending is done by debt (credit) funds, real estate investment trusts, and the like. This, of course, is not a surprise – if federally-chartered banks won’t provide regular banking services and free toasters to cannabis companies, they’re certainly not going to offer loans to them.

It’s an interesting contrast from the broader commercial real estate lending market described on the podcast, but, in my experience, Jim Costello’s view of debt funds in that market is very similar to my view of the lenders in the cannabis space – the ones I know are asset managers who are not necessarily afraid of default. They may not be pursuing a loan-to-own strategy, but they’re generally underwriting risk in a more aggressive manner than a traditional bank.

This creates a really interesting dynamic. On the one hand, you’ve got a lender that’s willing to call the bluff and take possession of its collateral, and the borrower can’t stop that by filing for bankruptcy protection. On the other hand, you’ve got a borrower that knows that the lender’s ability to actually take over the assets, and either get them sold or operate them itself, is costly, difficult, and extremely time-consuming. No state allows for a lender to actually take possession of cannabis assets or licenses without state permission, and only a handful of states have laws outlining a process for an orderly court-directed sale of foreclosed cannabis assets (and even those are cumbersome). When things are in distress, time is not a luxury, and the borrower (likely) knows this can work to its advantage.

In the end, you’ve got a (metaphorical) battle between a honey badger and a lion – the typical fears (of the other side’s leverage and tools) aren’t really at play. When neither side has outsized leverage, then neither side really has any leverage.

I suspect this ultimately leads to more stalemates in the form of maturity extensions, which I’m already seeing happen in the market. Why fight now when credit markets may loosen and more lenders may come into the industry, allowing for a refinance; financial prospects may finally turn around; and we may someday have federal legalization (a leben ahf dir!)? In a way, everyone wins and no one wins – kind of a metaphor for the current state of the industry, no?

Be seeing you!

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Hauser Advisory provides advice and strategy on business lifecycle events and cannabis industry navigation, tapping into a deep, national network

and twenty-five years of dealmaking and capital markets experience.

© 2023 Marc Hauser and Hauser Advisory. 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. Subscribe to Cannabis Musings at hauseradvisory.com.

Cannabis Musings - March 27, 2023

Friends – long-time readers of these Cannabis Musings will remember that we’ve been talking about the intersection between wine and cannabis for years. Although those early Musings (since 2018!) are lost to the ether, I’ve been kvetching that the two industries should find ways to work together (even if they’re currently limited due to federal law) in anticipation of eventual legalization. Large alcohol companies have the infrastructure, know-how, and capital to build brands and execute. Small alcohol companies capture the enthusiasts who care about the craft, the people, and the aesthetic (see, e.g., Pabst Labs). It’s not perfect, but to me, it makes a lot of sense.

Relatedly, I’ve been saying for years that the big legalization lobbying fight will be over distribution. Specifically, I think the alcohol distribution companies will push hard for federal law to require distribution of cannabis similar to how alcohol is required to be sold interstate through a three-tier system. Heck, I even kinda wrote about this back in 2019 for Bloomberg Law (which was also one of my early missives about interstate commerce).

This is for good reason from their perspective – in short, the three-tier distribution system requires that alcohol be sold wholesale through a federally-licensed distribution company, rather than directly to the retailer (with some exceptions). Similar to alcohol producers, the alcohol distributors have the equipment, infrastructure, capital, and logistics know-how and experience to also distribute cannabis (once it’s legal, of course).

Indeed, we’ve seen some US alcohol distribution companies dip their big toes into cannabis – consider Johnson Brothers’ circuitous investments into Humble & Fume in 2021 and 2022; and Southern Glazer’s 2021 agreement to distribute Canopy’s CBD beverages in the U.S. What keeps them from diving in fully is the same thing that keeps other highly-regulated industries (alcohol, tobacco, financial services) from playing directly in the space – cannabis is still illegal (but they’re getting ready). (Full disclosure: when I was a practicing lawyer, I advised cannabis, alcohol, and alcohol distribution companies on all of this, but I don’t currently have any such representations.)

Fast forward to last week, when the Wine & Spirits Wholesalers of America, the alcohol distribution trade association, issued a paper outlining its “Principles for Comprehensive Federal Regulation and Oversight” of U.S. adult-use cannabis. Among other things, this position paper recommends a federal licensing system for cannabis operators that imposes a three-tier distribution system just like what’s required in alcohol (and in some ways, even more restrictive):

May a producer sell cannabis to a consumer? A producer can sell cannabis to a consumer in the state in which the cannabis is manufactured if permitted by state law. Sales and shipments from producers to consumers across state lines are not permitted.

What activities does a distributor FBP [the contemplated license] allow? A distributor FBP allows the holder to engage in the business of purchasing cannabis for resale (from an FBP producer or another FBP distributor) and receive, sell, offer or deliver for sale, contract to sell, or ship in interstate or foreign commerce, directly or indirectly or through an affiliate, the products purchased for resale.

The alcohol distribution industry has thrown down the gauntlet, and it’s very interesting to me that they’ve chosen now to do so. I was right in my prediction - this is going to be a major lobbying battle over the structure of the national cannabis marketplace, one that will be as profound a change as interstate commerce (if not more so), and this paper is merely the first salvo.

I’m not necessarily taking sides in this, but I’ve got the popcorn popping.

Be seeing you!

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Hauser Advisory provides advice and strategy on business lifecycle events and cannabis

industry navigation, tapping into a deep, national network

and twenty-five years of dealmaking and capital markets experience.

© 2023 Marc Hauser and Hauser Advisory. 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. Subscribe to Cannabis Musings at hauseradvisory.com.