Fed rate cut could be crucial as cannabis debt maturity looms

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The Federal Reserve’s recent decision to lower interest rates by 50 basis points has reverberated through financial markets, prompting a careful analysis of its implications across all industries.

Investors in the battered marijuana industry have been buoyed by this action, but the benefits to cannabis operators from this monetary policy shift are more nuanced than initial reactions might suggest.

In the long term, the rate cut has potential to benefit cannabis operators by:

• Positively influencing investor sentiment.
• Providing favorable refinancing terms and creating potential for M&A activity.
• Lowering the interest due on unpaid federal taxes.

How soon could cannabis operators save money?

A rate cut is unequivocally positive news, but measuring the impact requires understanding the industry’s debt structure and composition as well as its sources of capital.

A company with fixed-rate debt, for instance, will experience no economic impact in its 2024 financials but might benefit from refinancing at lower rates in the future.

Since most operators in the marijuana sector – particularly the publicly traded companies – have fixed-rate debt, they will not see the benefit of lower rates until they refinance their debt. (See “Debt maturity on the horizon” below.)

Floating-rate debt, which is more prevalent in private companies and higher-risk businesses, is expected to see a reduction in interest expense of less than 4%.

To contextualize this, a $10 million loan with a 14% floating interest rate would result in annual interest savings of around $50,000, or approximately 3.6% of interest expense, which is unlikely to dramatically alter most companies’ financial trajectories in the short term.

Improved investment outlook

This shift in monetary policy could positively influence investor sentiment.

Lower-rate environments typically usher in a period of elevated risk-taking by investors.

Continued action by the Fed – as well as rescheduling marijuana – should prompt this shift in risk tolerance and deliver increased investor demand for cannabis securities.

This improved sentiment could be crucial for the industry, which has faced challenges in capital raising.

In a potential sign of investors’ changing risk appetite, the third quarter of 2024 saw a 15% increase in capital raised compared to the second quarter, before the rate cut was announced, according to data from Pitchbook.

Debt maturity on the horizon

The sector also should benefit from increased demand for cannabis debt instruments.

With increased investor attention for cannabis debt, the sector can benefit not only from increased capacity but also from lower risk premiums as investors compete for the debt being offered.

According to Viridian Capital Advisors’ latest report, 79% of public cannabis companies’ debt matures after 2025, with a substantial refinancing wave anticipated in 2026-27.

Should this easing cycle persist, the industry could be well-positioned to benefit substantially when refinancing opportunities arise.

Debt loads for major MSOs

An examination of some of the cannabis industry’s largest players provides further insight: Curaleaf Holdings, Green Thumb Industries and Trulieve Cannabis Corp. reported total debts of $563 million, $310 million and $480 million, respectively, in their second-quarter earnings reports.

Their interest expenses account for 10%, 6% and 12% of their total operating expenses, respectively.

Rate cuts could result in significant annual savings when those industry leaders refinance their debt.

The potential for this rate cut and future reductions becomes particularly intriguing for companies with higher debt-to-EBITDA (earnings before interest, taxes, depreciation and amortization) ratios.

The industry average as of the second quarter stands at 3.2x, but for some companies that are managing heavier debt loads, a continued easing cycle could provide valuable financial flexibility and opportunities for strategic restructuring.

Federal taxes

One further benefit of rate cuts is the interest due on unpaid federal taxes.

Many operators are delaying federal tax payments or, potentially, will challenge their federal taxes in court.

For past-due amounts greater than $100,000, the IRS charges the federal short-term rate plus 5%.

With the increase in short-term rates over the past few years, the rate stands at 10% today.

Decreases in short-term rates, which the Fed recently commenced, will reduce the amount of interest accruing for operators that ultimately pay their taxes.

Impact of federal rate cut

Looking ahead, while the Fed’s single rate cut is unlikely to revolutionize the industry overnight, it could be the harbinger of a trend that shapes the financial landscape in the coming years.

As the significant debt maturity window of 2026-27 approaches, continued easing of interest rates could lead to:

• More favorable refinancing terms.
• Potentially increased M&A activity as borrowing costs decrease.
• Opportunities for highly leveraged companies to restructure their debt more advantageously.

While the immediate effects of this rate cut might be subtle, its true significance lies in what it might herald for the industry’s future.

The cannabis industry’s capacity for innovation, resilience and strategic foresight will be crucial in navigating these changes and capitalizing on the potential benefits of a more accommodating monetary policy environment.

Anthony Coniglio is the president, CEO and a board member at Connecticut-based NewLake Capital Partners, an internally managed real estate investment trust. He can be reached at newlake.com/team/anthony-coniglio.