In the Cannabis industry, if banking has been a challenge, financing has been a nightmare. With few options to turn to, cannabis businesses have either had to find private loans or sell equity to fund their expansion plans. With federal legalization potentially on the horizon, banks interested in funding the legal cannabis industry should be laying their plans now, not tomorrow.
The current Cannabis lending landscape
To say there are no banks lending to Cannabis businesses would be incorrect. It just seems that way because so few are doing so. Roughly 90% of the financing going towards the Cannabis industry in the U.S. is coming from private firms and family offices. The 10% of banks that are extending loans are doing so through pilot programs, easing into the space to avoid the perceived risks of working with the Cannabis industry.
Bankers and their examiners are rightly concerned about the at least theoretical risk that a Cannabis borrower might have their assets (the lender's collateral) seized. This perceived risk undermines the viability of even a secured loan. As a result, most banks have deemed the current landscape too risky. Those that are lending generally do so on a case-by-case basis with long-time, trusted clients.
Private lenders have filled that vacuum with expensive loans, often at interest rates from 12% to 16%. These loans, while expensive, are a source of opportunistic growth capital for Cannabis businesses. Without conventional bank loans to turn to, Cannabis companies have no choice but to accept expensive private capital.
Moreover, private lenders generally offer a lower than otherwise typical loan-to-value (LTV) of 65% on the borrower's collateral. Compare this with conventional financing for other industries, where qualified businesses can expect an 80% - 120% LTV ratio, and the Cannabis industry's lending woes are amplified even further.
Finally, examiners have often taken the position that due to the theoretical risk of collateral forfeiture, institutions lending to Cannabis businesses must carry these assets on their books as unsecured, suffocating lender enthusiasm. Regulators have advised clients to maintain short-term liquidity on deposits in the event their Cannabis banking program needs to be terminated on short notice, leaving banks with large cash deposits that both cost money to keep on their balance sheet and are ineligible as capital to deploy for medium- and long-term lending and other traditional revenue-generating purposes.
Would federal legalization improve Cannabis lending?
Recent suggestions by Senate Majority Leader Chuck Schumer (D-NY) that comprehensive federal Cannabis legalization could soon be in the works, have offered encouragement. On May 11, Schumer said he would introduce a Cannabis legalization bill "shortly", along with co-sponsors Sen. Ron Wyden (D-OR) and Sen. Cory Booker (D-NJ). Schumer previously said the legislative effort would move forward regardless of whether President Biden decides to support it or not.
It is unclear what that bill would include, except for expungement of past non-violent cannabis convictions, according to Schumer. But federal legalization efforts, in any form, contribute to the momentum building behind banks that want to get involved in Cannabis lending.
Additionally, the MORE Act was recently reintroduced to the House of Representatives by Judiciary Committee Chairman Rep. Jerrold Nadler (D-NY). The bill would effectively de-schedule Cannabis from the Controlled Substances Act and eliminate criminal penalties associated with prohibition in a manner similar to hemp under the 2018 Farm Bill. This initiative would "legalize" Cannabis as a regulated agricultural crop/product, but without a regulatory framework.
So there seems to be two distinct paths to federal legalization: De-scheduling now and roughly take two years to implement regulatory framework or finalize the needed regulatory framework over the next two years and pass comprehensive legislation sometime in 2023 (after the 2022 midterms). While comprehensive public policy to legalize Cannabis and end the federal prohibition will take time, the declaration by Schumer and the reintroduction of the MORE Act should not be taken lightly. The momentum of these developments will likely spur more banks to get involved in C in the short term.
Whether de-facto legalization is one signature away or the current developments are indications of a shift in political culture, the Cannabis industry's future looks bright. Regulatory guidance already exists for banks to work with state-legal cannabis businesses in a federally compliant manner – and with care, that can apply for lending, too. Institutions that establish a pilot lending program now will have a competitive advantage over others when Cannabis is fully federally legalized and the booming demand for capital comes from businesses small and large nationwide.