Direct Lenders See Profits in Hemp Where Big Banks Fear to Tread

(Bloomberg) -- With banks steering clear and the industry surging toward $22 billion in sales, hemp and its trendy ingredient known as CBD could be the next lucrative frontier for direct lenders.

Direct Lenders See Profits in Hemp Where Big Banks Fear to Tread

Earlier this month, Mile High Labs -- which says it’s the largest extractor of cannabidiol in the world -- closed on a $65 million term loan from MGG Investment Group, a New York-based lender to lower middle-market companies with $10 million to $40 million in earnings. Mile High is using some of the proceeds to pay farm partners who grow the hemp it needs to produce CBD, which doesn’t give a high and is said to be a natural way to ameliorate health issues from anxiety and insomnia to inflammation.

It’s the latest example of direct lenders stepping up where more traditional banks have been hesitant. While federal lawmakers in December opened the door for banks to get involved in the hemp sector, most remain reluctant for fear of accidentally running afoul with regulators. Direct lenders in the past have swooped in to provide capital to out of favor businesses or smaller companies in the tech and consumer spaces, as well as during bouts of volatility in more liquid credit markets. Even though some direct lenders were hesitant to be first into the hemp industry, strong interest suggests others will soon be hot on MGG’s heels.

“We’ve talked to a lot of mezzanine lenders and they all want to jump into this space, but they don’t want to be the first mover,” said Mile High Labs Chief Financial Officer Jonathan Hilley.

Standard Covenants

Mile High needed the loan to secure enough hemp to keep expanding following last year’s passage of the Agriculture Improvement Act, which legalized the cultivation and sale of hemp at the federal level, but also prompted speculators to begin hoarding supply.

With the help of Danny Moses, who served as an adviser on the deal, the company talked with about a dozen potential lenders before selecting MGG. Moses, best known for shorting subprime loans prior to the financial crisis, is a private investor and on the investment committee of Merida Capital Partners, a cannabis-focused private equity firm.

The loan, which closed this month after an initial term sheet was signed in February, is priced at “L+single digits” -- meaning less than 10 percentage points above the London interbank offered rate -- and is for between four and seven years, Hilley said. The $65 million loan didn’t include any special terms due to Mile High’s business line, only the “standard” debt deal covenants.

A spokesman for MGG declined to comment.

Due to little regulatory oversight and looser capital requirement guidelines, private credit players are by their very nature able to make loans to newer or riskier industries.

“In some new, fast-growing sectors, banks are not typically the first to lend to them as it lacks track record,” said Floris Hovingh, head of alternative capital solutions at Deloitte.

If borrowers don’t have a history of stable cash flow, the loans aren’t secured by a hard liquid asset, or the debt raised isn’t against a fixed contract with a creditworthy counterparty, “it can take a lot more in-depth analysis to get comfortable with the deal, and this is an area where alternative lenders can be more flexible,” he added.

CBD Boom

The booming appetite for CBD may provide an opportunity for more debt deals in the sector going forward.

The U.S. market brought in $620 million last year before the December Farm Bill passed, and is poised to become a $22 billion industry by 2022, according to CBD and cannabis research company Brightfield Group. As CBD gets put into everything from pet food to beauty products, “extraction is a really key piece of that explosive growth,” said Bethany Gomez, managing director at the firm.

Yet any lenders that step into the space may still find themselves facing challenges, including having to contend with the U.S. Food and Drug Administration and other regulatory agencies, as well as potential reputational risk.

Still, Moses expects more direct lenders and ultimately the largest U.S. banks to follow the lead of MGG.

“The genie is out of the bottle so to speak, and it’s not going back in,” Moses said. “While the stigma of cannabis itself is still there for some of the large banks that don’t want to take a risk, hemp gives them an excuse to get involved.”

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