Viridian Capital Advisors calculates an “Effective Cost” that places all debt types (Convertible/Straight, with/without warrants, with/without OID etc) on a common basis.
We subtract OID and the Black Scholes value of embedded options from the proceeds before calculating yield based on the net amount. The green line shows the dollar weighted average effective costs for U.S. debt issues, and the orange line shows the trend line of effective costs. Note the 500+ basis points decline since the beginning of 2021.
There are several reasons for this decline:
Better credit quality: The top MSOs (>$1B mkt cap) now have debt/2021 EBITDA only slightly over 1x and debt/ mkt cap of .12x. These are exceptional statistics that compare favorably to issuers in the high yield market.
Increasing issue size: The average issue size was $11M, $72M, and $66M for the 1st, 2nd, and 3rd quarter-to-date. Larger issues generally correlate with bigger companies and better credit quality.
More straight debt: Non-convertible issues have increased from approximately 67% of total issuance in 2019 to nearly 84% in 2021.
More institutional lenders: Institutional lenders, including AFC Gamma and New Lake Capital, have become more aggressive in the space and are well funded through recent IPOs.
There is room for significant additional spread tightening. Current effective costs represent a spread of 940bp over 3 -year treasuries and 270bp over the Bank of America CCC High Yield Index. We expect spreads to continue tightening even in the absence of progress on federal banking reform.
Investors should be aggressively purchasing U.S. Cannabis debt and should be willing to give up yield for call protection. Passage of the Safe Act or similar banking reform is likely to produce nearly 200 bp of tightening with attendant portfolio gains for investors with established positions.
Companies should be taking advantage of the lower capital cost of debt while negotiating for the most liberal available call features.
Yields and terms are currently attractive for both companies and investors and negotiations will increasingly be geared to determining how the gains from significant spread tightening will be shared.