(Bloomberg) -- Crypto isn’t the only edgy new industry being roiled by the collapse of several banks.
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US companies that deal directly with cannabis, a federally illegal substance, are already shut out of large banks. So these companies have increasingly found support in an estimated 200 to 700 smaller financial firms that serve them, including state-chartered banks.
These are precisely the financial institutions that are at risk amid the turmoil that’s battered Signature Bank, Silicon Valley Bank, First Republic Bank and others. This could turn into a problem for their client cannabis companies that have extremely limited options to go elsewhere.
“A lot of the industry is with mid-tier banks,” said Morgan Paxhia, co-founder of one of the longest-running cannabis investment funds, Poseidon Investment Management. “The concern is those banks have a lot of default risk on the horizon because of their commercial loan books.”
The $150 million fund has already seen four or five of its 35 to 40 portfolio companies affected — one with SVB and most with Signature Bank, which was closed March 12. So far, all are still able to pay workers and continue operations. But if more banks fail, cannabis companies may have more trouble than other banking clients in finding new institutions to work with, Paxhia said.
The cannabis industry is already facing challenges. The AdvisorShares Pure US Cannabis ETF is down //around 9%// year-to-date following a 73% drop in 2022. The decline has been caused in part by US lawmakers’ failure to pass the SAFE Banking act, which sought to prohibit federal regulators from penalizing banks for providing services to marijuana companies and would have helped them to list on major stock exchanges.
On top of investors’ unease, the industry faces wholesale marijuana prices that are down steeply due to a thriving illicit market and the proliferation of synthetic knock-offs of cannabis’ psychoactive ingredient, THC. There are also growing questions about the drug’s health impact.
This combination of challenges puts the industry in a uniquely precarious position. It could be particularly hard for cannabis companies to make payroll, for example, amid bank failures.
There’s also a concern that cannabis companies will be treated differently than other bank clients in the case of a bank insolvency. Since cannabis is federally illegal, companies that deal with it directly aren’t eligible for some federal benefits, like bankruptcy law or income tax deductions. Therefore, it’s unclear whether companies would be eligible for insurance from the Federal Deposit Insurance Corp., which covers $250,000 per deposit on regular client accounts.
Peter Su, a senior vice president at Green Check Verified, a consulting and software company that specializes in cannabis banking, called the FDIC issue a “dicey situation.” Despite years of approaches to the agency for clarity on the issue, there’s been no clear answer, he said.
The FDIC declined to comment to Bloomberg when asked whether its insurance would apply to cannabis companies.
Some in the industry are optimistic, nonetheless. “We fully expect the FDIC will protect all creditors equally,” said David Culver, a vice president of Canopy Growth, speaking for the US Cannabis Council, a group that represents the cannabis industry.
Few banks that work with the industry are public about it. Some banks have policies that allow them to only work with “cannabis-adjacent” businesses such as real estate and software companies, but not the companies that directly touch marijuana.
Three people familiar with the industry said that among the best-known names in the industry are Valley Bank, East West Bank and Western Alliance Bancorp. Representatives for the banks didn’t return messages seeking comment.
Western Alliance shares have fallen more than 50% since March 8, while shares of East West’s holding company are down 25% over the same period.
While some estimates suggest that as many as 700 financial institutions work with cannabis companies, the actual number may be closer to 200, according to FinCann, a consulting firm. If more banks close, marijuana sellers will have even fewer places to turn, and the banks that remain may become more risk averse.
Additionally, if a mid-sized bank were to be rescued by a larger bank, the acquiring company may not want to keep any cannabis-related clients.
“The acquirer could have a position that they will exclude cannabis bank accounts,” said Paxhia, who is advising Poseidon’s portfolio companies to open multiple bank accounts.
The banking crisis is also dimming the industry’s prospects for political reforms, with the SAFE Banking legislation now seen as even less likely to move forward.
Banks and legislators are “trying to deal with Wall Street and Main Street now,” Paxhia said. “We’re not even going to fit into that conversation.”
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