Advanced Flower Capital Inc. annual report, FY2021

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Business context and reporting period

AFC Gamma, Inc. (Nasdaq: AFCG) filed this Form 10-K for the year ended December 31, 2021. The company is an externally managed commercial real estate lender focused on senior secured loans to state-licensed cannabis operators. It began operations in July 2020 and completed its IPO in March 2021. The filing’s “2020” comparator covers only July 31 through December 31, 2020, so it is not a full-year comparison.

Financial and operating highlights

  • Revenue and earnings: Interest income was $38.1 million and interest expense was $1.1 million, producing net interest income of $37.0 million. Net income was $21.0 million; basic and diluted EPS were $1.57 and $1.52. The filing does not present a conventional operating-margin measure.
  • Cash flow: Operating cash flow was $9.5 million; investing cash outflow was $248.5 million, mainly reflecting loan originations and fundings; financing cash inflow was $338.5 million, principally from equity and debt issuance. Year-end cash was $109.2 million.
  • Portfolio: At year-end, loans and debt securities totaled approximately $366.0 million in principal across 15 borrowers and one debt-security issuer, with about $55.5 million of unfunded commitments. Weighted-average estimated yield to maturity was approximately 19%. Weighted-average real estate collateral coverage was approximately 1.2 times committed principal. The four largest borrowers represented about 58.2% of outstanding principal.
  • Credit reserve: The CECL reserve was $3.1 million, including $2.4 million against funded loan balances and $0.7 million for unfunded commitments. The 2021 provision was $2.6 million. Management reported no write-offs.
  • Debt and liquidity: Consolidated indebtedness was approximately $175.0 million at year-end: $100.0 million of 5.75% senior notes due 2027 and $75.0 million drawn under the revolving facility. The revolver was repaid on January 3, 2022. Total assets were $464.8 million, total liabilities $191.8 million, and stockholders’ equity $273.1 million. Management said available cash, financing capacity and operating cash flows should cover requirements for at least the next 12 months.
  • Distributions: Common dividends declared for 2021 totaled $1.67 per share. The fourth-quarter dividend was $0.50 per share, paid in January 2022. The company declared a $0.55-per-share first-quarter 2022 dividend.

Changes versus the prior comparable period

Net income rose from $4.3 million in the approximately five-month 2020 operating period to $21.0 million in 2021; basic EPS was $0.76 and $1.57, respectively. These figures are not directly comparable because 2021 covers a full year and the company substantially expanded its lending and capital base. Year-end loans held at carrying value increased from $31.8 million to $257.2 million, while fair-value loans increased from $48.6 million to $77.1 million. Cash increased from $9.6 million to $109.2 million. The company also issued $100.0 million of senior notes and drew its $75.0 million revolver at year-end.

Outlook, commentary, risks and unusual items

  • 2022 targets: Management’s preliminary estimate was $500 million–$700 million of originations and $100 million–$200 million of borrower repayments. These are targets, not guarantees.
  • Subsequent activity: After year-end, the company reported approximately $46.9 million of increased commitments and $49.4 million of new and previously committed fundings. It raised approximately $67.5 million gross in a January 2022 share offering. Private Company E repaid approximately $20.0 million in February, generating a $1.3 million prepayment premium; the company also sold its $15.0 million Public Company G debt-security investment, reporting a loss of approximately $0.2 million.
  • Borrower issue: Public Company A’s loan parties had prior covenant and payment defaults unrelated to COVID-19. The lenders agreed to modifications and forbearance; the filing says the past-due payments were subsequently made and no delinquent amounts were owed at year-end. In January 2022, the real estate loan’s cash interest rate was reduced from 12% to 10%, while accrual interest increased from 2% to 4%.
  • Key risks: Cannabis remains illegal under U.S. federal law, creating regulatory, enforcement, banking, contract-enforceability and collateral-realization risks. The company cannot take title to cannabis-use real estate under current restrictions, potentially limiting or delaying remedies. Other material risks include borrower concentration, illiquid loans, competition, interest-rate and LIBOR transition exposure, reliance on the external manager, related-party conflicts, access to capital, and maintaining REIT and Investment Company Act exemption status.
  • Manager and governance: The manager earned $8.3 million in net management and incentive fees in 2021; reimbursable general and administrative expenses were approximately $2.3 million. The filing describes affiliated lending, agency and co-investment activity. On March 10, 2022, the management agreement was amended, including changes to investment guidelines and preliminary fee-payment procedures.
  • Controls and audit: The independent auditor issued an unqualified opinion on the financial statements. Management concluded disclosure controls were effective. The filing did not include management’s internal-control assessment or an auditor attestation, citing the transition period for newly public companies.

Important facts for investors to verify

  1. Confirm current borrower performance, especially the status and collateral coverage of Public Company A and the largest exposures.
  2. Review the assumptions behind the approximately 19% estimated portfolio yield, including PIK interest, fees, prepayments and realized cash collections.
  3. Assess the sufficiency of the $3.1 million CECL reserve against portfolio risk, unfunded commitments and borrower concentration.
  4. Check the revolver’s refinancing or replacement status and compliance with the 2027 notes’ debt and coverage covenants.
  5. Evaluate whether the 2022 origination and repayment targets, post-year-end fundings, equity issuance and dividend can be supported by cash generation and available capital.
  6. Review related-party arrangements, manager compensation and loan-allocation practices, as well as the continuing ability to satisfy REIT and Investment Company Act requirements.