Advanced Flower Capital Inc. (AFC Gamma) — FY2023 Form 10-K
Reporting period: Fiscal year ended December 31, 2023. AFC Gamma is an externally managed REIT lender specializing in senior secured loans to state-compliant cannabis operators; in 2023 it also expanded into commercial real estate (CRE) lending. The company reported as one operating segment. The audited financial statements received an unqualified opinion.
Financial performance and condition
| Metric | 2023 | 2022 |
|---|---|---|
| Interest income | $70.5 million | $81.5 million |
| Interest expense | $6.4 million | $6.8 million |
| Net interest income | $64.2 million | $74.7 million |
| Net income | $21.0 million | $35.9 million |
| Basic earnings per share | $1.02 | $1.80 |
| Distributable Earnings (non-GAAP) | $41.4 million; $2.04 per share | $49.9 million; $2.51 per share |
| Operating cash flow | $21.2 million | $31.3 million |
| Cash dividends declared per common share | $2.00 | $2.23 |
Net income declined despite lower interest expense. Management attributed lower interest income mainly to reduced fee, unused-fee and OID income, partly offset by higher interest income from deployed principal and variable rates. Results also included an $8.5 million net unrealized loss on loans at fair value, a $12.1 million CECL provision, $1.3 million of net realized investment losses, and a $2.0 million gain from repurchasing senior notes below par. Distributable Earnings is a company-defined non-GAAP measure and should not be treated as GAAP earnings or cash flow.
Operating cash flow was below the $42.5 million of cash dividends paid in 2023. Cash and cash equivalents were $121.6 million at year-end, versus $140.4 million a year earlier. Total assets were $466.6 million, total liabilities $146.5 million, and shareholders’ equity $320.1 million. Book value per share was $15.64, down from $16.65.
At year-end, the loan portfolio covered 12 borrowers, with $431.2 million in originated commitments and $388.3 million of outstanding principal. Estimated weighted-average portfolio yield to maturity was approximately 21%. Four borrowers accounted for about 69% of principal outstanding. The weighted-average real-estate collateral coverage outside TRS1 was approximately 1.0 times committed principal, based on closing-date estimates.
The CECL reserve was $26.4 million, or 8.71% of loans and loan receivables held at carrying value, compared with $14.3 million, or 4.97%, in 2022. The filing reports three carrying-value loans on non-accrual at year-end; a further $92.6 million of carrying-value exposure was rated highest risk (risk rating 5). Two loans held at fair value had a combined fair value of $61.7 million, down from $99.2 million in 2022; their year-over-year valuation included an $8.5 million net unrealized loss.
Debt at year-end included $90.0 million principal outstanding on 5.75% senior notes due 2027 and $42.0 million drawn on a $60.0 million secured revolving facility due April 2025. The revolver draw was repaid on January 2, 2024. The filing states management believed cash, available credit and operating cash flows would meet operating needs and debt service for at least the following 12 months. A $10.0 million note repurchase at 77.4% of par reduced outstanding notes and generated the $2.0 million extinguishment gain.
Material changes and developments
- Interest income fell 13.5%; net income decreased about 42% and Distributable Earnings about 17% versus 2022. Book value per share also declined.
- The common dividend was reduced from $0.56 per share in the first quarter of 2023 to $0.48 per share for each of the next three quarters. The Board declared a $0.48-per-share first-quarter 2024 dividend, estimated at $9.9 million in aggregate.
- Credit stress increased. Private Company A entered receivership after covenant defaults; AFC Gamma’s balance was $53.4 million at year-end, with subsequent prepayments reducing it to approximately $49.8 million. Private Company B’s loan matured unpaid and the borrower entered receivership. Subsidiary of Private Company G returned to non-accrual from December 1, 2023 after missing a cash-interest payment; its year-end principal balance was $79.2 million. Private Company K, with $13.4 million outstanding, was placed on non-accrual from December 1, 2023; a March 2024 forbearance deferred principal and allowed some interest to be paid in kind.
- In September 2023, AFC Gamma amended its investment guidelines to permit CRE mezzanine lending and capped non-cannabis CRE investments at 35% of assets. In February 2024, it announced a planned spin-off of the CRE portfolio into Sunrise Realty Trust (SUNS), expected in mid-2024. The companies expect about $115 million of loans and cash to be contributed to or held by SUNS. On completion, AFC Gamma’s guidelines are expected to refocus on cannabis-related lending.
- Daniel Neville became CEO in November 2023, succeeding Leonard Tannenbaum, who became Executive Chairman and Chief Investment Officer.
Outlook, risks and unusual items
Management’s preliminary 2024 targets are more than $100 million of originations and more than $50 million of repayments; the filing cautions these expectations may change and are not assured. As of March 1, 2024, the pipeline included approximately $701 million of prospective CRE commitments and $279 million of prospective cannabis commitments, all subject to underwriting, documentation and approval.
Key risks include cannabis’s continued federal illegality despite state legalization; borrowers’ licensing, banking, operating and refinancing challenges; concentrated borrower exposure and limited loan liquidity; and restricted or delayed recovery options because AFC Gamma generally cannot take title to property used for commercial cannabis activity. Higher rates, CRE market weakness, collateral valuations and non-cash PIK income also affect results and cash availability. The planned spin-off is subject to conditions and may be delayed or not completed; the filing warns it may entail costs, reduced diversification and taxable consequences for shareholders. Management reported effective disclosure controls and internal control over financial reporting as of year-end; the auditor did not provide an internal-control attestation.
Important facts for investors to verify
- Current status, collateral recovery prospects and cash collections for the non-accrual, defaulted and receivership loans, particularly Private Company A, Private Company B, Subsidiary of Private Company G and Private Company K.
- How the $26.4 million CECL reserve and fair-value marks compare with eventual recoveries; much of the fair-value portfolio uses Level 3, unobservable inputs.
- Dividend sustainability: 2023 operating cash flow was below cash dividends paid, and the company recognizes some accrued PIK interest before receiving cash.
- Completion terms, timing, asset and liability allocation, and tax treatment of the SUNS spin-off; confirm the expected $115 million transfer and post-separation financial profile.
- Availability and cost of refinancing or other capital, compliance with debt covenants, and progress against 2024 origination and repayment targets.