Business context and reporting period
AFC Gamma, Inc. (Nasdaq: AFCG) filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2022. The company is an externally managed lender to state-legal cannabis businesses, primarily making senior secured loans, and has elected REIT tax treatment.
Financial and operating highlights
- Second-quarter results: Interest income was $21.7 million, interest expense $1.7 million and net interest income $19.9 million, versus $8.7 million of net interest income in Q2 2021. Net income was $11.4 million ($0.58 basic EPS; $0.57 diluted), versus $4.6 million ($0.34 basic and diluted EPS).
- Six-month results: Interest income was $40.3 million, interest expense $3.4 million and net interest income $36.8 million, versus $13.4 million of net interest income in the prior-year period. Net income was $21.5 million ($1.10 basic and diluted EPS), versus $6.0 million ($0.58 basic; $0.57 diluted). Distributable Earnings, a non-GAAP measure, were $25.5 million, or $1.31 per basic weighted-average share, versus $9.0 million, or $0.87.
- Expenses and credit reserves: Six-month expenses totaled $12.2 million, up from $6.1 million; management and incentive fees were $8.0 million. The six-month CECL provision was $2.5 million, and the reserve for funded loans and unfunded commitments totaled $5.6 million at quarter-end, equal to 176 basis points of the related loan balances.
- Portfolio and balance sheet: At June 30, loans at fair value were $95.2 million; loans at carrying value were $315.9 million; and a loan receivable was $2.2 million. Cash was $45.6 million, total assets $459.3 million and shareholders’ equity $338.2 million. Book value per common share was approximately $17.03, compared with $16.61 at December 31, 2021.
- Debt and liquidity: The company had $100 million principal amount of 5.75% senior notes due May 2027 (net carrying amount $96.8 million). It entered a $60 million senior secured revolving facility, expandable to $100 million subject to conditions, but had not drawn it at June 30. The prior $75 million affiliate credit line was repaid and terminated. Management said cash, available revolver capacity and operating cash flows should meet operating needs and debt service for at least the next 12 months.
- Cash flows: Six-month operating cash flow was $15.2 million, investing cash outflow $49.1 million and financing cash outflow $29.8 million; cash declined $63.7 million to $45.6 million. Cash dividends paid during the period were $19.1 million, exceeding operating cash flow. The $0.56-per-share Q2 dividend, totaling about $11.1 million, was paid July 15.
Material changes versus the prior comparable period
- Net income and interest income increased substantially as outstanding loan principal grew to approximately $424.8 million at June 30, 2022, from approximately $164.0 million at June 30, 2021. Management fees and incentive fees also rose with equity and Core Earnings.
- The CECL reserve increased from approximately $3.1 million at year-end 2021 to $5.6 million at June 30, 2022. Management attributed the higher provision to macroeconomic inputs, portfolio changes and other estimation data.
- Six-month operating cash flow improved from $7.5 million to $15.2 million, while equity issuance proceeds fell from $180.3 million to $66.0 million. The company also repaid $75.0 million on the affiliate credit line.
- The company sold its $15.9 million available-for-sale debt security in March, recording an approximately $0.2 million realized loss; no debt securities remained at quarter-end. A $0.9 million net unrealized depreciation on loans at fair value was recorded for the first half.
Outlook, risks and notable items
- Management’s preliminary 2022 targets were $300–$500 million of originations and $100–$200 million of borrower repayments; these expectations may change. The company reported funding about $1.9 million of existing commitments after quarter-end.
- Undrawn loan commitments totaled $62.0 million, all expected to be available for funding within one year. Management expects to need additional equity and/or debt capital as the portfolio grows.
- Portfolio risk includes borrower and industry concentration: the top four borrowers represented about 64.1% of outstanding principal, and the largest facility about 20.4%. Weighted-average real-estate collateral coverage was approximately 1.1 times committed principal; this is not a guarantee of recovery.
- Cannabis remains illegal under U.S. federal law. State-law changes, licensing issues, borrower defaults, illiquid collateral and restrictions on taking ownership of cannabis assets could impair collections or limit remedies. Loans are largely illiquid and fair values rely on Level 3 inputs; forced-sale proceeds could be materially lower than recorded values.
- Interest-rate and benchmark-transition risks include possible mismatches between loan yields and funding costs. A hypothetical 100-basis-point rise in floating benchmarks was estimated to increase annual interest income by about $1.2 million; a 100-basis-point decline was estimated to reduce it by about $1.0 million.
- Management disclosed no material legal proceedings, no material subsequent events, and no material changes to the risk factors in the prior Form 10-K. Disclosure controls were concluded effective, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether the stated origination and repayment targets are achieved and what capital raising is required to fund growth and commitments.
- Borrower credit performance, concentration exposure, CECL assumptions and actual collateral recoveries relative to underwriting estimates.
- Availability and borrowing-base capacity of the new revolver, covenant compliance, and the effect of interest-rate changes on net interest income and funding costs.
- Cash generation and the extent to which dividends are supported by cash receipts, given that six-month operating cash flow was below dividends paid and includes non-cash OID and PIK income.
- Loan fair-value assumptions and the sustainability of reported non-GAAP Distributable Earnings; the filing cautions that this measure is not GAAP net income or a direct measure of taxable income.