Business context and reporting period
AFC Gamma, Inc. (Nasdaq: AFCG) filed this unaudited Form 10-Q for the quarter ended March 31, 2023. The externally managed REIT originates and manages senior secured commercial real estate loans, primarily to cannabis businesses in state-legal markets. It has also expanded its investment guidelines to include non-cannabis commercial real estate lending, including second-lien loans.
Financial performance and condition
| Metric | Q1 2023 | Comparable / prior period |
|---|---|---|
| Interest income | $18.5 million | $18.6 million in Q1 2022 |
| Net interest income | $16.8 million | $16.9 million in Q1 2022 |
| Total expenses | $6.4 million | $6.4 million in Q1 2022 |
| Provision for credit losses | $0.7 million | $0.9 million in Q1 2022 |
| Net income | $10.0 million; $0.49 basic EPS | $10.2 million; $0.53 basic EPS in Q1 2022 |
| Distributable Earnings (non-GAAP) | $11.6 million; $0.57 per basic share | $11.9 million; $0.62 per basic share in Q1 2022 |
| Cash and cash equivalents | $80.6 million | $140.4 million at December 31, 2022 |
| Operating cash flow | $4.4 million | $4.7 million in Q1 2022 |
Net income included a $2.0 million gain from repurchasing senior notes below par and a $1.5 million unrealized valuation loss on loans held at fair value. Distributable Earnings is a company-defined non-GAAP measure and includes accrued income that may not yet have been received in cash. The filing does not provide a clear net interest margin figure.
At March 31, total assets were $447.8 million and shareholders’ equity was $337.9 million. Loans held at fair value were $99.9 million; loans held at carrying value were $275.2 million before the credit-loss reserve. The total CECL reserve, including unfunded commitments, was $15.0 million, or 5.40% of the applicable loan balances, versus $14.3 million, or 4.97%, at year-end. Book value per share was $16.49, down from $16.65 at December 31.
Debt included $90.0 million principal amount of 2027 Senior Notes outstanding (carrying value, net, $87.6 million) and no borrowings on the $60.0 million revolving facility; the revolver was fully available subject to borrowing-base conditions. The company repaid its prior $60.0 million revolver balance in January and repurchased $10.0 million of senior notes during the quarter for 77.4% of par. Cash decreased by $59.8 million, mainly reflecting debt repayments and $11.4 million of dividends paid. Q1 operating cash flow was below dividend payments. Management said available cash, revolver capacity and operating cash flow should be sufficient for operations and debt service for at least 12 months.
Changes versus comparable periods
- Net income and per-share earnings declined year over year; interest income and net interest income were also slightly lower. Higher average loan principal supported interest income, but lower fee income—particularly the absence of a prior-year prepayment premium—offset that benefit.
- General and administrative expense rose 75% to $2.0 million, principally due to approximately $0.7 million of CFO severance expense. Stock-based compensation fell to $0.3 million from $1.0 million.
- Cash and total assets declined from year-end, while the company reduced debt and repaid its revolving facility. The loan portfolio at carrying value contracted, including a $15.0 million loan investment sale.
- The common dividend increased to $0.56 per share from $0.55 a year earlier. The Q1 declaration was paid April 14, 2023.
Outlook, commentary and risks
No specific earnings, originations or dividend guidance is provided. Management described opportunities in commercial real estate lending amid higher rates and tighter financing availability, and expects to seek additional debt and/or equity funding to support investment and growth. The company did not sell shares under its $75 million at-the-market program in Q1.
Credit developments warrant attention. One loan receivable of approximately $2.2 million and one fair-value loan with approximately $1.2 million principal were on non-accrual at quarter-end. After quarter-end, Subsidiary of Private Company G was permitted to pay 75% of accrued cash interest in kind through the May 1, 2023 payment; management said failure to resume full cash interest for the June 1 payment could reduce near-term Distributable Earnings and dividend capacity. Private Company I failed to make full principal and interest payments due May 1, and the agent delivered an event-of-default notice; lenders had not accelerated the loan and required an asset-sale process. Public Company H’s subsidiary facility was amended in April, including stronger real estate coverage covenants and additional funding by AFCG. AFCG also reported $3.6 million of its share of principal repayments from Private Company A in May.
Risks include borrower concentration (the top four borrowers represented approximately 73.5% of outstanding principal), uncertain recoveries and illiquid collateral, and cannabis’s federal illegality and regulatory uncertainty. Cannabis-related legal and listing restrictions may limit AFCG’s ability to take possession of collateral. Fair values for loans are Level 3 estimates using unobservable inputs; forced-sale proceeds could be materially below carrying values. Interest-rate movements, benchmark transitions, borrower payment-in-kind arrangements and refinancing needs may also affect cash income and credit quality. The filing reports no material legal proceedings and no material changes to previously disclosed risk factors.
The company appointed Brandon Hetzel as CFO and Treasurer effective March 17, 2023; former CFO Brett Kaufman’s employment with the manager ended April 17. Management reported disclosure controls were effective and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Track whether Private Company I cures its payment default or proceeds with the required asset sales, and assess likely loan recovery.
- Monitor Subsidiary of Private Company G’s return to full cash-interest payments and the effect of any further PIK interest or asset sales on earnings and dividends.
- Review the $15.0 million CECL reserve, non-accrual exposures, risk ratings and assumptions supporting Level 3 loan valuations.
- Assess cash generation versus distributions: Q1 operating cash flow was $4.4 million compared with $11.4 million of dividends paid, while Distributable Earnings was $0.57 per share versus a $0.56 dividend.
- Confirm revolver availability under borrowing-base conditions, compliance with debt covenants, and the need and terms of any future capital raising.