Advanced Flower Capital Inc. (AFC Gamma) — Q3 2023 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2023. AFC Gamma is an externally managed commercial real estate lender specializing in loans to cannabis businesses, and has expanded its investment guidelines to include other commercial real estate opportunities. Amounts below are in U.S. dollars.
Financial performance and position
| Metric | Q3 2023 | Q3 2022 | Nine months 2023 | Nine months 2022 |
|---|---|---|---|---|
| Interest income | $16.8 million | $19.8 million | $53.0 million | $60.1 million |
| Net interest income | $15.3 million | $18.1 million | $48.2 million | $55.0 million |
| Net income | $8.0 million | $11.5 million | $30.1 million | $33.0 million |
| Basic EPS | $0.39 | $0.57 | $1.47 | $1.67 |
| Distributable earnings (non-GAAP) | $9.9 million | $11.8 million | $31.4 million | $37.2 million |
| Distributable earnings per basic share | $0.49 | $0.59 | $1.55 | $1.89 |
- Balance sheet at September 30: Total assets were $445.1 million, versus $519.2 million at December 31, 2022. Loans held at fair value were $70.0 million; loans at carrying value were $308.0 million, before the $14.3 million CECL reserve on outstanding balances; cash was $73.2 million.
- Cash flow: Nine-month operating cash flow was $15.0 million, investing cash flow was $18.5 million, and financing cash outflow was $100.7 million. Cash declined $67.2 million from year-end 2022. Dividends paid in the period were $32.7 million, exceeding operating cash flow.
- Debt and liquidity: The company had $90.0 million principal outstanding on 5.75% senior notes due May 2027, reported net of financing costs at $87.9 million. The $60.0 million revolving facility had no balance at quarter-end; $21.0 million drawn during Q3 was repaid before quarter-end. Management said cash, available line capacity and operating cash flows should meet operating needs for at least the next 12 months. Facility availability is subject to borrowing-base and other conditions.
- Book value and dividends: Book value was approximately $16.56 per share, compared with $16.65 at year-end 2022. The Q3 common dividend was $0.48 per share, down from $0.56 in Q3 2022; $1.52 per share was declared for the first nine months of 2023, versus $1.67 in 2022.
Changes versus comparable periods
- Q3 net interest income fell about 16% year over year and net income fell about 30%; nine-month net interest income declined about 12% and net income about 9%.
- Management attributed lower interest income mainly to reduced fee and unused-fee income; Q3 also reflected two months of non-accrual income for a borrower. Higher variable rates and additional principal deployed partly offset the nine-month decline.
- Nine-month CECL provision was $0.15 million, down from $3.04 million in 2022, but the ending reserve was $14.4 million, or 4.66% of carrying-value loans and loan receivable, versus $6.2 million, or 1.80%, at September 2022.
- The company repurchased $10.0 million principal amount of 2027 notes for 77.4% of par, recognizing a $2.0 million gain on extinguishment. Senior-note principal fell to $90.0 million.
- Loans at carrying value increased to $308.0 million from $285.2 million at year-end, while fair-value loans declined to $70.0 million from $99.2 million. Cash fell from $140.4 million.
Outlook, risks and unusual items
- No specific financial or earnings guidance is provided. Management cited opportunities in cannabis and broader commercial real estate lending, and stated it expects to need additional equity and/or debt capital to support growth and liquidity.
- Credit events are significant. Public Company A’s fair-value credit facility matured in September without repayment; AFC Gamma recorded a $1.2 million realized loss. Private Company A received a covenant-default notice in October, was charged additional default interest, and entered receivership in November; its balance was about $53.2 million after October prepayments. Private Company B’s loan matured unpaid and the borrower entered receivership in October.
- Subsidiary of Private Company G was placed on non-accrual from June through August after a missed interest payment. A September forbearance required asset sales, additional collateral and cash equity; September and October interest payments were made, and the loan returned to accrual status. Private Company I remained on non-accrual and was subject to foreclosure proceedings.
- Portfolio credit and valuation risks are elevated: the four largest borrowers represented approximately 68.5% of outstanding principal. Fair-value loans are Level 3, illiquid investments; their estimated values may differ materially from realizable proceeds. A 50-basis-point change in market yield was estimated to change unrealized value by about $0.3 million in the opposite direction.
- Approximately 68% of portfolio principal was in floating-rate loans. Management estimated a 100-basis-point benchmark-rate increase would add about $2.7 million to annual interest income, while a 100-basis-point decrease would reduce it by about $2.4 million; funding-cost and asset-rate mismatches remain risks.
- Cannabis lending carries federal and state legal, licensing, collateral-enforcement and liquidity risks. Restrictions may prevent AFC Gamma from taking possession of cannabis assets after default. The company also identifies borrower concentration, refinancing, real estate values and changing interest rates as risks.
- Unusual items included approximately $0.7 million of nine-month severance expense related to the former CFO. The company reported no material legal proceedings, no material changes to its stated risk factors, and no material weakness in disclosure controls; management concluded disclosure controls were effective.
Important facts for investors to verify
- Recoveries, collateral sales and repayment prospects for the Public Company A, Private Company A, Private Company B, Private Company G and Private Company I exposures, including subsequent developments after the filing date.
- Whether the $14.4 million CECL reserve adequately reflects borrower defaults, non-accruals, forbearance terms and the concentrated portfolio.
- Cash generation relative to dividends: nine-month operating cash flow was $15.0 million against $32.7 million of dividends paid, with substantial use of cash in financing activities.
- Actual revolver availability under borrowing-base conditions, capital-raising plans, and compliance with debt covenants as credit conditions evolve.
- How non-GAAP distributable earnings are calculated and whether they support the current dividend; this measure includes accrued income not yet received in cash.