AFC Gamma Inc

NASDAQ:AFCG

Earnings Call Transcript 2023-Q1

[Operator]

Good day, and thank you for standing by. Welcome to the AFC Gamma First Quarter 2023 Earnings Call. [Operator Instructions]. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Gabriel Katz, Chief Legal Officer. Please go ahead.

[Gabriel Katz, Chief Legal Officer]

Good morning, and thank you all for joining AFC Gamma's earnings call for the quarter ended March 31, 2023. I'm joined this morning by Leonard Tannenbaum, our Chairman and Chief Executive Officer; Brandon Hetzel, our Chief Financial Officer; and Robyn Tannenbaum, our President. Before we begin, I would like to note that this call is being recorded. Replay information is included in our April 25, 2023 press release and is posted on the Investor Relations section of AFC Gamma's website at afcgamma.com, along with our first quarter earnings release and investor presentation.

Today's conference call includes forward-looking statements and projections that reflect the company's current views with respect to, among other things, future market developments, anticipated portfolio yield and financial performance and projections in 2023 and beyond. These statements are subject to the inherent uncertainties in predicting future results and conditions. Please refer to AFC Gamma's most recent periodic filings with the SEC for certain significant factors that could cause actual results to differ materially from these forward-looking statements and projections.

During this call, we will refer to distributable earnings, which is a non-GAAP financial measure. Reconciliations of non income -- of net income, the most comparable GAAP measure to distributable earnings, can be found in AFP Gamma's earnings release and investor presentation available on AFC Gamma's website.

The format for today's call is as follows. Len will provide introductory remarks and overview of our first quarter 2023 performance and strategic commentary, Brandon will summarize our financial results and we will then open the line for Q&A. With that, I will now turn the call over to our Chief Executive Officer, Leonard Tannenbaum.

[Leonard Tannenbaum, Co-Founder, Partner, CEO & Chairman]

Thank you, Gabe, and good morning, and welcome to AFC Gamma's earnings call for the quarter ended March 31, 2023. I would like to thank our analysts and investors for joining us today to discuss our results.

Before turning to the quarterly results, I want to take a moment to congratulate Brandon Hetzel on his promotion to Chief Financial Officer. We are excited to have Brandon as our CFO as he's been integral to the company's success since he joined in September 2020, most recently serving as Executive Vice President and Controller. Brandon brings with him a detailed knowledge of our business and over a decade of real estate experience, which will be valuable as we expand our investment strategy to include traditional commercial real estate investments.

Turning to the quarterly results. For the first quarter of 2023, AFC Gamma generated distributable earnings of $0.57 per weighted average share of common stock. As a reminder, distributable earnings is the primary metric that the Board considers when declaring AFC Gamma's quarterly dividend.

The Board of Directors declared a $0.56 dividend per share for the March quarter, which was in line with the previous 3 quarters. Since going public, we have generated distributable earnings in excess of our dividend in each quarter and paid out $4.10 in dividends per share.

We are pleased that we have continually outearned our dividend, yet we are cognizant that payment in kind interest currently makes up a meaningful portion of our earnings. The majority of the payment in kind interest earned in the March quarter is due to 1 loan, which we expect to revert to cash pay beginning in June. Should this borrower, which is rated a category 4 under a CECL reserve, pay its June interest in cash, we would anticipate the level of PIK interest as a percentage of investment income to decrease over the next few quarters.

Since mid-2022, given the market and interest rate volatility, AFC Gamma has taken a conservative view to deploying and managing our capital. We've raised the bar on originations, sought additional equity from borrowers to support their businesses and maintained ample cash on our balance sheet to capitalize on the opportunities as they may arise.

Until recently, cannabis market fundamentals that were challenged due to the oversupply from the illicit market, produce -- product crossing state lines and delta-8 and hemp product conversions have been improving. Recent state authorities have been cracking down on illegal activities and compensating illicit products.

One immediate result of this crackdown on the illicit market has been an increase in distillate prices in many states such as Michigan, in which we've seen an increase in 1 liter of distillate pricing from approximately $2,000 to $8,000, with pricing even higher in Pennsylvania and New Jersey. The rise in distillate prices has also driven the rise in trim prices and flower prices as a consequence of that.

We believe this uptick in pricing should last for at least the next few months and drive higher revenues for cannabis operators. Despite this positive momentum, we are cognizant that large inflows do come online with the October harvest, which may drive prices downwards due to increased supply, but we do remain optimistic longer term that prices may have bottomed.

Additionally, there have been positive trends in several states in recent months following the legalization of adult use. In particular, Missouri and New Jersey have surpassed our additional expectations for adult-use sales. As of May 1, approximately 20% of our portfolio based on commitments has significant Missouri exposure, and those borrowers have benefited from a cannabis market. It has outperformed expectations.

This was a market with thoroughly diligence meet several sizable investments in and given product shortages in the market, we believe will continue to perform well for the foreseeable future. Lastly, we are starting to see an uptick in acquisition activity, both from existing operators buying distressed assets as well as new investors coming into the market to purchase assets at a significant discount.

The capital formation around these assets is promising, and we continue to believe that there are several investable states in cannabis, including Missouri, Georgia, Maryland, Arizona and Ohio, to name a few. We believe that our focus on targeting operators and limited license states has set us up to mitigate certain risks.

Additionally, our focus on enterprise value lending and having cash flow -- cash equity below our debt provides a credit enhancement that ensures value declines are first absorbed by the equity before we would be impaired.

We have taken credit reserves with our CECL reserve currently at 5.4% on March 31, 2023, up from 5% as of December 31, 2022. We continue to closely monitor the large loan we downgraded as a category 4 last quarter. The borrowers project and experiencing increased revenue based on the launch of adult use in the core state but still has cash flow challenges.

The borrower sponsor has contributed significant additional equity. And as discussed earlier, AFC Gamma allowed a portion of the interest to be paid in kind to assist with some of the cash needs. The borrower is having difficulty raising additional equity in the capital in this market in the cannabis industry and has agreed to sell certain noncore assets to generate additional capital for its operations.

In conjunction, the borrower also agreed to add additional real property to our collateral pool and sell that noncore property to pay down the accrued PIK interest that we incurred. As stated earlier, the borrower is scheduled to move back to paying full cash interest beginning in June.

With our strong liquidity position, we continue to focus on originating and evaluating compelling first and second lien commercial real estate financing opportunities as well as additional deals in the cannabis market. The recent real estate deal volume has been slower than in preceding years, and there's been a discrepancy between bids and offers.

We are beginning to see the repricing in certain real estate markets, and we're evaluating noncannabis commercial real estate that's attractive from both the risk and return perspective. The overall macroeconomic environment has made it somewhat difficult to raise equity -- raise the equity that lenders are demanding to complete deals.

While this may be -- while we may be the lender on many deals, these same deals also need other components such as mezzanine and preferred equity to complete the transaction. We are focused on originating loans in the Southeastern United States based upon the favorable demographic trends, growing markets as well as our local presence in network.

Given the various regional bank failures and the rising interest rate environment, banks have reduced their traditional real estate lending activity, which has now created a void in the market for alternative lenders such as us to invest in deals with enhanced yields and strong risk-adjusted returns.

Looking ahead, I am excited about the trends in cannabis becoming more positive as well as the noncannabis real estate opportunities that are beginning to form as regional banks have pulled back from lending. We believe that AFC Gamma is well positioned to navigate the current market environment and opportunistically invest in our capital in deals with strong risk-adjusted returns. I will now turn the call over to Brandon to review our financial results.

[Brandon Hetzel, CFO & Treasurer]

Thank you, Len. We are pleased to report strong results in the first quarter of 2023. For the quarter ended March 31, 2023, we had GAAP net income of $10 million or earnings of $0.49 per basic weighted average common share and generated net interest income of $16.8 million and distributable earnings of $11.6 million or $0.57 per basic weighted average common share.

As previously mentioned, we believe providing distributable earnings is helpful to shareholders in assessing the overall performance of AFC Gamma's business. Distributable earnings represents the net income computed in accordance with GAAP, excluding noncash items such as stock compensation expense, any unrealized gains or losses, provisions for current expected credit losses, also known as CECL, taxable REIT subsidiary income or loss, net of dividends and other noncash items recorded in net income or loss for the period.

We ended the first quarter of 2023 with $390.9 million of principal outstanding spread across 12 borrowers. Subsequent to March 31, 2023, we funded an additional $9 million to a subsidiary of public company H. As of May 1, 2023, AFC Gamma's portfolio consisted of $415.4 million of current commitments with $399.8 million funded across 12 borrowers.

As of March 31, 2023, the CECL reserve represents approximately 5.4% of our loans at carrying value compared to 4.97% at December 31, 2022. We currently have 1 borrower on nonaccrual, which represents 0.9% of our portfolio. The weighted average portfolio yield to maturity, which is measured for each loan over the life of such loans was approximately 21% as of March 31, 2023, and May 1, 2023.

During the first quarter of 2023, we repurchased $10 million in principal amount of our 2027 senior notes at 77.4% of par value. This resulted in a gain on extinguishment of debt of approximately $2 million. This gain was partially approximately $0.7 million in severance expense related to the prior CFO, which was recorded within general and admin expense in the first quarter.

Next, let's take a look at our balance sheet, which remains strong. As of March 31, 2023, we had total assets of $447.8 million and cash and cash equivalents of $80.6 million. Additionally, we had 0 drawn on our line of credit, which provides us of up to $60 million in available funds that we can -- that can be drawn as needed.

Currently, the majority of our cash is earning approximately 3.5% to 4.5%. As of March 31, 2023, our total shareholders' equity was $337.9 million and our book value per share was $16.49. On April 14, 2023, ASC Gamma paid a dividend of $0.56 per common share for the first quarter to shareholders of record as of March 31, 2023. Year-to-date, we have paid out dividends of approximately 99% of our distributable earnings.

As a reminder, on an annual basis, our dividend policy is to pay between 85% and 100% of distributable earnings over the year. With that, I will now turn it back over to the operator to start the Q&A. Operator?

[Leonard Tannenbaum, Co-Founder, Partner, CEO & Chairman]

We did such a good job describing everything. I guess there is no questions today. So I want to thank everyone for being on the call and look forward to reporting next quarter.

[Operator]

This concludes today's conference call. Thank you for your participation. You may now disconnect. Everyone, have a wonderful day.