Earnings Call Transcript - AFCG Q4 2022

Gabe Katz, Chief Legal Officer

Good morning. And thank you all for joining AFC Gamma’s earnings call for the fourth quarter and full year ended December 31, 2022. I’m joined this morning by Leonard Tannenbaum, our Chief Executive Officer; Jonathan Kalikow, our Head of Real Estate; Robyn Tannenbaum, our President; and Brett Kaufman, our Chief Financial Officer. Before we begin, I would like to note that this call is being recorded. Replay information is included in our February 23, 2023, press release and is posted on the Investor Relations portion of AFC Gamma’s website at afcgamma.com, along with our fourth quarter and full year 2022 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 inherent uncertainties in predicting future results and conditions and certain factors could cause actual results to differ materially from those projected in these forward-looking statements. 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 net income, the most comparable GAAP measure to distributable earnings can be found in AFC 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 fourth quarter performance and strategic commentary. Brett will summarize our financial results and we will then open the lines for Q&A. With that, I will now turn the call over to our Chief Executive Officer, Leonard Tannenbaum.

Leonard Tannenbaum, CEO

Thank you, Gabe. Good morning. And welcome to AFC Gamma’s earnings call for the fourth quarter and full year ending December 31, 2022. I would like to thank our analysts and investors for joining us today to discuss our results. I am pleased to have continued to execute on our business plan during the fourth quarter of 2022. AFC Gamma generated distributable earnings of $0.62 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 December quarter, which is in line with our previous three quarters. Since going public, we have generated distributable earnings in excess of our dividend in each quarter and paid out $3.54 in dividends per share, including paying out $2.23 per share during the 2022 fiscal year. For the full year 2022, AFC Gamma paid out approximately 90% of distributable earnings in the form of dividends. For the first quarter of 2023, the Board of Directors has declared a fourth consecutive $0.56 dividend, which will be paid on April 14, 2023, to shareholders of record as of March 31, 2023. During 2022, the cannabis market faced pressure from a variety of factors, including the uncertainty of regulatory change, pricing compression, and longer lead times to raise equity. During this time, AFC Gamma made the calculated decision to monitor the environment, support our existing borrowers and build liquidity to take advantage of future opportunities without relenting on our stringent due diligence criteria. As a result, we have not originated any new cannabis debt investments that met our risk-adjusted return thresholds over the past nine months. We believe that Cannabis 3.0 will emerge with well-capitalized and sophisticated opportunistic acquirers who will target purchasing existing cannabis assets at significantly reduced prices to form new competitive multistate operators. We are continually monitoring the formation of capital around the next wave of cannabis investments and look forward to financing these well-funded platforms. In the meantime, we are seeing many operators take a pause on expansion opportunities and/or close non-profitable business units as they right-size their current businesses and adjust to rising rates, inflation, construction delays, and pricing pressure. Although we believe our cannabis portfolio has been carefully constructed, we are not immune to the effects that the broader market pressures present. Industry-wide cannabis pressures have resulted in AFC Gamma taking higher credit reserves. We believe that our focus on targeting operators in limited license states has set us up to mitigate certain risks and generate strong, risk-adjusted returns. We continue to not have exposure to unlimited license states such as California, Washington, Oregon, Oklahoma, or Colorado, and we have limited exposure to Michigan. We actively manage our portfolio, having regular dialogue with many of our borrowers, and we are comfortable with the coverage of our loans on an enterprise value basis. In general, our borrowers have continued to support their business with additional equity infusions. During the quarter, we downgraded one of our larger loans from a Category 3 to Category 4 under a CECL analysis. While the loan is still performing, given the current environment and uncertainty, we felt that it was prudent to move the asset down to a Category 4 and take additional credit reserves against that. Given the more challenging credit and broader market environment, we have increased our CECL reserve from 1.8% as of September 30, 2022, to 4.97% as of December 31, 2022. With our strong liquidity position and the state of the cannabis market, we have made the decision to expand our investment strategy to include investing in compelling first-lien and second-lien commercial real estate financing opportunities. In the current interest rate environment, banks have reduced their traditional real estate lending activity, which has created a void in the market for lenders such as AFC Gamma to invest in deals with enhanced yields and strong risk-adjusted returns. To that end, we are focused on opportunistically investing in commercial real estate bridge loans, construction loans, and direct loans, leveraging our management team’s core competency in commercial real estate lending and construction. We have expanded our origination efforts to source both cannabis and non-cannabis commercial real estate loans and view the opportunity in non-cannabis real estate lending as sizable. We continue to believe that the origination environment in commercial real estate lending will be more opportunistic as real estate values adjust and new capital is needed to finance growth. For example, for the Mortgage Bankers Association, $331.2 billion of the $2.8 trillion, which is 12% of the outstanding commercial and multifamily mortgages held by non-bank lenders will mature in 2023. That’s a 33% increase from the $249 billion that matured in 2022. With banks pulling back, we expect that number could be even higher, which should provide additional opportunities for alternative lenders such as AFC Gamma to finance. As a result of our current portfolio’s earnings power, we have the ability to be patient while delivering a consistent dividend to our shareholders. We believe that our available capital will allow us to take advantage of the opportunities that may arise in this volatile commercial real estate market. Overall, while transaction activity has been slower than usual, we are evaluating non-cannabis commercial real estate investments that are attractive for both risk and returns. The pipeline that we have developed in commercial real estate has been forming over the course of the past nine months. We’ve implemented various processes and procedures internally to source and evaluate these deals. We have a number of non-cannabis deals that we’re evaluating and we anticipate closing our first non-cannabis commercial real estate loan in the next 90 days. Last quarter, I noted that our Board has formed a special committee of independent and disinterested members to lead the company’s thinking around a potential early internalization of our external manager. Ultimately, the special committee determined that this was not the right time in the market to move forward with an internalization. Looking ahead, I’m excited about our market positioning, portfolio composition, and our opportunity set. We believe that AFC Gamma is well positioned to navigate the current market environment and opportunistically invest our capital in deals with strong risk-adjusted returns.

Brett Kaufman, CFO

Thank you, Len. We are pleased to report strong results in the fourth quarter and fiscal 2022. Beginning with our quarterly results, for the fourth quarter ended December 31, 2022, we had GAAP net income of $2.9 million or earnings of $0.14 per basic weighted average common share. For the three months ended December 31, 2022, we generated net interest income of $19.7 million and distributable earnings of $12.6 million or $0.62 per basic weighted average common share. We ended the fourth quarter of 2022 with total assets of $519 million. On an annual basis, for the year ended December 31, 2022, we earned GAAP net income of $35.9 million or earnings of $1.80 per basic weighted average common share. In 2022, we generated net interest income of $74.7 million and distributable earnings of $49.9 million or $2.51 per basic weighted average common share. We ended the fourth quarter of 2022 with $401.2 million of principal outstanding spread across 12 borrowers. As of March 1, 2023, AFC Gamma’s portfolio consisted of $421.4 million of current commitments, with $389 million funded across 13 loans. The weighted average portfolio yield to maturity, which is measured for each loan over the life of such loan was approximately 21% as of December 31, 2022, and March 1, 2023. As previously mentioned, we believe providing distributable earnings is helpful to stockholders in assessing the overall performance of AFC Gamma’s business. Distributable earnings represents the net income computed in accordance with GAAP, excluding non-cash items such as stock compensation expense, any unrealized gains or losses, provision for current expected credit losses, also known as CECL, taxable REIT subsidiary income or loss, and other non-cash items recorded in net income or loss for the period. As of December 31, 2022, the CECL reserve represents approximately 4.97% of our loans at carrying value, compared to approximately 1.8% at September 30, 2022. We currently have one borrower, Flower One on non-accrual, which represents 0.9% of our portfolio. AFC Gamma paid a fourth quarter dividend of $0.56 per common share. During 2022, we have paid out dividends of approximately 90% 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. For the first quarter of 2023, the Board of Directors declared a fourth consecutive $0.56 dividend, which will be paid on April 14, 2023, to shareholders of record as of March 31, 2023. Next, let’s take a look at our balance sheet, which remains strong. As of December 31, 2022, we had cash and cash equivalents of $140.4 million and our liquidity position as of March 1, 2023, is generally in line with our December balance. Currently, the majority of our cash is earning approximately 4% to 4.5%. As of December 31, 2022, our total stockholders’ equity was $339.1 million and our book value per share was $16.65. With that, I will now turn it back over to the Operator to start the Q&A.

Operator, Operator

Thank you. Our first question comes from Gaurav Mehta from Hutton Group. Your line is open.

Gaurav Mehta, Analyst

Good morning. Thanks for taking my question. I wanted to ask you about the CRE lending that you guys talked about. Can you maybe provide some color on what kind of real estate assets would you be targeting under non-cannabis real estate lending and how big do you expect that book to become?

Leonard Tannenbaum, CEO

We have adopted a cautious approach, considering our expertise, and are evaluating various asset types. We already engage in industrial construction within the cannabis sector and possess experience in non-cannabis areas as well. Our affiliates have owned a diverse range of properties, and we are focusing on commercial real estate overall. Specifically, we are targeting multifamily construction while also assessing some commercial real estate, being mindful of its current state. We need to maintain very tight loan-to-values in these situations, and we have considerable expertise in industrial properties, making it straightforward for us to transition into an industrial REIT. We are assessing all options, but doing so with a focus on safety. We will not pursue aggressive strategies in this area.

Gaurav Mehta, Analyst

Okay.

Leonard Tannenbaum, CEO

And what percent do I think that’s going to end up at the end of the year? My current guess is the portfolio could be more balanced towards 50-50 by the end of this calendar year.

Gaurav Mehta, Analyst

Okay. Do you expect capital sources that are available to you guys to change as a result of investing in traditional CRE lending versus, I guess, purely cannabis lending?

Leonard Tannenbaum, CEO

The good news is that we will be able to take on significantly more leverage if we have non-cannabis assets. Cannabis lenders have very limited options, and as we transition into first-lien and second-lien assets, primarily in non-cannabis sectors, we will be able to separate that asset pool and secure better sources of leverage.

Gaurav Mehta, Analyst

Okay. And lastly, can you provide some color on what kind of yields do you expect to get on the non-cannabis lending?

Leonard Tannenbaum, CEO

We still have not changed our yield range that we’ve had for a while, which is somewhere between 12% and 20%. So that’s the good news. The good news is, and you can see that our overall yield actually held up. I never know what it is each quarter until it’s calculated at 21% again. So we’re very encouraged by the environment and the opportunities in the environment, and so far, we’ve really been able to maintain strong yields.

Gaurav Mehta, Analyst

Okay. Thank you. That’s all I had.

Operator, Operator

Thank you. One moment for our next question. Our next question comes from Michael Elias from Cowen. Your line is open.

Michael Elias, Analyst

Great. Thanks for taking the questions. Just to double click on the prior question. Given your expertise in lending to the real estate space, I was just wondering if you could stack rank for us the commercial real estate subsectors based on what you’re seeing from a gross yield potential perspective. And then, secondly, this is more of a philosophical question for you guys. With your dividend yield around 14%, do you believe that you’re getting credit for the dividend, and to the extent you are, do you see an argument to be made for holding the dividend at your current levels of just retaining that capital into the uncertain macro environment? Thank you.

Leonard Tannenbaum, CEO

Yes, I consider this an appropriate level of dividend. We want to ensure we are fairly compensating our shareholders while also being mindful of our earnings. Maintaining a distribution in the 85% to 90% range is suitable, and I expect we'll continue along this path, although there will be fluctuations in earnings each quarter. So far, we've successfully met our dividend obligations quarterly. Regarding the commercial real estate environment, banks began to scale back around four to six months ago, which presents a significant opportunity for us. It’s surprisingly similar to the cannabis sector in terms of the time it takes to finalize deals, taking about two to five months. We started developing our pipeline nine months ago, and we’re now reaching the point where many deals are approaching closure. In terms of prioritizing opportunities, my experience spans 25 years and includes $5 billion in direct lending at my previous firm. My investment philosophy focuses on being a capital structure investor, ensuring that we have substantial equity and enterprise value. In cannabis, we prioritized having a safety cushion for market fluctuations, and we feel adequately protected. We view real estate investments similarly, as some attempt to minimize equity while maximizing debt, which I find quite risky. Our goal is not to take over properties but to build relationships and position ourselves as institutional lenders in the space. We seek situations with significant enterprise value and equity, alongside lower loan-to-cost and loan-to-value ratios, and we’re exploring various sectors due to our diversified expertise.

Michael Elias, Analyst

Great. Thanks for the color. That’s all I had. Thanks.

Operator, Operator

Thank you. And there are no other questions in the queue. I’d like to turn the call back to Mr. Len Tannenbaum for closing remarks.

Leonard Tannenbaum, CEO

Thank you. Thank you everyone for listening. We look forward to reporting our first quarter not too distant future since this was our year end results.

Operator, Operator

Thank you. This concludes today’s conference call. Thank you for participating. You may now disconnect.