AFC Gamma(AFCG) - 2021 Q4 - Annual Report

PART I Business AFC Gamma is an institutional lender providing senior secured loans to state-compliant cannabis operators, externally managed as a REIT - AFC Gamma is an institutional lender providing senior secured loans to established cannabis operators in states with legalized medical and/or adult use[11] - The company operates as a Maryland corporation, is externally managed by AFC Management, LLC, and has elected to be taxed as a REIT since its taxable year ended December 31, 2020[12] - AFCG's loans are primarily secured by real estate, equipment, and the value associated with licenses[16] - As of December 31, 2021, the portfolio had a weighted average real estate collateral coverage of approximately 1.2 times the aggregate committed principal[20] - The company targets annual gross yields on its portfolio between 12% and 20% through various fees and interest structures[15] - As of December 31, 2021, the company's loan origination pipeline consisted of potential new loans representing approximately $675.5 million in prospective total commitments[23] Our Manager and Our Management Agreement AFC Gamma is externally managed by AFC Management, LLC, with a renewable agreement and potential internalization clause - The company is externally managed by AFC Management, LLC, an affiliate of CEO Leonard M. Tannenbaum, Head of Real Estate Jonathan Kalikow, and Managing Director Robyn Tannenbaum[26] - The initial term of the Management Agreement runs until July 31, 2023, with automatic one-year renewals unless terminated by either party[28][33] - The company has the option to propose an internalization of the Manager once its equity equals or exceeds $1 billion[29] - If terms are not agreed upon, the company can force the transaction at a price equal to five times the Manager's earnings over the prior 12 months[36] - All loans require approval from the Investment Committee, which currently consists of Leonard M. Tannenbaum, Robyn Tannenbaum, Jonathan Kalikow, and Bernard D. Berman[41] Management Compensation The Manager receives a Base Management Fee based on Equity and Incentive Compensation tied to Core Earnings exceeding a hurdle rate Management Compensation Summary (FY 2021 vs. 2020 Period) | Fee Type | Year ended Dec 31, 2021 | Period from Jul 31, 2020 to Dec 31, 2020 | | :--- | :--- | :--- | | Management fees earned | $3,340,123 | $623,361 | | Less outside fees earned (Rebate) | ($1,029,315) | ($259,167) | | Base management fees, net | $2,310,808 | $364,194 | | Incentive fees earned | $6,010,704 | $0 (Waived) | | G&A expenses reimbursable to Manager | $2,319,074 | $671,605 | | Total | $10,640,586 | $1,035,799 | - The Base Management Fee is calculated quarterly at 0.375% of the company's "Equity" and is reduced by a 50% rebate on certain outside fees earned by the Manager[56] - Incentive Compensation is earned quarterly based on Core Earnings exceeding a 2% hurdle rate on Adjusted Capital[60] - The fee is 50% of earnings between the 2% hurdle and a 3.33% catch-up threshold, and 20% of earnings above that[69] Regulatory Environment Operations are subject to lending laws and the Investment Company Act exemption, navigating federal cannabis illegality versus state legalization - The company relies on the Section 3(c)(5) exemption of the Investment Company Act, which requires at least 55% of assets to be mortgages and other liens on real estate, and another 25% to be real estate-type interests[91] - Cannabis remains a Schedule I controlled substance under federal law (CSA), making cultivation, possession, and sale federal violations, despite state-level legalization[94][180] - The federal government has generally not enforced federal cannabis laws against state-compliant businesses for over seven years, a policy supported by the Joyce Amendment[94][181][186] Risk Factors The company faces risks from limited operating history, competition, external manager dependence, federal cannabis illegality, and REIT/Investment Company Act compliance - The company has a limited operating history, having been formed in July 2020, which introduces risks associated with new businesses[108][109] - Significant risk arises from the federal illegality of cannabis, which could lead to strict enforcement against borrowers, hampering their operations and ability to repay loans[102][179] - The business is highly dependent on its external manager, AFC Management, LLC, and its key personnel[102][306] - Conflicts of interest may arise from the manager's relationships with other investment vehicles[312] - Failure to qualify as a REIT would result in corporate-level taxation, substantially reducing funds available for distribution to stockholders[104][345] - Maintaining exemption from the Investment Company Act imposes significant limits on operations; failure to do so could require a major restructuring of the investment strategy[104][295] Properties The company maintains executive offices in Florida and Connecticut, leased by its Manager, with reimbursed expenses - The company's principal executive offices are located in West Palm Beach, Florida, with an additional office in Greenwich, Connecticut[395] - Office spaces are leased by the Manager or its affiliates, and the company reimburses its share of expenses, including rent for the Florida office, but not for the Connecticut office which is leased from the CEO, Mr. Tannenbaum[395] Legal Proceedings As of December 31, 2021, the company was not subject to any material legal proceedings - As of December 31, 2021, the company was not a party to any material legal proceedings[397] PART II Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities AFCG common stock trades on Nasdaq, with the company intending quarterly distributions to maintain REIT status - The company's common stock is listed on the Nasdaq under the symbol AFCG[398] - To maintain its REIT status, the company must distribute at least 90% of its REIT taxable income annually and intends to make regular quarterly distributions[399][400] Management's Discussion and Analysis of Financial Condition and Results of Operations Net income significantly increased in 2021 due to loan portfolio expansion and capital raises, with strong liquidity Financial Performance Summary (2021 vs. 2020 Period) | Metric | Year ended Dec 31, 2021 | Period from Jul 31, 2020 to Dec 31, 2020 | | :--- | :--- | :--- | | Net Income | $21.0 million | $4.3 million | | Basic EPS | $1.57 | $0.76 | | Interest Income | $38.1 million | $5.3 million | | Adjusted Distributable Earnings | $24.7 million | $3.8 million | | Adjusted Distributable EPS | $1.85 | $0.67 | - As of December 31, 2021, the loan portfolio totaled approximately $366.0 million in principal amount across 15 borrowers, with an additional $55.5 million in unfunded commitments[438] - The company completed its IPO in March 2021, a follow-on offering in June 2021, and issued $100.0 million of 5.750% senior notes due 2027, significantly increasing its capital base[425][426][429] - The provision for current expected credit losses (CECL) for 2021 was approximately $2.6 million, bringing the total reserve to $3.1 million, or 120 basis points of the total loan commitment balance[436] Loan Portfolio As of December 31, 2021, the portfolio comprised $366.0 million in principal across 15 borrowers, with a 19% weighted-average YTM Loan Portfolio Snapshot (as of Dec 31, 2021) | Metric | Value | | :--- | :--- | | Total Principal Balance | $366.0 million | | Number of Borrowers | 15 | | Unfunded Commitments | $55.5 million | | Weighted-Average YTM | ~19% | | Weighted-Average Cash Interest Rate | 11.8% | | Weighted-Average PIK Interest Rate | 1.8% | - During 2021, the company's gross funding was $302.5 million, with net funding of $275.5 million after repayments and amortization[465] - Total new debt commitments closed during the year were $341.3 million[465] - The company modified loans for Public Company A in January 2021 after it defaulted on certain covenants[466] - The modification included extending maturity, adjusting interest rates, and adding fees in exchange for forbearance[468] Liquidity and Capital Resources The company's liquidity is supported by cash, equity/debt offerings, and a revolving credit facility, deemed sufficient for the next year - As of December 31, 2021, the company held $109.2 million in cash and cash equivalents, up from $9.6 million at year-end 2020[501] - The company has a $75.0 million secured revolving credit facility with an affiliate, bearing a fixed interest rate of 4.75% per annum, maturing on September 30, 2022[502][503] - In November 2021, the company issued $100.0 million of 5.750% senior notes due May 1, 2027, with net proceeds of approximately $97 million[504] Cash Flow Summary (FY 2021 vs. 2020 Period) | Cash Flow Activity | Year ended Dec 31, 2021 | Period ended Dec 31, 2020 | | :--- | :--- | :--- | | Net cash from operating activities | $9.5 million | $1.5 million | | Net cash used in investing activities | ($248.5 million) | ($32.4 million) | | Net cash from financing activities | $338.5 million | $40.5 million | | Change in cash | $99.6 million | $9.6 million | Critical Accounting Policies and Estimates Key accounting policies involve valuing loans at fair value, estimating CECL reserves, and recognizing interest income including OID and PIK - Loans held at fair value are valued using a yield analysis with unobservable (Level 3) inputs, as there is no active market for these assets[530][721] - The company estimates its Current Expected Credit Loss (CECL) reserve using a model that considers historical loss data, loan characteristics, and macroeconomic forecasts[539] - Revenue is recognized as interest income, which includes accretion of Original Issue Discount (OID) and Payment-in-Kind (PIK) interest over the loan term[542][543] Quantitative and Qualitative Disclosures About Market Risk The company faces interest rate risk, credit risk from cannabis industry concentration, and real estate collateral risk - The company is subject to interest rate risk[557] - As of December 31, 2021, a hypothetical 100 basis point increase in LIBOR would increase annual interest income by approximately $0.1 million, as floating-rate loans have LIBOR floors[557] - The company faces significant credit risk due to its focus on the cannabis industry[564] - This risk is managed through a comprehensive due diligence and monitoring process[564] - The loan portfolio is concentrated, with the top four borrowers accounting for 58.2% of the aggregate outstanding principal balance as of December 31, 2021[567] Financial Statements and Supplementary Data This section incorporates the company's audited consolidated financial statements for 2021 and the prior period, starting on page F-1 - This item references the full consolidated financial statements and the independent auditor's report, which are included at the end of the Form 10-K, starting on page F-1[573] Consolidated Balance Sheets Total assets significantly increased to $464.8 million in 2021, driven by loan growth and capital raises Consolidated Balance Sheet Highlights (as of Dec 31) | Account | 2021 | 2020 | | :--- | :--- | :--- | | Total Assets | $464,848,360 | $93,961,692 | | Cash and cash equivalents | $109,246,048 | $9,623,820 | | Loans held for investment, net | $334,358,845 | $83,338,485 | | Total Liabilities | $191,773,186 | $2,313,980 | | Senior notes payable, net | $96,572,656 | $0 | | Line of credit payable to affiliate, net | $74,845,355 | $0 | | Total Stockholders' Equity | $273,075,174 | $91,647,712 | Consolidated Statements of Operations Net income for 2021 was $21.0 million, a substantial increase from the prior period, driven by higher interest income Consolidated Statement of Operations | Line Item | For the year ended Dec 31, 2021 | Period from Jul 31, 2020 to Dec 31, 2020 | | :--- | :--- | :--- | | Interest Income | $38,140,487 | $5,250,108 | | Interest Expense | $1,126,846 | $0 | | Net Interest Income | $37,013,641 | $5,250,108 | | Total Expenses | $14,398,460 | $2,379,419 | | Provision for credit losses | ($2,649,338) | ($465,397) | | Net Income | $21,000,497 | $4,313,632 | | Basic EPS | $1.57 | $0.76 | | Diluted EPS | $1.52 | $0.76 | Controls and Procedures Management deemed disclosure controls effective as of December 31, 2021, with no internal control attestation for this newly public company - Management concluded that the company's disclosure controls and procedures were effective as of the end of the period covered by the report[575] - The report does not include a management assessment or auditor attestation on internal control over financial reporting, as permitted for newly public companies[576] Other Information Recent amendments to the Management Agreement and an increase in authorized common stock shares were approved in March 2022 - On March 10, 2022, the Management Agreement was amended to update investment guidelines and the fee payment process[576] - On March 10, 2022, the company's charter was amended to increase authorized common stock from 25 million to 50 million shares[577] PART III Directors, Executive Officers and Corporate Governance Information on directors, executive officers, and corporate governance is incorporated by reference from the 2022 Proxy Statement - The required information for this item is incorporated by reference from the company's 2022 Proxy Statement[578] - The company has adopted a Code of Business Conduct and Ethics, available on its website[578] Executive Compensation Executive compensation details are incorporated by reference from the forthcoming 2022 Proxy Statement - Details on executive compensation are incorporated by reference from the forthcoming 2022 Proxy Statement[580] Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Security ownership information is incorporated by reference from the forthcoming 2022 Proxy Statement - Details on security ownership are incorporated by reference from the forthcoming 2022 Proxy Statement[580] Certain Relationships and Related Party Transactions, and Director Independence Related party transactions and director independence details are incorporated by reference from the forthcoming 2022 Proxy Statement - Details on related party transactions and director independence are incorporated by reference from the forthcoming 2022 Proxy Statement[580] Principal Accountant Fees and Services Principal accountant fees and services information is incorporated by reference from the forthcoming 2022 Proxy Statement - Details on principal accountant fees and services are incorporated by reference from the forthcoming 2022 Proxy Statement[581] PART IV Exhibits and Financial Statement Schedules This section lists included financial statements and exhibits, with schedules omitted as not required - The consolidated financial statements are included, beginning on page F-1[582] - A list of exhibits filed with the report is provided, including the company's charter, bylaws, management agreement, and debt indentures[583]