2024-01-02 06:03:33 ET
Summary
- AFC Gamma is currently paying out a 16% dividend yield that's 102% covered by distributable earnings.
- The mREIT is trading at a roughly 27% discount to its book value per share at the end of its third quarter.
- CECL reserves are rising and payment-in-kind income remains significant.
AFC Gamma's (AFCG) quarterly dividend distributions proved somewhat resilient in 2023. Whilst there was a 14.3% dividend cut in June, the cannabis lender has been able to keep its quarterly distributions stable through the rest of a year that saw cannabis companies face material headwinds. Acreage (ACRHF), previously one of its top borrowers, lost 75% of its value and is currently teetering on the brink of a Chapter 11 bankruptcy filing with a $17 million market cap set against long-term debt of $225 million . AFCG last declared a quarterly cash dividend of $0.48 per share , left unchanged sequentially for what's currently a 16% annualized forward dividend yield. This will be paid out in January and was the third dividend declaration since the cut.
AFCG offers three core points in its investment pitch; a fat double-digit 16% dividend yield, income-orientated exposure to the US cannabis industry, and what's now a widening discount to its book value. This discount against AFCG's fiscal 2023 third-quarter book value of $338.8 million , around $16.56 per share, currently stands at a huge 27%. The divergence opened up in 2023, deepened after the dividend cut, and has failed to get closed on the back of broader headwinds facing public cannabis companies.
Hence, AFCG's investment pitch is pretty straightforward; the ticker can close its discount to book whilst keeping its fat dividend payout for what would be a total return north of 40% if these two bullish factors played out through 2024. The risk is that there will be book value deterioration and that the dividend yield is a harbinger of a future cut. Indeed, CECL reserves remain high as AFCG works to reduce its payment-in-kind income.
Loan Portfolio And Underwriting Quality
AFCG's current commitments at the end of its third quarter stood at $433 million , up $24 million sequentially and with a weighted average yield-to-maturity of 19%. There was $397.8 million of principal outstanding spread across 12 funded loans with two borrowers being placed into receivership during the quarter. The company also funded a new cannabis investment to private company M of roughly $25 million.
AFCG is rightly selective on new investments, the cannabis space is a minefield, with over 1,000 potential loan deals reviewed and rejected for what was a flagged 2.8% deal selectivity rate. However, core metrics of underwriting quality have been flashing red. CECL reserve was $1.05 million at the end of the third quarter, representing roughly 6.9% of net interest income during the quarter and 4.7% of AFCG's loans at carrying value. This CECL reserve as a percent of net interest income was up from 3% in the year-ago quarter.
Further, interest income at $16.8 million was down 15% from its year-ago comp led by payment-in-kind income that constituted 10% of income. PIK income for the last 9 months as of the end of the third quarter was $9.4 million, a remarkable 31% of net income of $30.1 million during the period.
Dividend Safety And Balance Sheet
AFCG's GAAP net income at $8 million, around $0.39 per share, was down 18 cents from $0.57 per share in the year-ago quarter with higher CECL reserves and a $1.2 million realized loss on investments driving the decline. The lender placed its distributable earnings higher at $9.9 million , around $0.49 per share. This means the dividend was 102% covered by distributable earnings, with this coverage unchanged from the second quarter since I last covered the ticker. The risk here is that AFCG distributable earnings dip by more than 1 cent in the future quarters and the mREIT is forced to rightsize the dividend again. Further, most of its borrowers are private companies who are faced with the same liquidity pressures as their public peers but without the ease of being able to actively tap their equity to diversify their capital stack away from just debt.
AFCG's selectivity has so far kept loan defaults low but PIK income is significant and CECL reserves are rising. The high dividend yield and even higher weighted average yield-to-maturity reflect extreme credit risk with cannabis lenders undoubtedly the riskiest tranche of mREITs. AFCG and Chicago Atlantic Real Estate Finance ( REFI ) are the only two public lenders in the space. AFCG's balance sheet had cash and equivalents of $73.2 million at the end of the third quarter, down $9 million sequentially but enough liquidity when aggregated with an undrawn $60 million balance on their line of credit to support an event where the dividend is sustained through the balance sheet rather than earnings. AFCG remains a hold against its large discount to book and dividend yield even as coverage looks increasingly precarious.
For further details see:
AFC Gamma: How Sustainable Is The 16% Dividend Yield?