AFCG outlines BDC conversion strategy to broaden lending beyond real estate-backed cannabis assets

Earnings Call Insights: Advanced Flower Capital Inc. (AFCG) Q2 2025

MANAGEMENT VIEW

* CEO Daniel Neville reported distributable earnings of $0.15 per share and announced a second quarter dividend of $0.15 per share, noting, "While over the last year, we have made significant progress reducing our exposure to underperforming credits, there is still work to be done our earnings may be impacted by the underperformance of some of our legacy loans and any realized losses we take on assets."
* Neville detailed the exit from Public Company A's equipment loan, stating this write-off impacted earnings but not book value, as the loan was already fully reserved. He also highlighted ongoing portfolio management efforts with underperforming loans, including Private Company A where asset sales are progressing, and Private Company P, which was moved to nonaccrual status with a $16 million principal outstanding, backed by real estate in Michigan.
* Neville emphasized litigation involving Justice Grown, stating, "We are currently engaged in 3 separate legal proceedings with justice grown entities related to enforcing certain rights under the credit facility in connection with the alleged defaults."
* Neville addressed the challenging sector environment, stating, "There continues to be limited capital entering the market," and explained the shift in strategy: "Expanding our investment focus beyond real estate-backed companies is an important step to deliver value to our shareholders."
* President and Chief Investment Officer Robyn Tannenbaum announced, "We announced our intention to convert from a REIT...to a business development company, or BDC," adding this would allow AFCG to "originate and invest in a broader array of opportunities, which would include both real estate and non-real estate covered assets."
* Tannenbaum further stated the Board has "approved an expanded investment mandate effective immediately, that includes direct lending opportunities outside the cannabis industry."
* CFO Brandon Hetzel reported, "For the quarter ended June 30, 2025, we generated net interest income of $6.2 million and distributable earnings of $3.4 million or $0.15 per basic weighted average common share and had a GAAP net loss of $13.2 million or a loss of $0.60 per basic weighted average common share."

OUTLOOK

* Management stated that the proposed conversion to a BDC is expected to occur in the first quarter of 2026, subject to shareholder and board approval.
* Tannenbaum explained the rationale for the conversion, citing the limited universe of cannabis operators with real estate and the broader lending opportunities as a BDC, "allowing the company to lend to operators without real estate coverage as well as the ancillary cannabis businesses with high growth potential."
* The expanded investment mandate now includes direct lending opportunities outside of cannabis, which management believes will help diversify credit risk profiles.

FINANCIAL RESULTS

* Hetzel disclosed, "We ended the second quarter of 2025 with $359.6 million of principal outstanding spread across 15 loans. As of August 1, 2025, our portfolio consisted of $357.9 million of principal outstanding across 15 loans."
* The weighted average portfolio yield to maturity was approximately 17% as of August 1, 2025.
* As of June 30, 2025, the CECL reserve was $44 million or approximately 14.6% of loans at carrying value, and the balance sheet included a total unrealized loss of $21.5 million for loans held at fair value.
* The company had total assets of $290.6 million and total shareholder equity of $184.7 million, with a book value per share of $8.18.
* During Q2, AFCG expanded its senior secured revolving credit facility from $30 million to $50 million, with an additional $20 million commitment from the lead arranger bank.

Q&A

* Aaron Thomas Grey, Alliance Global Partners: "Can you talk about why you felt like [BDC conversion] was the right vehicle and so doing it as a conversion versus maybe setting up a different structure?" Tannenbaum replied that converting to a BDC is "the best path to realizing long-term value and being able to invest in more of these opportunities that we're seeing."
* Grey: Asked about pipeline limitations. Neville responded, "About 2/3 of the opportunities that come across our desk are not real estate covered...that gives you kind of a metric to evaluate the expansion and the opportunity set associated with the conversion."
* Grey: On impact of rescheduling, Neville stated that if rescheduling occurs, "that should allow more capital to be attracted to and flow into the space...help us to achieve better realizations as we work out as some of the troubled loans within the portfolio."
* Rahul Ilangovan, Zuanic & Associates: On problem loans, Neville and Hetzel discussed asset sales and GAAP accounting for fair value versus carrying value. On leverage, Tannenbaum stated a target of "between 1 and 1.5x leverage" and no plans to issue equity.
* Christopher Muller, Citizens Capital Markets: On borrower interest post-rescheduling news, Neville replied, "It's still pretty new and people were digesting...a lot of folks are really in a holding pattern at this point to see what the result is."
* Muller: On CECL reserve increase, Hetzel explained, "Inputs for the various loans themselves is the main driver of the increase in CECl reserves."
* Muller: On BDC conversion impact on credit lines and portfolio, Tannenbaum said, "It's hard to tell if the structure...would drive more banks in versus the REIT structure," and that portfolio composition is "hard to predict" until conversion is finalized.

SENTIMENT ANALYSIS

* Analysts pressed for clarity on the BDC conversion rationale, loan portfolio challenges, and the impact of sector developments, reflecting a slightly negative to neutral stance due to persistent concerns about underperforming loans and credit risk.
* Management maintained a measured but optimistic tone, emphasizing strategic flexibility and diversification. Phrases such as "we believe this is a positive step for the company" and "we remain extremely focused on realizing maximum value from these underperforming loans" illustrate confidence, though acknowledgments of sector headwinds and litigation signal caution.
* Compared to last quarter, analysts' questions remain focused on risk and pipeline selectivity, but there is heightened scrutiny regarding portfolio performance and the strategic implications of the BDC conversion. Management’s tone was more forward-looking and proactive compared to the previous quarter’s defensive posture regarding legacy loan performance.

QUARTER-OVER-QUARTER COMPARISON

* Guidance language shifted from caution about sector volatility and limited originations to a more proactive stance, emphasizing strategic expansion and the BDC conversion.
* Strategic focus evolved from protecting principal and cautious deal flow to broadening lending activities beyond cannabis real estate.
* Analysts maintained a consistent focus on loan performance, pipeline quality, and sector risks, but increased their emphasis on the potential impact of regulatory changes and the BDC conversion.
* Key metrics saw declines: distributable earnings dropped from $0.21 to $0.15 per share, and net interest income decreased from $6.6 million to $6.2 million. The CECL reserve increased from $29.9 million to $44 million, reflecting higher perceived credit risk.
* Management’s tone this quarter was more optimistic about long-term opportunities despite near-term headwinds, while analysts appeared more focused on risk and clarity regarding the new strategy.

RISKS AND CONCERNS

* Management highlighted ongoing risks from underperforming and legacy loans, asset liquidations, and litigation, particularly with Justice Grown.
* The company noted exposure to sector-wide capital shortages and the limitations of REIT structure in the current market.
* Analysts questioned the impact of rescheduling, CECL reserve increases, leverage, and the uncertain pipeline, reflecting concerns about asset quality, loan performance, and future growth prospects.

FINAL TAKEAWAY

Management underscored that the proposed conversion from a REIT to a BDC marks a strategic pivot intended to address the limited lending universe and unlock broader investment opportunities, both within and beyond cannabis. While the near-term environment remains challenging, with ongoing portfolio management and legal proceedings, the company believes diversifying its mandate and expanding its investment focus positions AFCG for greater flexibility and growth potential as market conditions evolve.

Read the full Earnings Call Transcript [https://seekingalpha.com/symbol/afcg/earnings/transcripts]

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* Advanced Flower Capital Inc. (AFCG) Q2 2025 Earnings Call Transcript [https://seekingalpha.com/article/4813709-advanced-flower-capital-inc-afcg-q2-2025-earnings-call-transcript]
* Advanced Flower Capital: The Dividend Is In Danger Again, I'm Out (Downgrade) [https://seekingalpha.com/article/4788814-advanced-flower-capital-the-dividend-is-in-danger-again-im-out-downgrade]
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* Historical earnings data for Advanced Flower Capital [https://seekingalpha.com/symbol/AFCG/earnings]
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