Executive Summary / Key Takeaways

• Advanced Flower Capital (AFCG) has fully transitioned to a pure-play cannabis lender following the July 2024 spin-off of its commercial real estate portfolio, focusing exclusively on senior secured loans to state-compliant operators.
• The company operates in a market characterized by a significant supply-demand imbalance for capital, driven by ongoing state-level legalization, M&A activity, and limited access to traditional financing, which management believes creates attractive lending opportunities.
• Recent financial performance reflects the impact of underperforming legacy loans, contributing to lower distributable earnings and a reduced dividend ($0.15 for Q2 2025), though active portfolio management has yielded significant paydowns and successful exits from other troubled credits.
• AFCG is pursuing an opportunistic origination strategy focused on high-quality operators and expects yields on new loans to remain in the mid-to-high teens, aiming to redeploy capital from resolved legacy issues into performing assets.
• Key risks include the federal illegality of cannabis, borrower performance issues, concentration risk in the portfolio, and potential delays or limitations in enforcing remedies due to regulatory constraints and listing standards.

A Focused Approach in a Dynamic Market

Advanced Flower Capital Inc., now operating as a pure-play cannabis lender following the strategic spin-off of its commercial real estate assets in July 2024, specializes in providing senior secured loans to state-law compliant cannabis operators across the United States. Founded in 2020, the company became publicly traded in March 2021, establishing itself as an institutional financing source in an industry often underserved by traditional banking. This focused strategy allows AFCG to concentrate its expertise and capital deployment within a sector management believes offers compelling risk-adjusted returns.

The cannabis industry landscape is marked by rapid evolution driven by state-level legalization initiatives. States like Ohio recently launched adult-use sales, and others such as Pennsylvania and Florida show potential for future flips, alongside the emergence of de novo medical programs in states like Alabama and Kentucky. This expansion fuels a growing demand for capital to fund cultivation, processing, and retail infrastructure, as well as M&A activity. However, the industry remains capital constrained, with traditional lenders largely on the sidelines due to the federal illegality of cannabis, creating a significant supply-demand imbalance that AFCG aims to capitalize on.

Within this market, AFCG competes with a handful of other active lenders, including publicly traded entities like Innovative Industrial Properties (IIPR), NewLake Capital Partners (NLCP), and Chicago Atlantic Real Estate Finance (REFI). While IIPR and NLCP primarily focus on real estate ownership and leasing (sale-leasebacks), AFCG and REFI are direct lenders. AFCG differentiates itself through its specialized underwriting process, combining top-down industry analysis with bottoms-up operational evaluation, enabled by management's deep network and experience. This bespoke approach allows for flexible and tailored financing solutions, which management believes provides an edge in navigating the complexities and unique requirements of cannabis businesses compared to more standardized lending models.

AFCG's operational approach leverages risk management tools, including third-party software and proprietary analytical methods developed by its manager. These internal capabilities support the company's underwriting and portfolio monitoring processes in a high-risk environment. While specific quantifiable performance metrics for these internal tools are not detailed, the strategic intent is to enhance credit analysis and portfolio oversight. This analytical rigor is foundational to AFCG's strategy of moving up the quality curve in its lending while targeting attractive yields.

The company's history, including its founding and IPO, laid the groundwork for its current structure. The pivotal spin-off of the CRE portfolio was a strategic move to sharpen its focus, allowing for more dedicated attention to the cannabis sector's specific dynamics and investor base. This strategic pivot underpins management's current priorities: actively managing the existing portfolio, particularly underperforming credits, and reinvigorating the origination engine to deploy capital into new, high-quality opportunities.

Performance, Portfolio, and Capital Deployment

AFCG's recent financial performance reflects the ongoing efforts to navigate its portfolio and capitalize on market opportunities. For the three months ended March 31, 2025, the company reported net income from continuing operations of $4.07 million. Distributable Earnings, a key metric for dividend decisions, were $4.5 million, or $0.21 per basic weighted average common share, a decrease from $9.97 million ($0.49 per share) in the same period of 2024.

This decline in distributable earnings was primarily driven by a significant decrease in interest income, which fell by $5.9 million (41%) year-over-year. This reduction was attributed to loans placed on nonaccrual status, lower loan exits and prepayments compared to capital deployed, and reduced commitments with certain borrowers. Interest expense saw a modest increase, while management and incentive fees decreased, the latter reflecting lower Core Earnings. The change in the provision for current expected credit losses (CECL) also impacted results, with a reversal of $0.7 million in Q1 2025 compared to a $4.9 million provision in Q1 2024, influenced by macroeconomic factors, portfolio changes, and borrower status.

As of March 31, 2025, AFCG's loan portfolio consisted of $366.3 million in principal outstanding across 17 loans, growing slightly to $372.5 million across 18 loans by May 1, 2025. The portfolio maintained a weighted average estimated yield to maturity of approximately 18%. Portfolio management remains a critical focus, particularly addressing underperforming legacy loans. As of March 31, 2025, the CECL reserve stood at $29.9 million, representing 9.75% of loans at carrying value. The portfolio exhibits concentration risk, with the top three borrowers accounting for approximately 46.2% of outstanding principal.

Management has highlighted successes in resolving other troubled credits, including receiving $119 million in paydowns from five underperforming loans in 2024. Notable exits include an $84 million loan to a subsidiary of Public Company H at par plus accrued interest (19.9% IRR) and a $24 million loan to Private Company C (25.5% IRR). Recent positive developments include the full repayment of the Private Company T loan ($7.7 million principal) in May 2025 and a $2 million prepayment from Private Company L in April 2025. Updates on the Justice Grown loan (Subsidiary of Private Company G), a significant exposure, indicate some operational improvements but also ongoing legal proceedings initiated in April 2025 to enforce rights under the credit facility.

Origination efforts continue, with a pipeline of $287 million in active deals as of May 1, 2025. Recent fundings include facilities to Story of Ohio, Private Company U, and Subsidiaries of Standard Wellness Holdings, demonstrating a focus on supporting growth and refinancing for established operators. Management is adopting an opportunistic and selective approach to originations, prioritizing high-quality borrowers and proven operators over simply hitting volume targets, given the current market volatility. The "sweet spot" for new loan sizes is seen between $10 million and $40 million.

Liquidity saw a significant decrease, with cash and cash equivalents falling from $103.61 million at December 31, 2024, to $3.32 million at March 31, 2025, largely due to net cash used in financing activities, including substantial repayments on credit facilities. The company's debt structure includes $90 million in 5.75% Senior Notes due 2027. The Revolving Credit Facility was renewed and amended in April 2025, extending maturity to 2028 and expanding collateral, with a lead commitment of $30 million expandable to $100 million. An unsecured facility with an affiliate was terminated. Unfunded commitments totaled $9.49 million as of March 31, 2025. Management believes current liquidity sources are sufficient for the next twelve months but expects to need to raise additional capital in the near future to support growth.

Outlook and Risks

AFCG's outlook is shaped by the interplay of ongoing challenges from underperforming legacy assets and the opportunities presented by the capital-constrained cannabis market. Management anticipates that earnings will continue to be impacted by the performance of legacy loans in the near term. The dividend declaration of $0.15 per share for the second quarter of 2025, following $0.23 for the first quarter, reflects a level management believes is sustainable based on the current performing asset base, excluding the impact of underperforming credits. Future dividend levels are contingent on the successful resolution of these legacy issues and the profitable deployment of capital into new loans.

The active deal pipeline suggests potential for future originations, but management emphasizes that deployment will be opportunistic and focused on credit quality rather than volume targets. Yields on new originations are expected to remain attractive, consistent with recent deals in the mid-to-high teens IRR range. The company's capital structure, including the renewed Revolving Credit Facility, provides flexibility for future investments, although raising additional equity or debt is anticipated to support growth.

Investing in AFCG involves significant risks inherent in the cannabis industry and its lending model. The federal illegality of cannabis creates uncertainty and potential enforcement risks for borrowers, which could impact their ability to operate and repay loans. State-level regulatory changes, including the inability of borrowers to maintain licenses, pose risks. The nature of the collateral, which often includes cannabis-related assets and licenses, can be illiquid, and legal/regulatory restrictions may prohibit AFCG from taking possession of collateral in the event of default, potentially limiting recovery to selling the loan to a third party.

Valuation of illiquid loans is inherently uncertain and can fluctuate based on market conditions, potentially differing significantly from realized values. The portfolio's concentration in a limited number of borrowers increases exposure to individual credit events. Interest rate risk exists, particularly if borrowing costs rise faster than asset yields, though the portfolio's fixed-rate exposure and SOFR floors provide some mitigation. Legal proceedings related to defaulted loans, such as the ongoing actions concerning Justice Grown, introduce uncertainty regarding potential outcomes and recovery. Furthermore, broader economic factors and changes to U.S. tariff regulations could indirectly impact borrowers and the value of collateral assets.

Conclusion

Advanced Flower Capital is strategically positioned as a pure-play lender in the underserved U.S. cannabis market. While the company faces near-term headwinds from underperforming legacy loans, impacting current earnings and dividend levels, management is actively engaged in portfolio management efforts that have demonstrated success in recovering capital from other troubled credits. The market's ongoing demand for capital, coupled with limited supply from traditional sources, presents a compelling opportunity for AFCG to deploy capital into new, high-quality senior secured loans at attractive yields.

The company's specialized underwriting expertise and opportunistic approach to originations are key strengths in this complex environment. However, investors must weigh these opportunities against the inherent risks of lending to a federally illegal industry, including borrower performance issues, concentration risk, and potential limitations in enforcing remedies. The successful resolution of legacy portfolio challenges and the disciplined deployment of recovered and new capital into performing assets will be critical determinants of AFCG's ability to enhance future distributable earnings and create long-term shareholder value.