Federal Agricultural Mortgage - Earnings Call - Q1 2018

Transcript

Speaker 0

Good morning, and welcome to the Farmer Mac First Quarter twenty eighteen Investor Conference Call. All participants will be in listen only mode. Please note this event is being recorded. I would now like to turn the conference over to Lowell Jenkins, Acting President and Chief Executive Officer. Please go ahead.

Speaker 1

Good morning. I'm Lowell Jenkins, Farmer Mac's Acting President and CEO. Farmer Mac is pleased to welcome you to our first quarter twenty eighteen investor conference call. We posted a slide deck on our website that we'll refer to throughout today's call. Information about where these slides can be found is included in this morning's press release.

Before I begin, I'd like to ask Steve Mullery, Farmer Mac's General Counsel, to comment on forward looking statements that management may make today as well as Farmer Mac's use of non GAAP financial measures.

Speaker 2

Thanks, Lowell. Some of the statements made on this conference call may constitute forward looking statements under the securities laws. We make these statements based on our current expectations and assumptions about future events and business performance, and we may not be obligated to update these statements after this call. We caution you that forward looking statements are subject to risks and uncertainties. Actual results may differ materially from the results expressed or implied by the forward looking statements.

In evaluating Farmer Mac, you should consider these risks and uncertainties as well as those described in our 2017 annual report on Form 10 ks and our subsequent quarterly report on Form 10 Q, which was filed with the SEC this morning. In the analysis of its financial information, Farmer Mac sometimes uses measures of financial performance that are not presented in accordance with generally accepted accounting principles in The United States, which we refer to as non GAAP measures. The three non GAAP measures that Farmer Mac uses are core earnings, core earnings per share and net effective spread. Farmer Mac uses these non GAAP measures to measure corporate performance and to develop financial plans. In management's view, are useful alternative measures for understanding Farmer Mac's business.

These non GAAP measures may not be comparable to similarly labeled non GAAP measures disclosed by other companies. Farmer Mac's disclosure of non GAAP measures is intended to be supplemental in nature. These measures are not meant to be considered in isolation from, as a substitute for, or as more important than, the related financial information prepared in accordance with GAAP. Disclosures and reconciliations of Farmer Mac's non GAAP measures can be found in the most recent Form 10 Q and earnings release posted on Farmer Mac's website, www.farmermac.com, under the Financial Information portion of the Investors section. A recording of this call will be available on our website for two weeks starting later today.

Speaker 1

Thank you, Steve, and thanks for all of you that joined us this morning. Our first quarter twenty eighteen results largely reflect the continuation of strong trends that developed over the course of the last few years. From business volume growth to continued favorable credit quality to double digit core earnings growth, Farmer Mac's performance hasn't skipped a beat. Our business volume grew by $19,400,000,000 Our substandard assets remained unchanged as a percentage of our portfolio and our core earnings per share grew 46% year over year. Even without the benefit of the lower federal corporate tax rate that became effective at the beginning of 2018, our core earnings per share still grew 19% year over year.

These results demonstrate the talent and commitment that Farmer Mac's leadership team and employees bring to their jobs every day. As you can see in the morning's press release, the new lower federal corporate income tax rate had a positive effect on Farmer Mac's first quarter earnings results. We expect to see a significant increase in core earnings per share related to the tax benefit, which was an important factor and why we increased our quarterly dividend 61% to $0.58 per share on all classes of our common stock beginning this past quarter. We believe that our strong earnings potential and overall capital position will continue to support our dividends going forward as we approach our targeted core earnings payout ratio of approximately 30%. Farmer Mac continues to execute on the strategic initiatives to increase capacity and efficiency, which includes investing in our people, enhancing our technology, improving our infrastructure and maintaining a leadership position in financing rural America.

The benefit from the new lower federal corporate tax rate has allowed us to further these initiatives, while also increasing returns to our common stockholders. As guided by our mission, Farmer Mac is committed to finding innovative ways to reach customers to increase the access to capital and to reduce the cost of credit for rural America. Farmer Mac's business model is performing well and may even be more valuable in tighter credit markets as demonstrated by our strong first quarter performance. Now I'd like to ask Dale Lynch, our Chief Financial Officer to cover the financial results in more detail. Dale?

Speaker 3

Thanks, Lowell. Farmer Mac is a one of a kind financial services company with a compelling mission. We provide a unique combination of high quality assets and a GSE funding advantage that is designed to generate benefits for rural America. We're positioned within an industry that also provides attractive growth opportunities and we efficiently serve this market as a $19,000,000,000 company through our 92 hard working employees. Farmer Mac is able to generate high teens return on equity while growing its earnings by double digits and maintaining a Tier one capital ratio similar to that of a well capitalized money center bank and a cumulative loss rate that is unique for a commercial credit company, only 14 basis points.

The combination of these fundamental and financial factors has led to significant benefits for rural America in the form of increased credit availability and lower cost of financing as well as for our stockholders as reflected in the stock and the strong performance of our common stock over the past several years. Turning to first quarter. Our first quarter twenty eighteen results reflect the ongoing strength of Farmer Mac's business model throughout market cycles. As business volume increased to $400,000,000 core earnings exceeded $21,000,000 and credit quality remained favorable. In terms of business volume, as you can see on Slide six, outstanding volume grew to a record $19,400,000,000 as of March 3138.

We completed more than $1,400,000,000 of new business during the quarter resulting in net growth of approximately $400,000,000 after maturities and repayments. This increase in outstanding business volume was driven by net growth in our institutional credit, Farm and Ranch and USDA lines of business. We purchased $813,000,000 of AgVantage securities in the first quarter, which resulted in net growth of $421,000,000 The increase was driven by two of our longstanding counterparties, National Royal Utilities Cooperative Finance Corporation, also known as CFC and Rabobank. During first quarter twenty eighteen, CFC completed a new $325,000,000 funding and Rabobank increased its AgVantage business volume by almost by $100,000,000 Also contributing to growth was $32,000,000 of new business with five other institutional counterparties in a series of smaller transactions with our newer AgVantage products such as FarmEquity Advantage and AgVantage for funds. As you can see in our financial results, more of our institutional customers are recognizing the value FarmEquity can provide as we continuously innovate our product set to meet our customers' needs.

Our Farmer Ranch loan purchases were $259,000,000 in first quarter, which was modestly lower year over year primarily due to a combination of reduced borrower demand resulting from rising interest rates and the lower average size of loans purchased. During first quarter twenty eighteen, Farmer Mac purchased four fifty six Farmer Ranch loans with an average principal balance of $570,000 compared to four forty Farmer Ranch loans purchased with an average principal balance of $714,000 in the first quarter and the previous year. We also added $159,000,000 of Farm and Ranch loans under standby purchase commitments during first quarter twenty eighteen, which was a 40% increase over the same period last year. We purchased $124,000,000 of USDA guarantees in first quarter twenty eighteen compared to $131,000,000 in first quarter a year ago. Our Royal Utilities line of business decreased 153,000,000 primarily due to partial termination of $120,000,000 of Royal Utilities loans under standby purchase commitments.

Also contributing to the decrease was a pay down of $41,000,000 of Royal Utility loans, which was modestly offset by the purchase of $8,600,000 in new Royal Utility loans. The decrease in Royal Utility loans purchased in first quarter twenty eighteen compared to last year was primarily due to a lack of loan purchase opportunities for larger, competitive loans to Rural Utilities borrowers. Now turning to the financials, as you can see on Slide seven, core earnings for first quarter twenty eighteen were $21,800,000 or $2.03 per diluted common share compared to $15,000,000 or $1.39 per share in first quarter twenty seventeen and $17,900,000 or $1.65 per share in fourth quarter twenty seventeen. The 6,800,000 year over year increase in core earnings was primarily due to a $3,600,000 after tax increase in net effective spread. Also contributing to the increase was a $2,600,000 decrease in tax expense due to the lower federal corporate tax rate and a $700,000 after tax decrease in credit related expenses.

The increase was offset in part by a $700,000 after tax increase in operating expenses driven by higher compensation and employee benefits as Farmer Mac continues to invest in its people. As Will mentioned earlier, we plan to continue to invest in our human capital and our technology and business infrastructure to increase our capacity and efficiency as we work to achieve our longer term strategic objectives. Accordingly, Farmer Mac expects the annual increases in its aggregate comp and benefits and G and A expenses to be above historical averages over the next several years. Specifically, management believes that the aggregate comp and benefits and G and A expenses will increase approximately 15% in 2018 relative to 2017 with increases likely to remain elevated in 2019. The $3,900,000 sequential increase in core earnings was primarily due to a decrease in income tax expense of $5,500,000 in first quarter twenty eighteen, again related to the lower federal corporate tax rate and a $700,000 after tax decrease in credit related expenses.

The increase was offset in part by a $1,100,000 after tax increase in operating expenses. Now turning to spreads on Slide eight. Farmer Mac's net effective spread for first quarter twenty eighteen was $37,100,000 or 91 basis points compared to $32,500,000 or 90 basis points in first quarter twenty seventeen and $37,500,000 or 93 basis points in fourth quarter twenty seventeen. The $4,600,000 year over year increase in net effective spread in dollars was primarily due to the growth of outstanding business volume, which increased net effective spread by approximately $3,900,000 The one basis point year over year increase in net effective spread in percentage terms was primarily due to change in Farmer Mac's funding strategies and improvements in LIBOR based short term funding costs for floating rate assets indexed to LIBOR, as well as a reduction in the average balance of lower earning interest investment securities in our investment portfolio. The $400,000 or two basis points sequential decrease in net effective spread is primarily due to two fewer days of interest in first quarter twenty eighteen compared to fourth quarter twenty seventeen in our USDA lines of business.

Turning to credit on Slide nine, as of March 3138, the total allowance for losses was $8,500,000 or 12 basis points of the $6,900,000 Farm and Ranch portfolio compared to $8,900,000 or 13 basis points of the Farm and Ranch portfolio as of year end 2017. The $400,000 release in first quarter twenty eighteen from the total allowance for losses is due to payoffs and pay downs of loans with an existing allowance that exceeded the increase in the allowance associated with net growth in Farm Ranch loans this quarter. Also contributing to the release were changes in credit quality that reduced the proportion of substandard assets rated in the lowest credit quality tier. As of March 3138, Farmer Mac's ninety day delinquencies were $47,600,000 or 0.69% of the Farmer Ranch portfolio compared to $48,400,000 or 0.71% of the Farm and Ranch portfolio as of December 3137. Those ninety day delinquencies were comprised of 65 loans as of March 3138 and fifty one loans as of year end 2017.

The modest decline in delinquencies from year end 2017 was primarily due to lower expected seasonal delinquencies associated with the loans that have January 1 payment terms, which account for most loans in the Farm and Ranch portfolio as well as the pay down on $15,300,000 in permanent planting loans to a single borrower that resulted in those loans becoming current. Farmer Mac's ninety day delinquencies have historically fluctuated from quarter to quarter both in dollars and as a percent of portfolio, we generally observe higher levels at the end of first and third quarters and lower levels at the end of second and fourth quarters of each year, which is related to the annual and semi annual payment terms of most of our Farm and Ranch loans. Farmer Mac expects that over time its ninety day delinquency rate will eventually revert closer to and

Speaker 4

possibly

Speaker 3

exceed Farmer Mac's historical average of approximately 1% due to macroeconomic factors and the cyclical nature of the ag economy. Now with regard to substandard assets due to a relative balance between newly substandard assets and upgrades and payoffs and pay downs of existing substandard assets, the overall portfolio substandard volume was little changed this quarter. As of March 3138 Farmer Mac's substandard assets were $221,200,000 or 3.2% of the Farmer Ranch portfolio compared to $221,300,000 or again 3.2 percent of the Farmer Ranch portfolio as of prior year end. Those substandard assets were comprised of three eighteen loans as of first quarter twenty eighteen compared to three zero seven loans as of fourth quarter twenty seventeen. Farmer Mac expects that over time its substandard asset rate will eventually revert closer to and possibly exceed Farmer Mac's historical average of approximately 4% due to macroeconomic factors and the cyclical nature of

Speaker 2

the ag

Speaker 3

economy. If Farmer Mac's substandard asset rate continues to increase in current levels, it is likely that Farmer Mac's provision fee allowance for loan losses and reserve for losses will also increase. Although some credit losses are inherent to the business of ag lending, Farmer Mac believes that any losses associated with the current ag credit cycle will be moderated by the strength and diversity of our portfolio, which Farmer Mac believes is adequately collateralized. Now turning to capital on Slide 10, Farmer Mac's $673,000,000 of core capital as of March 3138 exceeded the statutory minimum capital requirement of $536,000,000 by $137,000,000 or 26%. This compares to core capital of $657,000,000 or $137,000,000 of capital above the minimum requirement as of year end 2017.

An increase in retained earnings this quarter was modestly excuse me, was mostly offset by an increase in minimum capital required to support the growth of our on balance sheet assets this quarter. More complete information about Farmer Mac's first quarter twenty eighteen performance is set forth in our 10 Q, which we filed today with the SEC. And with that, Lowell, I'll turn it back to you.

Speaker 1

Thanks, Dale. Farmer Mac's business model is thriving as we continue to deliver upon the mission throughout agricultural economic cycles. Our capital base is strong and growing, providing capacity for future growth. But we believe our dividend policy has helped enhance stockholder value. We continue to bring in new personnel to fill key positions and to expand our investment in the technology and the capacity to better grow our business.

Farmer Mac has been a champion for and an integral part of this nation's real economy now for thirty years. We look forward to the decades that are ahead. As discussed earlier in our last earnings call, we established a subcommittee of the Board to lead our CEO search efforts and are actively conducting a search for a new CEO. Since our last update, the search committee has continued to solicit stakeholder feedback and has developed a CEO profile and position description and engaged an executive search firm. The CEO search committee will seek to recommend to the Board for its approval a new President and CEO with the appropriate qualifications and expertise in a timely manner.

Farmer Mac deserves a world class CEO to help us lead into this bright future that's ahead of us. We look forward to being able to provide you with more information on our next earnings call. We'd be happy now to answer any questions that you may have.

Speaker 5

We will now begin the question and answer session.

Speaker 0

The first question comes from Scott Valentin with Compass Point. Please go ahead.

Speaker 4

Good morning, everyone. Thanks for taking my question. Just with regard to the originations this quarter, I noticed the AgVantage product was active. Is that a reflection of any shift in strategy versus Farm and Ranch or just kind of what the market was giving you during the quarter?

Speaker 3

Scott, it's mostly what the market was giving us in the first quarter. We have several large counterparties in the business that they do with us can be very, I guess, lumpy is the best way to say it. CFC, our utilities partner tends to do a financing early in the year and this year they did it in the first quarter and it was $325,000,000 That was a huge lift to our business in the quarter. We may do subsequent business with them throughout the balance of 2018, but again that first quarter lift was a big driver. Rabo also contributed another $100,000,000 They tend to be more granular in how they fund.

So it's just a little bit random depending on who comes in what quarter.

Speaker 4

Okay. But still I know in the past, Farmer Ranch has been a category you guys have been somewhat focused on growing, that's still the case going forward?

Speaker 3

Yes, I mean look our Farm and Ranch loan business has been a growth driver for five years. I guess it's been growing 20% to 25% year over year for at least five years and our Ag Advantage business has also been growing in that sort of 7% -ish range which on a big base is pretty healthy growth. So the strategy that you're referring to remain intact around wholesale funding and trying to push that out to more counterparties. We did over $30,000,000 this quarter with five other smaller counterparties that reflect sort of the financial universe that we have spoken with you in the past on. So again, more granular business, but good from the breadth of counterparties that we did business with this quarter and we certainly hope to do more of that this year and in the future.

Speaker 4

Okay. Thanks. That helps. And then just a question on credit. It was very stable this quarter.

Obviously, there's concerns around potential tariffs and any impact on agriculture. Just wondering, as you reach out to different credit providers and borrowers, how are they reacting or are they reacting to potential tariffs and what kind of contingency plans would they have?

Speaker 6

Yes, is Curt Covington. So we do reach out to and have been reaching out to many of our counterparties across The U. S. We have a nationwide reach and it's talking to most of the sellers, I think the biggest concern obviously is in soybean sector when it comes to China. But when it comes to NAFTA, there's kind of differences of opinions depending on the bank and the commodity that you're talking about because for certain Mexico takes a wider array of commodities off take from U.

S. But in general, most of the banks we talk to and most of the actual growers and those that are involved in the processing and sale list have been actually fairly optimistic. And what we've been hearing is that the volume of activity in those countries right now continues to be pretty strong.

Speaker 7

Okay, all right.

Speaker 4

I'll get back in the queue. Thanks very much.

Speaker 5

The next question comes from Eric Hagen with KBW. Please go ahead. Thanks. Good morning, gentlemen. Dale, you mentioned the newer counterparties that you're exploring through AgVantage, just a follow-up on that.

I guess just how sensitive is the growth in that segment to the overall health and profitability of the ag economy? I mean is there even a correlation that we should be looking at? And I guess just from our perspective, since we can't see the loans on an inter quarter basis, is there anything that we can sort of track or follow that would provide some indication about the drivers of that growth in that segment? Thanks.

Speaker 3

Sure. Thanks, Eric. I think the counterparties in that space are financials and at some level, I mean, not immune from the ag economy at all. But having said that, their incentives are somewhat different than farmers. I think farmers to Curt's point earlier, we've seen a modest decrease in our a very modest decrease in our farm ranch loan purchase volume this year versus first quarter last year.

Smaller loan size contributed to that, but there's also a bit of an influence on higher rates, right? Financials at some level may be more immune to that from the standpoint that their investors require them to deploy the capital. The capital has to be deployed. The interest rate environment will be what it will be, but they do need a level of leverage within their capital structure to generate the level of returns that their equity investors demand. So the terms of their funding may change a bit, they may go shorter on the curve, they may choose floating rate, that's sort of their choice.

But in terms of volume, think it's a little bit less sensitive than say an individual farmers volume would be. So we're less concerned. Issue for us is really pushing the Farmer Mac message deeper and deeper and deeper within that universe of customers. And there's dozens and dozens of those counterparties that we can do business with and that's our challenge and we're starting to gain some real traction I think.

Speaker 5

Yes, no doubt that that's really positive. I guess just one more on that. Mean is what's the difference in spread that we can expect to see between those sort of newer counterparties versus I guess you could call them the core counterparties that have been in that segment for a while?

Speaker 3

Sure. So I mean the difference in spread is we haven't disclosed what it is, it's a short answer, but it's higher. It's significantly higher. These counterparties are smaller. They're not rated.

They may have a profile of BB minus, I don't know. But they're not all that different from a Farm and Ranch portfolio in terms of the spreads that we charge, right? As compared to MetLife, the spreads may be forty, fifty, sixty, seventy basis points depending on maturity. Spreads on the smaller counterparties may more closely approximate Farmer Ranch portfolio.

Speaker 5

Yes. That's a helpful answer, Dale. Then forgive me for just a slight technical question, but the move that we saw in three month LIBOR was somewhat late in the quarter. And I know that I think in your opening remarks, you mentioned that you guys benefited from that. But is there any sort of, I guess, timing difference between what you might see on the funding side with respect to short term interest rates and I guess what you're obviously able to capture on the asset side.

I guess you kind of get where I'm going with that question.

Speaker 3

Yes. No, it's a good question. I mean the three month LIBOR dynamic, especially relative to the one month LIBOR dynamic is striking, right? It's a stark difference. On the three month side, it's a huge advantage for us in terms of where we can fund.

At some level, we're taking this opportunity to push our funding on these types of assets further out the curve. So we're not necessarily trying to monetize and grab all the money we can today, but rather sort of term it out further and reduce the amount of basis risk presumably that we're taking on that population of assets. It's safe to assume we're probably picking up something though net on the balance on the 3s, but on the 1s we're probably giving it up. Over the course of this year, we've kind of indicated that we don't see a real opportunity as things play out right now for a significant improvement in our net refinancing rate over the course of the year, certainly not like we saw last year. So that's just one area of caution.

I'm not sure that I would be thinking that Farmer Mac's funding spreads are going to necessarily improve dramatically just because of what's going on in three month LIBOR.

Speaker 5

Okay, fair enough that they don't improve, but there's we shouldn't expect any sort of tightening or reversal due to timing in 2Q or anything like that?

Speaker 3

No, mean we're trying we're doing our best to kind of keep a pretty coherent funding strategy quarter to quarter to quarter and we don't the volatility frankly in the last, I'd say twenty four months on our funding on our refinancing business has been far less even though the LIBOR markets have been more volatile, I'd say that our refinance rates that we're achieving have been more stable.

Speaker 5

Yes, great. Thanks for that response. Appreciate it.

Speaker 0

The next question comes from Brian Holland with Sidoti. Please go ahead.

Speaker 7

Hi, thanks for taking my question. Was the amount of repayments in Farm and Ranch in line with your expectations? What was the big driver of the repayments in your view?

Speaker 6

Yes, would say it was in line with expectations. I mean some of the repayments have slowed down a bit. Most of that's because in certain sectors of the economy we've seen obviously some stress, particularly corn bean sector, little bit in the cattle sector and certainly in the hog sector, we've seen some of that as well. We don't have a lot of exposure to those last two, but I would say that those were pretty much in line with what we had expected.

Speaker 7

All right. And then are you surprised at all about how long ninety day delinquencies have persisted below the historical average?

Speaker 6

Yes. Here's what I would say. We all kind of view this as potentially issues arising just because we see the stress in the economy. But we pay very close attention to our delinquencies. And inside the Farmer Mac world, we do a lot of have a

Speaker 1

lot of discussions with our seller banks and

Speaker 6

our seller banks are telling us the exact same thing that we're seeing and that is their delinquencies just haven't materialized to any great extent. And a lot of this is because we're beginning to find out many of these farmers while we hear that there's stress out in the economy, there's still a good bulk of customers out there, many of whom those loans that are sold to us that even at prices of where corn and beans are today, they're eking out a small profit and or they've taken on second jobs, many of them in order to make sure their mortgage payments get made. So while we're pleasantly surprised, again, I would just say that we talked to many of our seller banks who are also telling us the exact same thing.

Speaker 7

And then sorry if I missed this, but is there any change in net effective in your net effective spread outlook? Is it kind of safe to assume flattish

Speaker 3

to up one

Speaker 7

or two basis points year over year for 2018?

Speaker 3

Yes, unless there's some major change in the market on our refinancing business, our goal for the year is to maintain the status quo. The funding that's coming off this year is actually very attractive funding. So it's going to be a challenge to achieve that. We think we can come close to that. But I think spreads on new business are largely stable.

Ironically, there might be a little bit of pressure to tighter spreads in some sectors in the Farm and Ranch business just to a pretty strong bid for the best credit quality business out there, right? When markets get tighter, you may pay up for the best

Speaker 2

business and there might

Speaker 3

be that dynamic. By and large, our spread on most of our asset classes are pretty stable. So our outlook is that there's no big change either on the refinancing or on the new business side.

Speaker 7

All right. And then last one for me just on the expense side. G and A rose kind of in line with your previous guidance. I guess just on the comp expense, I mean, is 5% to 6% kind of the right way to look at that? I guess that came in a little bit lower than what we had forecasted.

Speaker 3

You mean in terms of percent growth? Yes. So we really haven't broken it out between the two. If you kind of look in aggregate, just add the numbers together, and 2018 versus 2017 should be approximately 15% higher year over year. So really haven't gotten into the dissecting between the two.

I will say if you're looking optically at the dollars fourth quarter versus first quarter, keep in mind that the fourth quarter was a little bit anomalous from the standpoint that we had a reversal of compensation associated with the termination of our prior CEO in that quarter, which made that quarter look lower than it fundamentally is.

Speaker 7

Yes. Okay. Got it. Thank you.

Speaker 5

This concludes our question and answer session.

Speaker 0

I would like to turn the conference back over to Lowell Jenkins for any closing remarks.

Speaker 1

Seeing no more questions, I'd like to thank you for listening and participating this morning. Look forward to our next call to report our second quarter twenty eighteen results in August 2018. Thank you very much, everyone.

Speaker 0

The conference has now concluded. Thank you for attending today's presentation. You may now

Speaker 2

disconnect.