Federal Agricultural Mortgage - Earnings Call - Q2 2018

Transcript

Speaker 0

Good day and welcome to the Farmer Mac Second Quarter twenty eighteen Investor Conference Call. All participants will be in listen only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Lal Jenkins, acting President and CEO.

Please go ahead.

Speaker 1

Good morning. I'm Lowell Jenkins, Farmer Mac's Acting President and CEO. Farmer Mac's pleased to welcome you to the second 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.

Our General Counsel is not available today, so I'd ask Anjali Jahusayi to Farmer Mac's Assistant General Counsel to comment on forward looking statements that management may make today as well as Farmer Mac's use of the non GAAP financial measures.

Speaker 2

Thanks, Will. 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 and 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 subsequently filed quarterly reports on Form 10 Q.

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 develop financial plans. In management's view, there 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 and 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.firmac.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

Thanks, Angela. And thank you all for joining us. Our second quarter twenty eighteen results largely reflect the strong underlying fundamentals driving Farmer Mac's business. From double digit core earnings growth to continued favorable credit quality, Farmer Mac continues to post strong results. Our business volume grew to $19,500,000,000 Our substandard assets remained unchanged as a percentage of our portfolio and our core earnings per share grew 22% year over year.

These results demonstrate the focus and commitment of our team throughout the course of an ongoing and cultural cycle excuse me, economic cycle in Farmer Mac's transition period as we search for a new CEO. Our core earnings grew more than 20 year over year this quarter, the growth would have been even more significant at the absence of the payoff of an interest only mortgage security in our investment portfolio, which had a $1,600,000 after tax impact. In fact, growth would have been more than 30 year over year. Our strong year over year growth was driven by a combination of good business volume growth, stable spreads and the benefits of a lower federal corporate income tax rate. Dale Lynch will describe this and other financial results in more detail shortly.

Farmer Mac continues to execute its strategic initiatives to increase capacity and efficiency, which includes investing in our people, technology, infrastructure and maintaining our leadership position in financing rural America. The benefit from the newer low 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 availability and affordability of credit in rural America. And as demonstrated by our second quarter performance Farmer Mac's business model is performing quite well. Now I'd like to turn to Curt Covington, our Executive Vice President, Agriculture Finance to provide you with an update on the current agricultural environment.

Curt?

Speaker 3

Thanks, Walt. Good morning. Much has been said and written about the decline in farm income over the past three years. For 2018, USDA forecasts real farm net cash income at about $91,900,000,000 which is about 38% below levels experienced during 2012 farm income peak. The past three years have been very near the inflation adjusted average cash farm income.

On the three consecutive years with a lower average income level with this period, you must have to go back to the 1980s. However, conditions on the farm today, while not as rosy as we'd like them to be or perhaps not as bad as some thought it might be. There are a few dynamics at work that may help explain the better than expected credit performance. First, farm balance sheet generally came into the current downturn in very good shape, low leverage and good liquidity. Second, as markets deteriorated, farmers knew when and how to effectively tighten their belts.

Third, with the experience on their side, lenders didn't panic adhering to their time tested and pragmatic underwriting standards. And finally, relatively lower interest rates combined, with active buyers in the market continues for generally stable to higher farmland prices. These factors when added together may help explain why agricultural loan delinquency and loss rates remain better than expected. From a commodity perspective, USDA's cash farm income is mixed. Of the 11 main commodity sectors identified nearly all point to lower income in 2018 than in 2017.

And while the income forecast is not particularly good for grain, oil, seeds and certain meat proteins, other commodities particularly specialty crops such as nuts, tree fruit and vegetables appear to remain profitable despite lower average farm gate prices. Farm line values have remained stable to slightly stronger across many parts of the country. Just last week, the USDA released its 2018 land survey results, which showed an average increase in the value of national farmland and buildings of about 1.9% from June 2017 to June 2018. It appears the top quality land still commands top prices. This recent USDA report indicates good gain in primary Corn Belt states, some losses in the Upper Plain State, significant gains in the Lower Plain State and ongoing gains in the West.

Farmer Mac's credit and research team remain abreast of various headwinds in the ag economy that could impact both farm income and land values. The most important of these today is the current trade dispute and the prospects of rising interest rates. Global exports remain a vital outlet for U. S. Agricultural production and increasing friction with major markets in North America, Europe and Asia presents a challenge to producers.

However, in recent weeks, USDA has announced plans to help offset temporary market disruptions due to trade policy negotiations, which is viewed as welcome news for many farmers and ranchers. Similarly, a rising interest rate environment increases the absolute level of interest expense for farmers, but relative levels of interest to income remains very manageable for producers in a historical context. Despite these changes, we continue to believe that America's America's farmers and ranchers have a bright future and Farmer Mac has sufficient diversity in their portfolio to weather these challenges. And with that, I'll return this to Low.

Speaker 1

Thanks, Kurt. Now I'd

Speaker 4

like to ask Dale Lynch, our Chief Financial Officer to cover our financial results in more detail. Dale? Thanks, Lowell. Our second quarter twenty eighteen results reflect Farmer Mac's commitment to delivering upon our mission while at the same time producing strong returns for our stockholders. We provide a unique combination of high quality assets positioning within a market that provides attractive growth opportunities and a GSE funding advantage designed to benefit rural America.

Terms of business volume, as you can see on Slide five, outstanding volume grew to $19,500,000,000 as of June 3038. We completed more than $1,300,000,000 of new business this quarter resulting in net growth of $145,000,000 after maturities and repayments. This increase in outstanding business volume was driven by net growth in our Farm and Ranch and institutional credit lines of business. We purchased $825,000,000 of AgVantage securities in the second quarter, which resulted in net growth of $66,000,000 During the second quarter twenty eighteen, Firm Act purchased AgVantage securities from MetLife and RoboAgriFinance in the amounts of $500,000,000 and $175,000,000 respectively. And these proceeds were used to refinance maturing AgVantage securities in the same amounts.

Also contributing to the business volume this quarter was $30,000,000 of net new business with four other institutional counterparties in a series of smaller transactions primarily with our AgVantage for funds product. Our Farm and Ranch loan purchases were two twenty four million dollars in second quarter twenty eighteen, which was lower year over year primarily due to the absence of three larger loans totaling $85,000,000 completed in second quarter twenty seventeen, but which were not replicated during second quarter twenty eighteen. Excluding these larger purchases, business volume for loans purchased in the 2018 was in line with that of the first half twenty seventeen. We also added $126,000,000 of Farm and Ranch loans understand by purchase commitments during the second quarter twenty eighteen, which was 125% increase over the same period last year. We purchased $130,000,000 in our USDA guarantees line of business in second quarter twenty eighteen compared to $169,000,000 in second quarter twenty seventeen.

The decrease reflected an increase in competition for these assets and a decrease of the USDA Guaranteed loan programs. Due to a lack of loan purchase opportunities for larger more competitive loans to rural utilities borrowers, our rural utilities partner, National Rural Utilities Cooperative Finance Corporation or CFC did not sell any loans to Farmer Mac this quarter. Despite this lack of loan volume from CFC, we believe ongoing growth opportunities do exist within our institutional credit line of business within the rural utility sector. Now turning to the financials, as you can see on Slide six, core earnings for second quarter twenty eighteen were $19,400,000 or $1.8 per diluted common share compared to $16,000,000 or $1.48 per share in second quarter twenty seventeen and $21,800,000 or $2.03 per share in first quarter twenty eighteen. The $3,400,000 year over year increase in core earnings was primarily due to a $700,000 after tax increase in net effective spread, which did include a $1,600,000 after tax negative impact from the amortization of the IO security and a $4,800,000 decrease in tax expense due to the lower tax rate.

This increase was offset in part by a $1,200,000 after tax increase in operating expenses driven by an increase in G and A expenses. Specifically this increase in G and A is related to our continued investment in technology and business infrastructure and an increase in compensation and benefits as Farmer Mac continues to invest in its people. Also contributing to this offset was a $600,000 after tax decrease in net realized gains on the sale of real estate owned properties. As we've mentioned on prior calls, Farmer Mac expects the annual increase in its aggregate compensation and benefit 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% relative to 2017 with the increases likely to remain elevated in 2019.

The $2,400,000 sequential decrease in core earnings was primarily due to $700,000 after tax decrease in net effective spread, which again included a $1,600,000 after tax negative impact from the amortization of this IO security, a $900,000 after tax increase in operating expenses and $700,000 after tax increase in credit related expenses. As Will mentioned earlier, Farmer Mac experienced a payoff transaction in second quarter twenty eighteen related to a legacy interest only security within its investment portfolio. Farmer Mac purchased this IO security in second quarter twenty thirteen as part of a transaction through which the issuer repurchased and re securitized a prepayable structured adjustable rate mortgage backed security that was then held by Farmer Mac. As a result of this transaction, Farmer Mac realized a $3,100,000 gain upon the sale of the original security in second quarter twenty thirteen and acquired the IO security. Farmer Mac earned interest income over the five year period that it held this IO security in its investment portfolio.

Over the life of this transaction, Farmer Mac received a net after tax economic benefit of $3,200,000 Farmer Mac does not currently hold any other IO securities in its investment portfolio. Excluding this transaction, which again is not related to any Farmer Mac's four lines of business, our $19,400,000 core earnings this quarter would have been $1,600,000 higher and that would have made our year over year growth rate more than 31%. Now turning to spreads on Slide seven, Farmer Mac's net effective spread for second quarter twenty eighteen was $36,200,000 or 86 basis points compared to $35,300,000 or 91 basis points in the 2017 and $37,100,000 or 91 basis points in the first quarter twenty eighteen. The $900,000 year over year increase in net effective spread in dollars was primarily due to growth in outstanding business volume, which increased net effective spread by approximately $2,700,000 The increase was offset in part by the $2,000,000 amortization of this IO security within its investment portfolio. In percentage terms, the amortization of this security had a five basis point negative impact year over year.

The $900,000 and five basis point sequential decrease in that effective spread was again primarily attributable to the $2,000,000 negative impact of the amortization of this IO security. The decrease was offset in part by growth in on balance sheet AgVantage securities and Farm and Ranch loans, which increased net effective spread by $700,000 and an increase in the amount of cash basis interest income recognized on non accrual Farm and Ranch loans, which increased net effective spread by $500,000 Again, excluding the amortization of this IO security, net effective spread would have increased $1,100,000 sequentially. Turning to credit on Slide eight, as of June 3038, the total allowance for losses was $9,000,000 or 13 basis points of the $7,000,000,000 Farm and Ranch portfolio compared to $8,500,000 or 12 basis points of the Farm and Ranch portfolio as of March 3138. The $600,000 provision in second quarter twenty eighteen for the total allowance for losses primarily due to a modest decline in overall portfolio credit quality and an increase in the general allowance to the net volume growth in farm and ranch loans. As of June 3038 Farmer Mac's ninety day delinquencies were $43,100,000 or 0.61% of the Farm and Ranch portfolio compared to $47,600,000 or 0.69% of the portfolio as of March 3138.

Those ninety day delinquencies were comprised of 54 loans as of 2018 compared to 65 loans as of first quarter twenty eighteen. The modest decline in 90 delinquencies in first quarter twenty eighteen is consistent with our seasonal pattern of Farmer Mac's ninety day delinquencies fluctuating from quarter to quarter both in dollars and as a percent of the outstanding portfolio with higher levels generally observed at the end of first and third quarters and lower levels generally observed as of the end of second and fourth quarters of each year as a result of 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 possibly exceed Farmer Mac's historical average of approximately 1% due to macroeconomic factors and the cyclical nature of the agricultural economy. 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 of substandard volume was little changed this quarter. As of June 3038, Farmer Mac's substandard assets were $226,500,000 or 3.2% of the Farm and Ranch portfolio compared to $221,200,000 or again 3.2% of the portfolio as of March 3138.

Those substandard assets were comprised of three thirty three loans as of June 3038 and three eighteen loans as of March 3138. As of June 3038, the loan volume migrating into the substandard asset categories primarily comprised of feed grains, oilseeds and other crops. This is in line with previous quarter's trends. 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 the agricultural economy. Although some credit losses are inherent to the business of agricultural lending, Farmer believes that any losses associated with the current agricultural credit cycle will be moderated by the strength and diversity of our portfolio, which we believe is adequately collateralized.

Now turning to capital on Slide nine, Farmer Mac's $693,000,000 of core capital as of June 3038 exceeded our statutory minimum capital requirement of $543,000,000 by $150,000,000 or twenty eight percent. This compares to core capital of $657,000,000 or $137,000,000 of capital in excess of the minimum as of year end 2017. The increase in capital in excess of our minimum was due primarily to an increase in our retained earnings. More complete information about Farmer second quarter twenty eighteen performance is set forth in our 10 Q, which we filed today with the SEC. And with that, Lal, I'll turn it back to you.

Thanks, Tito.

Speaker 1

Farmer Mac's performance is strong as we continue to deliver upon the mission throughout agriculture's economic cycles. Our capital base is also strong and growing, providing capacity for future growth and we believe the dividend policy has helped enhance stockholder value. We continue to bring in new personnel to fill the key positions here at Farmer Mac and to expand our investment in technology and capacity to better grow our business. Farmer Mac has been a champion for and an integral part of this nation's rural economy for thirty years and we look forward to the decades ahead. Our CEO's search efforts have made significant progress and Farmer Mac's Board expects to hire a new President and CEO with appropriate qualifications and expertise in a timely manner.

We look forward to being able to provide you with more information in our next earnings call and we'd be happy now to answer any questions that you

Speaker 0

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

Speaker 5

Thanks, operator. Good morning, everybody. Just a couple of questions regarding credit. I know you made reference to the fact that at some point, credit may return to more historical levels, implying kind of an increase in delinquencies and substandard assets. And just wondering what that implies for the level of the allowance for loan losses as a percent of loans.

I think you mentioned right now you're running about 13 basis 0.13% of loans. Just wondering what that could increase to if we get it back to more kind of say 4% substandard assets and 1% delinquency level?

Speaker 4

Yes, Scott, this is Dale. So we haven't gotten to that level of specificity around that forward looking component. I mean if I were you, a good proxy would be to look through our cycles over the past ten years or so and sort of calculate historic sub standards and allowances as a percent of our relevant portfolio and that would give you good applicable long term average. But again, we've been trending at this 12 or 13 basis points amount for a long period of time now, a good five years or so if you exclude ethanol. So even reverting to historical averages would presumably take some time because they're higher than that.

So but we're not going to get a specific as you'd like on that statistic.

Speaker 5

Okay, fair enough. Yes, I know excluding the ethanol, obviously there's a high loss content in product. So I just wanted to see if there's a way to, you said, adjust for that and figure out what the appropriate level of loan loss reserve is. But I'll look back at this historical.

Speaker 1

We do

Speaker 4

give you all I think we give you all the dollars on the ethanol. So if you wanted to do that labor, you could get there. You could exclude the ethanol, I think, and get to a good proxy for that.

Speaker 5

Okay. We'll do that. And then just secondly, I think in the past you said July 1 is typically a large pay date or due date for loans. Just wondering if there's any way you can provide kind of a view into what you're seeing post July 1, if you see any change, material change in delinquencies?

Speaker 4

Yes, we haven't disclosed that. Again, good questions, but we haven't we don't have the data on that yet.

Speaker 5

Okay, All right. And then, just in terms of tariff impact, appreciate that the macro color in terms of land values and crop prices and farm income. Are you seeing any signs when you talk to the various banks and people that you purchase loans from, are you seeing any signs of reduced loan demand, as farmers maybe kind of cut, you know, pull back on production because of the perceived impact of tariffs?

Speaker 4

Kurt, can you, do you want to take that?

Speaker 3

No. Our that's a good question. But we keep pretty close track of that. And what we're seeing in terms of demand is for loan products is still fairly robust. There was a lot of renewal activity that took place over the last six months.

But we haven't seen any significant drawback in terms of demand for loan credit across the country.

Speaker 5

Okay. Thanks very much.

Speaker 0

This concludes our question and answer session. I would now like to turn the conference back over to Raul Junkins for any closing remarks.

Speaker 1

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

Speaker 0

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