Federal Agricultural Mortgage - Earnings Call - Q3 2019

Transcript

Speaker 0

Good morning, and welcome to the Farmer Mac Third Quarter twenty nineteen 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 Brad Nordholm, Chief Executive Officer.

Please go ahead.

Speaker 1

Thank you, operator, and good morning. This is Brad Nordholm, and I'm very pleased to welcome you to our twenty nineteen third quarter investor conference call. We have a number of positive developments to discuss today, but before we can do that, I would like to turn to Steve Mullery, our General Counsel, to comment on forward looking statements that we may be using today during the presentation.

Speaker 2

Thanks, Fred. Some of the statements made on this conference call may be 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 2018 annual report on Form 10 ks and our third quarter twenty nineteen Form 10 Q filed with the SEC. In analyzing its information, Farmer Mac sometimes uses measures of financial performance that are not presented in accordance with generally accepted accounting principles of The United States, also known as non GAAP measures. 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, 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

Thanks, Steve, and good morning to everyone. Thanks very much for joining us. This morning, I'm going to provide you with a high level overview of our third quarter twenty nineteen results. Then I'm going to turn the call over to Zach Carpenter, our Chief Business Officer, who will discuss customer and market developments. Kirk Covington, our Chief Credit Officer, will then give you an update on the current agricultural environment and related credit conditions.

And finally, Greg Ramsey, our Principal Financial Officer, will cover our financial results. Our third quarter twenty nineteen results continued our strong momentum from the first half of the year. We had another quarter of solid core earnings and we also had portfolio growth in our rural utility and agribusiness lines of business. Outstanding business volume grew $186,000,000 to $20,900,000,000 during the quarter. And we've grown net business volume year to date as of September 30 by $1,200,000,000 compared to $533,000,000 over the same period last year.

I would note that the delta between the $1,200,000,000 from this year and the $533,000,000 from last year is materially greater than the co bank transaction that we announced in February 2019. This accelerated growth is the result of the creation of our Chief Business Officer, Senior Vice President of Rural Infrastructure positions that we really established to lead our core lines of business. These changes within our organizational structure allow our businesses to begin to be more commercial and underscore our commitment to building and maintaining strong relationships with our customers, relationships that translate into financial results. Our agribusiness and rural utility businesses are foundational not only to our business model, but also to Farmer Mac's mission of providing financing to rural America. That said, on the two prior calls, I've mentioned that Farmer Mac's management team has been working on the development of a multi year strategic plan.

We recently had an opportunity over a three day session to review this with our Board of Directors. The plan focuses on ways Farmer Mac can further execute upon our mission of setting meaningful business by setting meaningful business volume objectives, meaning higher business volume objectives, that will require innovative approaches in how we acquire and retain customers, as well as how we develop new products. Zach Carpenter will discuss this a bit further, but let me provide an immediate example of how Farmer Mac can leverage innovation to execute on the objectives. And that is by focusing you on the fact that this last month, our rural utility line of business at Farmer Mac closed our first renewable energy project finance loan. This is a $10,000,000 loan participation in a larger syndicated transaction, twenty year term on two solar projects in rural California.

These projects have twenty year fixed price power purchase contracts with high quality investment grade offtakers utilities. By keeping our eyes open and being deliberate in the steps we take in these new areas, we believe that we'll be able to continue to take advantage of excellent opportunities to significantly grow our volume. And ultimately, this should expand our bottom line. We understand that this will be a large and all encompassing effort grounded in obvious common sense opportunities, but we believe our approach and the team we have in place will enable us to take this company to a higher growth trajectory and really the next level in the years to come. With that, I'd like to turn to Zach Carpenter, our Chief Business Officer, to give you an update on customer and market developments.

Speaker 3

Thanks, Brad. As Brad mentioned, we had another solid quarter of net volume increases at Farmer Mac, with net volume growth in the agriculture commercial lines of business, which include farm and ranch, institutional ag credit and USDA guarantees exceeding $200,000,000 for the quarter, driven by strong results in the retail space. Specifically, our farm and ranch portfolio grew $102,000,000 in the third quarter despite the seasonally large amount of repayments resulting from the July 1 payment date on almost all loans in the Farm and Ranch portfolio. In fact, our net volume growth this quarter in Farm and Ranch loan purchases doubled from the same quarter in 2018. And we saw modest growth in our long term standby purchase commitment product, a reversal from net decreases in previous quarters.

As I mentioned on our last call, I spent much of the summer meeting with our customers and understanding their needs and how we can better serve them. As a result, we have discovered new ways to deepen our relationship with our seller network. This includes tactically competing for growth in a very competitive interest rate environment, as well as incorporating additional product flexibility to retain customers. We began implementing these initiatives this past quarter, which we believe partly contributed to the growth in the Farm and Ranch line of business. As we continue to enhance our customer retention efforts, we are optimistic that these strategies will result in an improved customer satisfaction, volume retention, and a deepening penetration in the markets we serve.

There continues to be significant amount of institutional capital investing in the agricultural landscape, And Farmer Mac has positioned itself to be a unique as well as consistent financing source for this investor base. While competition is fierce and pricing and structural dynamics remain aggressive, we have been able to identify strong growth opportunities whereby the return has justified our investment. In fact, our pipeline is very strong and we feel that we can continue to leverage this opportunity set into the future. Lastly, as part of these growth efforts and the efforts Brad mentioned earlier, we continue to invest in infrastructure, including people and technology. These investments are crucial in order to improve our abilities of becoming a more commercial organization to providing consistent and reliable capital in existing but also new and untapped markets.

We continue to be excited about the strategic direction of the company and are looking forward to providing more details on these investments on future calls. And with that, I'll turn it back to you, Brad.

Speaker 0

Well, thank you, Zach.

Speaker 1

Now I'd like to turn to Kurt Covington, our Chief Credit Officer, to give you an update on the current agriculture environment.

Speaker 4

Fred, thank you. As the 2019 harvest comes to a close across our nation, it's a good time to reflect on how farmers and ranchers fared with a focus on how a few key commodities in our portfolio perform. Starting out West, the nut industry, primarily almonds and pistachios, closed out to harvest on a high note. Farmers generally saw good to excellent quality with bullish pricing and steady export demand. Buyer commitments to purchase, which is a strong indicator of future shipments, are up 19% year over year in light of a low crop carrying inventory from 2018.

Cattle prices appear to have recovered from the recent lows. Beef supplies are tight throughout the world, but The US maintains a supply advantage as production is expected to set a record in 2020. Both domestic and international demand for US beef remains strong, and there is significant potential for further export growth with the implementation of The U. S.-Japan trade agreement. Dairy is benefiting from tighter global supplies, and should provide firm footing under milk prices through most of 2020.

However, the prospects of the slowing global economy and uncertainty around trade disputes are keeping demand somewhat in check. Turning to the Midwest. With combines making their last passes through the fields, bears remembering what a different and perhaps difficult year it's been. The year started with heavy rain and flooding during the planting season. Wet weather gave way to unusually dry conditions mid season, followed by a cooler and unwelcome wet weather at the beginning of harvest.

Farmers are anxious to see under what market conditions they will be selling the twenty nineteen corn and soybean crops as they continue to be considerable uncertainty about the path of commodity prices. In the end, farmers and their lenders are simply looking for some degree of certainty before the 2020 planting season commences. One stabilizing element in 2019 has been the sizable government support payments across many commodities and geographies, which has helped many producers to offset some of the declines in commodity prices and production disruptions. Our credit quality remains healthy and near historical averages, despite the normal uptick in delinquencies due to seasonality. As of September 3039, our ninety day delinquencies were 59,700,000 or 0.81% of our farm and ranch portfolio, compared to $37,500,000 or 0.53% in the same year ago period.

No delinquencies exist in our institutional credit, our USDA guarantees, or our rural utility lines of business. So ninety day delinquencies represent only 2.29% of total business volume as of quarter end. As of September 3039, our substandard assets stood at $291,000,000 or 3.9% of our farm and ranch portfolio compared to $216,000,000 or three point one percent one year ago. About $54,000,000 of the substandard assets is attributed to large relationships in different commodities and regions across the country that are in varying stages of resolution. With an average 53% loan to value across our farm and ranch portfolio at origination, we believe we are well secured.

Even for substandard and special mention assets, 86% of those loans are secured at a 60% or better loan to value ratio. And while it's never too early to begin planning for the next crop year, it's certainly the time of year to be thankful for the hard work, dedication of the farmers, the ranchers, and rural Americans across all corners of our great nation. And with that, I'll send it back to you, Brad.

Speaker 1

Kurt, thank you very much. I'm now going to turn to Greg to talk about financial results. But before I do, a quick comment on our CFO search. We have interviewed a number of outstanding candidates with really appropriate qualifications and expertise to be the next CFO of Farmer Mac. I've been gratified that Farmer Mac is seen as a very desirable career opportunity for many of these qualified people.

And I think it's likely that we'll get to an announcement in the form of press release and SEC filing well before our next earnings call. I would expect no later than right around the end of the year. We're fortunate that we have so much bench strength in our finance area, beginning with Greg, but also Julie, Jalpa, Rob Owens and others, so that we really haven't been operating with any material gaps in our capabilities for executing on what is a very large and fairly complicated balance sheet here at Farmer Mac. And with that, Greg? So

Speaker 5

according to our third quarter twenty nineteen results, our outstanding business volume increased by a net $186,000,000 to $20,900,000,000 as of September 3039. This increase was primarily driven by net growth of $102,000,000 in farm and ranch and $77,000,000 in rural utilities. Farmer Mac's net effective spread for third quarter twenty nineteen was $43,000,000 a 9% increase from $39,000,000 in third quarter twenty eighteen due to growth in outstanding business volume. In percentage terms, net effective spread for third quarter twenty nineteen was 0.9% compared to 0.93% in third quarter twenty eighteen. Core earnings for third quarter twenty nineteen grew 5% to $23,000,000 or $2.17 per diluted common share compared to $22,000,000 or $2.08 per diluted common share for 2018.

The year over year increase in core earnings was primarily due to the increase in net effective spread, partially offset by an increase in our operating expenses related to increased headcount and continued investments in technology and business infrastructure. Thus far our year to date operating expenses have increased by roughly 7% over the same period last year. As we've guided on previous calls, we still believe that our full year operating expenses will be higher than last year by approximately 8% to 9% due to various growth and strategic initiatives planned in the 2019. As of September 3039, the total allowance for losses was $9,800,000 or 13 basis points of the $7,400,000,000 farm and ranch portfolio, which is a $600,000 increase from the 2019. The increase was primarily related to some idiosyncratic factors of a few large loans, and really less related to systemic macroeconomic factors.

Turning to capital. Farmer Mac's $793,000,000 of core capital as of September 3039, exceeded our statutory requirement by $185,000,000 or roughly 30%. This compares to $787,000,000 of core capital as of June 3039. The increase was due to an increase in retained earnings, partially offset by growth in our outstanding business volume. We have more complete information about Farmer Mac's third quarter twenty nineteen performance in the 10 Q that we filed this morning with the SEC.

And with that, Brad, I'll turn it back to you.

Speaker 1

Thanks very much, Greg. A couple of comments before we go to questions. The first is that we had a sad development here at Farmer Mac a couple weeks ago when one of our directors, Carrie Vitruva, very unexpectedly, passed away. Carrie was a farmer, rancher in Western Nebraska, very astute businessman. He also served as the chairman of another farm credit institution, Agro Bank in Minnesota.

And I know that the entire board and management team of Farmer Mac really appreciate Carrie's service and we'll miss him a great deal. Reflecting on what has been communicated today, I can't underestimate or understate how proud the management team of Farmer Mac is of these third quarter results. We're beginning to see results from some of the initiatives that we started taking earlier this year and we believe that those initiatives will begin are beginning to put us on a trajectory for higher growth. In sum, it's been an excellent 2019 thus far. We believe the best is yet to come as we continue to execute and stay on that higher growth trajectory.

We have a healthy foundation execute upon. We're in great financial condition, all aspects of our operations. And we have a very dedicated employee base here that is becoming very committed to our long term strategy and the strategic initiatives, the key elements of our strategic plan that we've mentioned. We continue to focus on customer service and our mission to increase the availability and affordability of credit to rural America through our inherent competitive advantage, cost of funding, and very efficient product delivery. Just a reminder, we are 105 people here at Farmer Mac now managing about $5,000,000,000 of annual originations and a balance sheet now well over $20,000,000,000 All of these factors should allow us to significantly expand our market share, grow our top line and grow our bottom line, And with that, operator, we'd now like to make sure that we have an opportunity to answer any questions that anyone on the line may have for us today.

Speaker 0

We will now begin the question and answer session. To ask a question, you may press star then one on your touch tone phone. If you are using a speaker phone, please pick up your handset before pressing the keys. To withdraw your question, please press star then 2. Our first question comes from Scott Valentin with Compass Point.

Please go ahead.

Speaker 6

Good morning, everyone. Thanks for taking my question. Just with regard to, Brad, you mentioned $5,000,000,000 of originations, give or take, is kind of, guess, where you guys are at now annually. How do you see that growing over time? You mentioned all the initiatives you've put in place or have put in place and are putting in place.

Just wondering how the trajectory of that growth should happen over the course of, call it, next couple of years.

Speaker 1

Yeah. Scott, some of these growth initiatives are really just beginning. At the heart of some of the planning that we've been doing are other initiatives that we'll be rolling out and talking about early in February even into 2021. Some of them just need to be sequenced. So when we talk about gross originations, we also have to consider the fact that as we get bigger, we also have a higher amount of repayments and in some cases prepays or refinancings of commitments as well.

And so kind of bridging from that gross number to a net number, particularly this year when we've had about a, what, 125, one and fifty basis point decline in the ten year Treasury, which is an interesting reference rate for us, has to be taken into consideration as well. But if our CAGR right now is somewhere in the 5%, 67% range, our aspiration, we see very real possibilities of increasing that compounded growth rate materially, maybe as much as 50% or even more. 2020 will be a year where it'll be more challenging because we're just getting around to implement some of these strategies. But as we look out another year or two, beyond that, 2021, 2022, we think that is very realistic.

Speaker 6

Okay. That's very helpful. I appreciate that. Thanks. And then in the past, you mentioned the renewable energy credit participation you guys did.

In the past, I think was earlier this year, you did some participations with the farm credit system. Just wondering if there's more opportunity there. It's just a matter of, I know this can be lumpy from quarter to quarter, but wondering if you see more opportunity on the farm credit system side.

Speaker 1

Yeah. And just a comment on the solar, and then I'm going to turn to Zach on the farm credit. I think I've previously disclosed that we see renewable energy, particularly in rural America, as a very mission driven and profitable growth opportunity for us. The significance of the $10,000,000 deal that was part of a larger syndicated deal that was closed in October is that it was our first. We now have our first one done and we can build upon that.

And in fact, there are a couple of what I would describe as conduit like opportunities for renewable energy financings that almost start looking like our farm and ranch program where we have originating those more granular C and I style solar project finance opportunities for us. So we are looking for growth in that even before the end of the year but certainly into 2020. I'll let Zach comment on relationship with farm credit institutions because it's not only around rural electric cooperatives, it is around our agribusiness opportunities as well.

Speaker 3

Yeah, hi Scott, this is Zach. We've had significant amount of interaction and conversations with the Farm Credit System over the summer, into the fall, and I think one piece to highlight is how the opportunity set and how interested they are in partnering with Farmer Mac going forward. We have seen, as we've said in previous calls, our opportunities that we with these institutions, but also additional institutional partners, is pretty immense. So on the agricultural front, you know, our innovation efforts specifically revolve around how we can partner with new and existing institutions to deploy a larger amount of capital, specifically at what I would say in more unique and structured credit transactions, larger credit transactions such syndications, and really creating a flow business between our current customers and new customers, including the Farm Credit System, going forward.

Speaker 1

Scott, one follow-up comment. This is Brad again. You were commenting on the CoBank transaction. I think when you dive into the third quarter numbers, what you will see is that our outstanding business with rural electric cooperatives have increased during the quarter. And not because we did anything of the magnitude of a $540,000,000 portfolio of transactions, but because we're beginning to see just a nice flow of new transactions through both of our partnerships, both of our origination channels for rural electric cooperatives.

That's really what we hope to have going forward. It's just a steady stream of new kind of individual opportunities, with rural utilities, with rural electric cooperatives in addition to the renewable energy project finance that we mentioned.

Speaker 6

Okay, thanks. And then just I'll ask one more question and I'll get back in the queue. But on credit, I know, Kurt, thank you for the color on the various different agricultural verticals. Normal seasonality, first quarter, third quarter are kind of the weaker credit performance quarters. But just wondering, are you seeing any trends either by sector or geography that

Speaker 4

would give

Speaker 6

you pause for concern, or is it just kind of one offs?

Speaker 4

Thanks, that's a good question. In fact, we're kind of just seeing the exact opposite. We monitor our delinquencies and our credit quality really closely. What I would say is that when you look at it from a commodity perspective, there's nothing that stands out on any commodity that suggests we have a systemic problem. There's a lot of newspaper print about the corn and bean sector, but we just simply don't have a lot of issues in that area at all.

And from a regional perspective, it's pretty much all over the country. We have a few larger deals in certain states that represent probably a more lumpy portion of our delinquencies, but there's nothing there that would suggest we have anything systemic.

Speaker 1

Greg in his comments labeled it kind of idiosyncratic issues. Kurt recently took me through some analysis done of credits that we're keeping an eye on. You know, if there was any pattern there, it was more around issues such as divorce, death, other things, other than commodity cycle and commodity price driven delinquencies.

Speaker 6

Okay, thanks very much.

Speaker 0

The next question comes from Greg Pendy with Sidoti. Please go ahead.

Speaker 7

Hi guys. Thanks for taking my question. I just want I guess I know it's early innings on the renewable energy side with the two solar deals but can you help kind of give us, I guess, color on how maybe the company is viewing this market maybe different? I believe in the past, the company was involved with the ethanol market and just kind of how you're looking at it maybe differently from a risk management perspective and why, you know, you might see this market being different from ethanol?

Speaker 0

Absolutely.

Speaker 1

Greg, I've spent the last twenty years doing some of this, so I think my perspective is quite informed in addition to Brian and his teams and our credit counterparties as well. The most fundamental difference is that in liquids, liquid fuels, it's almost impossible to lock in long term net margins. You might be able to do a dirty hedge against index heating oil, for example, but you're going go out two, three years and that's going to be it. And the issue with ethanol was that plant, which is essentially a tolling instrument, getting stuck between a mismatch in the price trends of the value of the output and the cost of the input. What is different about solar energy project finance and some other types of project finance as well is that there exist opportunities to lock in margin for a twenty year period of time.

So these loans that we are doing in solar fully amortize over the life of the fixed price for output revenue contracts that we have with investment grade entities. And that means that given that the costs of a solar project are essentially all fixed price costs, you have a very predictable revenue stream to service the debt and pay for the fixed operating expenses such as insurance and maintenance associated with these projects. Bottom line is that these projects lock in very predictable margins for servicing debt for the entire period that we amortize debt. And that is a very fundamental difference.

Speaker 7

That's very helpful. Thanks a lot.

Speaker 0

The next question is a follow-up from Scott Belenton with Compass Point. Please go ahead.

Speaker 6

Thanks for taking my question again. Just in terms of two items. One, I guess the I think Curt, you mentioned the aid that's out there to farmers. Just wondering how that's impacted credit. I assume it's been a positive for credit given the aid that's flowing.

And two, it's early days and no one wants to make a prediction on China U. S. Trade, but there's been talk about China resuming agricultural purchases. Just wondering what you think that would do for the outlook for the farm economy? Thanks.

Speaker 4

Yeah, again, that's a really good question. So it's a net positive in terms of I think where we are on The US China trade agreement. There's a lot of optimism out in rural America. We talk to community bankers virtually every day. And we talk to many farmers to see this, and some of them, you know, I mean there's, when you go into a coffee shop, get a mixed bag of answers, right, and feelings about all this.

The MFP has been obviously a real benefit. And no farmer would choose to take that over higher commodity prices. But in the end, I think it's particularly, I can only speak to our portfolio, it's been beneficial for our portfolio in maintaining credit quality, and helping these farmers make it through, particularly the bean farmers, the soybean farmers, to make it through. But in the end, when I look at our portfolio, and we talk to many, many farmers and ag bankers, these farmers have done a really good job of controlling their costs. So it's not just how much revenue you've received and where it's coming from, but it's been their ability to manage their costs.

They've done just an exceptional job of that.

Speaker 6

And just in terms of if there is a resolution hopefully by year end on China U. S. Trade, I mean comparing credit demand where it was in early 'eighteen or sorry, early 'nineteen, I assume that would be positive for credit demand if farmers felt there was a deeper end market for product and maybe see more demand for credit starting in the planting season?

Speaker 4

Yeah, I think you'd see it as a net positive for sure. With the bankers we talked to, obviously, from the operating side, I think you'd see some relief there, and some optimism. From our perspective, we support 700 rural community banks across The US who come to us for the opportunity for many of these farmers to expand. And I think you would see that in this marketplace, so we see it as a net positive.

Speaker 6

All right, thanks very much.

Speaker 0

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

Speaker 1

Thank you, operator, and thank you all for listening and participating in our call this morning. We'll be having our next regularly scheduled call in February to report on our fourth quarter and full year results. And we look forward to sharing that information with you at that time. In the meantime, wish that you all have a fabulous Thanksgiving and holiday season. And as always the case, if you have follow-up questions, let us know.

We're happy to jump on the phone with you and talk further about any of these matters and anything else on your mind. Thank you very much.

Speaker 0

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