Federal Agricultural Mortgage Corporation
Q1 2018 Earnings Call Transcript

Published: 12 May 2018

[Operator:]

Good morning, and welcome to the Farmer Mac First Quarter 2018 Investor Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Lowell Junkins, acting President and Chief Executive Officer. Please go ahead.

[Lowell Junkins:]

Good morning. I’m Lowell Junkins, Farmer Mac’s Acting President and CEO. Farmer Mac is pleased to welcome you to our first quarter 2018 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.

[Steve Mullery:]

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-K and our subsequent quarterly report on Form 10-Q, which is 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, they 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 is 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.

[Lowell Junkins:]

Thank you, Steve, and thanks for all of you that joined us this morning. Our first quarter 2018 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 $19.4 billion. 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 in 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 its 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 class 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?

[Dale Lynch:]

Thanks, Lowell. Farmer Mac is a one-of-a-kind financial services company with a compelling mission. It provide a unique combination of high-quality assets and the 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 billion 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 2018 results reflect the ongoing strength of Farmer Mac’s business model throughout market cycles. As business volume increased $0.4 billion, core earnings exceeded $21 million and credit quality remained favorable. In terms of business volume, as you can see on Slide 6, outstanding volume grew to a record $19.4 billion as of March 31, 2018. We completed more than $1.4 billion of new business during the quarter, resulting in net growth of approximately $400 million after maturities and repayments. This increase in outstanding business volume was driven by net growth in our Institutional Credit, Farm & Ranch and USDA lines of business. We purchased $813 million of AgVantage securities in the first quarter which resulted in net growth of $421 million. The increase was driven by two of our long-standing counterparties

[Lowell Junkins:]

Thanks, Dale. Farmer Mac’s business model is striving as we continue to deliver upon the mission throughout agricultural economic cycles. Our capital base is strong and growing, providing capacity for future growth, and 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 capacity to better grow our business. Farmer Mac has been a champion for and an integral part of this nation’s rural economy now for 30 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 that last update, the search committee has continued to solicit stakeholder feedback and has developed the 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.

[Operator:]

[Operator Instructions] The first question comes from Scott Valentin with Compass Point. Please go ahead.

[Scott Valentin:]

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

[Dale Lynch:]

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 million. 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 million. 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.

[Scott Valentin:]

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

[Dale Lynch:]

Yes. Look, our Farm & Ranch loan businesses have been the growth driver for five years. I guess, it’s been growing 20%, 25% year-over-year for at least five years and our AgVantage business has also been growing in that sort of 7%-ish range, which on a big base is pretty healthy growth. So the strategies that you’re referring to remain intact around wholesale funding and trying to push that out to more counterparties. We did for $30 million this quarter with five other smaller counterparties that reflect sort of the financial universe that we have spoken with you in the past. And 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.

[Scott Valentin:]

Okay. And then just a question on credit. It was very stable this quarter. Obviously, there’s some 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? Are they reacting to potential tariffs? And what kind of contingency plans would they have?

[Curtis Covington:]

This 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. In talking to most of the sellers, I think the biggest concern, obviously, is in the 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, and then been actually fairly optimistic that and what we’ve been hearing is, is that the volume of activity in those countries right now continues to be pretty strong.

[Scott Valentin:]

Okay, all right. I’ll get back in the queue. Thanks very much.

[Operator:]

The next question comes from Eric Hagen with KBW. Please go ahead.

[Eric Hagen:]

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?

[Dale Lynch:]

Sure. Thanks, Eric. I think the counterparties in that space are financials. And at some level – I mean, they’re 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 – 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 a 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, I think it’s a little bit less sensitive than, say, an individual farmers volume would be. So we’re less concern. The issue for us is really pushing that – 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.

[Eric Hagen:]

Yes. No doubt that that’s really positive. I guess, just one more on that. I mean is – what’s the different 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?

[Dale Lynch:]

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-, I don’t know, but they’re not all that different from a Farm & Ranch portfolio in terms of the spreads that we charge, right, as compared to MetLife, the spreads may be 40, 50, 60, 70 basis points depending on maturity spreads. The smaller counterparties may more closely approximate our Farm & Ranch portfolio.

[Eric Hagen:]

Yes. That’s a helpful answer, Dale. And then forgive me for just a slight technical question. But the move that we saw on three months 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 assets side? I guess, you’re kind of getting around where I’m going with that question.

[Dale Lynch:]

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 up 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 the three-month LIBOR.

[Eric Hagen:]

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

[Dale Lynch:]

No. I 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, 24 months in our funding on our refinancing business has been far or 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.

[Eric Hagen:]

Yup. Great. Thanks to that response. Appreciated.

[Operator:]

[Operator Instructions] The next question comes from Brian Hollenden with Sidoti. Please go ahead.

[Brian Hollenden:]

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

[Dale Lynch:]

Yes, I would say it was in line with the expectations. I mean, some of the repayments have slowed down a bit. I’ll say it’s because in certain sectors of the economy, we’ve seen, obviously, some stress, particularly corn bean sector, within cattle sector and certainly in hog sector it seems some of that as well. We don’t have a lot of exposure to those last 2. But I would say that those were pretty much in line with what we had expected.

[Brian Hollenden:]

All right. And then are you surprised at all about how long 90-day delinquencies have persisted below the historical average?

[Dale Lynch:]

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 lot of discussions with our seller banks. And our seller banks are telling us the exact same thing that we’re seeing, and that is our 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 on the economy, there’s still a good bulk of customers out – there are many of whom those loans are sold to us that even at prices where corn 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 talk to many of our seller banks who are also telling us the exact same thing.

[Brian Hollenden:]

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 to up one or two basis points year-over-year for 2018?

[Dale Lynch:]

Yes, unless there’s some major change in the market on our refinancing business, our goal for the year is to maintain a 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 the 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 & Ranch business just to – pretty strong bid for the best credit quality business out there, right? When markets get tighter, you may pay up for the best business. And there might be that dynamic. But 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.

[Brian Hollenden:]

All right. And then last one from me just on the expense side. G&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.

[Dale Lynch:]

You mean in terms of percent growth?

[Brian Hollenden:]

Yes.

[Dale Lynch:]

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 a 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.

[Brian Hollenden:]

Okay, got it. Thank you.

[Operator:]

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

[Lowell Junkins:]

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

[Operator:]

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