Federal Agricultural Mortgage Corporation
Q2 2013 Earnings Call Transcript

Published: 9 Aug 2013

[Operator:]

Good morning and welcome to the Federal Agricultural Mortgage Corporation Second Quarter 2013 Investor Conference Call. All participants will be in listen-only mode. (Operator Instructions) After today’s presentation, there will be an opportunity to ask questions. (Operator Instructions) Please note that this event is being recorded. I would now like to turn the conference over to Tim Buzby, President and CEO. Please go ahead.

[Timothy Buzby:]

Thanks Emily. Good morning. I am Tim Buzby, the President and CEO of Farmer Mac. The Farmer Mac management team and I are pleased to welcome you to our second quarter 2013 investor conference call. Before starting this morning, I will ask Steve Mullery, Farmer Mac’s General Counsel to comment on forward-looking statements that may be made today as well as Farmer Mac’s use of non-GAAP financial measures.

[Stephen Mullery:]

Thanks, Tim. 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. We do not undertake any obligation to update these statements after the date of this call. We caution you that forward-looking statements are subject to a number of risks and uncertainties. Actual risks 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, including those described in our most recent Annual Report on Form 10-K, our subsequent quarterly reports on Form 10-Q and our other filings with the SEC. Farmer Mac uses core earnings, a non-GAAP financial measure, to measure corporate performance and develop financial plans because in management’s view core earnings is a useful alternative measure for understanding Farmer Mac’s economic performance, transaction economics, and business trends. This non-GAAP financial measure may not be comparable to similarly labeled non-GAAP financial measures disclosed by other companies. Farmer Mac’s disclosure of core earnings is intended to supplement GAAP information and not to replace it. Both the 10-Q and the earnings press release we filed yesterday with the SEC contained a reconciliation of core earnings to GAAP net income. A recording of this call will be available on our website for two weeks starting later today.

[Timothy Buzby:]

Thanks, Steve. Overall this quarter we are pleased to report growth in business volumes, increased core and GAAP earnings and further improvements in credit quality. New business which came from contributions from all of our business lines and products raised our aggregate outstanding business volume to $13.6 billion as of June 30th. Second quarter core earnings were $16.5 million or $1.48 per share compared to $12.9 million or $1.17 per share in the second quarter of last year. The increase in core earnings was attributable to credit related gains of $700,000 or $460,000 after tax, a tax free gain of $3.1 million on the sale of an investment security and gain on the sale of real estate owned $1.1 million or $720,000 after tax. GAAP net income to common stock holders for the quarter was $27.7 million compared to a loss of $4.3 million last year. That significant improvement was primarily due to fair value changes on financial derivatives and hedged assets as we recorded net gains during the quarter this year compared to booking losses last year. In second quarter 2013 we added $647 million of new business volume which resulted in net growth of $158 million after maturities and prepayments. The most significant contributor to the net business volume growth was from our Farm & Ranch loan purchase business which grew at a net $172 million this quarter on $226 million of total purchases which was 56% higher than last year’s level. This reflects an ongoing trend of farmers refinancing their loans in the fixed rate mortgages as they consider the potential for increasing interest rate. Credit quality remains strong our 90-day delinquencies were $33.9 million were 0.69% of the Farm & Ranch loan portfolio as of June 30th 2013. An improvement from $47 million of delinquencies were 1.07% a year-ago. This continues a positive downward trend in delinquencies and seen our 90-day delinquencies decreased by more than half from $70.2 million or 1.63% back in 2010. With that as a background I’ll turn the call over to Dale Lynch our Chief Financial Officer to cover our financial results in more detail. Dale?

[Dale Lynch:]

Thanks Tim. As Tim mentioned our first quarter earnings core earnings were $16.5 million or $1.48 per diluted share this compares to $12.9 million or $1.17 per diluted share a year earlier. The $3.6 million year-over-year increase in core earnings in the second quarter of 2013 was driven by the $4.3 million in after tax realized gains and release of provisions that Tim mentioned earlier which was partially offset by a $1.1 million or $700,000 after tax decrease in net effective spread. Net effective spread of $26.1 million for the quarter compared to $27.2 million a year-ago on a percentage basis net effective spread contracted 12 basis points to 87 basis points this quarter due to general contraction in credit market spreads. Specifically lower rates on loans Farmer Mac guaranteed securities and USDA guaranteed securities combined with short term funding rates that did not decline compared to last year spread compressions. As we indicated on our first quarter conference call in April the advantageous short-term levels funding levels relative to LIBOR available to Farmer Mac in 2011 and the first part of 2012 return to levels more consistent with historical averages in the first quarter. And these levels remain stable through the second quarter. GAAP net income to common was $27.7 million or $2.48 per diluted share this quarter compared to a loss of $4.3 million or $0.41 per diluted share for the second quarter last year. That difference is almost entirely attributable to the effects of fair value changes and financial derivates and hedged assets. With the adoption of hedge accounting in the third quarter of 2012 we have reduced a substantial portion of the volatility, costs from changes in the fair values of financial derivatives. This will become more evident once comparisons are no longer made to periods before the adoption of hedge accounting which would be next question, third quarter of this year. On the undesignated portion of our derivative portfolio the general rise in interest rates in the second quarter of this year resulted in unrealized appreciation of $14.1 million. Which contrast to the general decline of interest rate in the second quarter last year which drove unrealized depreciation in that period. On the credit side total allowances and reserves for losses were $13.5 million as of the end of this quarter compared to $18.1 million in the year-ago quarter. Total net release of provisions were $700,000 this quarter compared to provisions of $174,000 last year. The net release of provisions this quarter was primarily the result of reduction in specific reserves as two loans were previously reserved for where been paid with only $70,000 of actual charge-offs. As Tim mentioned we achieved $647 million of new business this quarter and some of the key components were as follows. $226 million of Farm & Ranch loan purchases up 56% from last year. $200 million of Farm & Ranch AgVantage bonds which was flat up to last year, $100 million of Farm & Ranch standbys which was up 41% from last year. $111 million of USDA Guaranteed Securities which was down 33% from last year and $10 million rural utility loans purchased which was down 82% from last year. After re-payment we grew a net about $0.2 billion this quarter and our outstanding business volume. And this speaks to the benefit of our diversified portfolio where the strength in our Farm & Ranch line of business is offsetting a current environment with little net growth within rural utilities. Loans in Farmer Mac’s three lines of business continue to perform well in the second quarter. As Tim mentioned of $33.9 million our 90-day delinquencies are only 0.69% of our Farm & Ranch loan portfolio. As Farmer Mac considers the overall credit quality of this entire business we take into account more than this agricultural loan and delinquencies. A total program of business also includes AgVantage securities and rural utility loans neither of which currently have any delinquencies. And USDA Guaranteed Securities that are backed by the full phase and credit of the United States. On the total program businesses considered the overall level of 90-day delinquencies is just 0.25% this quarter compared to 0.26% as of December 31st 2012 and 0.38% in the year-ago quarter. As of quarter end our core capital of $564 million exceeded our statutory requirement of $385 million by $179 million for an excess capital percentage of 46%. In terms of liquidity current applicable regulations require Farmer Mac to hold a minimum of 60 days of liquidity and we target 90 days. As of June 30th 2013 Farmer Mac had 178 days of liquidity according to the methodology prescribed by our regulators. For more complete information about Farmer Macs performance for the quarter. Please see our Form 10-Q that we filed with the SEC yesterday. With that I’ll turn the discussion back to you Tim.

[Timothy Buzby:]

Thanks Dale. Our increase in outstanding business volume this quarter was our seventh straight quarter of growth. Our Farm & Ranch loan purchase business was the primary driver of this growth currently but we also believe we will see a return to growth over time within our rural utilities and USDA Guarantees lines of business when the general economy improves and once funding is replenished within USDA. Additionally over the long term we believe there will be further opportunities for us within rural utilities due to investment in the nation’s power generation and distribution infrastructure as investments are made for modernization. And there’s larger scale projects are undertaken in response to environmental regulations and clean energy initiatives. Overall this was a good quarter and a good first half of 2013 for Farmer Mac. We continue our focus of providing outstanding service to borrowers and lenders across rural America and are proud of the results we have been able to achieve for our shareholders. We’ll now take any questions that you may have.

[Operator:]

Thank you we’ll now begin the question and answer session (Operator Instructions) Our first question comes from [Evan Huddle] of Compass Point. Please go ahead.

[Unidentified Analyst:]

Good morning, everyone and congrats on another good quarter.

[Timothy Buzby:]

Thanks Evan good morning.

[Unidentified Analyst:]

Can you guys maybe talk a little bit more about the $3.1 million gain on the investment of security sales during the quarter?

[Timothy Buzby:]

Well as you know by regulation we were required to hold the liquidity investment portfolio and our regulations dictate what we can and cannot hold in that portfolio. From time to time we do sell securities out of that portfolio. This quarter we just happened to do so it was an investment in which we achieved a significant gain of $3.1 million. I would describe it as a one-time event not something that you should be modeling or thinking is going to happen on a regular basis but it does occur from time to time. Just as from time to time we will sell securities out of that portfolio at a loss. I think in general it’s, I would describe again it was one time event and wouldn’t expect to see something repeated like that on a regular basis.

[Unidentified Analyst:]

Okay and did you guys see any significant change or acceleration and origination volumes given the rate volatility seen during the quarter?

[Timothy Buzby:]

I wouldn’t say that the increase in rates during the quarter presented any significant increase in the purchase activity. We’ve seen increasing purchase activity in the Farm & Ranch portfolio over the past several quarters about 50% compared to last year. I think the increasing rates during the quarter however is sort of a broader signal that we’ve been talking about interest rates going up at some point in the future. And I think we’ve seen that now. It sort of stabilized over the last several weeks here. But I think it is the indication that many burrowers were looking for in terms of from a timing perspective when in fact the bottom will have been reached and it looks as that we passed that at this point.

[Unidentified Analyst:]

Okay that’s helpful. Okay and in kind of switching gears here, what’s sort of your base line expectation for the farm bill and how do you view that legislative process and the context in your business?

[Timothy Buzby:]

Well there is not a lot of positive moment that we’ve seen. We are keeping regular touch with members of Congress but for the most part the information that we have is what you’ve seen in the newspapers as well in terms of progresses being made and expectations. I think broadly in terms of the credit profile of our portfolio whether there is a new farm bill or farm bill extension or nothing occurs. The expiration on September 30th I don’t expect any immediate impact adversely on our portfolio. So we continue to monitor progress in Congress. We are hopeful that there will be a farm bill, less so for Farmer Mac but more for Farm & Ranch is to that.

[Unidentified Analyst:]

Okay and last one here. Are there any updates on the 250 million in preferred outstanding in terms of re-file, redemption opportunities?

[Dale Lynch:]

No update you are aware that, that is callable in the beginning of 2015 as we approach that quarter we’ll be looking at various possible options to restructure, replace or eliminate that security. But this time no update to…

[Unidentified Analyst:]

Thanks for taking my questions guys.

[Dale Lynch:]

Thanks [Evan].

[Operator:]

(Operator Instructions) And our next question comes from John Dunn of Sidoti & Company. Please go ahead. And Mr. Dunn your line is live, perhaps it’s muted on your end.

[John Dunn:]

Good morning guys. Great quarter.

[Timothy Buzby:]

Good morning John thanks.

[John Dunn:]

Good so just in general can you just give me a sense of how you guys view a good year for program asset growth. I mean do you have sort of a percentage where you would say that it was a good year?

[Timothy Buzby:]

Nothing specifically I think if you look back historically we would view our progress over the past several years as being successful and a combination of several good years. I think going back to say 2010 we were about a $10 billion company. Here we are in 2013 as a $13 billion company. So I think that’s a good trajectory for us going forward. As you’re aware that the business that comes in the Farmer Mac’s portfolio isn’t necessarily consistent quarter-over-quarter. So there are some ups and downs as we progress throughout the year, but I think that pace of $3 billion over three years that we've seen in the past is something that we would be pleased with going forward as well.

[John Dunn:]

Got you. And then more broadly can you talk about how higher rates are getting impacted you guys and particularly on the LTSPCs?

[Dale Lynch:]

Well with respect to the LTSPCs I don’t think higher rates have a direct impact as much as it would on other aspects of our business the long-term standby purchase currently that’s are off balance sheet. So from our portfolio perspective there is no interest rate risk from that standpoint. However as rate increase you could see more of refinances activity and if those refinances don’t come back to Farmer Mac you could see higher pay-offs with respect to that portfolio. In general higher rates not specifically related to your question but higher rates. We do think we’ll or have and we’ll continue to cause borrowers to look for long-term fixed rate products. And loans and we do think that is beneficial on an overall basis to the loan purchase activity that we’ve seen and hopefully will continue at an increasing pace for Farmer Mac.

[John Dunn:]

Right [LTSPCs.] And then on regulations can you just remind us about how the new, how changes are going to impact rural lenders and how that’s going to help you I mean is it just entirely about higher capital requirements or the other impact?

[Dale Lynch:]

Well that’s a big part of it I think in general when regulations increase and financial institutions are forced to look at. How they manage risk within their business. They look for other options and opportunities and assistance quite frankly. And we’ve always tried to position ourselves as a tool for lenders to use for risk management whether it be interest rate risk management or greater risk or capital ratio. So again as regulations become more restrictive on lenders we think that will bode well for Farmer Mac and the partnerships that we create with other lenders in rural America.

[John Dunn:]

Got you. And then just last one can you talk about merits of retaining loans versus securitizing and how that might change over next couple of years?

[Dale Lynch:]

Well for the most part Farmer Mac’s business model although we can securitize assets and that is certainly something we look at from time to time. We’ve largely been a buy and holder. And we feel that, that in within at least the current environment securitization is not quite as active and in general basis with that regard to were utilities loans or agricultural loans. We think the best value that we can deliver to lenders that they can then pass on the borrowers is through us using our own cost of funds and holding those assets currently. So I don’t anticipate a significant change in that model in the near term but certainly as things evolve, the interest rates change. And again as regulations change you may see something shift and there could be opportunities to securitize loans in future for us.

[John Dunn:]

Great. Thank you very much. Great job.

[Dale Lynch:]

Thanks John.

[Operator:]

And this concludes our question and answer session. I would like to turn the conference back over to Mr. Buzby for any closing remarks.

[Timothy Buzby:]

Since there are no more questions I would like to thank you for listening and participating this morning. And look forward to our next call to report our third quarter results in November. Thank you very much.

[Operator:]

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