Federal Agricultural Mortgage Corporation
Q3 2013 Earnings Call Transcript

Published: 13 Nov 2013

[Operator:]

Good morning. Welcome to the Federal Agricultural Mortgage Corporation Third Quarter 2013 Investor's 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. Now, I would like to turn the conference over to Timothy Buzby. Mr. Buzby, please go ahead.

[Timothy L. Buzby:]

Thank you. Good morning. I'm Tim Buzby, the President and CEO of Farmer Mac. The Farmer Mac management team and I are pleased to welcome you to our third 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 P. 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. Please note that last night we filed an amended quarterly report on Form 10-Q/A for third quarter 2013 to correct the technological error that resulted in the required CEO and CFO certifications being omitted from the original filing yesterday afternoon. 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 Form 10-Q/A and the earnings press release for third quarter that we filed with the SEC contain a reconciliation of core earnings to GAAP earnings. A recording of this call will be available on our website for two weeks starting later today.

[Timothy L. Buzby:]

Thanks, Steve. We are pleased to report continued and profitable growth in business volume and further improvements in credit quality. This quarter we added new volume across all business lines and products at net effective spreads that meet or exceed our current average spreads. This volume raised our aggregate outstanding business to $13.8 billion as of September 30, which represents a 10.4% growth compared to a year ago. Also, credit quality continues to improve with 90-day delinquencies lower in the both dollar and percentage terms compared to both last quarter and third quarter 2012. Core earnings this quarter were $11.8 million or $1.05 per share compared to $13.4 million or $1.22 per share in third quarter 2012. The decrease was primarily the result of lower net effective spread which resulted primarily from run-off of older, higher margin Farm & Ranch loans, combined with the effect of refinancing existing floating rate assets at higher costs. There was some volatility in agency spreads during the quarter, driven largely by events in Washington that contributed to this higher refinancing expense. On the plus side, higher volumes and stable margins partially offset these factors. The impact from run-off business is usually seasonally higher in the first and third quarters of each year for Farmer Mac due to the typical January and July payment dates of our Farm & Ranch loans. If you look historically, there tends to be a pattern of declining average Farm & Ranch net effective spreads in the first and third quarters, followed by spread stabilization and recovery in the following quarters. For example, Farm & Ranch net effective spreads decreased 7 basis points from second to third quarter this year. In 2012, there was a similar 8 basis point decrease from second to third quarter and in 2011, the decrease was 13 basis points. Prepayments can be particularly high when rates are falling. But as we expect interest rates to rise, we'd expect prepayments to slow. Future seasonal periods experiencing fewer prepayments and a broader slowdown in prepayments in general should allow our new business growth to positively impact our net effective spread over time. While core earnings for second quarter of 2013 were $16.5 million. If you adjust for gains on the sales of investment securities and REO properties as well as hedging costs, second quarter core earnings was similar to the $11.8 million earned this quarter. Core earnings for the nine months ended September 30, 2013 were $39.6 million or $3.54 per diluted common share, up from $38 million or $3.47 per diluted common share for the nine months ended September 30, 2012, as business volume growth gains from the sale of certain assets and favorable credit performance offset the dilution from run-off business and tighter spreads in 2013. GAAP net income attributable to common stockholders for the quarter was $15.4 million or $1.37 per share compared to $16.4 million or $1.49 per share last year. The decrease in Farmer Mac's net income in third quarter 2013 compared to the previous year was mostly due to lower net interest income mentioned previously. GAAP net income for the nine months ended September 30, 2013 was $59.3 million or $5.30 per diluted common share, up from $34.3 million or $3.12 per share for the nine months ended September 30, 2012. That increase was due to a growth in non-interest income primarily resulting from unrealized gains on derivatives. In third quarter 2013, we added $821 million of new business volume which resulted in net growth of $191 million after maturities and prepayments. The most significant contributor to net business volume growth this quarter was from our Farm & Ranch AgVantage securities business which grew at a net $102 million this quarter on $104 million of total purchases. Additionally, Farm & Ranch loan purchases were $193 million which is an increase of 45% over last year. This reflects an ongoing trend to farmers seeking longer term fixed rate mortgages as they consider the potential for increasing interest rates. Credit quality remains strong. Our 90-day delinquencies were $33 million or 0.66% of the Farm & Ranch loan portfolio as of September 30, 2013 that's down from $40.8 million or 0.93% a year ago. This also marks a sequential reduction in delinquencies from the June 30, 2013 amount of $33.9 million or 0.69% and continues a favorable trend in delinquencies that has seen our 90-day delinquencies decrease by more than half since 2010 when they were $70.2 million or 1.63%. Historically, our current credit qualities is at very favorable levels and while we could see some minor variations up or down from here, we would not necessarily view such variations as material changes to the current overall favorable trend. With that as the background, I'll turn the call over to Dale Lynch, our Chief Financial Officer, to cover our financial results in more detail. Dale?

[R. Dale Lynch:]

Thanks, Tim. Third quarter core earnings were $11.8 million or $1.05 per diluted share, as Tim mentioned, compared to $13.4 million or $1.22 per diluted share a year earlier. The $1.6 million year-over-year decrease in core earnings in the third quarter of 2013 was caused by a $1.5 million or $1 million after-tax reduction in net effective spread. Driven by the business run-off and refinancing expenses, as Tim mentioned, in the absence of the amount of [indiscernible] we experienced this quarter, our core earnings would have grown accordingly with the net growth of our business volumes and increase of non-interest operating expenses of $218,000 or $142,000 after tax as well as an increase in preferred dividends, other and tax-related expenses of $295,000 after tax contributed to the reduction in core earnings. These factors were partially offset by an increase in guaranteeing commitment fees of $455,000 or $296,000 after tax and a reduction in credit related expenses of $213,000 or $138,000 after tax. Net effective spread was $25.8 million for the quarter compared to $27.3 million a year ago. On a percentage basis, net effective spread contracted 12 basis points from a year ago to 83 basis points due to seasonal repayments of existing Farm & Ranch loans with higher spreads and higher refinancing expenses for existing floating rate assets. While the average rate on our short-term debt has not changed in absolute terms compared to a year ago, the shorter term funding levels which have typically swapped the floating rates of interest have become less favorable relative to LIBOR. This less advantageous funding level compared to swaps reduced the margin on existing floating rate assets and was largely a result of the volatility in agency spreads in the third quarter. Over time, we would expect these levels to normalize. GAAP net income to common was $15.4 million or $1.37 per diluted share this quarter compared to $16.4 million or $1.49 per diluted share for the third quarter last year. That difference was almost entirely attributable to a reduction in net interest income which was partially offset by increases in other non-interest income. Total allowances and reserves for losses were $13.4 million this quarter or 0.27% of total Farm & Ranch loans as of the end of this quarter compared to $17.8 million or 0.4% of total Farm & Ranch loans in the third quarter of 2012. Net release of provisions were $36,000 this quarter compared to a net provision of $94,000 in the prior year's third quarter. Net release of provisions this quarter is primarily a result of a reduction in the general reserve and this is consistent with the improving credit quality that Tim mentioned earlier. We achieved $821 million of total new business this quarter which was similar to the $841 million in new business in the year-ago quarter. But a substantial increase in the $647 million in new business we achieved in the second quarter of this year. Key components of this which is really spread across all of our lines of business and product were as follows. $193 million of Farm & Ranch loan purchases, $199 million of Farm & Ranch standbys which is a significant increase from previous quarters, $250 million of rural utilities AgVantage bonds, $104 million of Farm & Ranch AgVantage bonds, $70 million of USDA Guaranteed Securities and $5 million of rural utility loan purchases. After repayments, the net $191 million that we grew our outstanding business volume this quarter speaks to the benefit of our diversified mix of business with the strength in our Farm & Ranch lines of businesses offsetting a current environment with less net growth within rural utilities and the USDA Guarantees. From a credit perspective, loans and Farmer Mac's three lines of business continues to perform well in the third quarter this year. As Tim mentioned, that $33 million or 90-day delinquencies are 0.66% of the non-AgVantage Farm & Ranch loan portfolio. As Farmer Mac considers the overall credit quality of this entire business, we take into account more than just the agricultural loan delinquencies. Our 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 faith and credit of the United States. When a total program business is considered, the overall 90-day delinquencies is just 0.24% compared to 0.26% as of the end of the year 2012 and 0.33% as of September 30, 2012. On the capital side, at quarter end, our core capital of $578 million exceeded our statutory minimal capital requirement of $390 million by $189 million or an excess of nearly 50%. As of September 30, 2013, total equity was $605.2 million compared to $593 million as of December 30, 2012. We experienced a $55.5 million increase in retained earnings but this was offset partially by a $47.1 million decrease in accumulated other comprehensive income, AOCI. This change in AOCI resulted primarily from reductions in unrealized appreciation on available-for-sale securities due to increases in interest rates in 2013. I would just note that we intend and fund these assets to hold them to maturities, so these unrealized gains and losses really should [indiscernible] as we get closer to maturity on these instruments. In terms of liquidity, current applicable regulations require Famer Mac to hold a minimum of 60 days of liquidity. As of September 30, 2013, Farmer Mac had 168 days of liquidity according to the current methodology prescribed in the regulations. FCA recently approved a final rule to revise the current regulations governing the management of liquidity risk at Farmer Mac, which is expected to become effective during the second quarter of 2014. These new regulations will require Farmer Mac to hold a minimum of 90 days of liquidity and will revise the methodology for determining Farmer Mac's liquidity reserve, but we don't expect our compliance with this new reg to totally affect our operations or our financial condition. More complete information about Farmer Mac's performance for the third quarter of this year is set forth in Form 10-Q/A which we filed with the SEC yesterday. With that, I'll turn the discussion back to you Tim.

[Timothy L. Buzby:]

Thanks, Dale. We've achieved $771 million in net business volume growth so far this year with increases in Farm & Ranch loan purchases and new AgVantage bonds within both Farm & Ranch and rural utilities putting us at a double-digit overall annual growth for the year. And this quarter actually marks the eighth straight quarter of net growth for the company. With that said, we're also focused on producing reliable and growing core earnings which should increase the book value of our common shares over time. As we've seen, there can be modest variances up or down to our core earnings in any given quarter, but the underlying trends of our business are favorable with core earnings trending higher over the last several years. In summary, this is due to some simple fundamentals adding new business at good spreads while maintaining a strong portfolio credit profile. Management takes a long-term view of Farmer Mac's business and we believe our results reflect this. Overall, we are pleased with our results and progress this quarter and for the year-to-date and look forward to a strong finish for the year. Our management team is proud not just for the results we've achieved but also of our standing as a good partner for our customers and as a resource to borrowers and lenders across rural America. We'll now take any questions you may have.

[Operator:]

Thank you. We will now begin the question-and-answer session. (Operator Instructions). The first question comes from Evan Hutto from Compass Point.

[Evan Hutto:]

Good morning, everyone and thanks for taking my call.

[Timothy L. Buzby:]

Good morning, Evan.

[Evan Hutto:]

In terms of the elevated repayments in the quarter, I know this is largely a seasonal effect, but do you know how much or I guess what percentage of the repayments were a result to schedule maturities versus actual prepayments?

[Timothy L. Buzby:]

We don't specifically breakout the two. We do in our 10-Q filing disclose the expected schedule prepayments. So you could do the math and figure that out if you looked at last quarter's 10-Q. We are considering breaking out that disclosure for future periods.

[Evan Hutto:]

Okay. And I guess to sort of piggyback on that, has there been any change in repayments speeds or behavior, I guess I should say in 4Q?

[Timothy L. Buzby:]

Well, for fourth quarter we haven't seen those come in yet, but for the year they have been elevated this year compared to prior years as we've seen farmers looking at their outstanding debt, having a favorable trend toward longer term fixed rates and repaying older loans that have higher interest rates. So this year we have seen elevated prepayments compared to prior years.

[Evan Hutto:]

Okay, that's helpful. And in the release you all mentioned that new business from 3Q was kind of generally that or above your average spreads. I guess how should we think about where your net effective spread will kind of trend going forward assuming where they are now? Will it sort of be closer to the historical average in 4Q or will it still be under pressure heading into '14?

[Timothy L. Buzby:]

Well, for fourth quarter it will depend again on prepayments. What we saw this third quarter was that we did add new business at spreads that were higher than our average in prior quarters, but the payoff of the loans that were being prepaid were at spreads that were considerably higher causing an overall net reduction. We do see higher prepayments in third quarter than we typically see in fourth quarter. So we would expect a stabilization or perhaps a slight increase in fourth quarter assuming all else is equal.

[Evan Hutto:]

Okay, that's helpful. And then my last one. In terms of origination growth, it appears you got that nice sequential pickup in rural utilities and in some of the off-balance sheet product. Was there anything specific driving these pickups or…?

[Timothy L. Buzby:]

Well, the AgVantage bonds that occur, those generally are based on customer needs and are not trending in terms of quarter-to-quarter volumes. Some quarter we issue those bonds and some quarters we don't. With respect to the ongoing loan purchases, we've seen heavy activity in the Farm & Ranch business and a slowdown in the activity in terms of rural utilities. I would expect to see that trend continue in fourth quarter. We have a very good, strong base and pipeline of the Farm & Ranch loan activity and again, rural utilities we would expect to continue at a somewhat slower pace during fourth quarter but both of those trends could obviously change again as we get into next year.

[Evan Hutto:]

Okay. That's all I had, guys. Thanks.

[Timothy L. Buzby:]

Thanks, Evan.

[Operator:]

Thank you. (Operator Instructions). Our next question comes from John Dunn with Sidoti & Company.

[John Dunn:]

Good morning, guys.

[Timothy L. Buzby:]

Good morning, John.

[John Dunn:]

Yes, I'm also liking [ph] the quarter. So seasonality obviously had an impact in terms of quarter-over-quarter growth but it was still strong. Do you think some 4Q growth got pulled forward a little bit or you still think there's going to be a noticeable, seasonal reversal?

[Timothy L. Buzby:]

No, I don't think anything got pulled forward and we think actually some of our expected business volume may have gotten pushed off with the government shutdown and some of the funding for the USDA Guarantees business, you can see that dropped off in third quarter not to say that that necessarily is going to lead to higher volume in fourth quarter. We did see a slowdown in that business in third quarter and we would expect that to possibly return to the prior levels.

[John Dunn:]

Got you. And then do you guys have any preliminary thoughts on 2014 growth and/or the trends for next year?

[Timothy L. Buzby:]

Well, we've seen large increases from a percentage standpoint in terms of Farm & Ranch purchases. I think we're up about 50% compared to the prior year. That has been growing over the course of the past several years and we are seeing some momentum in terms of new sellers signing up and more activity from a larger group of lenders. We only have a certain amount of visibility in terms of rate locks, et cetera, but at this point I would expect 2014 to again be strong in terms of Farm & Ranch loan purchase activity.

[John Dunn:]

Got you. And you gave us some good info on 4Q spread compression, but in 2014 do you have any thoughts?

[Timothy L. Buzby:]

That's a little far out to tell. Again, I think as we see fewer prepayments of the older business and new business coming on with attractive spreads, we'd hope that that would stabilize and spreads would actually improve.

[John Dunn:]

Got you. And then just last, anything in 4Q on the expense control front, I mean you guys have done a good job this year, but anything that you're marking for?

[Timothy L. Buzby:]

Nothing in particular. We always look very closely and try to be as efficient as we can in terms of both headcount, locations and other things. We're always looking to reduce expenses where we can. That being said, as business growth occurs, the Farm & Ranch loan underwriting side of the business that is probably if we continue to see growth there, that could lead to additional headcount, nothing significant but generally in terms of the expenses overall we're pretty comfortable with where we are. We don't see any large areas where we can go in, for instance, and reduce expenses significantly.

[John Dunn:]

Got you. Great. Thank you very much. Nice job.

[Timothy L. Buzby:]

All right, thanks John.

[Operator:]

Thank you. There are no more questions at the present time, so I'd like to turn the call back over to management for any closing comments.

[Timothy L. Buzby:]

Thanks. With no more questions, thank you for listening and participating this morning. I look forward to our next call to report our year-end results in March. Thank you and goodbye.

[Operator:]

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