Q1 2022 Federal Agricultural Mortgage Corp Earnings Call
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Okay.
Good afternoon, and thank you for joining us for our first quarter 2022 earnings conference call I'm, dropping Nazareth director of Investor Relations and finance strategy here.
As we begin please note that the information provided during this call may contain forward looking statements about the company's business strategies and prospects, which are based on management's current expectations and assumptions. These statements are not a guarantee of future performance and are subject to the two risks and uncertainties that could cause.
Our actual results to differ materially from those projected please refer to farmer Mac's 2021 annual report and subsequent SEC filings for a full discussion of the company's risk factors.
On today's call. We will also be discussing certain non-GAAP financial measures disclosures and reconciliations of these non-GAAP measures can be found in the most recent Form 10-Q and earnings release posted on farmer Mac's website farmer Mac Dot com under the financial information portion of the investors section.
Joining us from management. This afternoon are our president and Chief Executive Officer, Brad Nord home, who will discuss first quarter business and financial highlights and strategic objectives, and our Chief financial Officer of Parnell, Ramesh, who will provide greater detail on our financial performance select members of our management team will also be true.
Joining us for the question and answer period at this time I'll turn the call over to President and CEO , Brad normal bread.
Thanks, Joe and good afternoon, everyone I'm really pleased that you're able to join us today.
I'm happy to report a very successful first quarter 2020 to our financial results are strong as we'll be discussing and we also are working to build upon a solid foundation for our future growth.
You provided a gross $3 billion in liquidity and lending capacity the lender serving rural America in the first quarter 2022. This result is an outstanding business volume of $24 $2 billion as of March 31, we generated consistent core earnings and most importantly, our.
<unk> remains strong and credit performance continued to be stable with 90 day delinquencies and substandard asset ratios improving relative to the same period last year.
The agricultural finance a line of business, which is approximately 75% of our total outstanding business volume and comprises all products secured by first liens on agricultural real estate, plus all USDA guaranteed loans.
Grew approximately $500 million this quarter or roughly 3% and this was primarily due to our advantaged securities and farm and ranch loan purchase programs.
We are pleased to see our strong institutional relationships and the overall dynamics of the macroeconomic environment that have resulted in our ability to return as an invaluable partner and our wholesale financing space.
At the onset of the pandemic opportunities for new business volume in our AG Vantage Securities program were limited.
Liquidity support provided by the Federal Reserve Bank resulted in the tightening of investment grade credit spreads to historically low levels and increased competition in.
Net farm and ranch loan purchase volume was stronger in the first quarter. Despite a seasonally large number of payments.
Because most of our farm <unk> ranch loans have annual and semiannual payment terms with January 1st payment dates.
During the first quarter markets experienced the disruption caused by a combination of factors, including inflation, a federal funds rate increase expectations for future increases as well as the conflict in Ukraine.
Farm expenses are rising in nearly all categories with higher grain fertilizer energy and labor prices driving the trend and the impacts of these increases will vary by operation and commodity type.
We believe the sector is operating expense ratio is likely to increase back towards a historically high level.
However firm commodity in food prices do leave room for farm profits this year.
The USDA is forecasting record net cash used homes for 2022.
While production expenses are forecast to increase in government payments are expected to fall rising cash receipts should offset these changes with recent commodity price data, suggesting that even stronger incomes are possible.
In terms of our portfolio, while we anticipate the future lower financings could result in lower levels of new loan purchases and some of our farm <unk> ranch and USDA products.
It could also result in lower portfolio prepayments speeds.
Our pipeline in this line of business remains strong and we will continue to be adaptive as we navigate through this environment that is characterized by significant uncertainty.
Our rural infrastructure Finance line of business grew nearly $150 million this quarter or 2%, primarily due to our loan purchase product.
This growth was fueled by a competitive but increasing interest rate environment.
Solving a demand for long term financing solutions for planned maintenance and capital expenditures.
Also contributing to growth this quarter and rural infrastructure line.
This was a $35 million commitment to a large solar project.
As I've said on prior calls renewable energy as both an important economic development opportunity for Rural America, and it's a business opportunity for us.
Another business opportunity for farmer Mac as our securitization program.
As mentioned in our last earnings call over the last few months, we've been focused on enhancing our infrastructure to support our securitization program and we are closely monitoring a changing market dynamic.
The market for new issue Securitizations was challenged during the first quarter as the volatility in the debt capital markets resulted in somewhat of a slowdown in securitization markets.
We remain committed to being a regular issuer in the market with a diverse set of securitized products that align with our investor interests.
With that said in the near term our plan is to slowly ramp up the number of issuances each year as we focus on building a strong foundation for the program.
Farmer Mac continues its measured and thoughtful investment in people technology and business infrastructure to improve our capacity and efficiency.
And we believe these will help us deliver on our long term goals.
We set meaningful market share goals for ourselves in our strategic plan and to achieve these goals over the long run we're going to need to be able to achieve gross annual business volumes that represent the growth over our current asset levels.
That's an example of our efforts to upgrade our technology platform, including doubling the eligible loan size for our egg express scorecard products from $1.5 million to $3 million and.
And upgrading and enhancing this underwriting solution to achieve this outcome will require appropriate investments.
Another initiative currently underway at farmer Mac is our rebranding efforts, which are currently in early stages.
We recognize that we have grown significantly in size over the last few years and as a result, we are reaching a larger set of audiences to stakeholders with different profiles, but all with a shared passion for rural America.
We hope that through our rebranding initiative, we're able to better to gain deeper insight from each of our stakeholders in order to continue to build on our strong reputation and as.
As the nation's key trusted secondary market for credit to Rural America.
The continuity of our culture and business model continues to deliver consistent positive results.
With the support of our board, we believe that our unified commitment to farmer Mac's strategic plan in conjunction with the organization's talented and committed employee base is enabling us to take farmer Mac to the next level.
Now I'd like to turn the call over to a part of our Chief financial officer to discuss our financial results in more detail our partner.
Thank you Brad and good afternoon, everyone core earnings for first quarter, 2020 to $25 $8 million or $2.37 per diluted common share compared to $30 million or $2.75 per diluted common share and fourth quarter 2010.
One and $25 9 million or $2.49 per diluted common share for the same period last year.
The sequential decrease was due to the non recurrence of the fourth quarter of 2021 $5 $2 million after tax gain on sale of mortgage loans, a net change in our total allowance for losses of $1 1 million after tax and a point $7 million after tax increase in operating expenses. These.
Factors were partially offset by $2 8 million after tax increase in net effective spread.
The year over year decrease in core earnings was primarily due to a $2 million after tax increase in operating expenses and the $1 5 million dollar increase in preferred stock dividends. These factors were partially offset by $3 1 million after tax increase in net effective spread.
Net effective spread for first quarter, 2022, but $57 $8 million, an approximate 7% increase compared to fourth quarter 2021, and the same period last year, the sequential and year over year improvement in net effective spread was primarily driven by net new business volume and cash.
Pieces interest income.
Also contributing to the year over year increase with an increase in net coupons.
Related to the acquisition of loan servicing rights in third quarter 2021.
Our liability side of the balance sheet remained strong as we continue to benefit from a dynamic funding strategies that we've outlined to you in the past and we've continued to maintain our disciplined asset liability management.
Actually we continue to very carefully analyzed our duration and convexity matches, especially in this rising rate environment to minimize our interest rate risk.
Last quarter, we introduced operating segments to allow us to offer more transparency into the various contributing components of our portfolio net effective spread.
Implemented a funds transfer pricing or FTP methodology.
This process allows us to allocate the interest expense much more accurately to each of the operating segments since.
Since funds transfer pricing or SDP assumes a match funded asset liability management approach it allocates booked benefits as well as the costs from the funding and hedging strategies to the funding segment. There's also allocates. The result of the investment portfolio that'd be primarily hold for liquidity purposes. We.
Belief that the new segment reporting construct provides shareholders and other stakeholders with clearer insight into the benefits of our disciplined alien practices and dynamic funding strategies and how they ultimately contribute to enterprise profitability.
The successful execution of a $299 4 million dollar agricultural mortgage backed securitization in October was a key contributor to our core earnings results and fourth quarter of 2021, while we have spent the last few months identifying ways to potentially execute these transactions more efficiently and we hope to have it.
Turning to the market to see it with another securitization transaction, we are taking a more measured approach and are shocked them just as Brad mentioned recognizing that current market dynamics are resetting credit market perspective, and read outlook first quarter 2022 was extremely challenging for the securitization market as the evolving macro reasons.
And has contributed to spreads widening and interest rate volatility that is increasing throughout the quarter.
We are however, still committed to building a robust securitization program, which we believe will provide farmer Mac with an opportunity to diversify funding sources and fulfill our mission of delivering low cost liquidity, even more effectively our current focus therefore strengthening the platform and remaining opportunistic in terms of timing and structure to ensure.
We are not issuing in the face of volatility and uncertainty and that could continue to create value for our shareholders with these and other transactions.
Operating expenses increased by 13% in first quarter 2022, compared to first quarter 2021, and this was primarily due to increased head count, including 10, new employees in connection with the strategic acquisition of loan servicing rights in third quarter 2021 increased stock compensation and increased spending on.
Software licenses in information technology, and other consultants to support growth and strategic initiatives, some of which Brad mentioned earlier.
The increase in loan servicing expenses are expected to be offset over a multiyear period by additional revenue that will be reflected in higher spreads in our farm and ranch segment, where we will not be paying a third party for servicing the loans that we will now service and this should make the initiative neutral to accretive for us in the midterm.
The remaining hires brought on to drive additional volume growth and support our long term technology strategy.
We plan to continue our investments in both headcount and technology through 2020 and into 2023, and this will be primarily to modernize and mitigate risk in our infrastructure and handset technology platforms to support our revenue and hedging strategies and add relevant talent across the organization, especially as we scale and enter into new areas of business.
As such as renewable energy and telecom over the next 12 to 18 months, we will continue as we've done before to closely monitor our efficiency ratio, which ended March 31st 2020% to 33%.
Going forward, we expect operating expenses to increase commensurately with revenue growth, but as we've noted previously we expect to stay within an annual range that is consistent with our historical averages and below a 30% operating efficiency level.
Our credit profile continues to be strong as of March 31st 2022, the total allowance for losses was $16 $3 million or more.
This decrease from year end 2021. This decrease was primarily attributable to a risk rating upgrade on a single loan related to the borrowers successful securitization of a large payable that was incurred as a result of the Arctic freeze that struck Texas in February of 2021, and this was partially offset by new loan volume.
Turning to capital now farmer Mac's $1.2 billion of core capital as of March 31st 2022 exceeded our statutory requirement by $489 million or 66%.
Cole capital modestly increase from year end, primarily due to an increase in retained earnings.
Tier one capital ratio improved to 15% from 14, 7% as of December 31 2021.
Subsequent to our February earnings call. The outlook for interest rates has changed materially low levels of unemployment and continued supply chain disruptions exacerbated by the situation in Ukraine has pushed inflation to levels not seen since the early 19 eighties interest rates began to rise even before the federal reserve raised its fed funds target in late March.
And rate hikes are predicted to come more quickly than we anticipated in the beginning of the year.
We locked in low fixed rate funding over the past two years and that has positioned us extremely well to it.
Either a rising or flattening rate environment, despite rising rates and higher input costs that are experienced by a borrower's credit quality remains strong given the increase in commodity prices that has outpaced the increase in input costs, we're managing expense growth thoughtfully I've mentioned before and commensurately with revenue growth as we navigate the small.
Two recent government and our opportunities.
However, overall very well positioned for the future and excited about the opportunities ahead of us and with that Brad I'll turn it back to you.
Thank you Arnaud.
We experienced a strong start to 2022, we are delivering well on all of our initiatives and we believe we're well positioned to deliver strong financial performance and consistent returns to shareholders over the rest of 2022.
Farmer Mac has significantly increased its profile and name recognition over the last few years and we believe this will help us as we bring new capital to agriculture and to rural communities of America.
And now operator, I'd like to see if we have any questions from anyone on the line today.
We will now begin the question and answer session to ask a question you May Press Star then one on your Touchtone phone.
If youre using a speakerphone please pick up your handset before pressing the keys.
And to withdraw your question. Please press Star then two and at this time, we'll pause momentarily to assemble our roster.
Okay.
And the first question will come from Marla backer with Sidoti. Please go ahead.
Thank you.
So could you give us a little bit more color on you.
You know how you see the impact.
A.
The current geopolitical situation on the general economic situation, how you see that impacting grain grain prices in terms of you mentioned in your prepared remarks, you know having an impact on the credit quality of your overall portfolio, but is there any expectation that that will sell.
Our down into you know increased business volumes for you down the road.
Yep Mara thanks.
Thanks, so much for that question and obviously this is an extremely volatile environment, which we're operating not only are we dealing with increases in interest rates and.
But the.
Global events, which are having a significant impact on commodity prices, including agricultural.
Prices and the inputs into agricultural production.
I'm going to ask Dr. Carpenter to comment on the business outlook and how we're seeing the combination of rising interest rates and volatility and generally good conditions in American agriculture impact from originations and I'm also going to ask Mark Crazy to comment a little bit on credit quality, but let me begin by.
I think that.
The overall condition of American agriculture, while these price changes are unnerving.
The outlook as I said remains generally quite positive with anticipated record levels of earnings in American agriculture.
In 2022, so you know if you if you look at the commodity sheets.
We're seeing corn approaching $8 of Bush, all we're saying we'd over.
$10, a bushel, but at the same time, we're seeing natural gas at 750, we're seeing a global oil and over $100 a barrel. So agriculture has the effect of rising cost of inputs.
But it also is saying really.
Level of commodity agricultural commodity prices, but we haven't seen frankly for about 10 years.
And that's both on a real as wells as nominal basis, but let me turn to Zack and let him add some color on how we're seeing that translate into ebbs and flows of demand.
For credit and we'll carefully distinguish between demand for short term operating credit, which may be a function of commodity prices for for inventories and longer term trends as it relates to lay out Jack.
Yeah, Thanks, Brad and Marla Great question, I think Brad summed it up you know very nicely. It's when you have all these numerous components coming into the market and it creates I would say a lot of pause.
So you know record grain prices are continuing to help with the economics of the farmer.
So we are seeing farmers continuing to execute on our real estate transactions that being said, we have seen the fast increase in interest rates.
For our products in many years. So you do get that sticker shock in terms of Ah severity of increase in rates and that create some old path you know coupled with all the uncertainties going on in the market.
When you look at the food and agribusiness space and in those transactions, we've had a pretty quick drop off in volume compared to <unk> 21, and again that goes back to just uncertainty in trying to understand what's happening in the market and making sure the transactions come up at the appropriate time overall, our borrowers are in a very strong <unk>.
Session.
From a historical perspective that is still relatively cheap, even though you've had a significant increase in interest rates.
As Brad mentioned in the remarks and in our partners said, we had a strong quarter in farm <unk> ranch loan purchases and walk through 'twenty, one and we're assessing the market and we're looking to be flexible and competitive in our race and support the sellers and the lenders and they're in their borrowers as they navigate this uneasy time so.
You know again assessing the market assessing the uncertainty.
And being able to support the customers and a very strong economic environment from a commodity in AG space with our products and services.
Uh huh.
Mark could you add anything relative to credit quality and what we're actually seeing in the numbers right now yeah.
Thanks, Glenn let me start out by saying that current credit quality is very strong.
As evidenced by strong firm it comes over over the last year going forward. You know as mentioned volatility has been very high input costs have been very high but we expect farm incomes continue to be strong in 2022.
So from an overall credit quality perspective in the portfolio, we expect to see continued strong.
That doesn't mean that there may be some operators some producers some farmers and ranchers.
And some commodity sectors that that wont experience some level of distress, but generally speaking we're we're optimistic in terms of continued high quality credit score.
Okay. Thank you for that comprehensive.
And so those comprehensive answer.
And then just one follow on which is.
A lot of the factors that you noted you know.
We're you know we're seeing obviously you know uncertainty impact a lot of factors a lot of you know general demand for.
Financing for transactions.
Given where you sit and how you know you have access to capital that you know certain other institutions don't how do you see this playing out in terms of perhaps you know providing some opportunity for market share gains.
Or do you see it playing out that way.
There there are opportunities and there are different.
Different corners of our portfolio and our lines of business I think marijuana for example.
Now one of the impact that the rapid run up in commodity prices is happening is that our farmers are drawing on their operating lines of credit very heavily that is resulting in banks.
Banks that have an agricultural concentration, including farm credit banks.
Experiencing.
Rapid and in and in fact quite unexpected run ups and asset levels and that in some cases is putting some pressure on capital.
One not the only driver, but one of the drivers of the increase in Hague vantage activity at the very end of the quarter was because of just that.
So interesting to think about how how it translates into new opportunity, where with the steepening of the yield curve. It actually is a bit <unk>.
Strapping from one of our real core competitive advantages, which is if the long end of the curve very long term fixed rate mortgages.
But we have others.
And in fact, our ratios published offerings across the full across the full curve and we do short term variable rate financing as well so.
We may see some pick up there and that may be a second example of the kind of opportunity.
Your.
Youre alluding to.
The third thing I'd just mention is that we are extremely disciplined in how we price our loans our asset liability management, we've talked about that on numerous occasions before them, but we pretty much match all of our business activity. Two current meeting real time. This minute. This hour at this stage that capped.
Market conditions and so when we first saw the rapid run up in interest rates.
That was reflected immediately in our ratio some of our competitors lagged the market a bet that was a little bit of a disadvantage to us but as they catch up and then begins translating more into an advantage for us. So those are three specific ways that we could see some increasing demand for product amidst this.
Unprecedented volatility that you're referring to.
Okay. Thank you very much.
Yeah.
The next question will come from Gary Gordon Investor. Please go ahead.
Okay. Thanks, a lot I appreciate your taking my questions.
A couple of about our interest rates our first on your existing portfolio, obviously, you've got a variety of our hedges to Oh.
Limit interest rate risk.
The dramatic market shifts in Q1 did that cause any adjustments.
Adjustments to the hedges or anything needed to be done to you.
Maintain the stability in the portfolio.
You know Gary one of the benefits of having kind of volatility is that we are going to prove to do what we've been talking about for years and that is the discipline of our asset liability management and so I think the short answer is no, but let me turn to a partner to give real color on just exactly why that is.
Absolutely Gary.
One you can see some of this volatility play out actually to the positive when you look at our net income profile.
But essentially you know we don't hold our derivatives on our balance sheet.
For a speculative reasons as you know we really hope that this is much more to manage our asset liability management. So pivoting to what you know what Brad said.
And actually really even responding to the first question you know the smaller had which which comes back to how we price them. We have some tremendous advantages because we really don't take on any basis risk or underlying interest rate risk and we're able to do that through managing our derivative activities and you know so we can.
Actually masbate, we can also issue.
And take off positions often vision.
That allow us to almost completely eliminate our interests.
So when you add all of that together, maybe its a slightly complicated would be looking at it we essentially.
Really the benefit, especially in this rising rate environment. Some of the positions that we've taken on in the last two years.
That are really coming coming off enough fever. So.
Some of them knocked one factor, but you know maybe the short answer to that is that it continues to be an advantage for us in terms of how we how we fund and manager our balance sheet too long.
Okay. Thanks, the second one is typically in volatile markets our spreads widen out.
Maybe you can discuss a minute your own funding costs versus treasuries and then maybe more important available spreads for new investment.
I'm sure let me I'll, let me take that first part of your question in terms of our our funding costs and we are seeing definitely a widening of our funding.
But I will say that when we look at the where we are relative to our competitors and by that I mean.
The farm credit funding Corp, or other GSE you know, we typically on the long end of the curve maybe been somewhere between five to 10 basis points.
You know on top of that so everyone is seeing widening across the board relative to what's happening, but I think also as the GSE, maybe from a credit standpoint credit spreads widening but not seeing as much.
You know relative to maybe.
No other issues, but we are a theme or dynamics that we've seen in the past two years relative to other GSE. So we're not seeing anything very different.
And as far as it relates to us specifically and just again just reiterate.
And you know the scary, but over the last two years, we've really been very opportunistic whether it's on a capital stack.
Preferred issuances or whether it's been through extending our debt funding I think the treasury team has done a very very good job of really extending our liabilities now we can be very opportunistic in terms of when we want to go out there and funded the long end of the curve.
Have a little bit of a bias not to do that until the volatility settles down, but we have an abundant amount of oh really debt funding at all points on the curve. So be a we can really manage our interest rate profile and that profile pretty opportunistically.
Okay. Good.
One last question on the net interest margin you said it was 97 basis points operating basis. This year at the same as last year the.
The servicing business, obviously the expenses of it runs through operating expense.
The revenue is there a way to estimate how much of an impact it had or benefit to the net interest margin.
Yeah, you know we can that we can actually come back to you on it. It's still early days in terms of really being able to give you a sense of that let's say about a third of the farm <unk> ranch portfolio is likely to be funneled back into the servicing business. So if you look at our incremental volume and again Q1, Oh, we need some dynamic shifting dynamics.
Going on with additional prepayments and so on and farm and ranch, because it's probably a little bit of a of a wash and you wouldn't have seen much of a benefit on that 97 basis points.
Time really used to be you know an incremental volume anywhere between 18 to 25 points of the pick up.
Third is our net incremental.
That's probably the way to think about it.
Okay. Thanks, and one last question on operating expense you said your efficiency ratio is 33% today and you've got spending plans for the next let's say four to six quarters, but ultimately you want below 30% efficiency ratio, which is fairly big move is this.
G. We hope one day or there's a three year plan to get it back to 30% how should I think about that.
Yeah, I'll, let let me jump in and you know I'm sure, Brad or others might want to add to this you know the first quarter typically when you think about revenue and this is not unusual go back to the first quarter of last year and the previous quarter and 2020 Q1 tends to be north of 30%.
One dynamic that we have additionally, seen playing out in fact, you know when you look at why the reason compensation tends to be something that really pops up and he's really done I think a fairly good job of managing just a run rate of conferencing and keeping that down, but it's not really out of line with last before.
And then you know you have done.
Rising towards our historical averages over the rest of the year, what do you likely going to see this year is that continued investment in technology and head count you've talked about that will keep that efficiency ratio at a highly elevated level, but we will see additional loan pick up activity because typically in Q1 you do.
A more seasonality in terms of prepayment so that also has a tendency.
Of making that efficiency, we should go up but you know, but we you know our census that will likely come down into its not not going to be a huge move because you can see some pretty big swings and then the second point here is just that seasonality around accretion that goes away in the remaining quarters. One dynamic is obviously the servicing acquisition that does have.
We see a higher efficiency ratio relative to the rest of our business. So that trend is likely to persist but back to your earlier question on seeing those spreads play out as you continue to sell this some of that volume and that additional spread pick up all of that will start to really help with respect to the denominator of that efficiency ratio and so we feel pretty optimistic that.
We can manage our efficiency ratio at under that 30% on an annualized basis, yeah, Yeah, Gary just to elaborate on that if you go back to Q1 'twenty. One we're between 32 and 33%. If you go back to Q1 2020, we were between 22 and 23%.
This is not really the outlier, although it is slightly it is slightly higher.
But to be also be specific.
Our goal is to get that efficiency ratio for the year 2000 fiscal 'twenty, two down to that 30% or below level.
Okay terrific. Thank you.
Yeah.
Okay.
This concludes our question and answer session I would like to turn the conference back over to Brad nor at home for any closing remarks. Please go ahead Sir.
No well. Thank you operator, and thank you all for participating in the call as always with follow up questions or.
Things that you'd like to have clarified please get in touch with chop them all put together the right the right people to answer your questions.
This is a time of great volatility, but you know I think you've heard optimism on this call today and you also heard confidence and the real confidence comes from farmer Mac's business model. It is designed from an asset liability standpoint from origination standpoint to be highly resilient.
And while we don't know exactly where commodity prices and interest rates will be six months from now.
We do know that the way we're structured we're very very well positioned to continue to deliver very very steady results and to continue to for our fulfill our mission of serving American agriculture. So I'll just leave you with that thought. Thank you very much for participating and look forward to talking to you all soon.
Yeah.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.
Okay.
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Okay.
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