Q1 2022 Federal Agricultural Mortgage Corp Earnings Call
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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 at farmer Mac 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 <unk>.
<unk> 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 <unk>.
Joining us for the question and answer period at this time I'll turn the call over to President and CEO , Brad normal Brad.
Thanks, John and good afternoon, everyone I'm really pleased that youre 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 in London capacity to lenders serving rural America in the first quarter 2022. This result is an outstanding business volume of $24 2 billion as of March 31.
Generated consistent core earnings and most importantly, our portfolio 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 product secured by first liens on agricultural real estate, plus all USDA guaranteed loans.
Grew approximately $500 million this quarter or roughly 3% and.
This is primarily due to our advantaged securities and farm <unk> ranch loan purchase programs.
We are pleased to see our strong institutional relationships and the overall dynamics of the macroeconomic environment.
<unk> and our ability to return as an invaluable partner and wholesale financing space.
At the onset of the pandemic opportunities for new business volume in our AG Vantage Securities program were limited as well.
Liquidity support provided by the Federal Reserve Bank resulted in the tightening of investment grade credit spreads to historically low levels and increased competition.
Net farm <unk> Ranch loan purchase volume was strong during 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 of future increases as well as the conflict in Ukraine.
<unk> 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 ins 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 that 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 prepayment 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.
<unk> and demand for long term financing solutions for planned maintenance and capital expenditures.
Also contributing to growth this quarter and rural infrastructure line of.
Our businesses was up $35 million commitment to a large solar project.
As I have 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.
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 represented growth over our current asset levels.
As an example of our efforts to upgrade our technology platform, including doubling.
Eligible loan size for our AG Express scorecard products.
$1 5 million to $3 million.
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.
Able to better to gain deeper insight from each of our stakeholders in order to continue to build on our strong reputation.
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 our Chief financial Officer to discuss our financial results in more detail Brian .
Our partner.
Thank you Brad and good afternoon, everyone.
Core earnings for first quarter 2020 to $25 8 million.
$2.37 per diluted common share compared to $30 million.
$2 75.
You did common share and fourth quarter, 2021, and $25 9 million.
$2 and 39.
<unk> common share for the same period last year the.
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, our net change in our total allowance for losses of $1 1 million after tax and a <unk> 7 million after tax increase in operating expenses.
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 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, with $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 basis interest income.
Also contributing to the year over year increase with an increase in net coupon.
Related to the acquisition of loan servicing rights in third quarter 2021.
Our liability side of the balance sheet remains strong as we continue to benefit from a dynamic funding strategies that we've outlined to you in the past and we continue to maintain our disciplined asset liability management. Additionally, 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 interest expense much more accurately to each of the operating segments.
Since funds transfer pricing or SDP assumes a match funded asset liability management approach it allocates booked benefits as well as the cost from the funding and hedging strategies to the funding segment. This also allocates. The result of the investment portfolio that would be primarily hold for liquidity purposes.
Please that the new segment reporting construct provides shareholders and other stakeholders with clearer insight into the benefits of our disciplined <unk> practices and dynamic funding strategies and how they ultimately contribute to enterprise profitability.
The successful execution of a $299 4 million.
Patrick cultural mortgage backed securitization in October was a key contributor to our core earnings results in 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 return to the market. This year with another securitization transaction, we are taking a more measured approach to this.
Short term just as Brad mentioned, recognizing that current market dynamics are resetting credit market perspective and outlook.
First quarter 2022 was extremely challenging for the securitization market as the evolving macro rate environment 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 diversified funding sources and fulfill our mission of delivering low cost liquidity, even more effectively.
Aren't focused 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 we 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 and third quarter 2021.
Stock compensation and increased spending on software licenses and 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 <unk> Ranch segment, where we will not be paying a third party with servicing the loans that we will now service and this should make the initiative.
True to accretive for us and the Minto.
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 risks 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.
Such as renewable energy and telecom over the next 12 to 18 months will continue as we've done before to closely monitor our efficiency ratio, which ended March 31, 2022 at 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 31, 2022, the total allowance for losses was $16 3 million.
Modest 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 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 31, 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.
Our 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 that fed funds target in late March.
And rate hikes are predicted to occur 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 withstand either a rising or flattening rate environment, Despite rising rates and higher input costs that are experienced by our borrowers credit quality remains strong given the increase in commodity prices that has outpaced the increase in input costs.
We're managing expense growth thoughtfully as mentioned before and commensurately with revenue growth as we navigate this volatile rate environment 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 Parnell Ria.
We experienced a strong start to 2022.
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.
And the first question will come from Marla backer with Sidoti. Please go ahead.
Yeah.
So could you give us a little bit more color on.
How you see the impact.
Current geopolitical situations on the general economic situation, how you see that impacting grain grain prices in terms of you mentioned in your prepared remarks.
Having an impact on the credit quality of your overall portfolio, but is there any expectation that that will filter down into.
Increased.
Volumes for you down the road.
Yes Mara.
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.
But the.
Global events, which are having a significant impact on commodity prices, including agricultural.
Prices and inputs into agricultural production.
I'm going to ask snack carpenter to comment on the business outlook and how we're seeing the combination of rising interest rates and volatility and generally good conditions and American agriculture impact originations.
I'm also going to ask Mark Crazy to comment a little bit on on credit quality, but let me begin by saying 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.
If you look at the commodity sheets, we're seeing corn approaching $8 push all we're seeing we'd over.
$10, a bushel, but at the same time, we're seeing natural gas at 750, we're seeing.
Global oil at over $100 a barrel. So agriculture has the impact of rising cost of inputs, but it also is seeing really.
Level.
Commodity agricultural commodity prices, but we haven't seen frankly for about 10 years.
And that's both on a realized rolls is nominal basis.
Now, 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 <unk>.
<unk> prices.
For inventories and longer term trends as it relates to lab zac.
Yes, Thanks, Brad and Marla Great question, I think Brad summed it up very nicely.
When you have all these numerous components coming into the market and it creates I would say a lot of pause.
<unk> record grain prices are continuing to help with the economics of the farmer and.
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 severity of increase in rates and that creates a little pause coupled with all the uncertainties going on in the market.
When you look at the food and agribusiness space 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 at the appropriate time overall, our borrowers are in a very.
Strong position.
From a historical perspective that is still relatively cheap, even though <unk> had a significant increase in interest rates.
As Brad mentioned in the remarks and.
<unk> said that we had a strong quarter in farm <unk> ranch loan purchases in <unk> 'twenty one.
And we're assessing the market and we're looking to be flexible and competitive in our rates and support the seller and the lenders and their borrowers as they navigate this uneasy time so.
Again.
The market is soft and 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.
Okay.
Mark could you add anything relative to credit quality, what we're actually seeing in the numbers right now.
Let me start out by saying that current credit quality.
Armstrong.
As evidenced by strong farm incomes over over the last year going forward as mentioned volatility has been very high input costs.
<unk> been very high, but we expect to continue to be strong in 2022, and so from an overall credit quality perspective in the portfolio. We expect to see continued strong performance.
That doesn't mean that there.
May be some operators some producers some farmers and ranchers.
And some commodity sector.
Won't experience some level of distress, but generally speaking we're.
We're optimistic in terms of.
Quality credit.
Okay. Thank you for that comprehensive.
And so those comprehensive answers.
And then just one follow on which is.
A lot of the factors that you noted.
Sure.
We're seeing obviously.
Certainty impact a lot of factors.
John will go ma'am.
For financing.
Jackson.
Given where you sit how are you.
You have access to capital that.
From other institutions don't how do you see this playing out in terms of perhaps providing some opportunity for market share gain or do you see it playing out that way.
Okay.
There are opportunities and there are different.
Different corners of our portfolio and our lines of business I think marijuana.
For example.
Right now one of the impact that rapid run up in commodity prices happening as debt.
Farmers are drawing on their operating lines of credit very heavily.
That is resulting in a.
Banks that have agricultural concentration, including farm credit banks.
Experiencing.
Rapid and in fact quite unexpected run ups.
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 vantage.
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 opportunities.
With the Steepening of the yield curve it actually is a bit.
Distracting 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 the ability and in fact, our ratios published.
Offerings across the pool.
Across the full curve when 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.
That youre alluding to.
Third thing I just mentioned 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 but we've pretty much match all of our business activity. Two current meeting real time. This minute hour at this date debt capital 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 bit that was a little bit of a disadvantage to us but as they catch up and then begin 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.
The.
Next question will come from Gary Gordon Investor. Please go ahead.
Okay. Thanks, a lot I appreciate your taking my questions.
A couple about interest rates first on your existing portfolio, obviously, you've got a variety of.
Hedges too.
Limit interest rate risk.
Obviously, a dramatic market shifts in Q1 did that cause any.
Adjustments to the hedges are there anything needed to be done too.
To maintain the stability in the portfolio.
Gary one of the benefits of having this kind of volatility is that we are going to approved new 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.
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 we don't hold derivatives on our balance sheet.
For a speculative reasons as you know we really have this much more to manage our asset liability management, so pivoting to what what Brad said and actually really even responding to the first question.
<unk>.
Which which comes back to how we price.
We have some tremendous advantages because we really don't take on any basis with good underlying interest rate risk and we're able to do that through managing our derivative activities and.
So we can actually we can also issue.
Antique physicians often mentioned.
That allow us to.
Almost completely eliminate our interest.
So when you add all of that together, maybe slightly complicated we're 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 up in our favor.
Some of the a lot to unpack there, but maybe the short answer to that is it.
Continues to be an advantage for us.
We fund and manage our balance sheet.
Okay.
Yeah.
Okay. Thanks, the second one is.
Typically in volatile markets.
Fred's widen out.
You can discuss a minute your own funding costs versus treasuries and then maybe more important available.
Spreads for new investment.
Sure Let me, let me take that.
The first part of your question in terms of our.
Our funding cost and we are seeing definitely a widening of our funding.
But I will say that when we look at where we are relative to our competitors.
In the farm credit funding Corp, or other GSE.
Typically on the long end of the curve.
<unk> been somewhere between five to 10 basis points.
On top of that so everyone is seeing widening across the board relative to what's happening or banking also has the GSC maybe.
<unk> standpoint credit spreads widening out we're not seeing as much.
Relative.
Maybe.
Other issues, but we are.
<unk> dynamics that we've seen in the past two years relative to other GSE announcing anything very different.
As far as it relates to us specifically and again I'll just reiterate.
Gary but over the last two years, we've really been very opportunistic whether it's on a capital stack.
Through preferred issuances or whether it's been through extending our debt funding I think the treasury team has done a very very good job.
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. So we have a little bit of a bias not to do that until the volatility settled down, but we have an abundant amount of.
Really that funding at all points on the curve.
We can really manage our interest rate profile.
Pretty opportunistically.
Hey, good.
One last question on the net interest margin you said it was 97 basis points operating basis. This year same as last year.
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.
Yes, 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 from.
From dynamic shifting dynamics going on with additional prepayments and so on and farm and ranch, because it's probably a little bit of a <unk>.
Wash and you wouldn't have seen much of a benefit on that 97 basis points, but over time really.
The incremental volume anywhere between 18 to 25 points of the pick up.
One third of our net incremental.
Probably the way to think about.
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.
We hope one day or there is 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 I am sure, Brad or others might want to add to this 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 on it.
When you look at why that reason.
Compensation tends to be something that really pops up, but you've 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.
Before.
And then.
That normalizing towards historical averages over the rest of the year, what's 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 pickup an activity because typically in Q1 you do.
More seasonality in terms of prepayment so that also has the tendency.
Making that efficiency, we should go up but.
Our sense is that that will likely come down and it's not going to be a huge move because you can see some pretty big swings and then the second point here is just the seasonality.
When that goes away in the remaining quarters.
One dynamic is obviously the servicing acquisition that does have I would say 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 we continue to service some of that volume and that additional.
Fred pick up all of that will start to really help with respect to the denominator of that efficiency ratio.
So we feel pretty optimistic that we can manage our efficiency ratio and under that 30% on an annualized basis.
Yes, Gary just to elaborate on that if you go back to Q1 'twenty one we're between 30% 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.
This concludes our question and answer session I would like to turn the conference back over to Brad Nord home for any closing remarks. Please go ahead Sir.
No. Thank you operator, and thank you all for participating in the call as always with follow up questions or.
Hi.
Things that you'd like to have clarified please get in touch with Jonathan will put together the.
The right people to answer your questions.
This is a time of great volatility but.
You've heard optimism on this call today and you also heard confidence and the confidence comes from farmer Mac's business model. It is designed from 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 fulfill our mission of serving American agriculture. So.
Leave you with that thought thank you very much for participating and look forward to talking to you all soon.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.
Okay.
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Hmm.
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