Federal Agricultural Mortgage Corporation (AGM) Q2 2016 Earnings Report, Transcript and Summary

Good day and welcome to the Federal Agricultural Mortgage Corporation Second Quarter 2016 Investor Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Timothy Buzby, President and CEO. Please go ahead.

Thank you. Good morning, I'm Tim Buzby, Farmer Mac's President and CEO. Farmer Mac is pleased to welcome you to our second quarter 2016 investor conference call. Before I begin I will ask Steve Mullery, Farmer Mac's General Counsel, to comment on forward-looking statements that Management may make today, as well as Farmer Mac's use of non-GAAP financial measures.

Thanks, Tim. Some of the statements made on this conference call may constitute forward-looking statements under the securities laws. We make these statements based on our current expectations and assumptions about future events and business performance. 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 results may differ materially from the results expressed or implied by the forward-looking statements. In evaluating Farmer Mac, you should consider these risks and uncertainties, as well as those described in our 2015 annual report on Form 10-K, our subsequent quarterly reports on Form 10-Q and our other filings with the SEC. In the analysis of its financial information, Farmer Mac sometimes uses measures of financial performance that are not presented in accordance with Generally Accepted Accounting Principles in the United States, which we refer to as non-GAAP measures. The three non-GAAP measures that Farmer Mac uses are core earnings, core earnings per share, and net effective spread. Farmer Mac uses these non-GAAP financial measures to measure corporate economic performance and develop financial plans. Because in management's view they are useful alternative measures for understanding Farmer Mac's economic performance, transaction economics, and business trends. These non-GAAP financial measures may not be comparable to similarly labeled non-GAAP financial measures disclosed by other companies. Farmer Mac's disclosure of these non-GAAP measures is intended to be supplemental in nature and is not meant to be considered in isolation from, as a substitute for, or as more important than the related financial information prepared in accordance with GAAP. Disclosures and reconciliations of these non-GAAP measures can be found in the Form 10-Q and the Earnings Release posted on Farmer Mac's website www.FarmerMac.com under the Financial Information portion of the Investor section. A recording of this call will be available on our website for two weeks starting later today.

Thank you, Steve. Farmer Mac had an excellent second quarter across the board. From new business to improving spreads, stable credit quality, and ultimately strong profitability, things came together very well. As you know, our new business can come in large amounts from time to time. And these amounts can vary quarter to quarter. Second quarter 2016 was a particularly good quarter for us in terms of new business volume and net growth. This growth was generated by healthy contributions across a number of products and lines of business. Farmer Mac ended second quarter 2016 with outstanding business volume of $17.1 billion. We added nearly $1.3 billion of new business this quarter, resulting in net growth of $901 million after maturities and repayments. The drivers of this increase were balanced across our Institutional Credit, Farm & Ranch, and Rural Utilities lines of business. In terms of absolute dollars of growth, our Rural Utilities line of business lead the way this quarter, growing nearly $424 million, driven by a new standby credit protection pool of $421 million. Keep in mind, the fees we earn for credit protection on these high-quality utility loans are relatively small. Our Institutional Credit line of business grew a net $330 million, which came from the Agricultural sector and was balanced across multiple customers. We completed $200 million of AgVantage funding for Rabo Agrifinance, which included a $50 million refinancing for a deal that matured in second quarter and a $50 million early refinance of a deal that matured in July. We also completed a new $150 million shorter maturity AgVantage funding for MetLife this quarter. $25 million of our net growth in Institutional Credit this quarter was attributable to the Farm Equity AgVantage product, primarily driven by a $27 million deal with a new customer we started doing business with in the first quarter. We are excited about this new relationship, which we expect to grow over time and for the long-term growth prospects for this wholesale funding solution in general. We believe that the growth that we are seeing in our Institutional Credit segment for our AgVantage family of funding products reflects the continued trend toward financial institutions recognizing the competitive benefits of Farmer Mac's wholesale funding solutions. The third main driver of volume growth this quarter was loan purchases within our Farm & Ranch line of business. We purchased $241 million of new loans this quarter, which reflects more than a 20% increase as compared to second quarter 2015. This higher volume is being driven by an ongoing level of primary demand from land sales, as well as increased demand for credit given the tighter agricultural economy. Net of repayments, our Farm & Ranch loan purchase business grew more than $166 million in second quarter 2016. Farmer Mac's net effective spread for second quarter 2016 grew in both dollars and percentage terms compared to first quarter 2016. This was driven by a combination of factors, including growth in our business, improved LIBOR-based funding costs, and other factors. Compared to second quarter 2015, net effective spread grew significantly in dollar terms and decreased modestly in percentage terms. Dale Lynch will describe those changes in more detail in a few minutes. The credit quality of our portfolio remains stable. As of June 30, 2016, $22.1 million, or 0.38%, of our $5.8 billion Farm & Ranch portfolio was 90 days delinquent, compared to 0.56% at year end 2015. As we have mentioned previously, we expect that over time Farmer Mac's 90-day delinquency rate will eventually revert closer to our historical average of approximately 1% due to macroeconomic or other potential factors. On balance, we believe a reversion closer to our historical averages is healthy, and that Farmer Mac's business can benefit through higher volumes and wider spreads in such an environment. We've discussed on previous calls the western part of the United States, and in particular California, continues to experience drought conditions to varying degrees. The persistence of drought conditions in certain areas of the West could have an adverse effect on Farmer Mac's delinquency rates or loss experience in the future, but we have not seen a material effect on our portfolio. Through regular discussions with Farmer Mac's loan servicers and lenders and their customers, we continue to remain informed about the drought conditions and their effects on those areas. With that as background, I'd like to turn to Dale Lynch, our Chief Financial Officer, to cover our financial results in more detail. Dale?

Thanks, Tim. As reflected in our second quarter 2016 results, Farmer Mac is executing well on the opportunities within its markets. We believe that the relative value that Farmer Mac offers its customers is greater when credit conditions are somewhat tighter, which we think can lead to greater volume opportunities for us. Fourth quarter 2015 and the first six months of this year seemed to reflect this trend, and we believe the outlook for us is positive. Even as the agricultural economy adjusts to lower commodity prices and drought conditions in some part of the West, as Tim mentioned, we grew to a record outstanding business volume of $17.1 billion as of June 30, 2016. As Tim mentioned, this growth was driven from a broad-based contribution from across our lines of business and products. Spreads on new assets are stable to increasing. And our funding costs on LIBOR-based assets have improved due to changes in our funding strategy and from general improvements in the market. Also, our credit quality remains good. Turning to our financials, Farmer Mac's second quarter 2016 core earnings were $13.0 million or $1.23 per diluted common share. Compared to $12.4 million, or $1.12 per share, for first quarter 2016; and $11.6 million, or $1.02 per share, in the year ago quarter. The $0.6 million increase compared to first quarter 2016 was primarily due to higher total revenues, which included a $0.7 million after-tax increase in net effective spread and a $0.1 million after-tax increase in guarantee and commitment fees. The increase was offset in part by an increase in credit-related expenses of $0.2 million after-tax. Operating expenses were relatively flat sequentially, as higher general and administrative expenses related to continued technology and business infrastructure investments, and expenses associated with business development efforts, were offset by lower compensation costs in second quarter 2016. These lower compensation costs were due to a decrease in stock compensation expense, which reflects the absence of the costs associated with the annual vesting of stock-based awards that occurred in first quarter 2016. The $1.4 million increase in core earnings from the year-ago quarter was driven primarily by increases in net effective spread of $0.8 million after tax, and guarantee and commitment fee income increases of $0.5 million after tax. Also contributing to the increase was a $0.5 million after-tax decrease in credit related expenses, as provisions to the allowance for losses were $0.3 million after tax in second quarter, compared to provisions of $0.8 million after tax in second quarter 2015. Partially offsetting this increase was a $0.2 million after-tax increase in operating expenses, driven again by higher general and administrative expenses related to continued technology and business infrastructure investments and expenses associated with business development efforts and other corporate initiatives and a $0.2 million after-tax increase in other expenses. Turning to GAAP net income, second quarter 2016 net income attributable to common stockholders was $12.0 million or $1.13 per diluted common share compared to $22.2 million, or $1.94 per share, in the year-ago quarter. The year-over-year decrease was due to the effects of unrealized fair value changes on financial derivatives and hedged assets, which was a $1.3 million after-tax loss in second quarter 2016, compared to a $10.4 million after-tax gain in second quarter 2015. Turning to spreads, Farmer Mac's net effective spread for second quarter of 2016 was $31.0 million or 84 basis points compared to $29.9 million, or 82 basis points, in the first quarter 2016; and $29.8 million, or 88 basis points, in the year-ago quarter. The sequential increase in quarterly net effective spread in both dollars and percentage terms was primarily due to lower LIBOR-based funding costs for floating rate assets indexed to LIBOR due to the adjustments in Farmer Mac's funding strategies for these assets, and an increase in cash basis interest income received on non-recurring Farm & Ranch loans. Each of these factors contributed about 1.5 basis points improvement to the margin percentage of net effective spread for the quarter. Additionally, a higher average balance of AgVantage securities during second quarter of 2016 contributed to the sequential growth in dollars of net effective spread. As we mentioned on our first quarter call earlier this year, the market increase in LIBOR-based funding costs is not unique to Farmer Mac and is simply due to treasury rates being higher relative to swap rates than in the past. Farmer Mac has adjusted its funding to mitigate this market-driven dynamic. And we have seen real improvements in terms of reductions to our LIBOR-based funding costs in the second quarter. The year-over-year decrease in quarterly net effective spread in percentage terms was due to a tighter spread on a large AgVantage security that was refinanced at a shorter maturity than the original security. And a higher average balance maintained in lower-earning cash in investment securities in the first half of 2016 compared to the first half of 2015 in order to increase Farmer Mac's liquidity position. The year-over-year increase in dollars was attributable to growth in our outstanding business volume. Turning now to our four lines of business, net effective spreads for second quarter 2016 and first quarter 2016 were as follows. $9.9 million, or 178 basis points, for Farm & Ranch, compared to $9.5 million, or 171 basis points, in first quarter. $4.6 million, or 96 basis points, for USDA guarantees compared to $4.3 million or 91 basis points. $2.6 million, or 103 basis points, for Rural Utilities, compared to $2.5 million or 102 basis points. And $11.4 million, or 77 basis points, for Institutional Credit compared to $11.1 million or 80 basis points. From a credit perspective, portfolio quality remained stable during second quarter 2016 as substandard assets, total allowances, and 90-daily delinquencies remained near first quarter 2016 levels. Substandard assets as a percent of our Farm & Ranch portfolio increased very slightly to 2.1% from 1.9% in first quarter 2016 driven by a few larger loans and several smaller loans being downgraded this quarter. As of June 30, 2016, the total allowance for losses was $7.1 million, or 12 basis points, of the $5.8 million Farm & Ranch portfolio compared to $6.6 million, or 12 basis points, of the Farm & Ranch portfolio as of March 31, 2016. As Tim mentioned, 90-day delinquencies in the Farm & Ranch portfolio were $22.1 million, or 38 basis points, of the Farm & Ranch portfolio as of June 30, 2016 compared to $34.7 million, or 61 basis points, as of March 31, 2016; and $31.9 million, or 58 basis points, in the year-ago quarter. For Farmer Mac's other lines of business, there are currently no delinquent AgVantage securities or rural utility loans held or underlying standby purchase commitments. And the USDA securities are backed by the full faith and credit of the United States. As a result, across all of Farmer Mac's four lines of business, the overall 90-day delinquency level comprised entirely of Farm & Ranch loans was just 0.13% of total volume as of June 30, 2016 compared to 0.21% of total volume as of March 31, 2016, and 0.21% in the year-ago quarter. In terms of business volume, we added nearly $1.3 billion in new business in second quarter 2016. Looking at the specifics for the quarter, we added the following new business volumes. $421 million of rural utility standby purchase commitments; $396 million of AgVantage securities purchases; $241 million of Farm & Ranch loan purchases; $111 million of USDA securities; $58 million of Farm & Ranch standby purchase commitments; $23 million of Farmer Mac guaranteed USDA securities; and lastly, $10 million of Rural Utilities loan purchases. After repayments, our net outstanding business volume increased $901 million this quarter. Turning to capital, Farmer Mac's $573 million of core capital as of June 30, 2016, exceeded the statutory minimum requirement of $497 million by $76 million or 15%. This compares to core capital of $564 million or $102 million of capital above the minimum requirement as of December 31, 2015. The decrease in core capital above the minimum required from year end is due to an increase in minimum capital required to support the growth of our on-balance sheet assets during the first half of this year. In terms of liquidity, Farmer Mac had 145 days of liquidity as of the end of second quarter 2016 compared to the minimum regulatory requirement of 90 days. More complete information about Farmer Mac's performance for second quarter 2016 is set forth in the 10-Q we filed today with the SEC. And with that, Tim, I will turn it back to you.

Thanks, Dale. Outstanding business volume is at an all-time high. We're seeing growth across most of our lines of business and products. Our financial performance is strong, and our credit quality remains good. While the agricultural economy continues to adjust to lower commodity prices and the persistence of drought conditions in some portions of the West, the overall business climate for Farmer Mac remains positive. We believe that the relative demand for Farmer Mac's products could increase as credit becomes somewhat tighter. And we believe this is evidenced by our new business volumes in the past several quarters' results. In terms of delivering upon our mission, Farmer Mac continues to communicate the value of our products and solutions to current and prospective customers. We continue to sign up new banks for our loan purchase and credit protection products. We see strong interest for Farm Equity AgVantage financing from existing and potential new counter-parties. In fulfilling our mission to serve rural America, we are actively seeking to help bring new capital to agricultural and rural communities. At this time, we'd be happy to answer any questions you may have.

[Operator Instructions] Our first question comes from Chas Tyson of KBW. Please go ahead.

Hi guys, good morning. Just wanted to ask on the reserve for the provision this quarter, a few delinquencies look pretty good coming down from 1Q but the provision was up a little bit, I think I saw in the Q there was due to long-term standby purchase commitments and some of the underlying loans there. Could you give us more color on what you saw and how that portfolio is performing?

Dale, you want to touch on that?

Sure. I think what we alluded to in the call here is earlier that was there was a large loan that was downgraded and several smaller loans that were downgraded. Those were within our long-term standby purchase commitment pool. And again, those are loans that are held on other entities balance sheet in this case typically it's going to be a farm credit system association balance sheet. As part of their credit reviews they will review their own loan portfolio and make adjustments from time to time. In this case they downgraded a number of these loans and we typically follow their lead on that, we're not going to typically challenge what their view on those loans are. So again, I think part of the normal cycle that we've been talking about for some period of time that we expect over time our delinquency rate to revert more to our historical norms. We have really yet to see that on our on balance sheet business in any significant fashion, but again on substandard assets you saw a modest change, I think it was a 20 basis point uptick from Q1 to Q2. And it was really driven by downgrade of farm credit system loans that are understand by purchase commitment with Farmer Mac.

Got it, do you typically see people downgrade the farm credit administration, downgrade associations credit downgrade loans like that, or do they immediately put back to you in most cases?

Sure. Keep in mind that this is just a downgrade -- in many cases, these loans are performing loans. They are probably not delinquent in many cases, they just got downgraded for say farmers have delivered their updated tax returns or what not and as they get updated financials they will typically do a review and an update on their loans just like we do every quarter. So again, not atypical at all these loans are -- I mean there's loans getting downgraded and upgraded in significant form pretty much every quarter. The net change here was 20 basis point uptick in our sub-standards, but again that's pretty typical.

Sure makes sense. And last question is just on, you've got a couple quarters with the Rural Utilities long term standby purchase commitments portfolio under your belt now, how does that -- I know there's not any delinquencies at this point, but how does that look like it's shaping up? How are the credit characteristics a little different from the more typical Farm & Ranch that you've done in the past, and is there a big difference in the commitment fees that are earned from the Rural Utilities program as opposed to the Farm & Ranch program?

I would keep in mind that the rural utility program and the loans that are in it perform very, very well. We've actually never had a delinquent loan in that portfolio and as a result that's the reason that the credit protection that we provide comes at a cheaper cost to the counterparty. So the fees that we collect on those loans as I mentioned earlier are much less than what we would earn on a similar agricultural portfolio, just because the risk profile is very different. Still good business for us, we still obviously receive additional dollars in revenues as a result, but it would not be any significant revenue increase like it would be if we did a portfolio that size of agricultural loans.

Makes sense, thanks guys.

Our next question from of Jesus Bueno of Compass Point. Please go ahead.

Thanks for taking my questions. It was certainly positive to see such solid asset growth program, asset growth in the quarter, it looked like paydowns were actually still pretty elevated Down from first quarter, but still elevated historically. I guess as we look into the third quarter, how should we I guess think about that line in terms of paydowns? Have you seen an increase I guess in demand given the move in rates and just how do you think about that going forward?

Yes go ahead. No, you go ahead.

The paydowns that you are seeing were scheduled maturities on AgVantage securities, Jesus, they weren't loans. Our loan paydown volume was relatively insignificant in second quarter, our gross purchases were roughly $240 million-some and our net growth was $166 million. So in terms of our loan business that's about as good as it gets in terms of net growth. So CPRs are remaining very low, our prepayment activity has really kind of been running at a very stable level for a couple of years now, the volume that you are seeing on prepayments was scheduled maturities. We had a $500 million AgVantage bond with MetLife come due on July 25 or 27 that got refinanced and that really is elevating the volume. And then we had I think $50 million or $100 million maturities come due with Rabo Agrifinance this quarter too. So that's just scheduled maturities. And those got all refinanced entirely, so we didn't actually lose any of that existing business but yet did have net growth due to some incremental business we did with MetLife, incremental business we did with Rabo and then some growth with our farm equity AgVantage product as well.

I appreciate the color. Just in terms of, you mentioned that there was some impact from rate movements during the quarter and I know that just for the third quarter we start -- we've seen some movements for example on three month LIBOR, I guess does that have any impact on your hedging results? And as we've kind of proceeded through the first month of the quarter, will that have any impact on your spreads, or your net effective spread going forward?

No, I mean there's a lot of parts to that question. The absolute move of rate when we lock in a new piece of business, we hedge our funding costs and so if rates move after that and prior to us executing the permanent funding our hedge is going to be either in the money or out of the money. From a core perspective we take that gain or loss, we reverse it out of income and then amortize it over the expected life of the asset. So when we fund that asset with our liability portfolio we've kind of locked in the spread at that point we are agnostic as to what happens to rates going forward. Generically there has been some distortions in the swap curve that began in mid-last year and it continued, and that's sort of the dynamic we mentioned on last call and this call we are talking about our funding cost on assets indexed to LIBOR. And we had some reasonable friction we experienced in the fourth quarter and the first quarter. In the second quarter we were able to adjust our strategies enough that I think we've kind of dampened that affect pretty significantly, in fact, in second quarter I think we pretty much neutralized it. There's a lot of activity in terms of LIBOR right now, LIBOR has gone higher due to some of the changes in the money market reform, if you will has caused LIBOR to widen. Our funding cost relative to LIBOR have actually improved significantly and we're funding three months at LIBOR more than 40 basis points currently, I would say a more normal historical range would be LIBOR less 15 to 20. What happens when you turn out the funding for those assets it becomes more expensive rather quickly, but our funding levels relative to LIBOR inside of six months right now are pretty favorable.

Got it. Appreciate that. And very quickly, just jumping to share repurchases. Obviously you have it looks like about $5 million remaining on your authorization. I guess should we expect that you should deploy that kind of opportunistically or how should we think about the buyback going forward?

I think in general we were buying shares back when the price was significantly lower than where it is today. We think that the reaction in the market has had both through the increase in our dividend policy, the share buybacks itself and the overall view of our business is better reflective in the share price today. If we were to for some reason either related to Farmer Mac's performance or the stock market in general, see the price of our stock drop down significantly we would likely reinstitute at some point. But at this point where we are I think going forward as long as we continue to see favorable share price movements we won't be buying back shares at this level.

Fair enough. Thank you for taking my questions.

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

Thanks, I'd like to thank you all for listening and participating this morning, we look forward to our next call to report our third quarter 2016 results in November. Thank you.

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