Federal Agricultural Mortgage Corp (AGM) 2004 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Federal Agricultural Mortgage Corporation First Quarter 2004 Earnings Conference Call. [Operator Instructions] It is now my pleasure to introduce your host, Mr. Henry Edelman, President and CEO of Federal Agricultural Mortgage Corporation.

Thank you. Good morning. Welcome to the Farmer Mac's First Quarter '04 Earnings Conference Call. I have with me this morning Nancy Corsiglia, our CFO, Tom Stenson, our VP of Agricultural Finance, Tim Buzby, our Controller, and Jerry Oslick, our General Counsel.

Let me first give you some quick statements regarding the press release. We will be giving some forward-looking statements this morning and those forward-looking statements cover areas that are more completely covered in our 10Q. In addition to historical information, this release includes those statements that reflect management's current expectations for Farmer Mac's future financial results, business prospects, and business developments. Our expectations for Farmer Mac's future necessarily involve a number of assumptions and estimates and the evaluation of risks and uncertainties. Various factors could cause Farmer Mac's actual results or events to differ materially from the expectations, as expressed or implied, by the forward-looking statements. With various uncertainties that are laid more fully in the copy of the earnings release, which you should be able to access either on our website or as our 8K. And we will make a transcript of this call available on-- an oral transcript of this call, a recording, will be available on our website.

With that, let me turn to the press release itself. Farmer Mac today reported U.S. GAAP net income for first quarter of 2004 of $7.8m, or 64 cents per share, diluted share, compared to $4.9m or 40 cents per diluted share for fourth quarter 2003, and $8.4m or 70 cents per diluted share for first quarter, 2003. Farmer Mac reports its core earnings, a non-GAAP measure, in addition to GAAP earnings. That measure was developed by Farmer Mac to present net income available to common stockholders, less the after-tax effects of unrealized gains and losses on financial derivatives, resulting from the application of the derivative accounting standards.

Core earnings were $5.9m, or 48 cents per diluted share for first quarter, 2004, compared to $5.8m, or 47 cents per diluted share for fourth quarter, 2003, and $5.9m, or 49 cents per diluted share, for first quarter, 2003.

Farmer Mac's financial results reflect the fundamental strength of its business model, as it fulfills its Congressionally mandated mission to serve farmers, ranchers, and rural homeowners of America.

New business volume for first quarter 2004 was $207.2m. Presently Farmer Mac's new business with agricultural mortgage lenders has been slowed by reduced growth rates in the agricultural mortgage market, increased capital and liquidity at those agricultural mortgage lenders and the current interest rate environment, and increased regulatory pressure on government-sponsored enterprises.

The Farm Credit System Insurance Corporation, a U.S.-government controlled corporation managed by a three-member board of directors, composed of the members of the Farm Credit Administration Board, has indicated that the farm credit system institutions should be cautious about the risk of doing business with government-sponsored enterprises, including Farmer Mac, and has raised objections to those institutions' use of Farmer Mac swaps because they generate Farmer Mac One guaranteed securities not subject to its insurance premiums.

Notwithstanding these circumstances, Farmer Mac continues to see promising new business opportunities, with marketing initiatives advanced by new and expanded business relationships, including a strategic alliance, product enhancements, and refined security structures. Performance of the portfolio of loans underlying our guarantees and stand-bys has been strengthening.

Taking into account our expectation the 90-day delinquencies will fluctuate from quarter to quarter, with higher levels likely at the end of the first and third quarters of each year, corresponding to the semi-annual payment characteristics of many Farmer Mac One loans, we are pleased that March 31st, 2004, 90-day delinquencies in Farmer Mac's portfolio were at their lowest first quarter levels in three years, in terms of both dollars and percentages. This underscores the effectiveness of Farmer Mac's ongoing credit risk management, aided by increasing strength in the U.S. agricultural economy.

As of March 31st, 2004, those delinquencies totaled $57.4m, representing 1.17% of the portfolio, down from $76.2m and 1.58%, as of March 31st, 2003, and $79.2m and 2.11% as of March 31st, 2002. We expect the current trend to continue.

Based on ongoing new business developments and the demonstrated credit strength of the loans underlying our guaranteed and stand-bys, we believe Farmer Mac's 2004 core earnings per diluted share will exceed the 2003 level by as much as 10%.

Turning to credit -- as of March 31st, 2004, Farmer Mac's 90 delinquencies totaled $57.4m, representing 1.17% of the principal balance of all loans held and loans underlying, post-Farm Credit System Reform Act, so-called 1996 act, Farmer Mac One's guaranteed securities and stand-bys, compared to $76.2m, 1.58%, as of March 31st, 2003.

As of March 31st, 2004, non-performing assets totaled $91.3m, representing 1.68% of the principal balance of all loans held and loans underlying, post-1996 Act, Farmer Mac One's guaranteed securities and stand-bys, compared to $94.8m, 1.97%, as of March 31st, 2003. The principal balance of non-performing assets includes certain segments of the portfolio that have cycled through foreclosure and into the REO asset category, and a group of loans that are current under the original loan terms, or a court-approved bankruptcy plan, though the borrowers on those loans have filed for bankruptcy protection.

As of March 31st, 2004, Farmer Mac analyzed the following three categories of assets for impairment, based on the fair value of the underlying collateral. One, the $91.3m of non-performing assets. Two, the $29.8m of loans for which Farmer Mac has adjusted the timing of borrower's payment schedules within the last three years, but still expects to collect all amounts due and has not made economic concessions. And three, the additional $59.1m of performing loans that have previously been delinquent or are secured by real estate that produces commodities under stress. Those individual assessments covered a total of $180.2m of assets, measured for impairment, against updated appraisals.

Other updated collateral evaluations were discounted values. Of the $180.2m of assets analyzed, individual collateral shortfalls totaled $4.4m and Farmer Mac allocated specific allowances of $4.4m to those under-collateralized assets as of March 31st, 2004.

After the allocation of specific allowances from the total allowance for losses of $22.2m, the non-specific or general allowance and the contingent obligation for inherent probable losses were one-- $17.8m.

During first quarter 2004, Farmer Mac charged off $1.5m in losses against the allowance for losses. In certain collateral liquidations scenarios, Farmer Mac may recover amounts previously charged off or incur additional losses, if liquidations proceeds vary from previous estimates. Based on Farmer Mac's analysis of its entire portfolio, individual loan by loan analyses, and loan collection experience, Farmer Mac believes that specific and inherent probable losses are covered adequately by its allowance for losses.

Turning next to interest rate risk, Farmer Mac measures interest rate risk through several tests, including the sensitivity of its market value of equity and net interest income, to uniform or parallel yield curve shocks. As of March 31st, 2004, our parallel increase of 100 basis points across the entire U.S. Treasury yield curve would have increased MVE by one half of one percent, while a parallel decrease of 100 basis points would have decreased MVE by .8%. As of March 31st, 2004, a parallel increase of 100 basis points would have increased Farmer Mac's NII, a shorter-term measure of interest rate risk, by 2.8%, while a parallel decrease of 100 basis points would have decreased NII by 4.33%. Farmer Mac's duration gap, another measure of interest rate risk, was minus .5 months, as of March 31st, 2004.

The economic effects of financial derivatives, including interest rate swaps, are included in the MVE, NII, and duration gap analysis. As an alternative to long-term fixed rate debt issuance, Farmer Mac issues short-term debt and enters into contracts to pay fixed rates of interest and receive floating rates of interest from counter parties. In addition, Farmer Mac enters into fixed to floating interest rate swaps and basis swaps to adjust the characteristics of its assets and liabilities to match more closely on a cash flow and duration basis, thereby reducing interest rate risk. As of March 31st, 2004, Farmer Mac had $791.4m of such interest rate swaps outstanding.

Farmer Mac uses financial derivatives for hedging purposes, not for speculative purposes. Farmer Mac accounts for its financial derivatives under FAS 133.

During fourth quarter 2004, the increase in net after-tax income resulting from FAS 133 was $1.9m, and the net after-tax decrease in accumulated other comprehensive income was $12.4m. During fourth quarter 2003, the decrease in net after-tax income resulting from FAS 133 was $0.9m, and the net after-tax increase in accumulated other comprehensive income was $11m.

For first quarter 2003, the increase in net after-tax income and accumulated other comprehensive income resulting from FAS 133 were $2.5m, and $1.1m, respectively. Accumulated other comprehensive income is not a component of Farmer Mac's regulatory core capital.

Let me turn for a moment to risk-based capital. Farmer Mac is required to meet the capital standards of a risk-based capital stress test, promulgated by the FCA, referred to the ``RBC test,'' pursuant to federal statute. As of March 31st, 2004, the RBC test generated an estimated risk-based capital requirement of $42m, compared to the risk-based capital requirement of $38.8m, as of December 31st, 2003. Farmer Mac's regulatory capital of $245.7m as of March 31st, 2004, exceed the RBC requirements by approximately $203.7m. Farmer Mac is required to hold capital at the higher of the statutory minimum capital requirement or the amount required by the RBC test.

Lastly, I'd like to discuss government relations, and here there has been two new government regulations developments that affect Farmer Mac within the last week. The Committee on Agriculture of the United States House of Representatives has announced its plan to hold a hearing for review of the corporation, and FCA has stated its intention to publish a proposed regulation relating to the corporation's investments and liquidity. Always conscious of the importance over oversight and sound regulation of the performance of its mission for farmers, ranchers, and rural homeowners of America, Farmer Mac looks forward to participating in the hearing the regulatory process.

This concludes our formal remarks for today, and we appreciate your time. We'd like to now open it up for questions.

[Operator Instructions] Our first question is coming from Eric Wasserstrom of UBS.

Thanks. Good morning, Henry.

Good morning.

On the-- when you mentioned, you know, some of the sort of economic factors that are creating some growth challenges, you mentioned the slowing the ag economy, et cetera, but the-- can you give us a sense that, you know, when we look at the residential mortgage market, for example, it appears that, you know, there's two things that are inhibiting GSE growth there. One is a very rich carry trade for banks, which I assume is probably very similar for ag banks, and the other is a lack of alternative asset classes in which to invest a pretty rich deposit. What is-- what is that'll get-- obviously a flattening yield curve would seem to be one catalyst for institutions, you know, to increase their selling to you, but is there another asset class that's going to become available to them that'll also be, you know, a bit of a catalyst to decrease their exposure to agricultural mortgages?

I don't see that happening readily, Eric, but what we do see is that as interest rates begin to climb, the inclination of borrowers could easily be toward longer-term fixed rates, which would be more of a funding challenge for many depository institutions, which could really be the counterpart that would resuscitate some of the volume that has been lost to the carry.

Thank you, sir. Our next question will be coming from Mark Mulholland of Matthew 25 Fund.

Hi, Mr. Edelman.

Good morning.

Good morning. In the press release, there was a comment here about the Farm Credit System Insurance Corp. has-- I guess they're objecting to using your swaps, and you have your press release right there-- I was just wondering how does that really affect you, business-wise, and you know, can you quantify something like?

It's hard to quantify it precisely, but when we compare demand among farm credit institutions, year-over-year, it's certainly down. There are other factors that tend to make the analysis imprecise, but we think it's a significant component. Tom Stenson, do you want to comment on that?

Well Henry, you've summarized, certainly, the effects in the results-- bottom line results of business from Farm Credit System institutions. And it includes system institutions who may want to migrate their long-term stand-by commitment to purchase that exists with us to a swap.

Thank you, Mr. Mulholland.

Thank you, sir. Our next question will be coming from Justin Hughes of Philadelphia Financial.

Good morning, Henry.

Good morning. How are you today, Justin?

Good. I was wondering, on the increased loss reserves, was that because of the-- I think you said you had a $1.5m of chargeoffs.

Yes.

OK, and if I can just squeeze in one more question--

Sure.

You mentioned there's a new strategic alliance, when you were talking about your new business initiatives, is that something new in this quarter or is that something that happened prior to this quarter?

It's been ongoing. The process was mentioned in our earlier earnings release, and we're beginning to really see clearer prospects, but they have not been reflected in the bottom line numbers.

Justin, I wonder if we could go back and clarify your first question, please? Could you restate that one again?

Sir, he is no longer in the queue. Hold on one moment; I'll make his line live.

Hello?

Yeah, Justin, I wonder if you could please restate your first question?

Yeah, your provision for loan losses, you know, were up year over year, from $1.2m to $2.8m, and I was just wondering if that was primarily driven by your chargeoff number in the quarter. I think you said you had a $1.5m of chargeoffs, net chargeoffs?

This is Tim Buzby, the controller. Really what you need to look at is on page ten of the press release. The provision for losses is broken out in total, and what you'll see is the make up of the four categories of reserves that we classify, and really, for analytical purposes, concentrating on the total amount gives you a reflection of the portfolio in general, as opposed to looking at the individual classifications. You're looking at, for instance, March 31, 2003, of $1.2m, compared to the current quarter of $2.8m, but you'll also notice, further down on the income statement, on the operating expense section, the provision for losses number, which shows a trend in the opposite direction. So I would, again, refer you to page 10, the chart that we added in the press release, which shows all the different components, and the totals of the provision for losses.

Thank you, sir. Our next question will be coming from [Andrew Rockschafen] of [Greenlight].

Hi, good morning. I just had one question -- it's really a housekeeping question. It looks like the income statement for the December quarter, because I had to update my model, changed from the December press release to this press release. The total revenue number was, you know, 11.757 in the December press release, and then it was 12.982 for the same quarter in this press release. I'm just wondering if there was some kind of a reclassification that went on, on the revenue and expense lines?

There were in the fourth quarter. If you take a look, also in our 10K, you'll see all the four quarters, individually laid out at the end of the financial statement footnotes. Between the time of the issuance of the press release and the issuance of the 10K, there were some accounting changes that were made which did cause the changes that you're referring to.

Thank you, sir. [Operator Instructions] Our next question will be coming from Eric Wasserstrom from UBS.

Thanks. Henry, I just wanted to test one other question -- on the circumstances with FISIC, which is-- do I understand correctly, that's that an insurance entity within the FCA, which is also your ultimate regulator, is that right?

It's a government-chartered corporation with the same board of directors but a different chairman as the FCA.

Thank you, sir. Our final question is coming from [Joe Jolson] of [JMP].

Hey, guys. Congratulations on coming in line here. I just have a question with-- you have a lot of excess capital, the way you describe it, both from a GAAP point of view and a risk-based point of view. And you don't seem to have much near-term growth opportunities. Is there any capital managing strategies that you might implement to help us long-term shareholders here?

We think that the capital we have is appropriate and necessary for future growth. We do not presently anticipate issuing dividends. I think that's your question. We believe that for the time being, earnings are better used to enhance the capital of the corporation, remembering that Farm Mac has to comply with the higher of the statutory minimums for the risk-based capital number, and the multiple of statutory minimums is not very high, although them multiple of risk-based capital is, at the moment.

Sir, we do have an additional question, coming from Mark Mulholland of Matthew 25 Fund.

Hi, Mr. Edelman, it's--

Yes--

--it's-- on that same question from the previous caller, instead of a dividend, you know, when you talk-- like a possibly stock buyback, because I don't know if this is the right way to look at it, but your-- it seems to me, it looks like on a core capital measure, it looks like you had, for total assets, you had somewhere around 2.3% equity to assets. Is that, like, a proper way to look at it?

The minimum capital calculation-- statutory minimum calculation is that off-balance sheet assets are required-- we're required to hold 75 basis points of capital against those, and for on-balance sheet assets, it's 275 basis points related to those. Not having right in front of me, the calculation, the blended average is somewhere in between the two, as you indicated.

Sir, we also have a follow-up question from Joe Jolson.

Sorry, I got cut off there. What would be the excess, then, of your core capital versus that ratio right now?

The core capital versus the ratio right now -- Farmer Mac's core capital, as we noted on page seven, as of March 31st, 2004, exceed statutory minimum of 132.2 by $91.5m, so it's approximately, just to use round numbers here, 1 and 2/3.

Thank you, sir. Our next question is coming from of Mark Mulholland of Matthew 25 Fund.

I'm sorry guys, I didn't-- you know, my question, I didn't finish it, and it still ties into the same thing -- like using the same ratio, it would show that your total assets, you know, off-balance sheet and on-balance sheet, can go up to about $9.5b, so it seems like there's a fair amount of growth, you know, or you have a fair amount growth potential already on the existing capital. You know, even a minimal buyback, like equivalent to earnings, you know, would get you pretty close to 8% or 9% of the outstanding stock. It just seems that would really help some of the long-term shareholders right now, and you can always reissue capital, either preferred or common later, you know, if the need comes up again.

Well, we'll take suggestion under advisement. As a regulated company, we have to be fairly conservative about these things, but I understand your point of view and we appreciate the comment.

We do have another follow-up question coming from Joe Jolson.

Sorry about these follow-ups, but you keep getting cut off before I can respond to what you say, but you don't have any sub debt, like the other GSEs, is that correct?

We have no sub debt but we do have a class of preferred stock.

Well, they have a lot of preferred stock, too. Is there some reason, with interest rates at record lows, that it wouldn't make sense to issue a little bit of subordinated debt in there, in your capital structure and perhaps look at buying back stock?

We have looked at that in the past and have been concerned about the treatment of equity and our needs to maintain a fairly high level of equity surplus in anticipation of growth. And although sub debt has a lot of value, it doesn't always work for these purposes, and we think that the equity approach is still more conservative. Again, this is one of the things that we think about, along with the possibility of issuing additional preferred stock and these are all alternatives available to us, and we appreciate your thoughts on those.

Our next question is coming from Eric Wasserstrom of UBS.

Great, thanks, and Henry, just to follow up on my question, I guess where I'm struggling to understand is why is there not an embedded conflict within the FCA if they have, you know, both as ultimate arbitrator for you and as, you know, this relationship with [inaudible].

Well, in fact, we have observed the existence of that conflict, going back to testimony that I gave in the United States Senate Agriculture Committee in approximately 1992. And the GAO observed it as recently as the report. They have stated that the FCA claims that they are managing the conflict and it's really not necessarily Farmer Mac's role to fine tune the FCA's management of that conflict. We are very aware of it. It's inherent. They are the only regulator of any GSE that regulates both primary lenders and the secondary market, and the philosophical question of the benefits of a secondary market versus the benefits of regulation of a primary lender are always somewhat in conflict, and it's a question of how well FCA manages that and I think in this instance, FISIC needs to be included with FCA in that analysis.

Our next question is coming from Joe Jolson of JMP.

Let me just summarize some of the stuff you said and maybe you can respond to it. I mean, a year or two ago, we were, as shareholders, we needed a lot of capital because we didn't know where delinquencies and chargeoffs might bottom out in the cycle. It appears that they bottomed out at a lot lower level than what some people feared, and in your press release, you're pretty optimistic about the trends. The other issue was this survey, by the GSA, about capital requirements. There's that uncertainty, that something could change there against you. That seemed to have gotten cleared up as well. So, is there something else that I'm not aware of that would make you guys nervous about keeping an extra $90m of excess equity right now?

Well I think that, first of all, we want to provide for growth, and growth certainly could include on-balance sheet as well as off-balance sheet, the $90 million, if it were directed to on-balance sheet growth, would not give us that much head room in terms of continuing to do [AMBS] that we would acquire, and we do earn a very good rate of return on retained [AMBS], so that looking at the statutory minimum capital analysis, that $90m gives us a certain amount of head room, but if you look at it, just in sort of roundhouse terms, you're talking about something on the order-- two-point-- call it $3b of future growth potential, and we wouldn't want to just do a U-turn in the market, go out, and issue a buyback program, and the turnaround and do another public offering on the heels of that buyback program. At this point, we don't think there's that much head room in the $90m, based on the statutory minimum capital analysis and on the worst case scenario, that we would be retaining [AMBS] on our books, to use all of that, relative to our potential in the market. I hope that helps, Mr. Jolson.

Thank you, sir. Our next question is coming from Andrew Rockschafen of Greenlight.

Hey guys, just one more question, because I went to the K, and I don't think I found the answer I was looking for, but I guess where we're- what this one looks like to me is, if I look at the reserve that you guys quote, and maybe this is where the change was, and if you could just explain to me what it was, that'd be really helpful -- 4Q, '03, if I look at the press release and the numbers from January, it's at $23.5m as of December 31st, but then when I try and build my schedule for the first quarter, and this is where I'm getting confused, the starting point in the press release and on the table is a reserve as of December 31st of, I guess, 22.1. So that 23.5 became 22.1, for the December 31st date, and I guess that's where I'm getting confused. If you could explain to me what moved around-- maybe things moved around there, or kind of what happened there.

That downward adjustment, you are correct, is the adjustment that you were referring to. In the development of the loss reserves between the time of the issuance of the press release and the issuance of the 10K, we did record a downward adjustment to the reserves, due to improving quality in the portfolio and reductions in delinquencies.

Thank you, sir. Our next question is coming from Mark Mulholland of Matthew 25 Fund.

Mr. Edelman, on the- and I know guys evaluate this, but assuming, then, what you have in capital now is good for future growth, but if you look at, you know, going forward, you know, approximately, you're going to earn $25m this year. I realize that a dividend would be a long-term commitment, but just, you know, a buyback, at these levels, would be over 900,000 shares, and I think that would do a lot to help, you know, eliminate some of the pressure from short selling and just, you know, shows a commitment to the company and you know, I think it's, from Wall Street standpoint, it looks, you know-- it's putting your money where your mouth is, that we think the stock is cheap.

We appreciate your comments on this, and I think they're very constructive, and we'll take them under consideration. Thank you, Mark.

Thank you, sir. Our next question is coming from [Brad Barra] of Bank One Advisers.

Hi, how are you doing?

Very well. How are you today?

Good. I was looking back at balance sheet growth over the last four or five years, and I was wondering how long you thought it might take to grow the $3b in assets that you're $90m in excess capital would allow? Thanks.

Yes, I think that's a function of our- two things. One, total growth. And then the distribution between on- and off-balance sheet assets, and we really do not have a two-year forecast that we're prepared to publicly publish at this point. We have had prior years that have generated as much as $2b and consistent with our expectation, the business will normalize over the next several years. That $3b is not an unreasonable amount of allowance for future growth. Thank you.

Sir, there are no more questions in the queue at this time.

Thank you all very much for participating, and we look forward to speaking with you again in July. Thank you.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time and have a wonderful day.