Federal Agricultural Mortgage Corp (AGM) 2006 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Federal Agricultural Mortgage Corporation conference call. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Mr. Henry Edelman, President and Chief Executive Officer of Federal Agricultural Mortgage Corporation. Thank you, Mr. Edelman. You may begin.

Good morning and welcome to Farmer Mac's fourth-quarter and calendar year 2006 earnings conference call. Before starting, I would like to comment on forward-looking statements that may be made today.

In addition to the historical information, this conference call may include forward-looking statements that reflect management's current expectations for Farmer Mac's future financial results, business prospects and business developments. Management's expectations for the corporation's future necessarily involve a number of assumptions and estimates and the evaluation of risks and uncertainties. Various factors or events could change Farmer Mac's actual results and cause them to differ materially from the expectations as expressed or implied by the forward-looking statements.

Some of those factors and events are identified in our press release issued yesterday, which was filed on Form 8-K this morning with the SEC and are discussed in Farmer Mac's 2006 Annual Report on Form 10-K, which was filed with the SEC yesterday. Any forward-looking statements made by Farmer Mac during this call represent management's current expectations. Farmer Mac undertakes no obligation to release publicly the results of revisions to any such forward-looking statements to reflect any future events or circumstances, except as otherwise mandated by the SEC. A recording of this call will be available on Farmer Mac's website approximately two hours after the conclusion of this call.

Farmer Mac yesterday reported that it obtained record new business volumes of $3 billion in 2006. Farmer Mac noted that this growth was achieved with a portfolio of loans underlying its guarantees and standbys but continues to perform well, with delinquencies remaining at low levels in terms of both dollars and percentages. This is ongoing evidence of the effectiveness of Farmer Mac's marketing strategies and credit risk management, the strength of the US agricultural economy, and the increasing value of US agricultural land.

For the year ended December 31, 2006, GAAP net income was $29.8 million, or $2.68 per diluted share compared to $47 million, or $4.09 per diluted share for the year ended December 31, 2005. For fourth quarter 2006, GAAP net income was $7.6 million, or $0.70 per diluted share compared to a GAAP net loss of $6.3 million, or $0.58 per diluted share for third quarter 2006, and $11.9 million, or $1.04 per diluted share for fourth quarter 2005.

Farmer Mac reports its core earnings, a non-GAAP measure, in addition to GAAP earnings. Farmer Mac uses the core earnings measure to present net income available to common stockholders, thus the after-tax effect of unrealized gains and losses on financial derivatives resulting from the application of the derivative accounting standards.

For 2006, core earnings were $25.9 million, or $2.33 per diluted share, compared to $28.7 million, or $2.50 per diluted share for 2005. Core earnings were $6.9 million, or $0.65 per diluted share for fourth quarter 2006, compared to $6.5 million, or $0.58 per diluted share for third quarter of 2006, and $7.2 million or $0.63 per diluted share for fourth quarter 2005.

Core earnings for 2005 include the after-tax benefit of a change in accounting estimate related to the allowance for losses of $3.1 million, or $0.27 per diluted share. Core earnings for the 3 and 12 months ended December 31, 2006 include the after-tax expense for stock options of $500,000 and $1.6 million respectively in accordance with FAS 123R.

Taking account of the change in accounting estimates as stock option expenses, core earnings would have been $23.5 million or $2.04 per diluted share for 2005, and $6.6 million, or $0.58 per diluted share for fourth quarter 2005, which would show 2006 core earnings for the referenced period higher than those for 2005.

2006's new business volume of $3 billion is an important measure of the increased liquidity and lending capacity Farmer Mac is providing to agricultural lenders who make mortgage loans throughout rural America. Farmer Mac's record business volume for 2006 was attributable principally to its marketing strategy, focused on large, high asset quality program transactions, backed by increasing numbers of mortgage loans to farmers, ranchers and rural homeowners.

These transactions achieved greater protection for Farmer Mac against adverse credit performance with commensurately lower compensation for the assumption of credit risk and administrative costs, resulting in projected risk-adjusted marginal returns on equity approximately equal to those of other Farmer Mac program transactions. That new volume brought the Farmer Mac portfolio of loans, guarantees and standbys to $7.2 billion, a 37% net increase for the year.

Farmer Mac's net interest yield, adjusted for the effects of FAS 133, was 77 basis points, $34.9 million, for 2006, compared to 88 basis points, $34 million, for 2005, principally due to narrowing spreads available in eligible capital markets invested. Throughout 2006, Farmer Mac's long-term interest rate sensitivity remained low, despite the significant change in the slope of the yield curve that occurred during the year. Farmer Mac's effective duration gap was positive 0.7 months as of December 31, 2006 compared to positive 0.5 months as of December 31, 2005.

The combination of strong -- continued strong business volume, effective loan administration and conservative asset liability management reflected in our 2006 results demonstrates the direction in which the Board and management of Farmer Mac seek to guide the corporation. Continuation of these results should advance our congressional mission for agriculture in rural America, while enhancing Farmer Mac's stockholder value. For complete information on Farmer Mac's performance for the quarter and year ended December 31, 2006 is set forth in the Form 10-K Farmer Mac filed yesterday with the SEC.

Turning to net interest income, that number was $8.4 million for fourth quarter 2006 compared to $9.1 million for third quarter 2006 and $12.3 million for fourth quarter 2005. Guaranty and commitment fees, which compensate Farmer Mac for assuming credit risk on loans underlying Farmer Mac guaranteed securities and standby commitments, were $5.9 million for fourth quarter 2006 compared to $5.5 million for third quarter 2006 and $4.9 million for fourth quarter 2005.

Farmer Mac's core capital totaled $243.5 million as of December 31, 2006, compared to $237 million as of September 30, 2006, and $244.8 million as of December 31, 2005. Farmer Mac's core capital as of December 31, 2006 exceeded the statutory minimum capital requirements of $174.5 million by $69 million.

Farmer Mac is required to meet the capital standards of a risk-based capital stress test promulgated by FCA pursuant to federal statute. As of December 31, 2006, the RBC test generated an estimated risk-based capital requirement of $42.9 million compared to the risk-based capital requirement of $46.3 million as of September 30, 2006 and $29.5 million as of December 31, 2005.

Farmer Mac's regulatory capital of $248.1 million as of December 31, 2006 exceeded the RBC requirement by approximately $205.2 million. Farmer Mac is required to hold capital at the higher of the statutory minimum capital requirement or the amount required by the RBC test.

Farmer Mac measures its 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 shock. As of December 31, 2006, a parallel increase of 100 basis points across the entire U.S. Treasury yield curve would have decreased MVE by 1.9%, while a parallel decrease of 100 basis points would have had no material effect on MVE.

As of December 31, 2006, 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 4.1%.

That concludes my formal remarks, and we will now open the call to questions.

(OPERATOR INSTRUCTIONS). Michael Chapman, AIM Investments.

I guess since I'm limited to one, the first one I'll ask and I will get back in queue is -- could you just give me a feel for how you think the investment portfolio will grow or shrink over time? Over the last few years, it seems to be the primary driver of the asset growth that you guys have seen. And there's been a slight decrease in the average balances for loans and guaranteed securities. I'm wondering if that's a trend we should expect to continue.

Nancy Corsiglia, our CFO, will address that.

Our investment portfolio has remained relatively constant as a percent of our entire balance of outstanding on-balance sheet program assets, combined with our off-balance sheet. The reason that the investment portfolio has grown in proportion to our balance sheet is that the bulk of our program asset -- our program growth has come from off-balance sheet guarantees. But in fact, the entire program growth is still greater than the (technical difficulty) -- it's a greater proportion than the investment.

Also, our non-program investments are limited by regulation to 35% of our total guaranteed and commitment --

And program assets on balance sheet combined.

[Jeff Modlin], [Kelfer Capital].

You mentioned the risk-adjusted return on equity was comparable from your -- I want to say the AgVantage programs versus your existing programs. Can you talk a little bit about the impact on the non-interest income line? What proportion of the guarantee and commitment fee income is represented by those types of businesses?

Our Controller, Tim Buzby, will talk about that.

The AgVantage transactions that you referred to and our other guarantees do all contribute guarantees and commitment fees to that non-interest income line item. For the loans which we buy in our program and keep on our books in the loans line item in the format guaranteed securities item, those items contribute in the interest income section.

(OPERATOR INSTRUCTIONS). Michael Chapman, AIM Investments.

I can probably ask more than one then I guess if there's just two of us asking questions. Could you then just talk about -- given the on-balance sheet and the off-balance sheet mix, how you think that's going to change over time? Do you think you're going to be having more loan growth on balance sheet in the future, or is the majority of the growth going to be off-balance sheet and we'll just see that coming through the fee line?

I think it's difficult to predict those because we have done large transactions of both types in recent years. And we really are neutral to those as a difference, because we earn a fee for assuming credit risk, and we earn a fee for asset liability management when we put assets on our book as compared to the off-book guarantees.

Farmer Mac accepts business opportunities as they come along, and we don't discriminate between on and off-book opportunities. I would say that as we go forward, there has been an increasing trend toward off-balance sheet transactions, but I wouldn't want to say that this is something that is predictive in nature.

Then just from the standpoint of the total market out there, given we're seeing a lot of data that -- on land values for foreign properties have been going up pretty consistently over time, and there seems to be quite a bit of liquidity chasing that asset class, would you expect the total loan on and off-balance sheet growth for that to be similar to just the increase in land values that you're seeing? Or do you think there is additional growth beyond that?

We believe there are many additional growth opportunities for Farmer Mac beyond the merely inflationary indicator that you're referring to.

Mr. Edelman, there are no further questions at this time.

Okay. If there are no further questions, then we appreciate very much the participation of everyone who has been on the call today.

Jeff Modlin, Kelfer Capital.

Can you talk a little bit -- I know there's a historical precedent and your -- for your capital structure and there are classes of stock. But I wondered if you had any, or if the Board had any flexibility as to the capital structure? And why, all else being equal, your policy would be to repurchase the more expensive Class C stock rather than the A and the B shares?

First of all, the capital structure is part of our statute. And as such, the combination of A, B and C is pretty much dictated by Congress, and having three distinct classes is something we would have to live with until Congress changed our statute.

In terms of our repurchase, we believe that although the Class C may be more expensive on a per-share basis, first of all, it's desirable for us to leave the Class A stock outstanding in order to facilitate lender participation in the program, because stock purchase is required for participation by lenders. And it's a relatively small float of Class A, and it's a thin market.

The Class B stock is held exclusively by the farm credit system, does not trade publicly, and we haven't seen any reason to go back and change that. And then, the third thing is the Class C stock, is the stock that is the general investment vehicle. And we thought that that was the most appropriate of the three classes, C, looking at for a buyback program, because it is the largest.

Michael Chapman, AIM Investments.

Just a question then, kind of framing the total market growth that you might see, given we're seeing some inflation. You had mentioned that the 3 billion was through marketing and everything else out there. Could you just give me an overview of what market share opportunities you have or what the competitive environment is out there, given a whole bunch of other asset classes are having some problems right now, whether it's more difficult for you to find loans out there or to get guarantees because other lenders are out there? And then, what type of kind of whole market growth you would see both on and off-balance sheet?

Sure. First of all, we do not consider that Farmer Mac is in competition with primary lenders, because we're a secondary market that is used by many primary lenders. And since we don't make loans at all, we only purchase loans made by primary lenders or guarantee them on the book of other than in the cases for our Farmer Mac-guaranteed securities, we consider that there is no competitive secondary market as such.

In terms of size, there is $1.3 trillion worth of agricultural real estate in the United States. Of that, approximately $120 billion of mortgages are outstanding against it. And if you were to assume a 50% loan to value ratio, you would say that approximately $240 billion, which is less than one-fifth of the total land, is mortgage. Within that $120 billion, approximately 40%, which is $48 billion, is estimated by Farmer Mac to be eligible for our program. So that with 7.2% -- $7.2 billion of guaranteed commitments outstanding, we would say that we are at about a 15% penetration of that 48 billion potential.

We think there are a lot of factors that could cause the 48 to increase as a percentage of the 120 billion, and there are factors that could cause the 120 billion to increase relative to the land base of 1.3 trillion. So looking at all those numbers, we think there is considerable opportunity out there for high-quality business for Farmer Mac in today's environment. Are there any other questions?

Michael Chapman.

It seems that -- just a quick comment here. Maybe on the next conference call, you might want to consider just leaving the lines open. Because I tried to ask a follow-up. But it seems as soon as I stop talking, I get cut off. And so, I have to hit pound one to ask a follow-up (multiple speakers), so there can't be any kind of ongoing dialogue. So I keep having to hit pound one, so you might want to change that next time.

Then just on -- from the standpoint of the market growth, are any of the primary lenders given what looks to be a great credit right now with land appreciation? Are they more likely to hold onto the loans as opposed to put them out for you to buy? So is there a decreased supply of loans for you to purchase, because the primary banks want to hold it because it seems like it's probably pretty good credit in this environment?

I think there are other considerations beyond just credit. Because of course, Farmer Mac is not a dumping ground for weak credit. But we believe our credit underwriting standards are such that we're able to discriminate.

The real issues there are liquidity and capital. That is, lenders who need liquidity because they are running out of funding for new loans would use Farmer Mac. Also, lenders who are capital constrained could use Farmer Mac because the risk weight of a whole loan on their books is 100%, while the risk weight of mortgage-backed securities backed by those same loans would be 20%.

The other factor is asset and liability management. In an environment with a relatively-flat yield curve, there are opportunities for borrowers to go out on the curve and take advantage of current rates. And there's a point where many conventional lenders on commercial banks, in particular, can't go out on the curve much past five years with reliable asset liability management. And that being the case, they can use Farmer Mac as a source of long-term, fixed-rate funding by selling mortgages into our program.

So I think there are a lot of other drivers beyond just the ones you had mentioned.

And from the standpoint of just the capital structure of the Company, you guys have been buying back stock? I know it's been of the Class C variety. Is that admission that there just isn't enough growth out there to leverage that capital in that market, or is some of the securities growth trying to kind of lever that underutilized capital?

What we're doing is basically considering the capital position of the Company, which as you heard in my formal remarks earlier, is that we do have considerable excess capital and at the same time looking at the stock price as well and considering whether the stock is undervalued relative to what we consider to be the long-term opportunities and value of the Company. And those are the factors that the Board and management consider in making those kinds of decisions.

As we grow, we will continue to look for efficient use of capital, and we will continue to consider both buyback programs and the cessation of buyback programs, as well as the issuance of stock in the future. I think this is a very flexible and fluid aspect of capital planning for any company, and Farmer Mac tries to be nimble.

Just because looking at it, it just appears that by my calculation, you have quite a bit of excess capital, probably between probably $6 and maybe $9 of excess capital. Is it more likely that you would use that to affect in securities to get a spread on that or dividend increases or special dividends or buybacks? How would you rank those and kind of what would be the pace of any of those?

I think I could not really predict how we would deal with those things in the future. But I would say that we look at all of those considerations on a regular basis.

And is the stock buyback then, is that dated by any regulatory constraint in the pace that you can do that, or is that strictly pragmatic based on management and the Board?

It's strictly pragmatic, recognizing that there are regulatory capital requirements, both the statutory and the risk-based capital. And we try to give ourselves a certain amount of leeway in those.

And what type of cushion above statutory would you normally expect to carry, since it looks like your--?

I think that's a question that would be dependent on the nature of our business at the time in terms of our sense of where our risks were and what the risks of new business were, and other factors that I could not tell you are driven by a formula.

Because right now, it would seem that the credit cycle should be very positive for you in the farm market, given low LTVs in the farm market and also just the increase in price of land and commodities and to the fact that you have 70 million of excess capital above the statutory. Is that a number that's higher than normal, lower than normal, or is that the level you have tended to keep it at historically?

I think that again, this is kind of a flexible thing and we're not rigid about that. I'm afraid I'm going to have to move to the next questioner right now. And if you have more questions, we will come back to you. Next caller please?

[Wayne Jarvis], Janco Partners.

I was wondering if you could tell me how you manage risk, inflationary risk of assets and say new loans that are put on the books backed by land values that are increasing in price due to say, regulatory changes like mandated ethanol content in gasoline. And how you would manage those risks, which could change with C. Changes in regulations and they're not standard risks (multiple speakers)?

Right now, the way we manage risk is, initially, through our underwriting standards, we evaluate the risk of each loans before we include it in a guaranteed security or purchase it or place it into a standby. And the underwriting standards are fairly well spelled out. But at the same time, they change as the market changes. And so, we think we're well-protected on that.

In terms of interest rate risk for on-book assets, we have very active asset and liability management. Thank you. Next question please?

Jeff Modlin, Kelfer Capital.

I just wanted to go back to the capital, the excess capital question again. In some financial situations, excess capital can dry up pretty quickly when credit conditions change. You suggested in response to an earlier question that you actually saw some growing market opportunities.

I'm concerned. Is it plausible that a change -- a severe change in credit conditions could actually find you in a short capital position as liquidity dries up and you've been buying back stock?

I think that's a fairly remote possibility based upon our considerable capital excess position right now and of course the quality of our assets and our underwriting standards looking into the future.

When I look at your standby commitment--?

Beg your pardon. Do we have another question? If not, go ahead. Proceed.

I was going to ask, is not your standby purchase commitment by its nature, isn't that a put (multiple speakers)?

Standby purchase is two things. First, it is our undertaking to purchase a defaulted loan, which of course is the same undertaking that we make with respect to any guaranteed security. Whether it's a standby or a conventional Farm Act-guaranteed security, we still have the obligation to purchase a default loan out of that group of guarantees or standby loans.

The technical aspect of the Farmer Mac purchase of agricultural mortgages that are subject to a standby is that we would step in and purchase those mortgages at a market-adjusted price. That is, it would not be par, but rather whatever the market value of the mortgages was on the day that a standby holder asked us for a bid. So it's a mark-to-market bid. It's not really a put.

Farmer Mac is always ready to make a secondary market and to purchase those loans, which are already under our credit enhancement at an arm's length price in the market at that time.

Michael Chapman, AIM Investments.

Just on the credit cycle, given you guys have been in this business for a while and given the strength in land values, do you see credits improving, staying relatively stable, or deteriorating? How would you characterize the trend in the credit cycle right now for you guys?

Tom Stenson, our VP Ag Finance.

How would we characterize it? We would characterize it in our disclosure. I would say what the USDA forecast is a continuation of what has been a fairly robust upward trend in land values. I believe they forecast '07 as not being quite as robust as '06. But nonetheless, that is their prognostication.

Earnings are strong as evidenced by the reduced amount of federal price support through the subsidy programs, meaning the prices have exceeded target prices under which subsidies are triggered. So if it looks good, someone mentioned ethanol. And certainly, renewable energy of various forms has provided some wind under the wings in certain locales for corn farmers and for that matter soybean growers as to biodiesel. So the near-term outlook is favorable, most especially in the corn belt.

Wayne Jarvis, Janco Partners.

I had a question regarding -- congressional treatment of [ashdies] like Farmer Mac. There was supposed to be some series of meetings that were held -- or decisions that were made about the regulatory capital requirements in November. I was wondering if you could give us any update on that, and what impact those changes might have had on any potential change in the ownership structure of Farmer Mac.

I think what you're referring to in November was our risk-based capital number, which went into effect at that time. If that's what you would be referring to, it did go into effect. But that had nothing to do with any recent congressional activity. There has been congressional activity unrelated to Farmer Mac, looking at the situation respecting Fannie Mae and Freddie Mac. But that has not included Farmer Mac.

Thank you, Mr. Edelman. There are no further questions at this time.

Thank you all very much for participating today and appreciate your continuing interest in Farmer Mac. Thanks a lot.

This concludes today's conference. Thank you for your participation.