Federal Agricultural Mortgage Corp (AGM) 2011 Q3 法說會逐字稿

Good morning and welcome to the Federal Agricultural Mortgage Corporation third quarter 2011 Investor conference call. All participants will be in listen only mode. (Operator Instructions) After today's presentation there will be an opportunity to ask questions. (Operator Instructions) Please note this event is being recorded. I would now like to turn the conference over to Mr. Michael Gerber, President and CEO. Please go ahead, sir.

Thank you, Denise, and good morning everybody. I am Mike Gerber, the President and CEO of Farmer Mac, and the Farmer Mac management team and I are pleased to welcome you to our third quarter 2011 investor conference call, but before starting this morning, I will ask Jerry Oslick, who is Farmer Mac's General Counsel, to comment on Forward-looking Statements that may be made today.

Thanks, Mike. In addition to 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 cause Farmer Mac's actual results to differ materially from the expectations as expressed or implied by the Forward-looking Statements. Some of these factors and events are identified in our Press Release issued yesterday and discussed in Farmer Mac's quarterly report on Form 10-Q for third quarter 2011. The Form 10-Q and the Form 8-K containing the Press Release were filed yesterday with the SEC. Any Forward-looking Statements made by Farmers Mac during this call represents management's current expectations. Farmer Mac undertakes no obligation to release publicly the result or 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 our website after the conclusion of the call.

Thank you, Jerry. We are pleased to share with you the results for the quarter ending September 30, 2011. They reflect continued improving strength to Farmer Mac. Core earnings again increased during the quarter. New program business and volume was $1.5 billion, and in addition, 90-day delinquencies were down compared to both the previous quarter and the prior year. Let's look at a few of these items just a little more closely. Third quarter of 2011 core earnings were $11.2 million, which was an increase of 42% compared to the $7.9 million in third quarter 2010, and also up from the $10 million in second-quarter 2011.

GAAP results were a loss of $23 million for the quarter, compared to GAAP earnings of $6 million in the third quarter of 2010. The third quarter 2011 decline in GAAP results was attributable to the effects of some fair value changes on financial derivatives. Ultimately, these fair value changes in financial derivatives are not expected to have a permanent effect on earnings or capital. During third quarter 2011, Farmers Mac added $1.5 billion of new program volume, bringing the total new volume for the first 9 months of 2011 to $3 billion. This new business volume in the third quarter was led by purchases of $1 billion of Farmer Mac I AgVantage securities, which replaced $1 billion of off-balance sheet Farmer Mac I AgVantage securities that matured during the third quarter of 2011. This continued addition of new business volume is obviously an important component to the growth of the company.

Most sectors of agriculture are enjoyed strong earnings, retail loan volume growth in the ag sector remains somewhat muted. We are pleased with the continued strong growth in our cash window business. This growth has offset the recent lower growth in the long-term standby commitments and our AgVantage opportunities. We continue to work with new customers to create new products and to find new ways to meet the needs of lenders, and ultimately the producers. Farmer Mac's outstanding program volume was $11.8 billion as of September 30, which was down from $12.2 billion as of December 31, 2010. Recognize that the decrease in overall volume was directly related to the maturity of a $475 million AgVantage security that was not replaced with new business during the third quarter. It is important to note, however, that the maturity did not have a significant negative impact on the core earnings.

One significant benefit of the continuing strong ag economy is in the third quarter we experienced a lower level of delinquencies. Farmer Mac's 90-day delinquencies were $44.9 million, or 1.02% of the Farmer Mac I portfolio, as of September 30, 2011, and this is down from $70.2 million or 1.63%, as of December 31, 2010, and $64.8 million, or 1.53%, as at the end of Q3, 2010. Importantly, given the history here, no ethanol loans were delinquent as of September 30, 2011, and that compares to $10.9 million of delinquencies as of December 31, 2010 and September 30, 2010. In addition, as we analyze the overall credit quality of our program business here at Farmer Mac, we take into account more than just the Farmer Mac I agricultural loan delinquencies. The total business includes AgVantage securities, rural utility loans, and neither of those currently have any delinquencies, as well as the USDA guaranteed portions of Farmer Mac II that are backed by the full faith and credit of the United States. When these are taking into consideration, the overall level of 90-day delinquent loans in all of Farmer Mac's programs were just 0.38% as of September 30.

They are pleased with the continuing improvements in the portfolio, credit quality, and while any sector or large loan could impact the numbers, the results reflect our continued focus on disciplined underwriting and the recognition that credit quality is the key component and driver to our long-term success. With that as background, what I'd like to do now is turn it over to Tim Buzby, our CFO, to cover our financial results in greater detail. Tim?

Thank you., Mike. As mentioned, third quarter core earnings were $11.2 million, or $1.04 per diluted share, up significantly from $7.9 million, or $0.74 per share, a year earlier. Farmer Mac uses core earnings and non-GAAP financial measures to measure corporate economic performance and develop financial plans, because in management's view core earnings is a valuable alternative measure for understanding Farmer Mac's economic performance, transaction economics, and business trends. This non-GAAP financial measure may not be comparable to similarly labeled non-GAAP financial measures disclosed by other companies, and Farmer Mac's disclosure of core earnings is not intended to replace GAAP information, but rather to supplement it.

The increase in core earnings was primarily due to higher net interest income and a reduction in the allowance for losses. Net interest income for the quarter exceeded $31 million, compared to $25 million in third-quarter 2010. Higher net interest income was driven by on-balance sheets program asset growth in late 2010 and throughout 2011. Our net effective interest spread for third quarter is consistent with our expectations at 93 basis points, down from 104 basis points in third quarter 2010. The 11 basis point decrease in the spread is mainly attributable to the addition of lower yielding assets to Farmer Mac's liquidity investment portfolio over the course of the past year, such as US Treasuries, which have a negative net yield but offer a source of contingent liquidity, and two, on-balance sheet AgVantage securities which yield less than the average overall net spread on all of Farmer Mac's interest earning assets. $1 billion of AgVantage securities purchased by Farmer Mac during the third quarter effectively replaced $1 billion of maturing AgVantage securities previously accounted for as off-balance-sheet guaranteed securities that, because they were off-balance sheet, did not contribute to net interest income or our net effective spread. These new AgVantage securities should provide increased future earnings, because the net interest margin earned by holding these securities on-balance sheet is expected to exceed guaranteed fees earned on the prior off-balance-sheet guarantees.

The second contributing factor to the higher core earnings was a reduction in the allowance for losses of $800,000, compared to provisions for losses of $500,000 in third-quarter 2010. Consistent with the overall improvement in credit quality, the allowance for losses at quarter end was $17.7 million, which was down from $20.1 million at the end of 2010, and $19 million as of September 30, 2010. For third quarter 2011, the GAAP net loss attributable to common stockholders is $23 million, or $2.22 per diluted share, compared to net income of $6 million, or $0.56 per diluted share, for third quarter 2010. GAAP net loss for the quarter was attributable to changes in the fair value of financial derivatives which are primarily interest rate swaps. Though this financial derivatives are not designated in hedge relationships for accounting purposes, changes in long-term interest rates affect the fair value of financial derivatives, changes in fair value are recorded in earnings, while much of the offsetting changes in the fair values of related assets and liabilities are not recorded in earnings. While these derivative fair value changes are expected to have no permanent effect on earnings or capital if held to maturity, as is expected, they can contribute significant volatility and periodic GAAP earnings, as was the case in the third quarter.

Farmer Mac's capital surplus above the statutory minimum capital requirement was $125 million as of quarter-end, down from $162 million at the end of the second quarter. That reduction is the combined effect of GAAP net loss for the quarter and the growth of on-balance sheet assets, which based on Farmer Mac's statutes require a higher amount of capital and similar off-balance-sheet guarantees or commitments. For complete information on Farmer Mac's performance for the quarter as set forth in the 10-Q we filed yesterday with the SEC. With that, I will turn the discussion back to you, Mike.

Thank you, Tim. As you can see, we do continue to make progress. Solid core earnings, the addition of new volume and, in spite of weaker demand at the retail level, some improvement in delinquent and distressed credits, all contributed to another quarter of improving results. Strong commodity prices and a healthy ag economy, many producers are using cash rather than debt to make purchases. While this has impacted our growth in the short-term, longer term producers should be well positioned to take advantage of opportunities. We expect continued new loan volume to offset the maturing volume and provide for continued improving earnings.

In addition, we continue to have an ongoing dialogue with an increasing number of lenders, in both the ag and rural utilities sector, as they continue to search for sources of capital and liquidity and to reduce their credit and concentration risk exposures. These tools will continue to be important as the economic cycles change, especially in these uncertain and volatile times. As a result we remain optimistic about the future opportunities in front of us, and we look forward to sharing those results with you. At this time I will turn it back over to Denise and we will be glad to take any questions you might have.

(Operator Instructions)

Jon Evans of Edmunds White Partners.

Can you talk just a little bit about, I guess, you guys have kept a very low-key profile, believing that if you just put up the numbers they will come, but if you look at it right now you've gone through 3 quarters. Your core earnings are like $2.92, and your stock sells at $19. So it's pretty cheap. I know you probably can't buy back stock because of the government issues, et cetera, but can you talk about potentially raising the dividend? It seems like you have excess capital and you had a little bit of your book that's running off just because the farm economy's so good. So help me understand that in your guys' thoughts.

Sure. Be glad to talk about that. First of all, I think our focus has been primarily to build the balance sheet and get ourselves well positioned for the future. Our focus, really, has tried to be more longer term rather than being a short-term look, and I know that impacts in the short-term some of these decisions, but we believe there's opportunities in front of us, and we want to be well positioned to take care of those opportunities and meet the mission that Congress set up for us.

In addition, one of the things that you have seen play out in this quarter is what the derivative book and the volatility of interest rates that are there, you've seen the impact that that can have on our capital position. So we tried to build that in, which has allowed us to use better funding tools and provide better earnings for the Company. So with all those things as trade-offs, we continue to look at things like the dividend. We continue to look at things like buying back stock, all the tools that might be available to us. The Board looks at those regularly and has those discussions regularly, and we're going to continue to do that as we go forward.

Well, so you have excess liquidity, is it of about $110 million, is that correct? So how much can you add to the portfolio with that kind of excess liquidity?

Well, it's really hard to come up with an exact number because there are different capital requirements based on the type of asset that it has, but there is opportunity for growth, clearly, in the capital that we have on our books, but when you look at that and, again, the volatility, we don't want to run that right down to the last dollar. That doesn't seem to be a prudent, in my view, a prudent way to think about operating the business when we could be quickly challenged, given the lumpiness of the business and the way it comes in. Tim, what would you add?

Just quickly, Jon. This is Tim Buzby. I think you were referring to, you used the term liquidity, but I think you were referring to our excess capital, which is $125 million.

Right, that's what I meant to say. I apologize.

And clearly we carried excess capital for many reasons. One is to support future growth. The other is to absorb changes in the value of financial derivatives if they were to drop again. In this period, again, those fair values in derivatives are tied to long-term interest rates, which didn't drop significantly during the third quarter. While further significant drops, given where rates are today, are unlikely they certainly could occur. So we do carry a significant amount of excess capital and that, as Mike indicated, to plan for upcoming growth that we may see or growth that may come all of a sudden. We wouldn't want to be in a position where we had a growth opportunity and had to raise capital in order to support it.

Sure. I guess I don't mean to badger or belabor this point, but you could double your dividend and it would cost you $1.7 million, and I think all of us here on the phone, with the 10-year on a 2%, what happens to your derivative book if interest rates go to 0%? If the 10-year goes to 0%. I don't think it's going to 0%. So I guess I just am baffled that you cannot increased the dividend, when doubling it would only cost you $1.7 million a year.

Agreed. Your calculation is correct in terms of actual dollars. The increase wouldn't be that significant. If rates were to drop by an additional 100 basis points, that would have a similar effect to the loss in derivatives that we experienced in third quarter. The drop in the 10-year during the third quarter was about 125 basis points and the drop in the five-year was about 80 basis points.

Right, and that cost you, what, about $35 million? Was it $35 million, roughly, or no?

After taxes that's about right.

Yes. So if I think about that. So if the 10-year went to 1% you'd still have $70 million in excess capital.

Right.

I guess when you talk about this business being lumpy, but do you see, when we come in over the next couple quarters, are you going to add $2 billion or $3 billion of new deals? Because if you're not, it seems like you should be giving a bigger dividend to your shareholders who have stuck here you with you. I just don't understand.

Well, I guess what I'd say is first of all, your points are well taken. They're not lost on us here. Our Board continues to look at it on a regular basis, and on an ongoing basis. We don't give future results and give guidance on the future, but all you need to do in terms of the volume discussion that you had is look at third quarter and fourth quarter in 2010, and you'd see the lumpiness and the ability for big pieces of volume to come in.

Again, I'm not saying that in any way to drive anything other than say this business is very lumpy. We are a very leveraged structure and business, and we believe it's prudent, I believe it's prudent, for us to be capitalized and in a position to be able to handle the business that Congress asked us to handle, and to be in a position to do that safely and soundly, and that's the balance we try to hit, and so will we take your comments? We certainly will share those and continue to look at this on an ongoing basis. So thank you.

(Operator Instructions)

Mr. Evans of Edmunds White Partners.

Can I just you ask another question, then? So obviously the 10-year's come down tremendously. Your spreads haven't blow out much,. Corporate spreads have. Have you see more interest in companies like Met Life, or big companies, coming to you, wanting to use your balance sheet because they can fund cheaper for farm issues? Can you help us understand kind of what you're seeing there, potentially, because I think those are the positive big deals that you're talking about.

Yes, and you're accurate in your assessment of what's happening, and the impact is we continue to have dialogue with customers about lots of different products, and certainly that's one of those. As corporate spreads right now, as banks deal with their regulators and concentrations, both portfolio concentrations and individual hold them at concentrations, as banks look at dealing with the larger loans that are coming on their books, all of those things are things that you've accurately identified as the things we're looking at and in dialogue with our customers about. And those in the case of funding AgVantage kinds of transactions, would likely be larger transactions if they were to occur. I think the same could be true of concentration risk kinds of loans. So certainly those are the kinds of things that factor into our discussions.

Steve Sullivan of Horizon Financial Group. Please go ahead.

Yes. I was wondering, kind of tagging along with the last question, is there any other restrictions by the government that a shareholder might not be aware of in regards to dividends or repurchasing of stock and that type of thing?

No. Those are driven by the SEC rules for the most part, other than the regs that we've talked about and the ratios we've given you that would be with our regulator. No, none other would be out there.

Okay. Thank you very much.

(Operator Instructions)

Mr. Evans of Edmunds White Partners.

When you talk about credit quality, obviously it was very good. It was abnormal seasonally. I guess with what you're seeing right now, can you talk a little bit about the normal seasonality in the December quarter? Does credit quality tend to get better normally in December, and then kind of what you're seeing. Should we expect you to continue to have sequential improvement in credit quality?

Well, first of all the seasonal question, and typically what we see is that third quarter and first quarter are the challenging quarters, primarily because of the semi-annual payment structures July 1 and January 1. And so it's accurate to say that seasonally those numbers were better, and that's kind of abnormal given what we've seen historically. As we come out of the fourth quarter, our expectation would be, that from a seasonal perspective you would typically see those numbers be lower any way, as some of the over 90-day delinquencies that we reported this third quarter would get resolved, and so that would be our expectation.

Overall, as you look at delinquencies, 2 comments I would make, agriculture, many, in fact most sectors of agriculture are reasonably profitable to very profitable at this point in time. As a result, I think directionally, you would think that delinquencies would continue to decline. That said, a couple things just to remember. At these levels, 1 or 2 significant sized deals could impact the ratios, not that we expect any or we have [as so] or anything like that, but they do have an impact. But generally speaking, as long as interest rates stay low, profitability stays strong, we would expect our portfolio to continue to be solid and have these lower levels of delinquencies.

Great. Thank you.

(Operator Instructions)

I'm showing no additional questions in the queue. This will conclude our question and answer session. I would like to turn the conference back over to Mr. Michael Gerber for any closing remarks.

Thank you, Denise, and thank you everybody for being on the call. We appreciate your interest in Farmer Mac, and we look forward to sharing the fourth quarter results with you. Have a great day. Thanks.

Ladies and gentlemen, the conference has now concluded. Thank you for attending today's presentation. You may now disconnect.