Federal Agricultural Mortgage Corp (AGM) 2020 Q2 法說會逐字稿

Good day, and welcome to the Farmer Mac Second Quarter 2020 Financial Results Conference Call. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Brad Nordholm, President and Chief Executive Officer. Please go ahead.

Good afternoon. I'm Brad Nordholm, and I'm very pleased to welcome you to our second quarter 2020 investor conference call.

Before I begin, I'll ask Steve Mullery, our 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, Brad.

Some of the statements made on this conference call may be forward-looking statements under the securities laws. We make these statements based on our current expectations and assumptions about future events and business performance, and we may not be obligated to update these statements after this call.

We caution you that forward-looking statements are subject to risks and uncertainties. Actual results may differ materially from the results expressed or implied by the forward-looking statements. Evaluating Farmer Mac, you should consider these risks and uncertainties as well as those described in our 2019 annual report on Form 10-K filed with the SEC in February as updated to discuss risks related to the COVID-19 pandemic and our quarterly report on Form 10-Q filed with the SEC today.

In analyzing 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, also known as non-GAAP measures.

Disclosures and reconciliations of Farmer Mac's non-GAAP measures can be found in the most recent Form 10-Q and earnings release posted on Farmer Mac's website, farmermac.com, under the Financial Information portion of the Investors section.

A recording of this call will be available on our website for 2 weeks starting later today.

Steve, thanks very much for that. And good afternoon, everyone, and thank you for joining us. I hope this finds you and your families all doing very well and being healthy and safe.

Our second quarter of 2020 was an exceptional one that reflects Farmer Mac's execution on our business plan and our disciplined approach, resilient business model and singular focus on a sector of the economy that is among the most essential: agriculture and the food that sustains us. We recorded another quarter of solid operating performance with strong asset growth across multiple lines of business, record core earnings growth, consistent net effective spread, stable operating expenses and good credit quality.

Outstanding business volume grew to $22 billion as we have provided $1.7 billion in new credit -- and that's a gross number -- $1.7 billion in new credit to rural America in the second quarter in 2020. The combination of historically low interest rates, strong demand for long-term credit from our agribusiness and rural utility customers, our proactive approach to outreach to our customers and uninterrupted access to the debt capital markets at competitive spreads resulted in our ability to offer competitive pricing. These all were among the primary drivers of growth this quarter.

Looking back over the last 12 months, our net business volume growth has increased significantly compared to the broader agriculture real estate lending sector. A key factor contributing to this growth over the last year was the country -- company-wide reorganization that led to the creation of the Chief Business Officer and the Senior Vice President for Rural Infrastructure. These positions were established to lead and to increase our focus on our core lines of business and our key customers. These changes within our organizational structure allow our businesses to be more commercial, and they underscore our commitment to building and maintaining strong relationships with customers. When we do this right, it translates into consistent volume growth and strong financial performance.

Turning to our financials. Core earnings were a record $26.3 million for the quarter, reflecting double-digit growth to a sequential and on a year-over-year basis. Net effective spread was 89 basis points in the second quarter. That's in line with our historical results and our business plan and the discussions we've had with you over many quarters.

Our overall credit quality remains healthy. We have maintained our consistent and conservative underwriting guidelines for credit approvals, and we're continuing to closely monitor the impact of COVID-19 on new applications.

Since March, we have approved 392 payment deferment requests related to COVID-19, and that's through July 31 of this year. Those payment deferral requests have total principal balance of $408 million or, put another way, 1.8% of total outstanding credit.

We remain focused on serving the needs of our customers and are challenging ourselves to find more efficient and effective ways to provide our customers with the flexibility and assistance that their borrowers need as they adapt to this new normal. Although the environment remains particularly fluid and there's a broad distribution of possible outcomes in the future, we will remain steadfast in our commitment to maintain the availability and flow of credit to American agriculture and rural communities. That is why we are here.

Before I turn it over to Zack, I'd like to take a moment to thank all the employees of Farmer Mac for their really extraordinary efforts during this time. Throughout this crisis, we've been able to maintain exceptional customer service levels, and we've continued the strong momentum we have in our business development efforts. These are all closely aligned with our multiyear strategic plan. We've increased our head count while operating remotely, adding additional talent to the team. Our second quarter results are a testament to the culture we have at Farmer Mac, and I'm extremely proud of the way our team has consistently found ways to overcome obstacles and deliver for all of our stakeholders.

With that, I'd like to turn to Zack Carpenter, our Chief Business Officer, to give you an update on customer and market developments. Zack?

Thanks, Brad. We are very proud of our second quarter results as they have validated our customer acquisition and retention initiatives as well as reflect the success that we are achieving by providing competitive interest rates across our product set and executing an efficient and effective loan approval and purchase process.

As we continue to develop new products and solutions for our agricultural utilities customers, these efforts have and will differentiate Farmer Mac in the credit markets we serve and are establishing a long runway for growth for Farmer Mac.

Outstanding business volume growth in the second quarter of 2020 was robust as multiple lines of business contributed to net outstanding growth of $502.8 million. The quarter reflects record net volume growth in Farm & Ranch, USDA Securities and Rural Utilities of a combined $748.7 million. This growth was partially offset by a sequential decrease in long-term standby purchase commitments, loans held in trusts and guaranteed securities of a combined $204.6 million as well as a decrease in institutional credit of $41.3 million.

In our Rural Utilities line of business, loan purchase net volume grew $311.9 million during the quarter compared to $98.1 million during the same quarter in 2019 due to increased loan purchase demand from our 2 primary counterparties in the Rural Utilities line of business, CoBank and National Rural Utilities Cooperative Finance Corporation. This growth was largely driven as a result of historically low interest rates.

Loan purchase net growth in our foundational Farm & Ranch line of business was $363.7 million during the quarter, over 2x greater than the same period in 2019, reflecting our ability to attract and retain borrowers in this low interest rate environment but also our ability to significantly increase our product utilization across an expanding seller network.

Active Farm & Ranch sellers, meaning a lender that has transacted with Farmer Mac this year through a loan sale, have increased by over 40% from the same period in 2019. In addition, the number of agriculture lenders selling Farmer Mac more than $1 million in loans this year has more than doubled from the same period last year. These are a few specific metrics that highlight how we are deepening penetration with our existing customers as well as broadening our available customer network through our collaborative approach to customer relationships, pricing, product structuring and efficient and effective execution.

As Brad mentioned, our strong business volume growth over the last year has outpaced the broader agricultural credit markets. Specifically, Farmer Mac's agricultural mortgage loan portfolio grew 18% over the last 12 months compared to the year-over-year growth rate of the total agricultural mortgage loan market of approximately 3% through March 2020.

Turning to our USDA Securities line of business. We achieved record gross loan purchase volume this quarter of $224 million, outpacing last quarter's performance by $76 million. The year-to-date growth rate in USDA Securities reflects the positive effect of adjustments that we made to our product structure in the second half of 2019 to more effectively meet customer demand, our consistent and reliable credit availability as well as the increased loan limits authorized by the 2018 Farm Bill.

Our Institutional Credit line of business experienced a net decrease of $41.3 million during the quarter primarily due to the maturity of 2 bonds from 1 large counterparty as well as regular scheduled amortization payments on bonds from another large counterparty, partially offset by continued strong growth in smaller fund volumes. The decision by the 1 counterparty to not extend the maturing bonds during the quarter is directly a result of the liquidity support provided by the Federal Reserve to facilitate the functioning in the capital markets during the quarter, which resulted in the tightening of investment-grade credit spread to historically low levels.

Looking ahead, our pipeline remains strong for the third quarter of 2020. Although some financial institutions may have paused capital deployment to the sectors we serve given the impacts associated with the pandemic, which has created a window of opportunity for incremental market share, the core agricultural lenders continue to compete for transactions, which in many cases is causing competitive pressures in terms of price, structure and execution.

We will remain steadfast in our commitment to deliver a broad spectrum of financial solutions to the agricultural community by working alongside our growing customer base. Our more dynamic and responsive business model has transformed the way we deliver upon our mission and has improved customer satisfaction, volume retention and penetration in existing and new markets.

As I have mentioned on prior calls, enhancing our infrastructure and product set is crucial to provide consistent and reliable capital to both existing and new markets. In the coming months, we will be expanding our AgXpress scorecard loan product by doubling the eligible loan size that sellers can offer to their borrowers from $750,000 to $1.5 million.

Since the launch of that product in early 2019, we have seen tremendous interest and utilization of this product throughout our seller network given the simplified application process, scorecard-based underwriting criteria and the receipt of a credit decision, in many cases, the same day. We believe this AgXpress product enhancement coupled with continued infrastructure innovation is necessary for us to provide the agricultural community with the capital needed to manage through this volatile time.

Looking at everything we've managed through over the last few months, the efforts of our entire team has been nothing short of exceptional in assisting our clients and communities in which we serve. As an organization, it is imperative that we continue to further promote our mission and remain dynamic and flexible in supporting our customers during these volatile times.

And with that, I'll turn it back to you, Brad.

Zack, thanks very much. I'd now like to turn to Jack Takach to give you an update on the current agricultural environment. What's going on out there, Jackson?

Thanks, Brad. The COVID-19 pandemic continues to disrupt the general and agricultural economies. In the second quarter 2020, U.S. gross domestic product contracted at the fastest pace in history, falling at an annualized rate of 32.9% according to estimates from the U.S. Bureau of Economic Analysis.

While the financial markets and corporate credit spreads have been remarkably stable through the quarter, civilian unemployment touched the highest level since before World War II driven by closures in the leisure and hospitality services sector. According to data from the U.S. Census Bureau, U.S. consumer spending on food services away from the home fell to 50% of pre-COVID levels in April. While some consumer mobility and spending on food returned by June, the virus resurgence in the South and West has slowed the pace of recovery in the services sector.

Despite the pandemic, America's food system has been humming. Sales at grocery and food stores smashed records in March ahead of many state-imposed quarantines, and they remained elevated in the second quarter as consumers rotated from food at restaurants and schools to food at home. U.S. meat processing was curtailed by significant COVID-related worker outages in April and May, but it recovered to near capacity in June and July. Drivers returned to the road in May and June, and ethanol production rebounded to nearly 90% of pre-COVID levels by July. Agriculture was the only major industry tracked by the U.S. Bureau of Labor statistics with a lower unemployment rate in June 2020 compared to June 2019, a testament to the essentiality and tenacity of the American food system employee.

But the agriculture sector is not without its challenges. COVID-19 case rates remain elevated in counties with high levels of farm output and food processing. Commodity prices remain well below year ago averages, and agricultural exports were sluggish in the second quarter due to reduced global economic activity.

However, farmers, ranchers and rural electric cooperatives had access to several stimulus programs in the first half of 2020 that helped offset these effects. The USDA distributed over $6.6 billion in direct payments to farmers and ranchers in June and July through the Coronavirus Food Assistance Program, or CFAP. And the Small Business Administration has distributed more than $7.9 billion in Paycheck Protection Program, or PPP, loans to the business is involved in agriculture, forestry, fishing and hunting. Heading into August, the USDA had nearly $24 billion in authorized and unused funding to support the sector through the pandemic.

Despite the economic headwinds, credit quality at Farmer Mac's loan portfolio continues to be strong. Loans past due by 90 days or more decreased in the second quarter of 2020 to 0.86% of the outstanding Farm & Ranch portfolio or 0.31% across all 4 lines of business. The drop is typical of the seasonal patterns in scheduled loan payments, but there are also a significant number of prior delinquent loans that cured or paid off during the quarter. There were no delinquencies in any of the other lines of business.

Individual loan risk ratings held steady in the second quarter of 2020 with substandard loans totaling $310 million across all lines of business loans and guarantees. This volume is spread across 48 commodities in 219 counties in 39 states. These metrics are near historical averages as a percentage of Farm & Ranch as well as the total loans and guarantees.

The American food, fuel and fiber systems continue to provide critical goods and services to millions at home and around the globe. The stress across our economic engine is significant, but fortunately, a reliable support system is in place for the sector to help stabilize the volatility in commodity prices and asset values.

And with that, I'll turn it back to you, Brad.

Jackson, thank you. Now I'd like to turn the call over to Aparna to discuss the financial results in more detail. Aparna?

Thank you, Brad, and good afternoon, everyone. We had another great quarter on an operating basis, and the results highlight the strength of our underlying fundamentals, our strong balance sheet and our ability to navigate this dynamic environment. Our earnings this quarter were extremely strong and driven by asset growth across nearly all our lines of businesses. We exercised disciplined expense control relative to the prior quarter and, consequently, also incurred substantially lower funding costs. Our access to the capital markets has remained strong despite market volatility, although with the fed intervention, we have seen a stabilization in the debt markets relative to the first quarter.

We issued debt daily, and we continue to maintain our disciplined asset liability management policies and practices. We continue to issue debt across all price points and tenors, and our spreads are within historical ranges of other GSE issuances.

We have also been effective in using our callable debt instruments to mitigate the ongoing rate of prepayments that have resulted from the low rate interest environment, and we thereby maintained our overall strength.

Our size of issuances are smaller than other GSEs, but this enables us to price our debt competitively. We frequently issue customized issuances to meet the needs of our end investors. This advantage allows us to offer products to our customers at competitive rates across the curve, and this is evidenced in our overall lower rate of funding this quarter of 1.29% versus 1.97% in the first quarter.

We remain well capitalized, and we have strong liquidity. We maintained a total cash position of over $800 million as of June 30. Additionally, we opportunistically raised $79.5 million of noncumulative perpetual Series E Preferred Stock, which further enhanced our capital position this quarter. This issuance strengthened our Tier 1 capital position and positions us well for our various growth initiatives, but it also buffers us in case of unforeseen stress.

Now turning to financial. Our core earnings increased $2.7 million to $26.3 million for second quarter 2020 compared to $23.6 million in second quarter 2019. Net effective spread was $46.5 million in second quarter 2020 compared to $41.4 million in the same period last year.

Net effective spread in percentage terms -- or basis points was 89 this quarter, and this was held well within our target range of plus or minus 5 basis points of 90 basis points. We continue to defensively hold a more liquid investment portfolio and a higher amount of cash balance, as I noted, than we've held prior to the pandemic. However, the weightage towards more cash has resulted in a slight reduction of 2 basis points in our net effective spread.

The $2.7 million year-over-year increase in core earnings was primarily due to a $4 million after-tax increase in net effective spread, a $300,000 after-tax decrease in the total provision for losses. And these increases were partially offset by a $1.6 million after-tax increase in operating expenses.

Our operating expenses increased by 16% in second quarter 2020 compared to second quarter 2019. This is primarily due to increased compensation and benefit expenses that are related to the annual higher cash bonuses as well as increased head count to support our growth.

General and administrative, or G&A, expenses also increased from the prior period, and this was due to continued investments in infrastructure to support our strategic initiatives. However, of note, both compensation and G&A expenses were lower than the first quarter of 2020 by $2.1 million. This quarter, we incurred lower levels of expenses related to consulting fees, travel and conferences, all of which have partially offset some of the increases in compensation in the first quarter of 2020.

We do, however, intend to continue to make ongoing investments in our internal infrastructure as we believe that this will allow Farmer Mac to more efficiently meet its customer needs and enable greater revenue retention over time. Going forward, we expect operating expenses to increase commensurately with revenue growth.

While we plan to keep our operating expense ratios relative to revenue within a range consistent with our historical averages, we will continue to make infrastructure investments and add relevant talent in the short run. However, these investments, we expect, will taper off over time as our operations and business model both mature.

The provision to the allowance for loan losses of $500,000 recorded this quarter was largely attributable to new loan volume in our Rural Utilities portfolio. The increase was partially offset by improving economic factors that uniquely impacted the Farm & Ranch portfolio. Specifically, improvements in commodity prices and expectations for stable farmland value primarily contributed to a $1.7 million release in Farm & Ranch portfolio-related allowance for losses.

Our earnings were also substantially higher than first quarter 2020 and increased by $6.2 million on an after-tax basis. This increase was driven by a decrease in the provision for credit losses of $3 million after tax, higher net effective spread of $1.8 million after tax and a reduction in our operating expenses relative to the prior quarter of $1.7 million after tax.

The higher net effective spread was attributable to higher overall average asset balances and substantially lower funding costs in the second quarter given our continued and uninterrupted access to debt capital markets.

Before moving on, I wanted to make one point on CECL, the new accounting standard we implemented on January 1, 2020. This new methodology incorporates provisioning levels that are predicated on loan growth, changes in our portfolio mix, net charge-offs and forward-looking macroeconomic assumptions that drive our economic model. In other words, this is different from the previous method that was driven by an incurred loss approach based on historical trends and is instead driven by projections of future expected losses. Hence, future provisions or releases on expected credit loss will be based on changing economic forecasts and changes in the credit composition of our balance sheet. This might worsen or improve from the quarter-end forecast, introducing some volatility in our earnings.

Turning to capital now. We continue to remain very well capitalized. Farmer Mac's $916 million of core capital as of June 30, 2020, exceeded our statutory requirement by $248 million or 37%. This compares to $815 million of core capital as of March 31, which exceeded our statutory requirement by $166 million or 25%. The increase in capital from the prior quarter is primarily due to the previously mentioned issuance of Series E Preferred Stock as well as a $23 million increase in retained earnings in second quarter 2020.

Our liquidity remains strong, and it far exceeds our regulatory requirements by 122 days. As mentioned previously, we are holding higher-than-historically-held average levels of cash. As we head into the second half of the year, we intend to continue to maintain a higher-than-required level of cash and liquidity as we believe that this elevated position will allow us to weather any unexpected cash flow shocks given continuing economic uncertainties. It will allow us to adequately fund deferments to meet our customers' needs, but it will also allow us to retain the flexibility to maintain lower but ample levels of liquidity as market conditions change.

In conclusion, Farmer Mac's underlying financial fundamentals continue to reflect a very well-capitalized balance sheet. We have stability in our core earnings, and we continue to maintain our discipline with asset liability management. Our strong access to capital markets positions us to continue to successfully deliver upon our essential mission and navigate these uncertain times effectively.

More complete information of our Farmer Mac's second quarter 2020 performance is in the 10-Q we filed today with the SEC.

And with that, Brad, I'll turn it back to you.

Thank you, Aparna. Let me close by thanking all of our team members for their extraordinary efforts the past few months. The pandemic's impact continues to weigh heavily on individuals, on families, on businesses, on the farmers and ranchers we serve, on agribusiness, and this is something that really causes us great concern and is a source for a number of sleepless nights. But we are actively engaged with our customers, and we're preparing not only to see this crisis through but also to execute on our strategic initiatives and to modify them as needed in order to emerge with strength in a clear competitive path forward and, I dare say, even a clear competitive advantage going forward.

At Farmer Mac, we've always believed that talent, diversity and inclusion are sources of pride for our employees and our customers, and they contribute strongly to our financial performance, they contribute to our ability to create value for our shareholders and for achieving our mission of serving rural America. We work hard every day to continue to build upon a strong reputation as the nation's trusted secondary market for credit to rural America. And our second quarter results, I think, validate and further emphasize the value and partnership that we provide to our customers.

I remain very optimistic about the future even in these uncertain times, and that's primarily from just knowing the ability of our team, the strength of our balance sheet, the power of our core operations. We will continue to remain diligent, well positioned and focused on the future.

As I've said on a number of prior calls, Farmer Mac was created in response to a crisis and is intended to be a resource for financial institutions serving rural America during all times, and this is especially true during times of economic pressure and uncertainty.

So now I'd like to see if we have any questions from anyone on the line today.

(Operator Instructions) And our first question will come from Greg Pendy of Sidoti.

First question is just on the business volume growth. I assume the interest rate environment had a big part of it. So just how should we think about that? Does that pull some -- did that pull some demand forward? Or is this maybe going to be a couple-of-quarter phenomenon?

Is there any kind of point in history where you can kind of -- I know this is an unusual time in terms of rates. But any kind of periods that we can look back to historically to get -- just to get a sense of how we should think about things going forward in light of a strong volume?

Greg, Brad here. It's great to hear from you. We really appreciate your question. I'm going to let Zack get into the details of this. I think the one thing I would like to emphasize at the outset is that while there have been external factors such as the drop in interest rates, high levels of refinancing, as an example, that actually, there have been a number of things that we've been doing associated with our strategic plan that have actually driven these results as well. And that part is more sustainable and another reason for our optimism.

But Zack, you might just add some detail about both the initiatives as well as the interest rate environment.

Yes. Thanks, Brad. And Greg, great question. Clearly, the interest rate environment has helped in terms of demand for long-term credit. I think the knife cuts -- kind of cuts both ways, right? It's a competitive market out there, and there's other ag lenders that are also competing alongside our core seller network to provide that core capital to the farmers and ranchers that we look to serve. So I think with this volume growth, as Brad mentioned, highlights a lot of the initiatives we put in place to retain and attract new business.

So a couple of things I noted on in our prepared remarks in terms of deepening and broadening our penetration. In fact, our active sellers are almost 50x -- or 50% larger than we had in active sellers in the same period in 2019. And as I mentioned, sellers selling us over $1 million of loans have more than doubled since the same period. So showing the active nature of our sellers is a key metric we look to, to see if we're broadening and our product utilization is taking place.

In addition, we're also effectuating a lot of great modifications to keep the borrowers on our balance sheet working with our sellers to just drop the rate, keep the maturity and the amortization the same and execute a simple rate mod to help facilitate the customer receiving the lower interest rate but also keeping that borrower back on our balance sheet.

Looking back in time at Farmer Mac, I think it'd be difficult to go back to see a very similar time period, and you can go back post the financial crisis to kind of see a relatively similar rate environment. But I think it's going to be hard to ascertain the same nature of the retention and the relationship strategy put in place that's also driving this volume. The feedback we're receiving from our sellers is that our customer focus, our flexibility in working with them is really driving their interest to bring more volume to us, which can be seen by our increasing seller market share.

Great. That's helpful. And then just one more, I think, on the expense front. Operating expenses were up around 16%, and you mentioned an increase in head count. You've always had a very efficient head count. So assuming you are adding more people within the company, how do you think you can -- how should we be thinking about that? I mean, is there going to be a continual hiring for a couple more quarters? Or was this kind of a onetime bump in head count?

Yes. We -- I think you're going to see some additional head count from now through the end of the year, Greg, and it will probably significantly slow down next year. But a couple of things I'd like to emphasize about that. We're paying a lot of attention to head count expense. And when you look at our P&L, you'll see that compensation, employee benefits are a large part, but we also have a lot of G&A as well. So as we go to the 2021 budgeting process, we're really going to be taking, I think, a tougher look at G&A going forward.

Whatever -- wherever we end up with that G&A and comp balance, we're going to be looking at the total expense relative to our business. And I think we've highlighted in the past that our total operating expenses usually run in a band of between about 25 and 30 basis points. Going into this year, we expected that they would hit 30 or even track a little bit higher.

Frankly, what's happened this year is that, in the first quarter, it did nudge that 30 basis point level, but we had additional onetime comp expense in the first quarter associated with bonuses that we hadn't accrued for because of an unexpectedly strong finish to the year. Now when you look at that number, you'll see that it's dropping back in the 26, 27 basis point range. And that's something that we're paying a lot of attention to.

As Aparna mentioned, we expect expenses will grow approximately proportionally to the business. But to be more specific, we want to hold that operating expense level in that 25 to 30 basis point range. And we don't foresee -- other than any onetime event, we don't see that our recurring expenses are going to go outside of that range for any reason over the next 4 to 6 quarters. And over time, as Aparna mentioned, as we become a more mature organization with some of this essential infrastructure built, then we would hope to manage it to a slightly lower level, even at the bottom of that range or even slightly below.

But look for our management -- our active management of those expense levels in that range. Expect that as we do that, we will be adding additional people through the end of the year and some going into the next year but that, when we manage to that expense ratio, our profitability will continue to expand commensurate with our volume growth as long as we keep maintaining that 90 basis point net interest margin, which is the other key management metric for us.

Our next question comes from David Eidelman of Eidelman Virant Capital.

One of my questions was, I noticed in the news release you didn't show a book value. And if I calculated, it was down a little bit from the last quarter. Maybe that's because of the hedges. And if so, could you kind of explain what caused at least the stated book value on the balance sheet to go down after deducting the preferred? And what would take place to cause it to go back up?

Yes, David, I'll let Aparna get into the details of that. But you're exactly right: it is the mark-to-market nature of our swaps, of our hedges, where we have asymmetric accounting treatment of that. And those are all term structures that are matched off against liabilities that we have. It is the volatility of those on a mark-to-market basis that results in the volatility of our -- well, both GAAP earnings as well as our book equity.

So I think directionally, over the last 2 quarters, there's interesting illustration of that, and I'll let Aparna comment a little bit more detail.

Yes. I think, Brad, you've hit it pretty accurately, and you're absolutely right. We do have some of the fluctuations that come from our accumulated other comprehensive income. You might have noticed that we had a fair amount of volatility in the first quarter, and this was a result of the hedge accounting treatment as a result of our derivatives. And that really gets reflected within our AOCI calculations, which does cause some degree of volatility in our equity.

You also note that some of that has reversed, as we had mentioned, in the first quarter, where we had a favorable reversal this particular quarter. So some of that has actually been closed off.

But in aggregate, our book value of equity is higher than the same period last year. And again, as you noted, this is a result of us adding on the additional preferred stock.

I think the important thing to note with respect to the fluctuations that you see within our AOCI from derivatives is, because we use derivatives, as you know, as a risk management tool, we fully expect the value of these derivatives to pull back to par over time. And we really exclude this when thinking about our core earnings for this particular reason, both the hedges on our operating statements as well as those that hit our balance sheet. And that's why I think our net effective spread is such a good measure of the consistency in our earnings.

And I think it's important to maybe recognize that some of the fluctuation that you see in the book value within our balance sheet of our equity really does result primarily from these cash flow hedges that hit our AOCI.

But I'm happy to have a conversation with you off-line about this as well.

Our next question comes from Chip Oat of Tradition Asset Management.

My question will be about the loans under COVID-19 deferment. My lead into that has 2 pieces. The first is that for the last 3 years, probably under both this management team and prior management, cautionary statements regarding a normalized 1% 90-day delinquency number would represent reversion to the mean and that should be watched for. And we know that in the management world, cautionary statements eventually come true, which is not a criticism. It's just the way it is. So nothing has happened that brings that number even close to 1% since.

The other, and you've gotten this question several times, is you can't open mainstream press these days without seeing stories with anecdotal examples of farmers being -- going bankrupt, not just dairy farmers but farmers and ranchers. And even the Wall Street Journal, which is pretty friendly to the current administration, printed up something on that last week. So the news has been nothing but bad. Your results have been nothing but good. That's great.

So we're now at loans under COVID-19 deferment, which don't show up in your 0.31% delinquent loan statistics. Could you flesh out where you see that going? And are you still concerned about reversion to the 1% mean? Or are we -- have we got a new normal?

Chip, that's a difficult question to answer. We will give it our very best. And I'll ask -- also ask Jackson to jump in if he has additional perspective on this since he works with much of this data.

But at Farmer Mac, I don't think we see a lot of evidence that a reversion to a 1% 90-day delinquency is really a normal for us. As you note, we've consistently been below that. And even this quarter, we saw a seasonal decrease in 90-day delinquencies from where we were in the first quarter. That is a very normal seasonal pattern. At the end of the second quarter, our 90-day delinquencies are higher than they were a year ago and very, very slightly higher than they were 2 years ago. So we're seeing the seasonal pattern kind of follow itself.

The level of deferments that we granted -- and we reviewed each and every request and tried to be generous, recognizing that this is a time of great economic stress for a lot of people, including some farmers and ranchers. It's hard to make a lot of generalizations about the deferments that were granted, everything from wineries with retail tasting rooms to companies that -- or ranchers and farmers that were impacted in many other ways.

As you note, the highest level of deferments were for a period of 6 months that runs off at the end of the year, actually July 1 to January 1 of 2021. And that level of deferments, I think, was equal to about 1.8% of total principal outstanding. So if -- to do rough math, if every single one of those deferments all of a sudden after recapitalizing those payments and reamortizing those, if every single one of those borrowers was then unable to meet the next payment, we would be above 2%, but we don't believe that, that's going to happen.

We are not able to provide you with a good forecast today of what percentage of those borrowers to whom we've granted deferrals will be well prepared to resume making payments after having this cash flow relief event, the payment deferral. From what we've seen with the other delinquencies, we would kind of expect those to follow a more normal seasonal pattern. But what percentage of those deferments result in borrowers unable to then make the subsequent payments, very, very hard to forecast.

We've been running a lot of stress tests and analysis to make sure that we're prepared if it's a higher percentage. We think it will be lower, but if it is a higher percentage, we're -- we think we're well capitalized and making sufficient earnings to be prepared to weather it. I'm just not prepared, I'm afraid, to give you a more precise forecast right now.

Jackson, do you have some additional color that you can add or additional thoughts that you'd like to add? Or Zack for that matter?

Yes, I think you did a great job, Brad, in your description there in your response. The only thing I'll comment on is the 1%. I mean agriculture is a highly cyclical business. So you put the 1% in there as a historical average to Farm & Ranch and say, okay, that's where we -- if you average all the periods, yes, you're going to have some higher and some lower, but that number kind of moves up and down around that 1%. So that's why it's out there. It's more of a historical average. Not to say we're always going to be below it or always above it, but that's -- it's there for context.

Okay. Let me just toss in another item, and it's really the only thing that I think about a lot. And that is one of your prior answers to that question by someone else, is that what we're all reading about in the press are operating loans, not mortgages. And you don't do operating loans. You do mortgages. And I've just scratched my head on that a little because there has to be some read-through, does there not, between farmers that are not able to cover their operating costs and the cash flow that they need to stay current on their mortgages, right? It just seems like this should be a worry.

Yes. Well, you look at the overall delinquencies of the sector, and on average, agricultural lenders do have higher delinquencies on agriculture loans on average than we do. And you are correct, Chip, to point out that, that is primarily around operating loans. We consider the renewal and current condition of operating loans to be an important bellwether for us. Our borrowers who have mortgage loans with us and with others having their seasonal, they're usually a year having their operating loans renewed. And it's something we pay a lot of attention to in January and July. And we've been very pleased, very relieved that the level of operating loan renewals has continued at a very high rate. We're not seeing anything there that is causing us a huge amount of concern, really, that much concern at all.

But you're correct: the Wall Street Journal, the article last week cited an uptick of 8%, I think, in the number of Chapter 12 bankruptcies. Yes, that is 8% higher, but it's not 50% higher. It's still a number in the hundreds, not a number in the thousands. And the overall ability of farmers and ranchers in the United States to service the debt service that they do have in our analysis remains good.

Low interest rates have certainly been a contributor to that. In fact, Jackson, why don't you just cite some of the data relative to debt service coverage and cash flow coverage for the sector versus historic levels attributable to low interest rates? I think that's a very interesting and important part of the answer to Chip's question.

Yes, it's a very different interest rate environment today than we existed in 20, 30 years ago. When we peaked out, let's say, $0.30 of every farm dollar earned was paid to cover interest expense. Today, we're more $0.12, $0.13, so a much lower percentage, which makes interest rate changes and movements in cash flow a lot easier to continue to service the debt. So it's just a very different picture in terms of leverage and debt service coverage.

Okay. We'll keep up the good work.

Thank you, Chip.

Our next question will come from [Gary Gordon], a private investor.

I actually had 2 quick questions, hopefully. One is, any update on Zions Bank's planned or required sale of their stake in Farmer Mac.

And then two, thinking about debt financing with the 10-year at 50 basis points or so, are you sort of rethinking the value of the call feature and your callable debt? And is there any thought to extending maturities on your debt against rising rates from here?

Yes, [Gary], that's both excellent questions. In terms of Zions, you -- if you look, you can find securities filings out there indicating that they have occasionally sold additional shares, generally, when the stock has been above $65 to $70 a share.

What we have filed regarding our understanding of their situation and what they have filed is really the best current information available on that. And that is that they are -- have a situation -- regulatory situation has nothing to do with their financial condition, only associated with reorganization, where they're going to be -- and are disposing of their Class C stock, not their Class A but their Class C.

So we really don't have any further update other than to note that there have been a couple of additional sales. We have conversations with them about alternative approaches to the market but nothing further really that we can discuss or are aware of to discuss about their status.

As it relates to asset liability management, Zack, I think, provided a very clear description of how we have been proactively going to customers who may have 3-, 5-, 10-year fixed rates with us, even 20-year fixed rates with us. And if those rates are really at a level today where that customer could refinance and refinance away from us, we've been proactive in offering them today's rate. And the way that we have maintained our net interest margin is by then really calling bonds that are callable and refunding the new lower rate loan at today's interest rates and basically re-locking in a net interest margin that meets our spread objective.

So we have found that in the debt capital markets, we really haven't been paying premiums for those callable bonds. And as long as that's the case, that is a very low cost, very valuable option. For us, that option being callable is, given the way we manage our balance sheet, really a hugely more valuable option to us than apparently it is to debt capital markets investors. So for us to continue this approach rather than to extend maturities and -- for example, longer than the tenor of the -- fixed rate tenor of the loan really won't accomplish anything for us and would really kind of go against the asset liability management discipline that we have of match funding each of the loans we make.

Sorry. Just to add one thing. I'll just note, to what Brad said, the cost actually for us to issue callable debt as spread relative to treasuries has actually decreased in the recent months. So it continues to remain a very viable tool for us. But we've continued to have really good access to market conditions even some years ago.

This concludes our question-and-answer session.

I would like to turn the conference back over to Brad Nordholm for any closing remarks.

Great. Thank you, operator, and thank you all for participating. We do appreciate the interest. We appreciate the great questions you ask. And as always, we are here in between these quarterly calls to provide additional response to questions that you have, may have about Farmer Mac. We truly hope to create a reputation with you of being very responsive and transparent.

So again, thank you. We're very proud of our performance during this time. And please be in touch with Jalpa if we can follow up with anything. Thank you all for participating.

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