Federal Agricultural Mortgage Corp (AGM) 2022 Q1 法說會逐字稿

Good afternoon, and thank you for joining us for our first quarter 2022 earnings conference Call. I'm Jalpa Nazareth, Director of Investor Relations and Finance Strategy here at Farmer Mac.

As we begin, please note that the information provided during this call may contain forward-looking statements about the company's business, strategies and prospects, which are based on management's current expectations and assumptions. These statements are not a guarantee of future performance, and are subject to risks and uncertainties that could cause our actual results to differ materially from those projected. Please refer to Farmer Mac's 2021 annual report and subsequent SEC filings for a full discussion of the company's risk factors.

On today's call, we will also be discussing certain non-GAAP financial measures. Disclosures and reconciliations of these 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 Investor section.

Joining us from management this afternoon are our President and Chief Executive Officer, Brad Nordholm, who will discuss first quarter business and financial highlights and strategic objectives; and our Chief Financial Officer, Aparna Ramesh, who will provide greater detail on our financial performance. Select members of our management team will also be joining us for the question-and-answer period.

At this time, I'll turn the call over to President and CEO, Brad Nordholm. Brad?

Thanks Jalpa, and good afternoon, everyone. I'm really pleased that you are able to join us today. I'm happy to report a very successful first quarter 2022. Our financial results are strong as we'll be discussing, and we also are working to build upon a solid foundation for our future growth.

We provided a gross $3 billion in liquidity and lending capacity to lenders serving rural America in the first quarter 2022. This resulted in outstanding business volume of $24.2 billion as of March 31. We generated consistent core earnings and most importantly, our portfolio remains strong and credit performance continued to be stable with 90-day delinquencies and substandard asset ratios improving relative to the same period last year.

The Agricultural Finance line of business, which is approximately 75% of our total outstanding business volume and comprises all products secured by first liens on agricultural real estate plus all USDA guaranteed loans, grew approximately $500 million this quarter or roughly 3%. And this is primarily due to our AgVantage Securities and Farm & Ranch loan purchase programs. We are pleased to see our strong institutional relationships and the overall dynamics of the macroeconomic environment that have resulted in our ability to return as an invaluable partner in the wholesale financing space.

At the onset of the pandemic, opportunities for new business volume in our AgVantage Securities program were limited as the liquidity support provided by the Federal Reserve Bank resulted in the tightening of investment-grade credit spreads to historically low levels and increased competition. Net Farm & Ranch loan purchase volume was strong during the first quarter despite a seasonally large number of payments. That's because most of our Farm & Ranch loans have annual and semiannual payment terms with January 1 payment dates.

During the first quarter, markets experienced a disruption caused by a combination of factors, including inflation, a federal funds rate increase, expectations of future increases as well as the conflict in Ukraine. Farm expenses are rising in nearly all categories with higher grain, fertilizer energy and labor prices driving the trend, and the impacts of these increases will vary by operation and commodity type.

We believe the sector's operating expense ratio is likely to increase back towards a historically high level. However, firm commodity and food prices do leave room for farm profits this year. The USDA is forecasting record net cash income for 2022. While production expenses are forecast to increase and government payments are expected to fall, rising cash receipts should offset these changes with recent commodity price data suggesting that even stronger incomes are possible.

In terms of our portfolio, while we anticipate that future -- lower financings could result in lower levels of new loan purchases in some of our Farm & Ranch and USDA products, it could also result in lower portfolio prepayment speeds. Our pipeline in this line of business remains strong, and we will continue to be adaptive as we navigate through this environment that is characterized by significant uncertainty.

Our Rural Infrastructure Finance line of business grew nearly $150 million this quarter or 2% primarily due to our loan purchase product. This growth was fueled by a competitive but increasing interest rate environment, resulting in demand for long-term financing solutions for planned maintenance and capital expenditures.

Also contributing to growth this quarter in Rural Infrastructure line of businesses was a $35 million commitment to a large solar project. As I've said on prior calls, renewable energy is both an important economic development opportunity for rural America and it's a business opportunity for us.

Another business opportunity for Farmer Mac is our securitization program. As mentioned in our last earnings call, over the last few months, we have been focused on enhancing our infrastructure to support a securitization program, and we are closely monitoring a changing market dynamic. The market for new issue securitizations was challenged during the first quarter as the volatility in the debt capital markets resulted in somewhat of a slowdown in securitization markets.

We remain committed to being a regular issuer in the market with a diverse set of securitized products to align with our investor interest. With that said, in the near term, our plan is to slowly ramp up the number of issuances each year as we focus on building a strong foundation for the program.

Farmer Mac continues its measured and thoughtful investment in people, technology and business infrastructure to improve our capacity and efficiency, and we believe these will help us deliver on our long-term goals. We set meaningful market share goals for ourselves in our strategic plan. And to achieve these goals over the long run, we're going to need to be able to achieve gross annual business volumes that represent the growth over our current asset levels.

As an example of our efforts to upgrade our technology platform, including doubling the eligible loan size for our AgXpress scorecard products from $1.5 million to $3 million, and upgrading and enhancing this underwriting solution to achieve this outcome will require appropriate investments. Another initiative currently underway at Farmer Mac is our rebranding efforts, which are currently in the early stages.

We recognized that we have grown significantly in size over the last few years. And as a result, we are reaching a larger set of audiences and stakeholders with different profiles, but all with a shared passion for rural America. We hope that through our rebranding initiative, we're able to better -- to gain deeper insights from each of our stakeholders in order to continue to build on a strong reputation as the nation's key trusted secondary market for credit to rural America.

The continuity of our culture and business model continues to deliver consistent positive results. Through the support of our Board, we believe that our unified commitment to Farmer Mac's strategic plan in conjunction with the organization's talented and committed employee base is enabling us to take Farmer Mac to the next level.

Now I'd like to turn the call over to Aparna, our Chief Financial Officer, to discuss our financial results in more detail. Aparna?

Thank you, Brad, and good afternoon, everyone. Core earnings for first quarter 2022 were $25.8 million or $2.37 per diluted common share compared to $30 million or $2.75 per diluted common share in fourth quarter 2021 and $25.9 million or $2.39 per diluted common share for the same period last year.

The sequential decrease was due to the non-recurrence of the fourth quarter of 2021 $5.2 million after-tax gain on sale of mortgage loans, a net change in our total allowance for losses of $1.1 million after tax and a $0.7 million after-tax increase in operating expenses. These factors were partially offset by a $2.8 million after-tax increase in net effective spread.

The year-over-year decrease in core earnings was primarily due to a $2 million after-tax increase in operating expenses and the $1.5 million increase in preferred stock dividends. These factors were partially offset by $3.1 million after-tax increase in net effective spread.

Net effective spread for first quarter 2022 was $57.8 million, an approximate 7% increase compared to fourth quarter 2021 and the same period last year. The sequential and year-over-year improvement in net effective spread was primarily driven by net new business volume and cash basis interest income. Also contributing to the year-over-year increase was an increase in net coupon yields related to the acquisition of loan servicing rights in third quarter 2021.

Our liability side of the balance sheet remains strong as we continue to benefit from our dynamic funding strategies that we've outlined to you in the past, and we continue to maintain our disciplined asset liability management. Additionally, we continue to very carefully analyze our duration and convexity matches, especially in this rising rate environment to minimize our interest rate risk.

Last quarter, we introduced operating segments to allow us to offer more transparency into the various contributing components of our portfolio's net effective spread. We've implemented a funds transfer pricing or FTP methodology. This process allows us to allocate interest expense much more accurately to each of the operating segments.

Since funds transfer pricing or FTP assumes a match-funded asset liability management approach, it allocates both the benefits as well as the costs from the funding and hedging strategies to the funding segment. This also allocates the results of the investment portfolio that we primarily hold for liquidity purposes.

We believe that the new segment reporting construct provides shareholders and other stakeholders with clearer insight into the benefits of our disciplined ALM practices and dynamic funding strategies, and how they ultimately contribute to enterprise profitability. The successful execution of a $299.4 million agricultural mortgage-backed securitization in October was a key contributor to our core earnings results in fourth quarter of 2021.

While we have spent the last few months identifying ways to potentially execute these transactions more efficiently, and we hope to return to the market this year with another securitization transaction, we are taking a more measured approach in the short term, just as Brad mentioned, recognizing that current market dynamics are resetting credit market perspectives and REIT outlooks.

First quarter 2022 was extremely challenging for the securitization market as the evolving macro rate environment has contributed to spreads that are widening and interest rate volatility that is increasing throughout the quarter. We are, however, still committed to building a robust securitization program which we believe will provide Farmer Mac with an opportunity to diversify funding sources and fulfill our mission of delivering low-cost liquidity even more effectively.

Our current focus therefore is strengthening the platform and remaining opportunistic in terms of timing and structure to ensure we are not issuing in the face of volatility and uncertainty, and that we continue to create value for our shareholders with these and other transactions.

Operating expenses increased by 13% in first quarter 2022 compared to first quarter 2021, and this was primarily due to increased headcount including 10 new employees in connection with the strategic acquisition of loan servicing rights in third quarter 2021, increased stock compensation and increased spending on software licenses and information technology and other consultants to support growth and strategic initiatives, some of which Brad mentioned earlier.

The increase in loan servicing expenses are expected to be offset over a multiyear period by additional revenue that will be reflected in higher spreads in our Farm & Ranch segment, where we will not be paying a third-party but servicing the loans that we will now service. And this should make the initiative neutral to accretive for us in the midterm. The remaining hires were brought on to drive additional volume growth and support our long-term technology strategy.

We plan to continue our investments in both headcount and technology through 2022 and into 2023. And this will be primarily to modernize and mitigate risk in our infrastructure, enhance our technology platforms to support our revenue and hedging strategies, and add relevant talent across the organization, especially as we scale and enter into new areas of business such as renewable energy and telecom.

Over the next 12 to 18 months, we'll continue as we've done before to closely monitor our efficiency ratio, which ended March 31, 2022 at 33%. Going forward, we expect operating expenses to increase commensurately with revenue growth. But as we noted previously, we expect to stay within an annual range that is consistent with our historical averages and below a 30% operating efficiency level.

Our credit profile continues to be strong. As of March 31, 2022, the total allowance for losses was $16.3 million, a modest decrease from year-end 2021. This decrease was primarily attributable to a risk rating upgrade on a single loan related to the borrower's successful securitization of a large payable that was incurred as a result of the arctic freeze that struck Texas in February of 2021 and this was partially offset by new loan volumes.

Turning to capital now, Farmer Mac's $1.2 billion of core capital as of March 31, 2022, exceeded our statutory requirement by $489 million or 66%. Core capital modestly increased from year-end primarily due to an increase in retained earnings. Our Tier 1 capital ratio improved to 15% from 14.7% as of December 31, 2021.

Subsequent to our February earnings call, the outlook for interest rates has changed materially. Low levels of unemployment and continued supply chain disruption exacerbated by the situation in Ukraine have pushed inflation to levels not seen since the early 1980s. Interest rates began to rise even before the Federal Reserve raised its Fed Fund target in late March, and rate hikes are predicted to occur more quickly than we anticipated in the beginning of the year.

We locked in the low fixed rate funding over the past 2 years, and that has positioned us extremely well to withstand either a rising or flattening rate environment. Despite rising rates and higher input costs that are experienced by our borrowers, credit quality remains strong, given the increase in commodity prices that has outpaced the increase in input costs.

We're managing expense growth thoughtfully as mentioned before and commensurately with revenue growth as we navigate these volatile rates environment and our opportunities. We are, however, overall very well positioned for the future and excited about the opportunities ahead of us.

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

Thank you, Aparna. We experienced a strong start to 2022. We are delivering well on all of our initiatives, and we believe we're well positioned to deliver strong financial performance and consistent returns to shareholders over the rest of 2022. Farmer Mac has significantly increased its profile name recognition over the last few years, and we believe this will help us as we bring new capital to agriculture and to rural communities of America.

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

(Operator Instructions) And the first question will come from Marla Backer with Sidoti.

Yes, so could you give us a little bit more color on how you see the impact of current to your political situation and the general economic situation. How you see that impacting grain prices? In terms of -- you mentioned in your prepared remarks, having an impact on the credit quality of your overall portfolio, but is there any expectation that that will filter down into increased business volumes for you down the road?

Yes, Marla. And obviously this is an extremely volatile environment which we're operating. Not only are we dealing with increases in interest rates and -- but the global events, which are having a significant impact on commodity prices, including agricultural prices and the inputs into agricultural production.

I'm going to ask Zach Carpenter to comment on the business outlook and how we're seeing the combination of rising interest rates and volatility and generally good conditions in American agriculture impact originations. And I'm also going to ask Marc Crady to comment a little bit on credit quality.

But let me begin by saying that the overall condition of American agriculture while these price changes are unnerving, the outlook, as I said, remains generally quite positive with anticipated record levels of earnings in American agriculture in 2022. So if you look at the commodity issues, we're seeing corn approaching $8 a bushel, we're seeing wheat over $10 a bushel. But at the same time, we're seeing natural gas at $7.50, we're seeing global oil at over $100 a barrel.

So agriculture has the effect of rising cost of inputs, but it also is seeing really a level of commodity -- agricultural commodity prices that we haven't seen frankly for about 10 years, and that's both on a real as well as a nominal basis. But let me turn it Zach and let him add some color on how we're seeing that translate into ebbs and flows in demand for credit. And we'll carefully distinguish between demand for short-term operating credit, which may be a function of commodity prices for inventories and longer term trends as it relates to land. Zach?

Yes and Marla, great question, I think Brad summed it up very nicely. It's -- when you have all these numerous components coming into the market, it increase, I would say, a lot of pause. So record grain prices are continuing to help with the economics of the farmer. So we are seeing farmers continuing to execute on real estate transactions. That being said, we have seen the fastest increase in interest rates for our products in many years.

So you do get that sticker shock in terms of the severity of increase in rates. And that creates a little pause coupled with all the uncertainties going on in the market. When you look in the food and agri business space in those transactions, we've had a pretty quick drop-off in volume compared to 1Q '21. And again, that goes back to just uncertainty in trying to understand what's happening in the market and making sure transactions come at the appropriate time.

Overall and our borrowers are in a very strong position. From a historical perspective, debt is still relatively cheap even though you've had a significant increase in interest rates. As Brad mentioned in his remarks and Aparna said that we had a strong quarter in Farm & Ranch loan purchases in 1Q '21.

And we're assessing the market and we're looking to be flexible and competitive in our rates and support the sellers and the lenders and their borrowers as they navigate this uneasy time. So again, assessing the market, assessing the uncertainty and being able to support the customers in a very strong economic environment from a commodity and ag space with our products and services.

Marc, could you add anything relative to credit quality and what we're actually seeing in the numbers right now?

Yes, let me start off by saying that current credit quality is fairly strong as evidenced by strong farm incomes over the last year. Going forward, as mentioned, volatility has been very high, input costs have been very high, but we expect farm incomes to continue to be strong in 2022. And so from an overall credit quality perspective in the portfolio, we expect it to continue the strong performance.

That doesn't mean that there may be some operators, some producers, some farmers and ranchers in some commodity sectors that won't experience some level of distress. But generally speaking, we're optimistic in terms of in these high quality credit portfolio.

Okay. And then just one follow-on, which is a lot of the factors that you noted, we're seeing obviously uncertainty impact a lot of sector and a lot of general demand for financing for transactions. Even where you sit and how you have access to capital that certain other institutions don't, how do you see this playing out in terms of perhaps providing some opportunity for market share gains or do you see it playing out that way?

There are opportunities and they're in different corners of our portfolio and our lines of business I think, Marla. For example, right now one of the impact that the rapid rate run up in commodity prices is happening is that farmers are drawing on their operating lines of credit very heavily. That is resulting in banks that have agricultural concentration, including farm credit banks experiencing rapid and in fact quite unexpected run-ups in asset levels. And that, in some cases, is putting some pressure on capital. So one, not the only driver, but one of the drivers of the increase in AgVantage activity at the very end of the quarter was because of just that. So interesting to think about how it translates into new opportunity.

With the steepening of the yield curve, it actually is a bit distracting from one of our real core competitive advantages, which is at the long end of the curve, very long-term fixed rate mortgages. But we have the ability. And in fact, our rate sheets publish offerings across the full curve and we do short-term variable rate financing as well. So we may see some pick up there, and that may be a second example of the kind of opportunity that you're alluding to.

The third thing I just mentioned is that we are extremely disciplined in how we price our loans, our asset liability management. We've talked about that on numerous occasions before, but we pretty much match all of our business activity to current meeting real time this minute, this hour and this day debt capital market conditions. And so when we first saw the rapid run-up in interest rates, that was reflected immediately in our rate sheet. Some of our competitors like the market a bit. That was a little bit of a disadvantage to us. But as they catch up, it then begins translating more into an advantage for us. So those are 3 specific ways that we could see some increasing demand per product amidst this unprecedented volatility that you're referring to.

The next question will come from [Gary Gordon], investor.

Okay, I appreciate you taking my questions. A couple about interest rates, first on your existing portfolio, obviously you've got a variety of hedges to limit interest rate risk due to obviously dramatic market shifts in Q1. Did that cause any adjustments to the hedges or anything needed to be done to maintain the stability in the portfolio?

Gary, one of the benefits of having the kind of volatility is that we are going to prove to you what we've been talking about for years, and that is the discipline of our asset liability management. And so I think the short answer is no. But let me turn to Aparna to give you some real color on just exactly why that is.

Yes, absolutely, Gary, one, you can see some of the volatile play out actually to the positive when you look at our net income profile. But essentially, we don't hold derivatives on our balance sheet for speculative reasons as you know. We really hope there's much more to manage our asset liability management. So pivoting to what Brad said and actually really even responding to the first question that Marla had, which comes back to how we price, we have some tremendous advantages because we really don't take on any basis risk or underlying interest rate risk, and we're able to do that through managing our derivative activities. And so we can actually match funds, but we can also issue and take positions to offset [solutions] that allow us to almost completely eliminate our interest rate risk.

So when you add all that together, maybe it's a slightly complicated way of looking at it, we essentially have really the benefit, especially in this rising rate environment, some of the positions that we've taken on in the last 2 years that are really coming out in our favor. So there's probably a lot to unpack there, but maybe the short answer to that is it continues to be an advantage for us in terms of how we fund and manage our balance sheet through our portfolio.

Okay. Second one is typically in volatile markets, spreads widen out. You can discuss a minute your own funding cost versus treasuries and then maybe more important, available spreads for new investment.

Sure, let me take that first part of your question in terms of our funding costs. I mean we are seeing definitely a widening of our funding. But I will say that when we look at where we are relative to our competitors and by bank I mean the Farm Credit Funding Corp. or other GSEs, we've typically on the long end of the curve, maybe been somewhere between 5 to 10 basis points on top of them.

So everyone is seeing widening across the board relative to what's happening. But I think also as GFC, maybe from a credit standpoint, credit spreads widening out, we are not seeing as much relative to maybe other issuers. But we are seeing the same dynamics that we've seen in the past 2 years relative to other GFCs. So we're not seeing anything very different.

As far as it relates to us specifically and this -- again, I'll just reiterate this and you know this, Gary, but over the last 2 years, we've really been very opportunistic, whether it's on our capital sack through preferred issuances or whether it's been through extending our debt funding. I think the treasury team has done a very, very good job of really extending our liabilities. So now we can be very opportunistic in terms of when we want to go out there and fund at the long end of the curve.

So we have a little bit of a bias not to do that until the volatility settles down, but we have an abundant amount of really debt funding at all points on the curve. So we can really manage our interest rate profile and our [net debt] profile pretty opportunistically.

Okay. Good. One last question on the net interest margin. You said it was 97 basis points operating basis this year, same as last year. The servicing business, obviously the expenses of it runs through operating expense. The revenue, is there a way to estimate how much of an impact it had or benefit to the net interest margin?

Yes, we can actually come back to you on it. It's still early days in terms of really being able to give you a sense of that. Obviously, about 1/3 of the common branch portfolio is likely to be funneled back into the servicing business. So if you look at our incremental volume and again Q1 we have some dynamics -- shifting dynamics going on with additional fee payments and so on in Farm & Ranch. So there's probably a little bit of a wash, and you wouldn't have seen much of a benefit on that 97 basis points. But over time really, you should see on incremental volume anywhere between 18 to 25 basis points of a pickup on 1/3 of our net incremental volume. I mean that's probably the way to think about it.

And one last question on operating expenses. You said your efficiency ratio is 33% today, and you've got spending plans for the next, let's say, 4 to 6 quarters. But ultimately, you weren't below 30% efficiency ratio, which is a fairly big move. Is this do we hope one day or there's a 3-year plan to get it back to 30%? How should I think about that?

Yes let me jump in, and I'm sure Brad or others might want to add to this. The first quarter, typically, when you think about revenue and this is not unusual, go back to the first quarter of last year and the previous quarter in 2020. Q1 tends to be north of 30%. One dynamic that we have additionally seen playing out, in fact when you look at why that's the reason compensation tends to be something that really pops up but we've really done I think a fairly good job of managing just a run rate of compensation and keeping that down. But it's not really out of line with last year or year before. And then you've seen some of that normalizing towards historical averages over the rest of the year.

What you're likely going to see this year is that continued investment in technology and headcount we've talked about. That will keep that efficiency issue at a highly elevated level. But we will see additional loan pickup, loan activity because typically in Q1, you do see a more seasonality in terms of prepayment. So that also has the tendency of making that efficiency ratio go up. But our sense is that that will likely come down. And it's not going to be huge move because you can see some pretty big swings.

And then the second point here is just a seasonality around compensation. That goes away in the remaining quarters. One dynamic is obviously servicing acquisition that does have, I would say, a higher efficiency ratio relative to the rest of our business. So that trend is likely to persist, but back to your earlier question on seeing those spreads play out as we continue to service some of that volume and that additional spread pickup. All that will start to really help with respect to the denominator of that efficiency ratio. And so we feel pretty optimistic that we can manage our efficiency ratio at under that 30% on an annualized basis.

Yes, Gary, just to elaborate on that, if you go back to Q1 '21, we're between 32% and 33%. If you go back to Q1, 2020, we were between 22% and 23%. This is not really the outlier, although it is slightly -- it is slightly higher. But to also be specific, our goal is to get that efficiency ratio for the year in fiscal 2022 down to that 30% or below level.

This concludes our question-and-answer session. I would like to turn the conference back over to Brad Nordholm for any closing remarks. Please go ahead, sir.

Well, thank you, operator, and thank you all for participating in the call. As always, with follow-up questions or things that you'd like to have to clarify, please get in touch with Jalpa, and we'll put together the right people to answer your questions. This is a time of great volatility. But I think you've heard optimism on this call today, and you also heard confidence and that real confidence comes from Farmer Mac's business model.

It is designed from an asset liability standpoint, from an origination standpoint to be highly resilient. And while we don't know exactly where commodity prices and interest rates will be 6 months from now, we do know that the way we're structured, we're very, very well positioned to continue to deliver very, very steady results and to continue to fulfill our mission of serving American agriculture. So I'll just leave you with that thought. Thank you very much for participating, and look forward to talking to you all soon.

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