Federal Agricultural Mortgage's CEO Discusses Q4 2013 Results - Earnings Call Transcript

Mar.14.14 | About: Federal Agricultural (AGM)

Federal Agricultural Mortgage Corporation (NYSE:AGM)

Q4 2013 Earnings Conference Call

March 14, 2014 11:00 AM ET

Executives

Timothy L. Buzby – President and Chief Executive Officer

Stephen P. Mullery – Senior Vice President, General Counsel and Corporate Secretary

R. Dale Lynch – Senior Vice President, Chief Financial Officer and Treasurer

Analysts

John J. Dunn – Sidoti & Co. LLC

Frank Rango – Purchase Capital Management, LLC

Evan Hutto – Compass Point Research & Trading LLC

Operator

Good morning and welcome to the Federal Agricultural Mortgage Corporation Fourth Quarter and fiscal year 2013 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 that this event is being recorded.

And I would now like to turn the conference over to Timothy Buzby, President and CEO. Please go ahead.

Timothy L. Buzby

Thank you Emily. Good morning. I'm Tim Buzby, the President and CEO of Farmer Mac. The Farmer Mac management team and I are pleased to welcome you to our 2013 fourth quarter and year end investor conference call.

Before starting this morning, I will ask Steve Mullery, Farmer Mac's General Counsel to comment on forward-looking statements that may make today as well as Farmer Mac's use of non-GAAP financial measures.

Stephen P. Mullery

Thanks, Tim. Some of the statements made on this conference call may constitute forward-looking statements under the Securities laws. We make these statements based on our current expectations and assumptions about future events and business performance. We do not undertake any obligation to update these statements after the date of this call.

We caution you that forward-looking statements are subject to a number of risks and uncertainties. Actual risks may differ materially from the results expressed or implied by the forward-looking statements. In evaluating Farmer Mac, you should consider these risks and uncertainties, including those described in our 2013 Annual Report on Form 10-K, which was filed with Securities and Exchange Commission yesterday.

Farmer Mac uses core earnings, a non-GAAP financial measure, to measure corporate performance and develop financial plans, in management's view, core earnings is a useful 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. Farmer Mac's disclosure of core earnings is intended to supplemental in nature and is not to be considered in isolation from as a substitute for or as more important than the related financial information prepared in accordance with GAAP. A recording of this call will be available on our website for two weeks starting later today.

Timothy L. Buzby

Thank you, Steve. I’m pleased to report record outstanding business volume as of year end. That was just shy of $14 billion reflecting an annual growth rate of 7.2%, with contributions from all of our lines of business. Our core earnings for 2013 were also a record at $54.9 million. And as important the credit quality of our portfolio which has been favorable for sometime continued to improve throughout the year.

Core earnings for fourth quarter were $15.3 million or $1.36 per share compared to $11.6 million or $1.05 per share in fourth quarter 2012 [ph]. The increase was due to several factors including a decrease in operating expenses and increase in net effective spread. Additionally fourth quarter results included a $2.1 million tax benefit from the use of capital loss carry-forwards to offset capital gains recognized on certain investment securities for tax purposes.

Also of note, on a percentage basis, the stabilization of our net effective spread that we saw in the third quarter continued yielding 85 basis points in the fourth quarter compared to 83 basis points in the third quarter. This increase resulted primarily from new Farm & Ranch loan purchases, at spread that met or exceeded average spreads as of the end of third quarter 2013, combined with the a decline in the seasonal business run-off that typically occurs in the fourth quarter each year.

For the full year of 2013, core earnings totaled $54.9 million or $4.90 per share compared to $49.6 million or $4.51 per share for 2012, an increase of 8.6% on a per share basis. This improvement was driven by net business volume growth gains from the sale of certain assets, lower operating expenses and favorable credit performance. GAAP net income attributable to common stockholders for fourth quarter was $12.5 million or $1.11 per share compared to $9.6 million or $0.87 per share in the fourth quarter of 2012.

For the full year 2013 GAAP net income was $71.8 million or $6.41 per share, up from $43.9 million or $3.98 per share in 2012. The increases in net income for those periods were mostly due to the same factors that drove core earnings plus unrealized gains in the fair value of derivatives. These items more than offset an increase in premium amortization recognized in fourth quarter of 2013.

As we recap certain rural utility loans prior to their maturity, resulting in the acceleration of $15.9 million, we’re $10.3 million after-tax with premium amortization into the fourth quarter. The loan recasts were favorable for us as we’re able to work with our customer, The National Rural Utilities Cooperative Finance Corporation to retain more than 80% of the $300 million of rural utility loans that have borrower recast options in the early parts of 2014.

As we waited until the originally stated recast dates, borrowers could have sought alternative sources of financing. We expect these transactions to be accretive to our spreads over the long-term, because the vast majority of the new loans are long-term fixed rate loans earning higher spreads for Farmer Mac than the prior loans. In 2013, we added $3.1 billion of new business volume, resulting in net growth after maturities and repayments of $1.0 billion. The most significant contributor to new business in 2013 was $825 million of Farm & Ranch loan purchases, a 45% increase over 2012.

During 2013, we also purchased $454 million of Farm & Ranch AgVantage securities and $820 million of Rural Utilities AgVantage securities. Throughout the year, Farmers continued to prefer long-term fixed rate on RM [ph] loans, which has contributed to our Farm & Ranch loan purchases having nearly doubled over the last two years.

Additionally, we are pleased with our success in signing up new banks as potential customers with 669 total approved lenders as of year-end, up from 536 at the start of the year. The credit quality of Farmer Mac’s portfolio remains strong. As of December 31, 2013, only $28 million of our $5.2 billion non-AgVantage Farm & Ranch portfolio was 90 days delinquent. That’s down from $33 million a year ago.

This reduction continues a favorable trend in delinquencies that has seen our 90-day delinquencies decrease by nearly two-thirds since 2010, when delinquencies were $70 million. The western part of the United States including California is currently experiencing drought conditions with the water level in many California reserves are just over half of their average year-to-date water storage levels.

While we have not observed any measurable impact on the credit quality of our portfolio due to drought conditions as of December 31, 2013, any protraction of extreme or exceptional drought conditions, beyond the 2014 water year could have an adverse effect on loss for delinquency rates. We believe Farmer Mac remains well collateralized on loans in our Farm & Ranch line of business, including loans in drought areas. And we will continue to monitor the effects of the droughts.

With that as background, I would like to turn to Dale Lynch, our Chief Financial Officer to cover our financial results in more detail. Dale.

R. Dale Lynch

Thanks, Tim. Fourth quarter 2013, core earnings were $15.3 million or $1.36 per diluted share as compared to $11.6 million or $1.05 per diluted share a year earlier. The $3.7 million year-over-year increase in core earnings in the fourth quarter of this year was driven by several things. First $1.5 million or $1 million after tax reduction in operating expenses, a $1.1 million or $0.7 million after tax increase in net effective of spread and guarantee fees, and lastly $0.6 million or $0.4 million after tax reduction in credit expenses.

Farmer Mac was also able to realize for tax purposes gains on certain investment securities in the fourth quarter and utilized some of its capital loss carry forwards that resulted in a $2.1 million tax benefit for the quarter. Fourth quarter core earnings were $3.5 [ph] million sequentially from the $11.8 million reported in the third quarter of this year of 2013, driven primarily by an after tax increase of $0.9 million and net effective spread and guarantee fees as well as a $2.1 million tax benefit already mentioned.

Net effective spread was $105.3 million or 86 basis points for 2013, compared to $106.6 million or 95 basis points in 2012 driven by the growth in outstanding business volume, offset by tightening new business spreads in the first half of 2013 and dilution from business run-off primarily in the first to third quarters.

Net effective spread for the fourth quarter of 2013 was $27.1 million or 85 basis points compared to $26.5 million or 91 basis points for the same period in 2012. For 2013 – for third quarter 2013 it was $25.8 million or 83 basis points, while approximately $0.8 million of the higher net effective spread for fourth quarter 2013, was related to a net benefit from recovered interest on a delinquent loan and several other items net effective spreads still grew by nearly $0.6 million sequentially in the fourth quarter of 2013 excluding this benefit.

This growth is primarily a result spread stabilization helping new business volume growth in decrease business run-off, result was attractive growth in dollars of net effective spread for fourth quarter 2013 at a modestly lower percentage margin which contributed to a 20 plus percent annualized core earnings return on equity for the quarter.

From a credit perspective total allowanced and reserves for losses were $13.3 million or 0.26% of the total $5.2 billion Farm & Ranch loan portfolio at year end 2013 compared to $16.9 million or 0.36% of the total Farm & Ranch loan portfolio as of year-end 2012. Total net provisions were only $12,000 this quarter and $0.4 million for the year compared to a net provision of $1.2 million in the prior year's quarter and $1.9 million for full-year 2012. Charge-offs were $0.1 million in fourth quarter of 2013 and $4.0 million for the year, resulting in a $3.6 million decrease in the overall allowance for losses to $13.3 million as of December 31, 2013.

As we analyze the overall credit quality of our business, we take in to account more than just Farm & Ranch loan delinquency. Total business volume includes AgVantage securities and rural utilities loans, neither of which currently have any delinquencies, and USDA Securities, which are backed by the full faith and credit of the United States. Across Farmer Mac's three lines of business, the overall level of 90-day delinquencies was just 0.20% as of December 31, 2013, which is down from 0.26% as of December 31, 2012.

In terms of volume we achieved $716 million of new business this quarter, which is moderately less than the $852 million of new business in the year ago quarter. Our Farm & Ranch loan purchases and AgVantage securities purchases were higher than the prior year’s amount, while Farm & Ranch standbys are materially less due to a significant size standby that was completed by in the fourth quarter a year ago.

Key components of this were as follows; $246 million of Farm & Ranch loan purchases, $76 million of Farm & Ranch standbys, $50 million of Farm & Ranch AgVantage securities, $245 million of Rural Utilities AgVantage securities, $41 million of Rural Utilities loan purchases and $58 million of USDA securities.

After repayments our net outstanding business volume grew $164 million in the fourth quarter. This growth speaks to the benefit of our diversified mix of business where the strength in our Farm & Ranch line of business and AgVantage products is offsetting a current environment with bit less growth in rural utility loans in USDA Guarantees lines of business.

Turning to capital. As of yearend 2013, Farmer Mac's $591 million of core capital exceeded the statutory minimum capital requirement of $399 million by $192 million, or by 48%. This compares to $145 million of capital above the statutory minimum capital requirement at yearend 2012. In terms of liquidity, current applicable regulations require Farmer Mac to hold a minimum of 60 days. As of December 31, 2013, Farmer Mac had 134 days of liquidity accordingly to the methodology prescribed in our current regulations down from 164 days as of December 31, 2012.

FCA recently approved a final rule to revise the current regulations governing the management of liquidity risk at Farmer Mac, which is expected to become effective during second quarter of 2014. These new regulations will require Farmer Mac to hold a minimum of 90 days of liquidity and will revise the methodology for determining Farmer Mac's liquidity reserve. However Farmer Mac does not expect its compliance with this new regulation to materially affect its operations or our financial condition.

More complete information about Farmer Mac's performance for 2013 is set forth in 10-K we filed yesterday with the Securities and Exchange Commission.

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

Timothy L. Buzby

Thanks, Dale. As we’ve seen at our times our core earnings may vary modestly up or down in any given quarter, but the underlying trend of our core business continue to be favorable. This is due to some simple fundamentals; we just try to add new customers and new business at favorable returns while maintaining the strong portfolio of credit profile and operating efficiently.

Our management is proud of the results achieved during 2013, looking forward we take a long-term view of the accomplishment of our congressional mission and in providing a return to stockholders. We will continue to deliver the outstanding service that our customers have come to expect from us and we look forward to building upon our success.

At this time we are glad to answer any questions you may have.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions) at this time we will pause momentarily to assemble our roster. And our first question comes from John Dunn of Sidoti & Company. Please go ahead.

John J. Dunn – Sidoti & Co. LLC

Good morning guys.

Timothy L. Buzby

Good morning John.

John J. Dunn – Sidoti & Co. LLC

Can you first talk about your look for – it seems like spreads have stabilized and maybe even go better than Farm & Ranch. Can you talk about your outlook for spread next year?

Timothy L. Buzby

Well I think the word you used stabilize is a good word to use, we’ve seen a trend through 2012 in the first part of 2013 where it was coming down into the mid 80s down to 83 in third quarter, back up a little bit in fourth quarter 85, but as Dale said in his remarks a little bit of noise in there related to an old loan became current that we recognized interest on.

So from our perspective I think having seen the stabilization looking at the way we are pressing new loans and seen what is coming in I think where we are today is probably what we can expect at least in the near-term unless there are some changes in the capital markets.

John J. Dunn – Sidoti & Co. LLC

Got you. And then you talked about California, could you maybe elaborate on that but then more broadly or generally talk about sort of the protections you have in place to keep credit benign over the next part of the cycle.

Timothy L. Buzby

Sure. Well as you know a national AG lender with diverse geography and also more than a 100 different commodities, there are always going to be certain areas of the country or certain commodities that are under stress. Currently we are seeing California and the larger part of the western part of the United States seeing extreme drought conditions.

And from a pretention standpoint water quality, water availability, primary and secondary sources or water are generally addressed in the appraisal process. We review all of the appraisals that come from that part of the country. We are confident that we’re well collateralized but given the nature of the stress that we’ve seen if that continues to be the case for the course of the next year or so. Certainly we could see some additional stress there. We haven’t seen it come to bear in the portfolio yet, but I believe it’s a little bit early for that to have occurred.

John J. Dunn – Sidoti & Co. LLC

Got you and seen some quotes from you in the news, maybe if you could just talk about you think this system is generally is different from the 1980s?

Timothy L. Buzby

Well I think you have had a lot o change, one of the largest parts would be lessons learned from the 80s, you haven’t seen loan to value ratios increase, you haven’t seen what you saw in the 80s which was pretty market increase in interest rates with a lot of variable rate loans, as we’ve talked about quite a bit. The primary business or a large part of the business that we’ve been doing over the past two years or so has been towards longer-term fixed rate loans, and that provides some protection.

With respect to land values. We have seen the softening in the increases of land values that varies from county-to-county and state-to-state based on a number of factors including land quality. Many times you have seen our original LTV statistics that we’ve published with average LTVs, original LTVs in the 50s. We do see a lot of loans that come in even though we have a maximum LTV of 70% in some places in the country 60%. We do see a lot of loan volume that comes in much lower than that.

So I think there are a number of differences. I don’t think we’ve seen industry-wide competitors of ours, or customers lending more or decreasing their lending standards in order to achieve volume. The reality is there is there is a lot of competition out there. Lenders are fighting over the best borrowers that is true, but at the same time I don’t think we’ve seen people chasing market share while reducing quality standards and certainly that's not something we are going to do.

John J. Dunn – Sidoti & Co. LLC

Got you and then just switching to growth, could you give us an update on sort of your ranking of where you think the best possible sources of particularly Farm & Ranch loans are going to be – come from...

Timothy L. Buzby

We’ve seen growth in the loan purchases, we wouldn’t expect to see 45% or 50% increases year-after-year. We have been fortunate for the last two years to experience something in those ranges. While we are hopeful of that we had a pretty good run there and a lot of momentum. We do see a healthy pipeline at this time. So I don’t think we are going to see a market slowdown, but to predict further growth in that area like we’ve see in the past would be challenging.

Rural Utilities that business comes primarily or entirely from one customer it’s based on their business, their capital needs and other things, so it is a bit difficult to predict. The USDA Securities business while that is healthy and we do expect that to be up this year compared to last year. It’s much smaller portion of business. So as far as the overall impact, that will probably have lesser than impact than the other two.

John J. Dunn – Sidoti & Co. LLC

Got you. Great. Thank you very much.

Timothy L. Buzby

Sure.

Operator

Our next question is from Frank Rango of Purchase Capital Management. Please go ahead.

Frank Rango – Purchase Capital Management, LLC

Yes, good morning. Just following up on the previous caller’s question on the spreads. A footnote on the press release on Page 14 about 14 basis point adjustment one way and I think 11 basis points on the other way. Is that the noise that you were alluding to and could you explain a little bit better what those adjustments are and if I take in the face value, it looks like your actual spread was more like a 81 basis points or 82 basis points, supposed to be 85 basis points. Is that correct?

Timothy L. Buzby

Its 83 basis points, when you back up the noise and those – talking about the noise. One of them is our yield maintenance payment, it’s essentially a prepayment penalty on a loan that gets recognized in interest income. And those payments can be large. The other one, I believe we have term buyout interest, essentially, what’s occurred there as we’ve got a loan on our balance sheet that is delinquent and we’re not accruing interest on it.

And then when the loan comes current, we end up recognizing the interest that hadn’t been accrued previously. So you may see, up to full years of interest maybe or more getting recognized in one period. So I would characterize those as noise and when you strip all of that out, 83 basis points is what we had in the fourth quarter, which is as same as what we achieved in the third quarter.

Frank Rango – Purchase Capital Management, LLC

Okay. So just so I understand it, 14 basis points in terms of prepayment and the 11 basis points was, can you just repeat that again, please? I’m sorry.

Timothy L. Buzby

14 basis points was the combination of the interest on the delinquent loan and the yield maintenance payments.

Frank Rango – Purchase Capital Management, LLC

Right.

Timothy L. Buzby

And then there was another item going the other direction for 11 basis points.

Frank Rango – Purchase Capital Management, LLC

Okay.

R. Dale Lynch

The other item going the other way is related to – Tim mentioned in his comments, in fact, the fact that we recast a bunch of rural utility loans, which involved an acceleration of premiums, while it also involves, there is some friction on funding costs by recasting those loans early. So we had some funding cost friction in the quarter. There will be a little bit more of that in the first quarter as well, but that’s what’s going the other direction there.

Frank Rango – Purchase Capital Management, LLC

Okay, got it. And just I wanted to question, if you look at the income statement, net interest income was – the net interested income reported line was down a lot year-over-year and obviously that there’s some adjustments to that – below that, but I guess it’s in the derivatives line, we would find the sort of the equalizing feature between last year and this year?

R. Dale Lynch

No, what is on the net interest income is the $15.9 million of premium amortization acceleration that time referenced. That’s flowing through that line.

Frank Rango – Purchase Capital Management, LLC

Okay.

R. Dale Lynch

So you would need to add that $15.9 million back to NII and when you do that find that the year-over-year decline is only roughly $3 million.

Frank Rango – Purchase Capital Management, LLC

Okay, great. Thank you for those details.

Operator

And our next question from Evan Hutto of Compass Point. Please go ahead.

Evan Hutto – Compass Point Research & Trading LLC

Good morning guys and thanks for taking my call.

Timothy L. Buzby

Good morning Evan.

Evan Hutto – Compass Point Research & Trading LLC

You had very solid overall growth into the program assets for the fourth quarter and I was kind of wondering if it was the first quarter of 2014, did you all see any changes in demand once the Farm Bill is passed and some of the uncertainty was removed there.

Timothy L. Buzby

Nothing significant. The reality is the Farm Bill was a long time coming, finally did pass. There wasn’t anything in there, in particular that we expect to have any major impact on our business flow.

Evan Hutto – Compass Point Research & Trading LLC

Okay. Switching gears in terms of AOCI on the balance sheet. Can you maybe talk a little more about what happened specifically for the quarter and how you guys are thinking about this trending going forward and the corresponding impact of both given that rates are likely to move higher in the future?

Timothy L. Buzby

Yes, certainly, you are going continue to see some volatility there. Evan, we had some AFS securities that are going to flow through that line. When interest rates spikes significantly in any given period, you are going to see volatility in those line items. And we are working to move some of those securities that are held as AFS and held the maturity, but the reality is we can’t move all of them there is still going to be a significant portion, what’s driving that, is our USDA loans.

There are program assets, but they are also technically part of our liquidity portfolio. So we have to hold them as available for sale. I mean that’s what is driving that volatility. So, you will see that noise there is not much we can do about it. On the plus side, our core equity does not include AOCI, and the new capital reg that we are in the progress of complying from USDA also does not include program asset AOCI. So, it does creates some GAAP noise on the balance sheet, but it is not any of the important metrics that our core equity or our Tier 1 capital ratio.

Evan Hutto – Compass Point Research & Trading LLC

Okay, and my last one. Given some of the recent headlines we’ve seen surrounding the expectation at farm income and commodity prices will come down in the future. I was wondering, how do you guys kind of model origination growth in a scenario where we see some pressure in those areas.

Timothy L. Buzby

Well we obviously recognize that there is going to be a range to our growth and the patterns of business coming in. Historically, our business when it was more large transaction based, it was more difficult to get a sense as to one customer who is going to come to us and do large transactions, while we still do see some of that. We have a little more visibility because of the pipeline of the loan rate lock and purchase process. We can look out several months and get a sense as to new loans being underwritten, appraisals that are being completed in another things.

Certainly, as we see commodity prices fluctuate, that causes Farmer’s to make decisions, it can cause stress in the loan portfolio. At this time, where our commodity prices are now and the expectations we see, we don’t think that will have a meaningful impact on the flow of business in the Farmer Mac, more so I would say changes in interest rates may have an impact again as we’ve seen a lot of refinance activity and borrowers looking to have longer-term fixed rates as rates go up or down, their decisions will also change.

As rates go up many farmers look at that and take that as a signal as it’s time to lock in a long-term fixed rate. Other farmers will look at that and decide that it’s time to keep a lower variable rate loan at the time. So again, often a lot of borrowers also have a mix of debt, they have some adjustable rate debt to some fixed rate debt, some of it comes to Farmer Mac and so it doesn’t. So I think there are a lot of moving parts there and I wouldn’t want to overstate the impact of some of those global macroeconomic issues and the impact they might have on our book of business.

Evan Hutto – Compass Point Research & Trading LLC

Okay. thank you, guys.

Timothy L. Buzby

Thanks, Evan.

Operator

(Operator Instructions) I’m showing no further questions. This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Buzby for any closing remarks.

Timothy L. Buzby

Thanks Emily. Seeing no further questions, I would like to thank you for listening and participating this morning. I look forward to our next call to report first quarter 2014 results in May. Thank you and have a nice weekend.

Operator

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.

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