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Federal Agricultural Mortgage Corporation (NYSE:AGM)

Q2 2014 Earnings Conference Call

August 11, 2014, 11:00 AM ET

Executives

Timothy Buzby - President and Chief Executive Officer

Stephen Mullery - Senior Vice President, General Counsel and Corporate Secretary

Dale Lynch - Senior Vice President, Chief Financial Officer and Treasurer

Analysts

John Dunn - Sidoti & Company

Bose George - KBW

Jordan Hymowitz - Philadelphia Financial

Matthew Dodson - JWest

Operator

Good morning, and welcome to the Federal Agricultural Mortgage Corporation second quarter 2014 investor conference call. (Operator Instructions) I would now like to turn the conference over to Timothy Buzby, President and CEO. Please go ahead.

Timothy Buzby

Thank you, Emily. Good morning. I am Tim Buzby, the President and CEO of Farmer Mac. The Farmer Mac management team and I are pleased to welcome you to our second quarter 2014 investor conference call.

Before starting this morning, I will ask Steve Mullery, Farmer Mac's 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. Steve?

Stephen 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 results 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, as well as those described in our 2013 Annual Report on Form 10-K, our subsequent quarterly reports on Form 10-Q and our other filings with the Securities and Exchange Commission.

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 be supplemental in nature and is not meant 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 Buzby

Thank you, Steve. Farmer Mac had a fundamentally strong quarter on a number of fronts in second quarter 2014. Most notably, net effective spread rebounded, reaching 84 basis points for the quarter. That's up from first quarter, which was lower as a result of a few individual transactions that temporarily increased our financing cost. The recovery in spread added $1.7 million after-tax to core earnings compared to first quarter.

Credit quality also remains favorable and we had $1.7 million after-tax release from the allowance for losses due to the paydown of $38 million of ethanol loans during the quarter. In addition to those items, Farmer Mac also recognized a substantial tax benefit of $11.6 million in second quarter.

That tax benefit resulted from our ability to now apply capital loss carryforwards against capital gains expected to result from a cash management and liquidity initiative we put in place during the second quarter. The combination of all of these factors drove core earnings to a record $23.2 million.

I'd like to quickly discuss the changes to our cash management and liquidity strategies, and then defer to Dale Lynch, our CFO, to describe it in greater detail in a few minutes. Historically, we've used a variety of financial instruments, transactions and investments to manage our liquidity. Over time, as we've evaluated numerous vehicles for doing so, we've concluded that one advantageous vehicle is repurchase or repo agreements.

Further, we've concluded that the best way to conduct repo transactions would be if we were able to participate in the Federal Reserve Bank of New York to reverse repurchase facility, known as the RRP Facility. If accepted into the program that would provide us the opportunity to deal with the most creditworthy counterparty.

The repo transactions will result in capital gains, as a result of the flexible financing strategy we have in place. Therefore, a by-product of implementing the strategy was the reduction of the valuation allowance set up against deferred tax assets, which resulted from capital losses incurred, coming out of the financial crisis of 2008.

As mentioned earlier, the adjustment of the valuation allowance increased core earnings in second quarter by $11.6 million. Our strategy and its effects on our financial statement is described in more detail in our Form 10-Q. And as I mentioned, Dale will describe it more fully here on the call in a few minutes.

In terms of outstanding business volume, during second quarter 2014 maturities modestly outpaced new business, and our outstanding business volume decreased $35.7 million from first quarter 2014 to $14.1 billion at quarter end. Farm & Ranch loans grew at a net $47 million in the quarter.

However, maturing AgVantage securities and the paydown of loans under long-term standby purchase commitments caused a modest net decline in outstanding business volume during the quarter. As compared to yearend, outstanding volume is up year-to-date by net $122 million.

We also enhanced our capital position for the second time this year through the issuance of an additional $75 million of fixed-to-floating rate perpetual preferred stock in June. We've now completed our intended capital raises in anticipation of calling $244 million of other preferred stock that will become callable in March 2015.

We do not anticipate needing to issue any additional equity to accomplish that redemption. Once that redemption is complete, the annual net cost of our preferred stock dividends will be $9.7 million compared to $23.7 million after-tax today and $14.4 million after-tax in 2013.

Core earnings for second quarter 2014 were $23.2 million or $2.05 per share compared to $16.5 million or $1.48 per share in second quarter 2013, and $11 million or $0.97 per share in first quarter 2014.

Our GAAP results, net income attributable to common stockholders for the second quarter was $20.2 million or $1.78 per share compared to $27.7 million or $2.45 per share in second quarter 2013. The decrease compared to the previous year quarter was mostly attributable to the effects of unrealized fair value changes on financial derivatives and hedged assets, which was a $3.1 million after-tax loss in second quarter 2014 compared to an $11 million after-tax gain a year ago.

Also contributing to the decrease were smaller gains on sales of investment securities of $2.9 million that were offset by capital loss carryforwards, an increase in preferred stock dividend payments of $1.4 million, increases in operating expenses of $0.6 million after-tax and smaller gains on sales of REO of $0.6 million after-tax.

The decrease was offset in part by federal income tax benefits of $11.6 million related to Farmer Mac's cash management and liquidity initiative discussed previously, and $1.2 million after-tax in releases from the allowance for losses.

Credit quality of Farmer Mac's portfolio remains strong. As of June 30, 2014, only $26 million or 0.49% of our $5.3 billion Farm & Ranch portfolio was 90 days delinquent. That's down from $34 million or 0.69% a year ago.

The western part of the United States, including California, continues to experience severe drought conditions, with water level in many California reservoirs at only half of their average year-to-date water storage levels. While we've not observed any material effect on Farmer Mac's portfolio due to the drought conditions, continuation of extreme or exceptional drought conditions beyond the 2014 water year could have an adverse effect on future delinquency rates and could ultimately produce losses. That said, we believe Farmer Mac is well collateralized on loans in its Farm & Ranch line of business, including those that could be affected by drought conditions.

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

Dale Lynch

Thanks, Tim. As Tim mentioned at the outset of the call, Farmer Mac had a strong second quarter with continued strong credit quality, increasing net effective spread, the refinancing of most of our maturing AgVantage securities at goods spreads and net growth in Farm & Ranch loans, being the fundamental drivers of the growth this quarter. In addition to these drivers, Farmer Mac recognized an $11.6 million tax benefits related to the cash management and liquidity initiative that we established this quarter.

Before moving on to the discussion of our financial results this quarter, let me give you some more detail on this initiative. As described in more detail in our Form 10-Q filed today, Farmer Mac significantly increased the size of its reinvestments and repurchase agreements or repos in second quarter 2014.

As of June 30, 2014, Farmer Mac's repo investment and financing strategies resulted in $1.6 billion of term repo investments presented as securities purchased under agreements to resell in Farmer Mac's financial statements, and $1.7 billion of related liabilities presented as securities sold not yet purchased in Farmer Mac's financial statements.

As Tim mentioned, this action was undertaken as part of an initiatives to diversify Farmer Mac's short-term investment alternatives and in a size that we believe could position Farmer Mac to apply for acceptance to participate in the Fed's RRP Facility. We believe that repo investments will be an increasingly important short-term investment for Farmer Mac's cash management in the future, especially in light of recently approved reforms of regulations governing money market funds.

These reforms include potential daily fluctuation value among other things that could raise significant operational implications and result in imposition of fees and restrictions which could adversely affect liquidity at the time it is most needed.

Although there is no assurance that the Federal Reserve will approve Farmer Mac as a participant in the RRP Facility, if and when the Fed invites new applicants. Farmer Mac believes that its recent significant repo activity increases the likelihood that Farmer Mac would be in a position to meet or exceed all of the eligibility requirements.

If the Federal Reserve accepts new applicants and if Farmer Mac is accepted, we believe that participation in the RRP Facility would provide us with key benefits, including: one, diversifying Farmer Mac's short-term investment alternatives by providing a cost-effective alternative to other sources of short-term investments, that can be utilized in significant size and that is likely to be available even in times of stress in the financial markets; and two, reducing Farmer Mac's counterparty risk compared to the typical commercial counterparty risk inherent and similar transactions with non-governmental agencies or entities.

Farmer Mac's increased repo investments during the second quarter were executed in a series of smaller transactions with terms ranging from overnight to up to 90 days, and primarily financed by immediately selling the securities delivered as collateral under the terms of the repo investments.

The cash proceeds from the sale of those securities, which are effectively borrowed and must be returned to the counterparty on the maturity date of the repo transaction, effectively funds Farmer Mac's related repo investment. Funding of the repo investments through the sale of borrowed collateral provides a flexible financing source that can be unwound at any time by simply covering the position, as opposed to utilizing debt financing that would be outstanding for its full term.

Farmer Mac intends to reinvest these term repos as they mature throughout 2014 and maintain the related financing position for most of the year to further enhance its position to apply to the RRP Facility.

To maximize cash liquidity across the end of the year, Farmer Mac expects to close these term repo positions as they mature throughout the fourth quarter by purchasing U.S. Treasury securities sold, not yet purchased in the open market and delivering them to the repo counterparties, which will also then liquidate the related liability. Farmer Mac will then evaluate the amount of repo investment activity it believes is appropriate, going forward in 2015.

Before closing out these positions, Farmer Mac will carry its liability for the securities sold, not yet purchased at fair value, with the changes in fair value being included in earnings. As Farmer Mac closes out the positions of the securities sold, not yet purchased in fourth quarter of 2014, it expects to recognize capital gains based on the difference between the sales and purchase prices of the U.S. Treasury securities.

On a pre-tax basis, Farmer Mac expects the financing cost of this strategy will exceed the capital gains. However, on an after-tax basis, Farmer Mac expects to realize a significant net tax benefit associated with this strategy in 2014, because Farmer Mac has capitalized carryforwards that can be applied to offset the expected capital gains.

For both three and six months ended June 30, 2014, Farmer Mac incurred a total of $7.8 million of interest expense related to financing cost of this strategy. For both three and six months ended June 30, 2014, Farmer Mac recognized unrealized gains of $7.8 million from the securities sold, not yet purchased. As of June 30, Farmer Mac recognized an $11.6 million tax benefit by reducing its valuation allowance against deferred tax asset related to the capital loss carryforwards.

Farmer Mac estimates that the full year net economic benefit of this cash management and liquidity initiative will be approximately $8 million to $9 million in 2014, after netting the related incremental after-tax net financing cost over the term of this transaction with the tax benefit they would recognize in second quarter.

Farmer Mac estimates that the incremental after-tax financing expenses that will be incurred in the second half of 2014 related to this strategy will be about $2 million. All of these estimates related to this strategy assume that interest rates remain constant.

The interest expense, unrealized fair value changes, and the tax benefits of this strategy are included as part of core earnings, just as the investment portfolio losses that generated the related capital loss carryforwards were included in core earnings when the losses occurred in 2008 and 2009.

The related interest expense is excluded from net effective spread, because the associated benefit is not similarly recorded in net effective spread, but rather through tax benefits. Please see the section titled cash management and liquidity initiative in MD&A for our second quarter 10-Q for full discussion of this initiative.

Turning back to the financials. Second quarter core earnings were $23.2 million or $2.05 per diluted share, as compared to $16.5 million or $1.48 per diluted share a year earlier. The $6.7 million year-over-year increase in core earnings was primarily driven by $11.6 million from tax benefits previously discussed, as well as $0.2 million after-tax increase in net effective spread.

This increase was offset in part by several factors: a $2.9 million decrease in gains on sales of investment securities, which were offset with capital loss carryforwards; a $1.4 million increase in preferred stock dividends associated with a new preferred stock issuances, $0.6 million after-tax increase in operating expenses; and a $0.6 million after-tax decline in gains on sales of REO properties.

As compared to first quarter of 2014, second quarter core earnings of $23.2 million increased $12.2 million. This increase was primarily attributable to several fundamental factors, as well as the tax benefits already mentioned. Net effective spread of $26.3 million or 84 basis points in the second quarter increased $2.6 million or 9 basis points as compared to the $23.7 million or 75 basis points in first quarter.

A strong credit performance also contributed to the increase. Specifically these factors included a $2.1 million after-tax benefit from net releases from the allowance for losses and $1.7 million after-tax increase in net effective spread.

This increase in net effective spread resulted primarily from: a $0.8 million after-tax decline in borrowing cost, resulting from the expiration of the double funding discussed in the first quarter; a $0.9 million in after-tax benefit associated with increased spreads on recently refinanced assets, which were the assets we discussed in the first quarter; seasonally lower repayments typical for the second quarter of the year; and net growth in Farm & Ranch loans.

This increase was partially offset by the following factors. One, $0.6 million increase in operating expense. And two, a $1.4 million increase in preferred stock dividends associated with our recent preferred stock offerings.

Turning back to net effective spread. Net effective spread was $26.3 million or 84 basis points for second quarter 2014 compared to $23.7 million 75 basis points in the first quarter and $26.1 million or 87 basis points in the year ago second quarter. The $2.6 million or 9 basis points sequential increase in net effective spread was attributable primarily to the expiration of legacy financing associated with the early refinancing of assets. Increase in spreads related to those recently refinanced assets, seasonally lower loan repayments typical for the second quarter and net growth in our higher margin Farm & Ranch loans.

In terms of a year-over-year comparison net effective spread grew $0.3 million in the second quarter, but decline 3 basis points as a percentage of interest earning assets. This 3 basis point decline was due to repayments of higher spread assets in the second half of '13 and the first half of 2014, as compared to the spreads of new assets purchased over the same period. Significantly, however, as new assets spreads have been stable for over a year now and loan prepayment rates have slowed, we expect less of a dilutive impact from run-off business going forward.

Regarding our business segments, net effective spreads for second quarter of 2014 were: $7.8 million or 164 basis points for Farm & Ranch; $4.2 million or 99 basis points for USDA Guarantees; $3 million or 116 basis points for Rural Utilities; and $7.3 million or 57 basis points for Institutional Credit.

From a credit perspective, total allowances and reserves for losses were $11.4 million or 0.21% of the total $5.3 billion Farm & Ranch portfolio at June 30, 2014, compared to $13.5 million or 0.27% of total Farm & Ranch portfolio, as of June 30, 2013.

Total net releases were $2.6 million for the second quarter compared to net release of $0.7 million in the prior year second quarter. Charge-offs were $57,000 in the second quarter of 2014, as compared to $70,000 in the second quarter of 2013.

For Farmer Mac's other lines of business, there are currently no delinquent AgVantage securities or Rural Utilities loans, and the USDA Securities are backed by the full faith and credit of the United States. As a result, across all of Farmer Mac's lines of business, the overall level of 90-day delinquencies represented just 0.18% of total volume as of June 30, 2014 compared to 0.2% of total volume at yearend 2013 and 0.25% as in the year ago second quarter.

We achieved $590 million in new business this quarter. While Farm & Ranch loan purchases, purchase plans are modestly less than last year's amount, prepayments have slowed, and outstanding loans grew a $104 million. Rural Utilities and USDA securities were also lower than the prior year's amount, while AgVantage were significantly more.

The decrease in USDA securities line was a result of more lenders retenanting those guaranteed assets in their portfolio in the second quarter as compared to the higher purchases experienced in the second quarter 2013. The higher volume of AgVantage securities purchases were driven by a significant amount of maturing AgVantage deals in the second quarter 2014, combined with $150 million of new AgVantage deals with CFC in that room.

Key components of this quarter's business volume were: $159 million of Farm & Ranch loan purchases; $35 million of Farm & Ranch standbys; $91 million of USDA securities; $5 million of Rural Utility loan purchases; and $301 million of AgVantage securities.

After repayments, our net outstanding business volume contracted $36 million in the second quarter. Notably, we had a significant amount of AgVantage maturities in the second quarter of this year and through the month of August. Once we get passed the month of August, we don't have any scheduled amortization on new bullet AgVantage securities.

Turning to capital. As of June 30, 2014, Farmer Mac's $750 million of core capital exceeded the statutory minimum capital requirement of $433 million by $317 million or by 73%. This compares to $192 million of capital above the statutory minimum at yearend 2013. As Tim mentioned, we increased our capital position through the issuance of $75 million of non-cumulative preferred stock in June. And don't anticipate issuing any additional preferred stock associated with the recapitalization of the FALConS.

In terms of liquidity, FCA recently adopted a final rule that became effective on April 30, revising its regulations governing the management liquidity risk at Farmer Mac and requiring that Farmer Mac maintain a minimum of 90 days of liquidity and use a different methodology for calculating these available days of liquidity. Under this new liquidity regulation now in place, Farmer Mac had a 168 days of liquidity. More complete information about Farmer Mac's second quarter performance is set forth in the 10-Q we filed today with the SEC.

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

Timothy Buzby

Thank you, Dale. Second quarter 2014 marked significant progress as Farmer Mac's spreads continue to stabilize, our credit performance remained strong and we successfully raised capital that will allow us to redeem other outstanding preferred stock. We continue to manage our business to fulfill our mission of increasing the availability of credit to maintain a strong and vibrant rural America and to focus on the fundamentals that will bring long-term value for our stockholders.

We believe that our strategy of pursuing prudent growth coupled with high credit quality standards will provide attractive returns, resulting in growth and earnings and capital. We are excited about our prospects for the rest of the year and well in this 2015.

At this time, we'd be happy to answer any questions you may have. Emily?

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is from John Dunn of Sidoti & Company.

John Dunn - Sidoti & Company

You started to talk about back half of the year asset growth, typically in the AgVantage. Can you just remind us some of the seasonality? And then also, what some of the other categories might look at or at least what you might expect?

Timothy Buzby

Well, with the AgVantage securities, there really isn't seasonality. That's really driven by the needs of our counterparties. Often times, those needs are driven by current maturing AgVantage securities. So with current customers that have maturing securities, we obviously are in regular conversations with them about refinancing those directly. And then also their additional needs are driven by their business growth in their own lines of business.

Other lines, we've seen, and I think Dale mentioned a little bit of a less purchase volume compared to last year in Farm & Ranch. I think that's driven by lot of the demand last year, as people were positioning for rises in interest rate. I think a lot of that refinance activity that was expected has occurred at this point.

We still do see transaction volume, and that's driven from bringing new sellers into the program. And a lot of that business, the seasonality of that is related to the harvest cycles, when farmers are busy in the fields compared to when they're looking at their balance sheets and their financing, et cetera. So that comes and goes throughout the year.

USDA Securities, you recall, last year that business volume slowed down towards the end of the year as funding at the government dried up. We don't expect that to occur then this year. So we think that business volume should be healthy through the year.

And Rural Utilities loan purchases, as you can see, that was a small number this quarter. That's really not particularly indicative of what it will be next quarter. That's just the current demand that there are with the businesses with CFC, our counterparty in the Rural Utilities industry. So there are a number of moving parts there. We have often stated, and continue to state, we expect that there will be opportunities for growth in all of our lines of business. And we do expect that to occur.

John Dunn - Sidoti & Company

So for Farm & Ranch, would you say that, going forward likely most of the new business comes from new customers rather than existing?

Timothy Buzby

I would say, we still get quite a bit of business from our existing bank customers, but also we're signing up new customers on a regular basis and are actively seeking to do that in many of the ag states and our initiatives there remain unchanged. We are looking to grow the volume of customers from which we participate in our programs, as well as increase the business from those who are already in the program.

Dale Lynch

John, just to add to Tim's point though on the Farm & Ranch loans. For example, Tim mentioned that the volumes are a little bit less than prior year, if you add about six months to date or maybe 7% or 8% below last year's gross purchase volume for Farm & Ranch loans, but if you look at the unscheduled prepayment volumes in our Q, you will also notice that those are down significantly. Those are down some 50% to 60% depending on what time period you look at. So from a net perspective, we're still seeing pretty attractive net growth in Farm & Ranch loans. And that's what helped drive the spread expansion this quarter.

Operator

Our next question is from Bose George of KBW.

Bose George - KBW

Question just on the DTA valuation allowance, can you reverse that now since it looks like you'll be able to utilize that with the RRP strategy?

Timothy Buzby

I'm sorry, Bose, I didn't quite catch the question you're asking?

Bose George - KBW

It looks like you have a $26 million valuation allowance on your deferred tax asset. So I was just wondering, if that gets reversed since you'll be able to utilize that with the capital gains that you should be able to generate with the new strategy?

Dale Lynch

Well, we already reversed $11.6 million of that in second quarter. So we've done what we think will be -- we've made our estimate now. In conclusion of this transaction in late fourth quarter, we may have an adjusting entry to that estimate, but that $11.6 million is the estimate for the full tax benefit that we expect to recognize related to this strategy.

Bose George - KBW

And then, actually just in terms of modeling, and that just to confirm, that the offset to the spreads will be the capital gains, sort of the tax adjusted capital gains that you'll mark at the end. Is that right?

Dale Lynch

That's exactly, right. That's why it's hard to look at net interest income from the GAAP income statement in this regard, because there is some key differences. In this quarter it's particularly important just given that there is about $8 million of interest expense associated with the financing of this strategy and that's factored into net interest income, while the benefit that's offsetting that is in the tax line.

So it's kind of apples and oranges there. So we encourage people to turn the net effective spread, which we think is the most reliable indicator in terms of looking at the business and what it's producing. It includes all the derivative positions and it excludes the interest expense associated with this transaction.

Operator

Our next is from Jordan Hymowitz of Philadelphia Financial.

Jordan Hymowitz - Philadelphia Financial

Just first, I want to follow-up on Bose's question. So going forward, the $8 million in extra interest expense, will that be the run rate going forward and/or will that be reduced back and the tax rate be higher?

Dale Lynch

It will be approximately similar to that, what we expect over the balance of the year. So the next two quarters will be that. We'll have an interest expense similar to what we have had in the second quarter. And then we'll have unrealized gains from the sold Treasuries, if you will, that will be similar to that.

On a pre-tax basis, however, we expect that the interest expense associated with this in Q3 and Q4 in aggregate would be about $2 million after-tax greater than the gains that we post. So when you take that net $2 million after-tax incremental financing cost, if you will, and compare it to the $11.6 million tax benefit we posted this quarter, that's how you get to the net benefit where you estimate $8 million to $9 million of net benefit this year.

Jordan Hymowitz - Philadelphia Financial

And that's why they had back the income tax benefit in core earnings, so to speak?

Dale Lynch

Well, that's right, exactly.

Jordan Hymowitz - Philadelphia Financial

Second question is why you're adding back the release of provision?

Timothy Buzby

Well, Jordan, as we add to the release, we add items to the allowance for losses. That goes through earnings as a cost. In this case, we had ethanol loans that we were carrying on allowance against, that actually paid off. So we reversed out that allowance and brought down the reserve for losses against the ethanol portfolio. So that benefit comes through core earnings as well.

Jordan Hymowitz - Philadelphia Financial

I am just not sure, because it's kind of one-time, if that should be core earnings.

Timothy Buzby

Well, it's one-time, if you look at the specific effects related to those individual loans. But as if we were to have, same way when we put an allowance against those loans, that would have those cost, charge against core earnings. When it then comes back, we add that back to core earnings.

So it's a one-time event specifically. But every quarter we have additions and releases from the allowance for losses related to various transactions. So it's ongoing for various reasons. This one specific reason was somewhat of a one-time event.

Jordan Hymowitz - Philadelphia Financial

But is the run rate on core earnings is it really $23.2 million or is it that less at $2.05, should I say?

Timothy Buzby

Well, we always expect to have some activity in the allowances for losses in our portfolio, sometimes its $1 million or $2 million increase to the allowance, sometimes its $1 million or $2 million release to the allowance. So from our perspective, if you're modeling the business, I would model it not looking at what those credit charges are, because they do fluctuate, sometimes they're positive, sometimes they are negative.

I wouldn't use the $23 million as a run way in your analytical models, because that is increased by the $11 million-plus related to the deferred tax valuation allowance. So I wouldn't encourage to remove that deferred tax asset valuation allowance. Considering, however, as Dale mentioned, there is going to be $2 million in the next couple of quarters, which will be impacting and look at that sort of in the foremost of time for the full year to come out to that $8 million or $9 million, which will be positive. So that was very positive this quarter and will be somewhat negative in each of the next two quarters.

Dale Lynch

Jordan, from a net effective spread perspective that's where we really encourage you to look at that, because the net effective spread will exclude the interest expense associated with this repo transaction.

Jordan Hymowitz - Philadelphia Financial

And last question, is your capital is incredibly large at this point. I mean you didn't buyback any common stock in the quarter and you're well in excess of capital needed. Could you buyback common to offset part of the preferred that was, in other words are they fungible?

Dale Lynch

Well, they're fungible from the standpoint of compliance with our statutory and regulatory capital requirements. However, they're different in that. We believe that buying back common stock would be counterintuitive to the idea of wanting to ultimately increase the flow of stock for our investors. And also as we've mentioned, we do fully plan to repurchase $244 million of preferred stock that becomes callable in March of next year.

So when you look at our capital position today, our plan is to reduce that by $244 million three quarters from now. At the same time, we'll have three quarters of incremental additional core earnings during those three periods. So the excess that you see today or the amount that looks like a very large capital number, we are planning to manage that downward over the course of the next three quarters, and that will significantly reduce our amount of preferred stock dividend expense.

Jordan Hymowitz - Philadelphia Financial

And that was my final questions. So on the $244 million, what's the interest expense?

Dale Lynch

On an after-tax basis, the coupon on that preferred stock is 8.875%, but because of the tax treatment of that stock, the overall net cost of that is about 5.75%. So whatever 5.75% of $244 million is roughly.

Timothy Buzby

Jordan, so the way to think about it is, once we do call these FALConS in March of next year, will increase core earnings, all else being equal, by roughly $4.7 million compared to the run rate of core earnings entering 2014, if that make sense to you. And that will offload obviously each of the benefit of common shareholders.

Jordan Hymowitz - Philadelphia Financial

That's $14 million at 5.37% high after-tax, 11.3 million divide, that's a $1.20?

Dale Lynch

It's 5.7% on an after-tax basis on $244 million is roughly $13.9 million of after-tax dividend expense associated with those FALConS.

Jordan Hymowitz - Philadelphia Financial

Right, divided by 11.3 million shares is $1.20.

Dale Lynch

Right.

Jordan Hymowitz - Philadelphia Financial

So the run rate in the '16 rather would be $1.20 higher from just this thing.

Dale Lynch

Compared to where we are today, that's right.

Operator

Our next question is from Matthew Dodson with JWest.

Matthew Dodson - JWest

Can you just talk a little bit about, I guess, on the ethanol side. You had a lot of payoffs. Do you continue to expect that book to payoff just because ethanol margins are so high right now and the producers are making a lot of money?

Timothy Buzby

In general the answer to that question is, yes. Often times what we find is that the ethanol producers who are in the best position and doing very well, finalized either paydown their existing loans or they have refinancing opportunities, which happen to be away from Farmer Mac. We're currently not increasing or adding to our ethanol portfolio. So we do expect that it will payoff over time.

If you recall, we had a 1 point outstanding ethanol loans of almost $350 million, and I believe that's now below $40 million. I would anticipate that over the course of the next year or two that number will likely come down, if not close to zero, it will be gone.

Matthew Dodson - JWest

And then the last follow-up question. I mean obviously, we've seen commodity or corn specifically and soybean, but corn come down pretty significantly. Do you expect your credit quality to start to deteriorate next year, as the farmers start to harvest this? I know you have pristine credit quality now, but is that something you guys were concerned about or can you just help us understand kind of what your customers are saying or what you're thinking?

Timothy Buzby

Well, much variance is to be seen as to how things unfold with respect to the price of corn in particular. I do think that you have to remember that farmers have done very well over the past several years, maybe up as much as a decade. So they're often times in a very good position to withstand a lower corn price than what we saw over the last year or the last two years.

Also with our portfolio will be made up entirely of real estate loans. It's unlike operating lenders, which many of our customers quite frankly are, who have loans that are coming due every year and are based on the farmers production for that year in particular, as far as our long-term loans with relatively low LTVs. So well, we may have some customers, certainly they're going to be farmers who may experience stress.

The likelihood that we'll see that comes within our portfolio remains to be seen, but we feels that we're in a pretty good position, having reduced our loan-to-value requirements in many areas of the countries, as we saw land values going up and the expectation of prices might come down. It will all depend on the price of corn, ultimately when farmers sell. They often times don't sell directly into the markets that you've seen today. Many of them wait and see where prices go.

So they are a lot of moving parts. We don't and haven't disclosed any particular concerns at this point. I think as you see in the media and other outlets, you'll see people talking about the impact that lower corn prices will have. But we being a national lender that are in many different commodities, those low corn prices benefit our dairy portfolio, and our ranches, et cetera. Low corn prices work well for those commodities.

Ethanol is another good example. The reason ethanol facilities are doing so well is because the price of corn is low currently. So we have a natural hedge across our portfolio that a lot of other local or regional lenders don't have. And ultimately some of that stress on some of our customers or perhaps potential customers could cause them to look and say, you know, now, with corn prices down much at half of what they were over the course of last couple of years, maybe it's time to look at Farmer Mac's way of managing risks in our own business. So while there maybe some stress that's come through in the portfolio, there may also be business opportunities that result from it.

Timothy Buzby

So I'd add one clarification as a follow-up to the previous question by Jordan regarding preferred dividends. Just to clarify, once the redemption in March of 2015 is complete, our annual rate of preferred dividends will be about $13.2 million. So I just wanted to make sure that that number was clear.

Operator

Thank you. I'm showing no further questions. This concludes our question-and-answer session. I'd like to turn the conference back over to Mr. Buzby for any closing remarks.

Timothy Buzby

Thank you, Emily. With no further questions, I'd like to thank you for listening and participating this morning. I look forward to our next call to report third quarter 2014 results in November. Thank you. Good bye.

Operator

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

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