Federal Agricultural Mortgage Corporation (NYSE:AGM) Q2 2023 Earnings Call Transcript

Federal Agricultural Mortgage Corporation (NYSE:AGM) Q2 2023 Earnings Call Transcript August 7, 2023

Federal Agricultural Mortgage Corporation beats earnings expectations. Reported EPS is $3.7, expectations were $3.1.

Operator: Good day, and welcome to the Farmer Mac Second Quarter 2023 Earnings Conference Call. All participants will be in listen-only-mode. [Operator Instructions] Please note, today’s event is being recorded. I would now like to turn the conference over to Jalpa Nazareth, Senior Director of Investor Relations and Finance Strategy. Please go ahead.

Jalpa Nazareth: Good morning, and thank you for joining us for our second quarter 2023 earnings conference call. I’m Jalpa Nazareth, Senior 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 the risks and uncertainties that could cause our actual results to differ materially from those projected. Please refer to Farmer Mac’s 2022 annual report and subsequent SEC filings for a full discussion of the company’s risk factors.

On today’s call, we will 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 Investors section. Joining us from management this morning are President and Chief Executive Officer, Brad Nordholm, who will discuss second quarter business and financial highlights and strategic objectives; and 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?

Brad Nordholm: Thank you, Jalpa, and good morning, everyone. Thank you very much for joining us. I’m pleased to report that for the second quarter 2023, Farmer Mac once again surpassed previous records in revenues, core earnings and net effective spread, building on the strength of our performance. Our capital base remains strong, which, along with our disciplined asset liability management and uninterrupted access to the capital markets supports our long-term strategic growth objectives and also serves as a buffer against market volatility and changing credit market conditions. These results further demonstrate the resilience of our business model and the success of strategic initiatives designed to grow the company profitably while fulfilling our mission to rural America and generating shareholder returns across changing market cycles.

In the second quarter, we recorded core earnings of $42.2 million, reflecting a 37% increase over the same period last year. We achieved gross new business volume of $2.2 billion during the quarter, resulting in total outstanding business volume of $26.7 billion as of June 30, 2023. Included in the $2.2 billion of new volume was incremental volume in the form of an acquisition of mortgage servicing rights on $600 million of Farm & Ranch loans held by a third party. Since the strategic acquisition and expansion of our loan servicing functions in the third quarter 2021, we have looked for opportunities such as this recent acquisition to scale this portfolio while creating more process transparency and greater efficiencies across our loan servicing platform.

This capability gives us more direct oversight and governance of our portfolio, enhance security, more control over timely access to data and better visibility into loan performance from inception to maturity. We’ll continue to work with our key partners to identify ways to capitalize on this initiative to create a more efficient process for our customers and their borrowers. The volume growth we’ve seen in the last – first half of this year is largely attributable to the efforts we’ve made over the last few years to diversify our business model across several key markets. The agricultural finance line of business grew over $500 million in the second quarter, predominantly due to the previously mentioned acquisition of new loan servicing rights and growth in our corporate Ag Finance segment.

There was good activity in corporate Ag Finance, reflecting our success in building our reputation in this market. For example, during the second quarter, we were invited to participate in deals with very large well-known counterparties and have received more inquiries in recent months than we have ever seen before. Opportunities in this segment are generally more accretive from a net effective spread standpoint, the volume tends to be lumpy on a quarter-to-quarter basis. We remain focused on this segment as it is a key component of our diversification strategy, central to our mission and impactful for earnings and continued growth. Activity in our Farm & Ranch segment continues to be moderate as a result of the higher interest rate environment, but prepayment rates remained at historically low levels during the second quarter.

We saw an increase in the number of loan applications and approvals during the second quarter, reflecting borrowers’ adjustments to the new rate environment. The agricultural mortgage market has been – seen a shift to primarily variable rate products as borrower sentiment generally expects rates to decrease over the next 5 to 10 years. Another key contributor to the increase in loan applications this past quarter was the enhancement of our scorecard underwriting product, AgXpress which allows more loans with up to 65% loan-to-value ratios, which is an increase from our previous criteria of 55% max loan to value. The expansion of this criteria allows us to better support our customers with a product that aligns with other lenders in the marketplace today, and we can do this without increasing our credit risk appetite.

Turning to our rural infrastructure line of business. We saw continued healthy growth in the Renewable Energy segment during the second quarter. Our participation in syndicated renewable energy transactions has increased the number of opportunities we can participate in with key counterparties. The pipeline remains strong in the near term as we continue to focus on upsizing existing deals and bringing on new renewable energy opportunities. We also continue to invest additional resources to further support this segment. Offsetting growth this quarter was the maturity of a single large AgVantage security in the Rural Utilities segment that resulted in a net decrease in the rural infrastructure line of business. During the disruptions in the banking industry in March, many of our counterparties opted to delay the refinancing of upcoming maturities to better navigate the market volatility and evaluate their capital and liquidity needs.

In recent months, as market has stabilized, we’ve seen many of those conversations resume, and we’re having more discussions about our product offerings as potential capital efficiency and liquidity conduit for our customers. We anticipate that this will result in a growing volume pipeline as we look ahead to the second half of the year and into 2024. Over the last few years, we have invested in our infrastructure by upgrading technology platforms, processes and product offerings to improve the customer experience. I’m pleased to announce today that we will be rolling out a pilot program to complete collateral valuations using technology, which, if successful, should reduce total loan processing times. This pilot will begin with many Midwestern properties with the goal of launching the program more broadly in the first quarter of 2024.

As we’ve mentioned previously, we are well into a significant upgrade of our treasury and cash management platforms and embarking on something similar with our loan purchase and processing platforms. Our commitment to incorporating innovation and modernizing existing technology is expected to continue to differentiate Farmer Mac and contribute to the transformation of the agricultural sector overall. Our underlying business model, strong capital position and uninterrupted access to the debt capital markets through the various market disruptions, uniquely positions us to partner with our customers to help them manage their business and the risks they face around future capital requirements and liquidity. The foundation of our strategy is our consistent financial and operational execution, coupled with proactive management of our balance sheet and funding sources.

This has positioned us well in changing credit environments and is expected to continue to create more opportunities to enhance shareholder value and fulfill our mission. So now I’d like to turn the call over to Aparna Ramesh, our Chief Financial Officer, to discuss our financial results in more detail. Aparna?

Aparna Ramesh: Thank you, Brad, and good morning, everyone. Our record second quarter 2023 results highlight our balanced well-measured approach, continued strong credit quality and resiliency across market cycles. We achieved $2.2 billion of gross new business volume this quarter. Some of the key components included $675 million of wholesale financing from our large traditional counterparties in the Farm & Ranch segment, the majority of which was refinancing of existing advantage securities, $563 million of additional loans serviced for others, $199 million in Farm & Ranch loan purchases, $165 million in new corporate ag finance loan purchases and unfunded commitments, $135 million in new rural utilities loan purchases, $80 million of which was telecommunications loans and $72 million in new renewable energy loan purchases and purchase commitments.

Even after repayments, maturities and acquisition of servicing rights, we grew about $300 million this quarter in our outstanding business volume, and this speaks to the benefit of strategic decisions over the last few years that we’ve undertaken to diversify our portfolio. Turning to core earnings. Core earnings was $42.2 million or $3.86 per share in second quarter 2023, and this reflects a 37% year-over-year increase. This increase was driven by record net effective spread of $81.8 million in second quarter 2023 compared to $60.9 million in the same period last year. In percentage terms, our net effective spread in second quarter of 2023 increased to 120 basis points, and this was primarily driven by a low-cost excess capital and our ability to redeploy this excess capital into higher earning assets as well as the continued trend towards higher spread volumes.

The capital that we raised opportunistically when rates were at historical lows in 2020 and 2021 continues to reduce the need for us to raise more expensive term and callable debt in a rising refund [ph]. We continue to defensively hold about $600 million to $800 million of cash and other short-term instruments in our liquidity portfolio. Not only does this help us weather potential market disruptions are excess and highly liquid capital generates immediate returns in a high nominal rate event. This benefit is expected to continue to create downward pressure on our non-GAAP funding costs as the short end of the curve continues to increase with Fed actions and the reinvesting of excess capital generates additional returns with an upward repricing of our short-term investment portfolio.

While the rise in short-term rates has provided an asymmetric benefit to earnings, we project limited downside to earnings if reached decline in the future due to our proactive equity capital allocation strategy. Specifically, we expect to retain some of the benefit over the medium term if rates decline as we have started extending maturities in our investment portfolio. Again, these are all practices that are highly consistent with our disciplined approach, which is designed to minimize earnings volatility. Our fundamental asset liability management approach, where we match fund the duration and convexity of our assets and liability in all rate environments remains unchanged as it has allowed us to successfully navigate changing market environments and contain earnings volatility.

Our business has certain natural hedges that we have honed over time, and this helps us be insulated from interest rate volatility. We see this as a key differentiator for us relative to other financial services entities, especially depository institutions. For example, when interest rates rise, prepayments also tend to decline, but interest earned on excess cash and capital would likely increase, and we would continue to have strong market access as we’re not reliant on deposits as a source of funding. Conversely, when interest rates decline, loan purchase volume often increases, but prepayments also tend to increase and interest on our liquidity portfolio usually ends, but we’re able to manage our interest rate risk through exercising callable issuances and thereby, we’re able to maintain our margins.

Although these natural business dynamics are not perfect offset, they do counterbalance to mitigate volatility from changes in short-term interest rates. Our liquidity and capital positions are well in excess of all regulatory ratios and our projections show minimal change in our profitability and market value, regardless of the direction and size of any rate shop that we apply to stress our balance sheet. Let’s move turn to operating expenses. Expenses increased by 21% year-over-year, and this is primarily due to the expenditures that are associated with a multiyear technology investment that we’re making in our treasury and cash management systems to enhance our trading, hedging and reporting platforms. This modernization effort is expected to position us to be defensive against cyber and fraud threats and also allow us to scale our portfolio and diversify our product offerings.

We expect our run rate operating expenses to increase at a pace above historical averages over the next several years, given plans to continue to make investments in our team and our infrastructure to support our growth and strategic objectives. Our operating efficiency is 27% year-to-date and below our strategic plan target of 30%. And this is primarily because revenue growth increased at a significantly higher rate than expenses. We will continue to closely monitor our efficiency ratio as we continue to make investments in our loan infrastructure and funding platform and innovate our loan processes to accelerate growth, we may see some temporary increases above the 30% level. Our credit profile remains very strong in aggregate despite economic headwinds.

We saw a seasonal decrease in 90-day delinquencies from the first quarter as well as a repayment from a single $16 million permanent planting loan that became delinquent in first quarter of 2023. As of June 30, 90-day delinquencies reflect 17 basis points of our entire portfolio. As of June 30, 2023, the total allowance for losses was $19.1 million, reflecting a $1.1 million increase from first quarter of 2023. The increase was primarily attributable to new telecommunications business volume in the rural infrastructure portfolio and new agricultural storage and processing volumes in the agricultural finance portfolio. Subsequent to quarter end, an entity purchased the assets and assume the liabilities of a single agricultural storage and processing loans that were subject to bankruptcy proceedings in the first half of the year.

As a result of this, Farmer Mac has received proceeds from this bankruptcy field, and we, therefore, expect to release during the third quarter, the entire allowance for loan loss attributed to this loan, which was approximately $4.6 million as of June 30. Now turning to capital. Farmer Mac $1.4 billion of core capital as of June 30, 2023 exceeded our statutory requirement by $566 million or 70%. Core capital increased sequentially, primarily due to an increase in retained earnings. Our Tier 1 capital ratio improved to 15.9% as of June 30, 2023, from 15.7% as of March 31, largely due to strong earnings results and higher retained earnings. Maintaining credit standards that reflect our risk profile, coupled with strong levels of capital is a fundamental part of our long-term strategy.

So in conclusion, our entire team delivered exceptional quarterly results, surpassing the key metrics that we highlight on each call while staying within our credit framework. Notably, we delivered a record 19% return on equity this quarter and stayed well below our efficiency target of 30%. We believe that our balance sheet has continued to be well positioned for uncertainty, and we’re more optimistic than ever to deliver on our long-term strategic plan objectives. And with that, Brad, let me turn it back to you.

Brad Nordholm: Thanks, Aparna. Our business model is resilient and diversified and our balance sheet is very healthy. We operate with high capital levels and believe that we’re well positioned to deliver earnings growth and strong profitability for the remainder of 2023 and into 2024. We’ve emphasized that our ability to issue long-dated fixed rate debt in all rate environments and economic cycles is a core competitive advantage that when combined with our approach to asset liability management, helps to produce consistent spreads and provides forward visibility to future earnings. I’m extremely proud of our team and the excellent progress that we’re making on our multiyear strategic initiatives. We remain focused on our mission to increase the accessibility of financing for American agriculture and rural infrastructure.

We are aligned across our organization and with our customers to bring even greater efficiencies and lower costs in providing financings to lenders for the benefit of their Farm & Ranch agribusiness and rural infrastructure customers. And now, operator, I’d like to see if we have any questions from anyone on the line today.

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Q&A Session

Operator: Thank you. We will now begin the question-and-answer session. [Operator Instructions] Today’s first question comes from Bill Ryan with Seaport Research Partners. Please go ahead.

Bill Ryan: Good morning. Thanks for taking my questions and very nice quarter. Just kind of looking at your mix of business, obviously changed a little bit in the quarter. You talked about the acquisition of the servicing asset. Some acceleration in corporate AgFinance. I know we’ve got 6 months left to go in the year, but how do you see the mix of business kind of playing out through the rest of 2023? That’s the first question.

Brad Nordholm: And it’s an important one as we’ve emphasized we’re pleased with the increasing diversification of our business. We think it brings more stability through different economic cycles. And we tried to emphasize some of the reasons for that in the call today. As we look out, Bill, to the rest of 2023, with increasing acceptance and, I guess, experience with higher interest rates, we’re optimistic that we’ll see some increase in Farm & Ranch applications. We do expect to see more opportunity with corporate AgFinance, primarily because of our growing credibility in that market sector, including with leading syndicate banks. The overall credit demands are not necessarily increasing, but our presence is. I think looking out to the rest of the year and then looking forward the next couple of years in terms of a percentage increase projection, but starting from a small notional base, we see probably the greatest growth in renewable energy.

So kind of looking out towards the end of the year, continued growth in renewable energy is still small, it’s just starting to move the needle, hopefully, some higher levels of both Corporate AgFinance and Farm & Ranch. And at the end of the year, the balance will probably shift slightly towards – ever so slightly towards Farm & Ranch and corporate agribusinesses, just because they’re larger books of business here at Farmer Mac. I want to emphasize that the servicing is very strategic for us. It is not a huge driver of top line or bottom line earnings results. But it provides us with a way to create more opportunities for how we create valuable relationships with our seller servicers. It gives us more immediate access to data that, for example, among other things, supports our securitization programs.

And it allows us to focus more on operational excellence in servicing, not just for our own operation, but for our seller servicers too. So you’re going to continue to hear about that but it’s not going to be a large breakout number in our earnings for at least the next couple of years.

Bill Ryan: Okay, then…

Brad Nordholm: Bill, I’m, go out, but Aparna I wanted to add something to that.

Aparna Ramesh: Just to augment with Brad said on the Farm & Ranch space. We’re also seeing increased demand for our AgVantage facilities. So we expect that to be another area of, I would say, compositional shift as you look out through that.

Brad Nordholm: That’s true, Bill. And Aparna makes a very good point, and AgVantage tends to be very lumpy. So one expected or unexpected new AgVantage facility in the back half of the year can move the needle by hundreds of millions of dollars.

Bill Ryan: Okay. And a follow-up question on the modernization efforts. Obviously, we saw the acceleration in expenses this quarter, as you’ve been broadcasting for the last couple of quarters. What is the kind of the time frame you’re thinking for the modernization effort? Is this going to go through 2024 or 2025? And the other part of that is, did you say the expense run rate you kind of expect it to return back to historical levels after this quarter? I just wanted to be clear on that.