Earnings Call Transcript - AGM Q2 2021

Jalpa Nazareth, Director of Investor Relations and Finance Strategy

Good afternoon, and thank you for joining us for our Second Quarter 2021 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 the risks and uncertainties that could cause our actual results to differ materially from those projected. Please refer to Farmer Mac's 2020 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 Investors section. Joining us from management this afternoon are our President and Chief Executive Officer, Brad Nordholm who will discuss second 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 our President and CEO, Brad Nordholm. Brad?

Brad Nordholm, President and Chief Executive Officer

Jalpa, thanks very much. Good afternoon, everyone and thank you for joining us today. I'm pleased to report that Farmer Mac produced record core earnings this quarter. We did that while expanding our net effective spread, maintaining strong credit quality and further rationalizing our portfolio in ways that are very consistent with our strategic plan. These results largely reflect the continuation of the trends that have developed over the course of the last few years including excellent funding execution in the debt capital markets, disciplined asset liability management and ongoing shifts in the composition of our portfolio towards higher spread loan purchase products. We achieved record core earnings of $30 million during the second quarter and net effective spread above 1% for the first time in a number of years. Our asset quality metrics remained strong with 90-day delinquencies and substandard asset ratios moving favorably, in other words, moving lower quarter-over-quarter. And we're pleased with the overall performance of the portfolio. As you've probably read in the news, while the persistence of drought conditions in certain parts of the American West are causing real pain, real hardship for a number of farmers and ranchers in the American West, particularly in California, we really have not seen any evidence of this in our portfolio. For loans in areas that commonly experience exceptional drought conditions or do not always have access to underground water as a primary or supplemental source, Farmer Mac's underwriting process provides for the assessment of anticipated long-term water availability for the property and includes analysis of how that impacts the collateral value in the borrowers' cash flow. While we pay close attention to what is going on in American agriculture and empathize strongly with people who are experiencing drought conditions, we must state emphatically that the overall tone of the agricultural real estate market today is very positive. Commodity prices are strong and farm land values are projected to be stable or even slightly higher as we're seeing evidence of that in numerous public auctions and sales. In fact, a few of them have record high sale prices. During this last quarter, we provided a gross $1.5 billion of new credit to rural America. This resulted in our expanding business volume exceeding $22 billion at quarter end. Our success continues to be driven by consistent customer-centric approach, which focuses on providing products and solutions that address funded needs through all agricultural economic cycles and to both our existing and our new markets. Strong loan purchase growth in our Farm & Ranch line of business this quarter was largely attributable to our proactive outreach to our customers. Farm & Ranch long-term standby purchase commitment product also exhibited some growth, a reversal from prior quarters. Regional Farm Credit System associations growth within our core sectors resulted in lenders exceeding commodity concentration limits and we're acquiring additional need for capital relief and that is provided by Farmer Mac's purchase commitment product. Across our other lines of business, we continue to see increased levels of competition in terms of price structure and execution, primarily due to the historically low interest rate environment and the Federal Reserve Bank's continued support of the lending market. In our USDA guaranteed line of business, in addition to increased competition, we're seeing lower demand for the product in certain regions due to strong increases in commodity prices. In other words, because farmers' financial health is stronger, they need the guarantee program less. This has also resulted in a higher increase in the high coupon USDA loans paying off compared to 2020. Although we've seen maturities in our institutional credit line of business, we did successfully fund four new AgVantage bonds with our rural infrastructure counterparty for an aggregate amount of $375 million. We also funded a $25 million AgVantage bond with a new counterparty that we believe offers significant agricultural holdings and growth potential. The successful funding execution of these institutional counterparties is a testament to Farmer Mac's focus on expanding its customer and business relationships and challenging ourselves to find more efficient and effective ways to provide our customers with the flexibility and assistance their borrowers need. We have stated in the past that we won't do AgVantage when the margins are too thin. This quarter we were able to find a number of situations where that wasn't the case. While we had limited loan purchase activity that closed from our rural utility counterparties, we do see positive momentum in the broadband and renewable energy project finance pipeline. We view this growing sector as a significant opportunity for Farmer Mac over the next several years, given the greater level of interest from rural electric cooperatives to develop and deploy broadband services and invest in renewable energy generation as well as renewed interest from a federal policy perspective in broadband and renewable energy. When I joined Farmer Mac nearly three years ago, I took steps to do a couple of simple things at Farmer Mac, among them making Farmer Mac a more commercial institution, making sure that we are listening to and responding to the needs of our customers by coming up with more competitive and responsive products and delivery systems. This vision really had attached to it meaningful business volume objectives that required our team to develop innovative approaches and how we acquire and retain customers and how we develop and deliver new products. We also took into consideration the appropriate investments in people and infrastructure required to meet our long-term plans. I am really proud to say that our consistent financial performance over the last three years and effective execution in a highly competitive lending environment where there's an abundance of liquidity today is the direct result of the team's dedication to successfully broadening and deepening our business that's come about by learning to listen to and respond to our customers' needs. This ultimately helps us support our mission of developing and delivering more credit products that are a benefit to all of rural America. As part of our efforts to identify opportunities to reach a larger audience, we recently engaged in a joint marketing campaign to promote a white paper that we co-authored with the American Bankers Association. It's available on our website. The multi-week promotional campaign is intended to shine light on the agricultural mortgage market in the United States and Farmer Mac's role in helping agriculture lenders grow their business and relationships with their customers ultimately to benefit all of those in rural America. This has been an exciting opportunity for Farmer Mac to demonstrate to a wider audience how our mission is helping create tangible benefits in the agriculture marketplace. So in summary, we are very pleased with the second quarter results and we generally expect the positive trends we've seen in the first half of 2021 to continue. While the emergence of the delta variant creates some level of near-term uncertainty, we are confident that our current infrastructure, strong capital position and commitment to our customers as well as our employees' resilience and demonstrated ability to execute on our plans while working from home is going to help us navigate whatever comes our way during the remainder of the year. And now with that I'd like to turn the call over to Aparna, our Chief Financial Officer, to give you a little bit of additional insight into the financial results for the quarter. Aparna?

Aparna Ramesh, Chief Financial Officer

Thank you, Brad and good afternoon everyone. I'm pleased to share with you Farmer Mac's record second quarter results. This reflects focused execution throughout the organization as Brad just noted. Farmer Mac's second quarter 2021 earnings growth was driven by higher spread business volume and substantially lower funding costs given our strong access to debt capital markets. Our return on equity to a common stockholder was 18% year-to-date and this is well in line with our historical averages and this is despite the continued investments we're making to support our strategic growth initiatives. Notably, we exceeded 100 basis points this quarter for net effective spread and this exceeded our 90 basis points plus or minus five basis points guidance that we have previously provided. Our access to capital markets remains strong. We've issued debt daily. We raised preferred capital of $125 million as historically low rates for us and we've continued to maintain our disciplined asset liability management practices and this includes a methodical transition out of LIBOR-based instruments. The year-to-date average balance of spread earning assets was $22.3 billion, which is comprised of $4.8 billion in cash and investments and $17.5 billion of loans and securities. Farmer Mac's net effective spread for the second quarter 2021 was $56.6 million, a 22% increase from $46.5 million in the second quarter 2020. In percentage terms, this translates to a net effective spread that I mentioned previously, of 1.01% compared highly favorably to 0.89% in the same period last year. The overall composition shift this quarter of $395 million of net new higher spread Farm & Ranch loan purchase products combined with a net decline of $100 million in AgVantage bonds that earn lower spreads, combined with our effective funding execution were the primary drivers of our record net effective spread increase during the quarter. Year-to-date we have successfully issued $6.6 billion in long-term debt funding across the maturity sectors with increases in the five to 9-year and greater than 10-year sectors. By extending our liabilities, we were able to adequately prepare for a potential rising rate environment at pricing levels that are very attractive. We're also actively analyzing our duration and convexity matches on both our existing portfolio and our pipeline to ensure that we minimize our interest rate risk in the event of a sustained rise in interest rates. Turning to core earnings. Our core earnings for the second quarter 2021 grew 14% to $30 million or $2.77 per diluted common share compared to $26.3 million or $2.45 per diluted common share in the same period last year. The year-over-year increase in core earnings was primarily due to an $8 million after-tax increase in net effective spread and this was potentially offset by $2.2 million after-tax increase in operating expenses and a $1.9 million increase in preferred stock dividends from our recent series G preferred issuance. Our operating expenses increased by 20% year-over-year and this is primarily due to increased headcount and high spending on software licenses and IT consultants, information technology consultants to support various core and strategic initiatives. These increases were offset by lower levels of expenses that were related to consulting fees, travel, and conferences. However, as we've mentioned previously, these decreases are very likely to be temporary and expected to normalize post-pandemic once normal activity resumes. We expect to see higher investments for the foreseeable future primarily to modernize our infrastructure and to enhance our technology platform to support our revenue strategy and will continue to add relevant sales across the organization as we grow. While we expect these efforts to increase over the next 12 to 18 months as we innovate and grow our business, we do expect to see a tapering off in expense growth. Moreover, we have instituted a very disciplined approach to controlling both our personnel and non-personnel expenses. We monitor our operating expense ratios, and we do a thorough and rigorous review of our results each quarter as a management team. Our efficiency ratio ended the second quarter 2021 at 26% and this is below our target 30% level. As we continue to upgrade our platforms and invest strategically in multiyear technology commitments that we hope will improve customer service and our competitive position, our efficiency ratios are projected to stabilize at historical levels and remain under 30%. We benefited from an improving macro environment as evidenced by a $1 million release of our total allowance for credit losses from March 31, 2021, bringing us to $16.6 million at June 30, 2021. Turning now to capital, we opportunistically strengthened our capital levels through a successful issuance of $125 million in Series G Preferred stock and this happened in May. The addition of preferred capital together with our strong earnings increased our Tier 1 capital ratio this quarter from 14% as of March 31 to 15.3% as of June 30, 2021. Farmer Mac's $1.2 billion of core capital as of June 30, 2021, exceeds our statutory requirement by $483 million or 71%, putting us in a very robust position. Additionally, in March 2021, our Board of Directors reinstated our share repurchase program, which has been suspended since the first quarter of 2020. The plan was reinstated on its previous terms and has a remaining authorization of up to $9.8 million and an extended expiration date of the program March 2023. We have not repurchased any shares in the first half of 2021 and we must note that we intend to repurchase stock only when we view repurchases as both accretive and consistent with our strategic objectives. Overall and in conclusion, we are very pleased with the consistency in our results this quarter and this is reflected both in our profitability and is bolstered by consistent credit quality and our capital adequacy. More complete information about Farmer Mac's second quarter 2021 performance is in our 10-Q we filed today with the SEC. And with that, Brad let me turn it back to you.

Brad Nordholm, President and Chief Executive Officer

Great. Thanks so much Aparna. The results we generated thus far in 2021 I think are reflective of a business that can expand profitability while successfully serving our mission of increasing access to and reducing the cost of credit for the benefit of agriculture in America's rural communities. We continue to manage our capital prudently, focused on consistently building shareholder value for the long-term. Additionally, we continue to develop peer-leading operating efficiency, while making investments to position the company for continued growth as we see over the next few years. Overall I'm very, very pleased with the results so far this year and very, very excited about the future that we have here at Farmer Mac. And now operator, I'd like to see if we have any questions from anyone on the line today. Thank you.

Operator, Operator

Excellent. Thank you. Ladies and gentlemen, the floor is now open for questions. And our first question comes from Greg Pendy with Sidoti. Please go ahead sir.

Greg Pendy, Analyst

Hi, guys. Thanks for taking the question. I guess, I got to ask this because you're at your highest net effective spread here that we've seen in some time. What is the scenario here that brings it down? Because I'm assuming the Farm & Ranch side is rather sticky in terms of you're putting on longer duration loans here. But is the most likely scenario that we see decreased liquidity in the system and mix just hurts you with more institutional credit potentially coming back? In other words, total volumes will go up, but your mix will have much lower spread business coming in there. Is that fair to say?

Brad Nordholm, President and Chief Executive Officer

Yes, Greg, it's Brad. Thank you for your participation and for the question. I would like Zack Carpenter to provide some additional insight into our portfolio composition and asset mix. It's important to note that NES is influenced by the entire portfolio. The assets we place in that portfolio remain there for some time, resulting in gradual fluctuations. While favorable conditions in the debt capital markets can affect this more quickly as we refinance maturities, our current spreads in the debt capital markets are at historical lows, making significant upward movement in NES unlikely from rolling over debt instruments. With that said, I’ll now turn it over to Zack Carpenter to discuss how NES is affected by factors such as above-average growth in Farm & Ranch compared to the rest of the portfolio, or strong performance in agribusiness and large complex credits, as well as the potential impact of below-average growth in rural utility and lower-margin assets. Zack, could you share your thoughts?

Zack Carpenter, Analyst

Thank you, Brad, and great question, Greg. You’ve accurately identified the shift in our compositional mix. Since 2020, our balance sheet has moved towards higher-earning assets. We are continuing to experience robust growth in our Farm and Ranch sector. A significant part of this business is our agribusiness value chain lending portfolio, which has a much higher net economic spread compared to other business lines. As we advance through the year and increase our lending in this area, we expect to see increased earnings in that sector. However, we’ve also noticed some positive movement in our rural utilities AgVantage product, although these are more variable and tend to have a lower net economic spread than other portfolios. Changes in capital markets may require us to support our customers in those segments, which could lead to fluctuations that lower our overall spread. Additionally, we have fee-based and off-balance sheet products where we earn fees, and any slowdown in those will reduce that business but likely increase our net economic spread from on-balance sheet loans. Overall, we are seeing solid growth in Farm & Ranch purchases, which will be a driving force moving forward. Some adjustments from AgVantage and rural utilities loans later in the year may moderate that growth slightly, but we expect strong ongoing growth in agribusiness to support our net economic spread.

Greg Pendy, Analyst

That's very helpful. Regarding the rural utilities, if a bill is passed, it will take time for beneficiaries to see the effects. This could be a key area for your divisions, especially from an infrastructure build perspective.

Brad Nordholm, President and Chief Executive Officer

The most likely positive impact on the rural utilities portfolio from an infrastructure build would come from broadband and renewable energy. Renewable energy has higher margins, while the impact of broadband will depend on the structure of any federal programs or stimulus and its effect on credit quality. We anticipate that both broadband and renewable energy could benefit significantly from infrastructure bill funding over the next few years and could further contribute to our growth. However, we need to see the details and feasibility of the federal infrastructure plan regarding actual loan opportunities before we can confidently project the extent of the impact. Overall, the direction appears positive.

Greg Pendy, Analyst

That's very helpful. Thanks a lot.

Operator, Operator

And there appear to be no further questions at this time. I'd like to turn the floor back over to Brad.

Brad Nordholm, President and Chief Executive Officer

Well, thank you. You may have noted that, we attempted to make a few changes in our call today. We attempted to make it a little bit shorter, providing more time for questions or just for going home at 5 o'clock, on a very, very nice Thursday afternoon. But we appreciate your attendance very much. We will have our next regularly scheduled call in November, when we will be reporting on our third quarter 2021 results. We look forward to sharing information with you of course, at that time. And as always, if you have questions, you'd like to follow up with any additional information, any additional questions just get in touch with us. We're always very pleased to speak with you. So with that, thank you very much. And have a good evening.

Operator, Operator

Thank you. Ladies and gentlemen, this does conclude today's teleconference. We thank you for your participation. You may disconnect your lines at this time. And have a great day.