Earnings Call Transcript - AGM Q3 2021

Operator, Operator

Good day, and welcome to the Farmer Mac’s Third Quarter 2021 Earnings Conference Call. After today’s presentation, there will be an opportunity to ask questions. Please note today’s event is being recorded. I would now like to turn the conference over to Jalpa Nazareth, Director of Investor Relations and Finance Strategy. Please go ahead.

Jalpa Nazareth, Director of Investor Relations and Finance Strategy

Good afternoon and thank you for joining us for our Third 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 CEO, Brad Nordholm who will discuss third quarter business and financial highlights and strategic objectives; and our CFO, 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 CEO

Thanks, Jalpa, and good afternoon, everyone. I appreciate you joining us. As outlined in today’s press release, we’re experiencing another remarkable year, marked by significant achievements such as the expansion of our internal loan servicing function in the third quarter and recently structuring a new syndicated agriculture mortgage-backed securitization in the fourth quarter. These accomplishments, along with our consistent financial performance and strong credit quality, reflect the execution of our multi-year strategic plan. We delivered another quarter of robust core earnings and net effective spread, showcasing the disciplined structure of our asset liability management and pricing strategies, as well as the consistency and durability of our business model. Our asset quality metrics remain solid, with favorable movement in 90-day delinquencies and sub-standard asset ratios on a quarterly basis. We are satisfied with the overall portfolio performance and do not foresee any material issues ahead. The enhancement of our internal loan servicing capabilities through this quarter’s strategic acquisition represents a significant opportunity for Farmer Mac and will provide numerous benefits to our core customers, the lending institutions serving rural America, who are integral to our seller servicer network. We plan to leverage this opportunity to create greater efficiencies across our loan servicing platforms and gain enhanced oversight and governance over a significant part of our portfolio, which will improve security, control, and timely access to data, as well as better visibility into loan performance from start to finish. We are also eager about the growth opportunities this strategic investment will offer, as it will enable us to service larger and more complex commercial loans more effectively, a crucial element of our long-term growth strategy. This initiative exemplifies our dual strategies to expand our business opportunities while strengthening relationships with our existing customers. We believe this will ultimately help us provide more capital to support rural America and enhance customer service for our lender network, aligning with our mission to increase access and competitive pricing for credit to benefit the nation’s farmers, ranchers, and rural residents. I’m very proud of the $302 million newly structured and syndicated agricultural mortgage-backed securitization that we closed in early October. The success of this transaction showcases Farmer Mac’s high-quality credit, strong balance sheet, and consistent financial performance, along with the resilience of America’s farmers and ranchers. This capital flow development for agricultural producers has strengthened their access to capital markets and demonstrates Farmer Mac’s core mission to lower borrowing costs and improve credit availability, while also creating an appealing new investment opportunity for leading institutional investors. Aparna will share more details about this transaction shortly. Looking ahead, we aim to expand the securitization program in the coming years and become a consistent issuer within the marketplace. The general outlook for the agricultural real estate market is positive, with farmland values expected to remain stable or slightly increase, as evidenced by a rise in public auctions and sales reflecting some of the highest values this year. We provided a gross $2.5 billion in new credit to rural America in the third quarter, leading to an outstanding business volume exceeding $23 billion at the end of the quarter. Our ongoing success is driven by our consistent customer-centric approach, which focuses on delivering products and solutions that meet funding needs throughout all agricultural economic cycles, addressing both existing and new markets. This quarter's strong loan purchase growth in our Farm & Ranch line of business was primarily due to our proactive customer outreach and retention strategies. We also added a net new $15 million commitment this quarter for a borrower looking to acquire and enhance farmland in a federally designated opportunity zone. This marks our largest commitment to opportunity zones to date, with $21 million funded in the third quarter. Farm & Ranch’s long-term standby purchase commitment product also saw healthy growth, reversing some negative trends observed over the past few years. The growth of Regional Farm Credit System Associations within their core sectors led some lenders to exceed commodity concentration limits, providing Farmer Mac an opportunity to purchase commitments that relieve these limits for them. Despite the ample market liquidity from other sources, our institutional credit line of business grew almost $500 million, a reversal from previous quarters, driven chiefly by demand for short-term liquidity funding from two of our largest counterparties. This growth demonstrates Farmer Mac’s competitiveness in pricing and its capability to effectively meet customer needs, while also being flexible in adapting to their rapidly changing requirements. In our Rural Utilities line of business, we successfully added $50 million in unfunded telecommunication loan commitments with one of our key customers. This reflects some of the positive momentum we've observed in broadband and renewable energy project financing. We see these growing sectors as significant opportunities for Farmer Mac in the upcoming years, given the increasing interest from rural electric cooperatives to develop and deploy broadband services and invest in renewable energy generation. As we approach the fourth quarter and build on this quarter’s accomplishments, we continue to identify many opportunities. We have confidence in our robust business model, strong capital position, and dedication to our customers, all of which support our ability to generate consistent returns across various market environments and economic cycles, as we have historically. With that, I’ll turn it over to Aparna to discuss our financial results in more detail.

Aparna Ramesh, CFO

Thank you, Brad and good afternoon, everyone. I’m pleased to share with you another quarter of consistent earnings results, reflecting focused execution throughout the organization. Farmer Mac’s third quarter 2021 earnings results were driven by higher spreads, business volume and lower funding costs, giving us strong access to debt capital markets. Our access to capital markets, as in the previous quarters, remains extremely strong. We’ve issued debt daily and continue to maintain our disciplined asset liability management practices, including a methodical transition out of labor-based insurance. Farmer Mac continues to increase this activity in the sector-based asset, debt and derivatives markets and we’ve seen a significant uptick in sector activity, especially true in the derivatives market, which should aid the LIBOR transition in the loan market. The year-to-date average balance of spread earning assets was $22.4 billion, and this is comprised of $4.8 billion of cash and investments and $17.6 billion of loans and securities. Farmer Mac’s net effective spread for third quarter 2021 was $55.9 million. This represents an 8% increase from $51.8 million in third quarter 2020. In percentage terms, net effective spread was 0.99% compared to 0.96% in the same period last year. Year-to-date, our net effective spread has increased 7 basis points to 0.99% compared to the same period last year and this is a result of net new business volume, coupled with a decrease in funding costs. There was also an increase in the cash collection account from non-accrual loan payments. By effectively extending our liabilities in a low-rate environment, we’re able to adequately prepare for a potential rising rate environment while retaining attractive pricing levels. We’re also actively analyzing, as I mentioned before, our duration and convexity matches on our existing portfolio and looking at our pipeline to ensure that we minimize our interest rate risk in the event of a sustained rise in interest rates. Core earnings for third quarter 2021 were $27.6 million or $2.55 per diluted common share compared to $27.7 million or $2.57 per diluted common share in the same period last year. The year-over-year results were in line with our expectations and were driven by strong revenue increases, and core earnings were flat despite the increase in our cost of capital that resulted from our recent preferred issuance in the second quarter that we told you about. We saw a $3.3 million after-tax increase in net effective spread and a $0.7 million after-tax decrease in the provision for credit losses, and these were partially offset by a $2 million after-tax increase in operating expenses, a $1.6 million increase in preferred stock dividends and the $0.3 million after-tax decrease in guarantee fees. Operating expenses increased by 17% year-over-year and this was primarily due to increased headcount, as well as higher spending on software licenses and information technology consultants that were brought on board to support various core and strategic initiatives. The increase in headcount in the third quarter was related to the expansion of our internal loan servicing function that Brad mentioned, as we welcomed 10 members of a talented loan servicing group to the Farmer Mac’s team in August. Their expertise will allow us to offer without interruption the same level of service and quality service that our customers deserve and expect whenever they interact with us or through any of our third-party central service. The additional loan servicing expenses are expected to be offset over a multi-year period by additional revenue that will be reflected in higher spreads in our Farm & Ranch and USDA lines of business, where we will not be paying a third party for servicing the loans that we will now serve, and this should make this initiative neutral in the short term to accretive for us. We expect to see higher operating expenses for the foreseeable future, and this is primarily as we invest to modernize our infrastructure, enhance the technology platforms to support our revenue strategy, and add relevant talent across the organization. We expect these efforts to continue and increase over the next 12 to 18 months as we innovate and grow our business and we’ll continue to monitor the growth in operating expenses such that they remain commensurate with the growth in our revenue. We’ve instituted a very disciplined approach to controlling personnel and non-personnel costs and we monitor this closely through an operating efficiency ratio metric, and we do a rigorous review of our results every quarter. Our efficiency ratio in the third quarter 2021 was 27%, below our targeted 30% level. As we upgrade our platforms and invest strategically in multi-year technology commitments to improve customer service and enhance our competitive position, our efficiency ratios are projected to stabilize at historical levels and remain under 30%. Turning now to capital, Farmer Mac remains in a strong and well-capitalized regulatory capital position. Farmer Mac’s $1.2 billion of core capital, as of September 30, 2021, exceeded our statutory requirement by $480 million, or 69%. Our Tier 1 capital ratio was 15.1% at quarter-end, remaining well above the regulatory threshold. I also want to review our two recent accomplishments that Brad highlighted earlier on. First, the strategic servicing transaction. During this quarter, we acquired the loan servicing rights for a sizable portion of our Farm & Ranch loan and USDA portfolio. And we hired, as I mentioned, a talented team from the seller of the servicing rights and invested in a servicing platform that we are tailoring to unveil. This initiative will increase our interest income on the loans that we do service, as there will not be, as I mentioned, any third-party central service for retaining a servicing fee on those assets. This additional interest income is expected to be partially offset by the increase in our headcount-related operating expenses that I mentioned earlier. The second transaction that Brad highlighted is a $302.7 million newly structured and syndicated agricultural mortgage-backed securitization that took place on October 14. This deal was structured around two tranches, a senior guarantee tranche, and a subordinated unguaranteed tranche. The transaction was very well received by the investment community and resulted in an oversubscription of up to $2.3 billion in total investor demand with repeated tightening of pricing levels. The success of this transaction has provided Farmer Mac with an opportunity to diversify funding sources and its revenue and fulfill our mission more effectively. We expect to return to the market in 2022 with another similar securitization, as we seek to make this a more programmatic effort for us in the future. An inaugural securitization transaction takes a great deal of work enterprise wide, and we are currently identifying ways to potentially execute these transactions more efficiently and thereby more frequently in the future. I’m looking forward to providing you more financial details on this transaction during our next earnings conference call, when we will discuss full year 2021. More complete information about Farmer Mac’s third quarter 2021 performance is in our 10-Q that we filed today with the SEC. And with that, Brad, I’ll turn it back to you.

Brad Nordholm, President and CEO

Thanks, Aparna. Well, in summary, our third quarter results were strong and continued to demonstrate the strong foundation for visibility and growth in earnings here at Farmer Mac into the future. We will continue to rely on the same principle of serving our mission of increasing access to and reducing the cost of capital for the benefit of agricultural and rural communities, and really the people who are there in the agricultural economies. We continue to manage our capital prudently focused on consistently building shareholder value for the long run, and delivering pure leading operating efficiency while making investments to position this company for continued growth that we see over the next few years. And now operator, I’d like to see if we have any questions from anyone on the line today.

Operator, Operator

Thank you. Today’s first question comes from Gary Gordon, a Private Investor and please go ahead.

Gary Gordon, Private Investor

Okay. Thanks for taking my question. A couple of things, if you don’t mind. One, my math hopefully I got it right says that there were no charge-offs in the third quarter or actually looks like for the year-to-date. Is that correct? Am I missing something?

Brad Nordholm, President and CEO

No, Gary, that is correct.

Gary Gordon, Private Investor

Okay, great. Regarding the asset-backed securitization, my understanding is that the reasons for pursuing it include lower financing costs, reducing some risk on the balance sheet, and freeing up capital. Farmer Mac has had excellent access to the markets, low funding costs, and ample excess capital, so I'm curious about how this securitization benefits you.

Brad Nordholm, President and CEO

Yeah, Gary, and I’m going to ask Aparna to jump in here in a minute and elaborate on some of these points. But when we think about the benefits that you just mentioned, lower financing costs, freeing up capital, risk transfer, that may be true, we haven’t fully realized lower financing costs yet but as systems programmatically expect to come down. But another very important objective here, Gary, is for us to always diversify and deepen our sources of funding. At the beginning of the pandemic, we had extraordinarily great access to debt capital in the markets but, you know, we’d never take that for granted. And by tapping into a different investor market for a different form of issuance by Farmer Mac, we can make sure that we have even further diversified and deepened our sources of liquidity. So let me just turn to Aparna to elaborate on some of these different benefits because they really are significant and over time, we expect them to become even more valuable to us.

Aparna Ramesh, CFO

Yeah, thank you, Gary. I think that’s a very good question. Certainly this allows us to better diversify both our funding sources, but especially on the long end, I want to maybe focus a little bit on the point that Brad just talked about. At the start of the pandemic, we didn’t see very good assets, especially at the short end of the curve, but when we’re fully reliant on debt capital markets and only debt capital markets at the long end of the curve, especially in times of volatility that leaves us with only one source of funding. And so by diversifying our sources of funding, especially on the long end, to remind you, this securitization transaction really targets the 15 to 30 year sector, I think it’s important for us to continue to have that. So, that’s one reason why we did that. The second piece is this does allow us to also fulfill our mission more deeply by offering that lower cost of financing, but also add a tenor, especially as rates are likely to rise, allowing us to continue to be competitive in that long end of the curve. So, that’s another point. And then finally, you talked about capital, absolutely, we are a very well-capitalized institution. Our reason for doing this is not for reasons of capital efficiency but that said, a transaction like this is incredibly capital efficient, and allows us to continue to really deploy our capital in a way that makes a lot more sense, as we diversify our product line. So those, I think, are the primary reasons we entered into this transaction and I hope that helps.

Brad Nordholm, President and CEO

Gary, I just want to add that if it sounds like we were concerned about something and that motivated us to do this, that’s really not the case at all, we’ve been having fabulous access, we are over-capitalized. But I think when you look to us as the leadership of Farmer Mac, you’ve entrusted us with your investments with your capital investments. When you look to us, you want us to be proactive and always looking for new and better ways of doing things that makes the organization stronger, even more resilient in the future, even more profitable in the future. That’s really what we’re trying to do here.

Gary Gordon, Private Investor

Okay, great. Quick question on the servicing business that you bought, were these businesses servicing for others that you get fees on, one? And then two, you said there’s more long-term benefits and certain short term, the expectation of more and more of your portfolio is serviced by yourself as opposed to third party?

Brad Nordholm, President and CEO

Yeah, well, we’ve been sitting here for this call. Aparna and Jalpa, I have been joined by our General Counsel, Steve Mullery; by our Chief Credit Officer, Marc Crady; and our Chief Business Officer, Zack Carpenter. Zack, to put much of this transaction together along with Rob Maines, Head of Operations, and Mario was really a huge team effort. But in terms of the strategic intent and the near term as well as intermediate term business strategy and relationships, I’ll let Zack answer that question and give you some good color on that, Gary.

Zachary Carpenter, Chief Business Officer

Thanks, Gary. Great question. As Brad indicated, we see a lot of near-term immediate benefits as well as long-term benefits. I’d say more on the immediate, and in prior calls we’ve talked about enhancing our infrastructure, predominantly as we enter new lines of business. As Brad indicated and Aparna commented on creating new products and services for our customers and solutions for farmers and ranchers, we need to continue to evaluate and enhance our infrastructure to be able to support those new products. A key component that this new servicing function platform and team gives us the ability to execute on more complex and increasing loan products that we see in the market. I’d say in the medium to longer-term benefits, we do anticipate consolidating a fairly broad central servicing platform. That being said, we expect to fully work with a lot of our key central servicers to really create a more efficient process for their customers, our customers, and the farmer and ranchers. And really what that means is getting more functionality with data, getting quicker access to data so we can make more access to capital for farmers and ranchers in a much more efficient way. We do anticipate an increasing portfolio that we will service and Aparna mentioned the benefits that we will receive but overall, we plan to work more strategically with our key central servicing partners.

Gary Gordon, Private Investor

Thank you. I have one last question; I haven't seen any information and I'm not an expert on this, but regarding the Infrastructure Bill that's currently being proposed or any other upcoming legislation from the new administration, is there anything particularly relevant to Farmer Mac?

Brad Nordholm, President and CEO

You bet. Let’s just talk about what is in there. A lot of emphasis on transportation and transportation infrastructure and you might say, well, what does that cut to a Farmer Mac? Well, that has a lot to do with the farmers and ranchers and agribusinesses around the United States because they are all very dependent on efficient truck, shipping, and port facilities across this country. I mean, the portion of US agricultural crop commodities that are exported varies by crop, but in many cases over 50%. So, to the extent that we can improve transportation infrastructure, that is a big win for rural America. So, that’s a positive. We can’t quantify that for you but it’s a positive. There are funds allocated for broadband to do that as an economic development matter for rural America, improving the ability for businesses to operate competitively again, and in a competitive world economy for rural communities and rural businesses and farms, to continue to attract talented young people who expect great access to internet-based services. Frankly, there’s a very large portion of activity that goes on in farms and in production agriculture today, increasing about what we would generally call precision agriculture. We are using broadband and satellite-based technology to assess what’s going on in the fields to optimize decision-making, for planting, for application of inputs, for harvesting; these activities all benefit from improved rural broadband access. So yes, there is renewable energy; we are financing renewable energy, specifically solar and wind projects in rural America. That’s an important economic development opportunity for rural America, it is an important business opportunity for us. And then even with other aspects of proposed legislation and even COP26, we see discussion about all fuels, specifically biodiesel. We see discussion about methane capture and renewable gas. These are all things that are at the convergence of agriculture and energy in rural America. And so we follow these very closely and, frankly, see very little downside and quite a bit of upside, although difficult to quantify.

Gary Gordon, Private Investor

Okay, terrific. Thank you. Thanks for your time.

Brad Nordholm, President and CEO

Thank you. We appreciate it.

Operator, Operator

Ladies and gentlemen, that concludes our question and answer session. I’d like to turn the conference back over to Brad Nordholm for any final closing remarks.

Brad Nordholm, President and CEO

Well, as always, we appreciate your interest. We’ve really had a number of calls over the last few weeks wondering what’s going on with stock performance. We’re going to continue to focus on the fundamentals of building this business here at Farmer Mac, and we see, actually, as I mentioned earlier in my comments, pretty good environment looking out over the next couple of quarters for doing just that. So, again, we really appreciate your interest. Thanks for joining us today. If you do have any follow-up questions, please reach out to us; reach out to Jalpa in particular. And thanks again.

Operator, Operator

Thank you. This concludes today’s conference call. We thank you all for attending today’s presentation. You may now disconnect your lines and have a wonderful day.