Earnings Call Transcript - AGM Q2 2022

Operator, Operator

Good afternoon, and welcome to the Farmer Mac Second Quarter 2022 Earnings Conference Call. After today's presentation, there will be an opportunity to ask questions. Please note that this event is being recorded today. I would now like to turn the conference over to Jalpa Nazareth. Please go ahead.

Jalpa Nazareth, Director of Investor Relations and Finance Strategy

Good afternoon, and thank you for joining us for our second quarter 2022 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 2021 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 under the Financial Information portion of the Investors section. Joining us from management this afternoon are 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 President and CEO, Brad Nordholm. Brad?

Brad Nordholm, President and CEO

Thanks, Jalpa, and good afternoon, everyone. I want to thank you for joining us today. We're extremely proud of the accomplishments and the financial results we're going to be sharing with you this afternoon. I think they provide further proof of our continuing successful execution of our strategic plan and also provide further evidence of the value of Farmer Mac's business model throughout agricultural cycles. The diversity of our revenue streams, combined with our credit discipline and strategic balance sheet positioning enable us to deliver a very strong quarter. More specifically, we generated record core earnings, our highest ever, and our portfolio and credit performance remained strong, with 90-day delinquencies ending the quarter at eight basis points across our entire portfolio. That's the lowest level in eight years. Despite ongoing macroeconomic concerns and potential headwinds, such as inflation and rising interest rates, the ongoing COVID pandemic, and the war in Ukraine, Farmer Mac delivered strong results. Our financial results in the first half of 2022 reflected a variety of factors, and I'm just going to review some of them with you. First, the resilience of the farm economy. Producers have benefited from healthy farm income and liquidity from relatively high commodity prices that have come about because of heightened demand. The revenues that these producers experienced have risen faster than the cost of their inputs. Another factor is an increase in Farmer Mac's outstanding business volume at higher spreads. In other words, we had volumetric growth and margin growth, and we did this with improved credit quality. Another factor is Farmer Mac's disciplined approach to interest rate risk management that helps us protect earnings from the effects of interest rate volatility, such as we have experienced during the second quarter. The final factor worth noting is Farmer Mac's effective funding strategies that resulted in advantageous execution during the first half of 2022. We provided a gross $1.9 billion of liquidity and lending capacity to lenders serving rural America in the second quarter of 2022. This resulted in growth in outstanding business volumes to $24.5 billion as of June 30, 2022. Our rural infrastructure finance line of business grew $193 million during the second quarter or 3%, and this is primarily due to loan purchase products. The growth in the demand for this product was really to fuel planned maintenance and capital expenditures by rural electric operators across the U.S. Also contributing to growth this quarter in the Rural Infrastructure Finance line of business was a $34 million commitment to a large solar project. Our renewable energy portfolio ended the quarter at about $150 million compared to about $87 million at year-end, and the pipeline looks strong for the second half of the year. As I have said on prior calls, renewable energy is both an important economic development opportunity for rural America and a business opportunity for us. The Agricultural Finance line of business grew approximately $43 million this quarter, primarily due to strong Farm & Ranch loan purchase volume. This growth is partially offset by scheduled maturities and an early refinance of a large AgVantage security. Net Farm & Ranch loan purchase volume was strong during the second quarter as the rising interest rate environment resulted in demand for intermediate and long-term financing solutions. While we anticipate that lower refinances could result in lower levels of new loan purchase in some of our Farm & Ranch and USDA products, it also could result in lower portfolio prepayment activity. Our pipeline in this line of business remains strong, and we will continue to be flexible as we navigate through this uncertain environment. Let me now turn to our recent securitization transaction. I'm proud to announce that we successfully marketed and priced our second $300 million agriculture mortgage-backed securitization. That happened subsequent to the end of the quarter and is expected to close in just a few days. The successful execution of this transaction reflects our efforts over the last few months to identify and implement effective operational strategies to support a securitization program and closely monitor the changing market dynamics during this period to ensure that we could execute at just the right time. Securitization is a tremendous opportunity for Farmer Mac. Developing this capital flow to agriculture producers really exemplifies Farmer Mac's core mission to lower costs for the end borrower and to improve credit availability to rural America, while creating a well-received new investment opportunity for leading institutional investors. As we have said after an inaugural transaction in the fall, we remain committed to being a regular issuer in the marketplace with a diverse set of securitized products that align with our borrower and investor interests. In the near term, we will slowly increase the number of issuances per year and continue to identify opportunities to improve operational efficiencies and automation in support of the program, making sure that we have a strong foundation for the future. Looking ahead, we'll strive to continue to be a source of stability for our customers by remaining adaptive and flexible to their needs in this changing environment while remaining vigilant about any indicators of potential market contraction. And with that, I'd like to turn over to Aparna Ramesh, our Chief Financial Officer, to discuss our financial results in a bit more detail. Aparna?

Aparna Ramesh, Chief Financial Officer

Thank you, Brad. Good afternoon, everyone. Core earnings for second quarter 2022 were $30.7 million or $2.83 per diluted common share compared to $25.8 million or $2.37 per diluted common share in the first quarter of 2022 and $30 million or $2.77 per diluted common share for the same period last year. The sequential increase was due to a $2.5 million after-tax increase in net effective spread, an increase in our release of credit losses of $1.2 million after tax, and a $1.1 million after-tax decrease in operating expenses. The year-over-year increase in core earnings was primarily due to a $3.5 million after-tax increase in net effective spread and an increase in our release of credit losses of $400,000 after tax. These factors were partially offset by a $2.5 million after-tax increase in operating expenses and a $900,000 increase in preferred stock dividends. Net effective spread for second quarter 2022 was $60.9 million compared to $57.8 million in first quarter 2022 and $56.6 million in the same period last year. The sequential and year-over-year improvement in net effective spread was driven, as Brad noted, by net new business volume, which occurred primarily in the Farm & Ranch and Rural Utilities segments. Contributing to the year-over-year increase was an increase in net coupon yields, which is related to the acquisition of loan servicing rights in the third quarter of 2021, showing up in our net effective spread. Our liability side of the balance sheet remains strong as we continue to benefit from the low-cost debt and capital that we layered into our balance sheet over the past two years while interest rates were at historical lows. We also continue to maintain a very disciplined approach to asset liability management. We carefully analyze the duration and convexity matches, as we've mentioned in previous calls, that help us minimize our interest rate risk as rates rise. Our consistent funding and hedging strategies have also allowed us to maintain our profitability despite an inversion in the yield curve. Operating expenses increased by 19% in second quarter 2022 compared to the same period last year, primarily due to increased headcount. This included 10 new employees in connection with the strategic acquisition of loan servicing rights that I mentioned occurred in the third quarter of 2021. Additional factors include increased stock compensation and an increase in spending on software licenses, information technology, and other consultants, mainly to support growth in many of our strategic initiatives. We plan to continue to expand our investments in both headcount and technology over the next one to two years. As we've mentioned before, we are closely monitoring our efficiency ratio, which ended at 30% for second quarter 2022. We'll especially monitor this as we continue to make investments in our infrastructure and funding programs to support our innovation strategies and also enable us to scale with our growth. Our credit profile continues to be strong. As of June 30, 2022, the total allowance for losses was $14.8 million, reflecting a $1.5 million release from March 31, 2022. This release comprises a $1.2 million release on the rural infrastructure portfolio and a $300,000 release on the agricultural finance portfolio. The $1.2 million release on the rural infrastructure portfolio was primarily driven by forecasted model parameter updates, while the $300,000 release in the agricultural finance portfolio resulted from a $1.1 million release driven by forecast model parameter upgrades, rating upgrades, paydowns, and payoffs. These were offset by a $700,000 provision attributable to a risk rating downgrade on a single agricultural storage and processing loan. Let's turn to capital now. Farmer Mac's $1.3 billion of core capital as of June 30, 2022, exceeded our statutory requirement by $506 million or 67%. Core capital modestly increased from year-end, primarily due to an increase in retained earnings. Our Tier 1 capital ratio was 14.7% as of June 30, unchanged from December 31, 2021. As Brad mentioned, after quarter-end, we successfully priced our second $300 million agricultural mortgage-backed securitization, which is expected to close on August 11. This deal, much like the first one, was also structured around two tranches: a senior guaranteed tranche and a subordinate unguaranteed tranche, both of which were very well received by the market despite an extremely volatile environment for structured products. The success of this transaction further demonstrates Farmer Mac's capabilities to diversify long-term sources of funding, and we intend to use this conduit to generate additional revenues. Most importantly, this capability is highly central to our mission. We expect to return to the market soon with another similar securitization as we are committed to making this a more programmatic effort for us in the future to continue to build liquidity for our investors and enhance our mission. In summary, our entire team delivered exceptional quarterly results in a volatile economic environment. This was done while fulfilling a number of key strategic objectives. We had record core earnings, continued strong credit performance, a 15% return on equity, an efficiency ratio of 30%, and a dividend payout ratio of 35%. And with that, Brad, let me turn it back to you.

Brad Nordholm, President and CEO

Great. Thank you, Aparna. So just to sum up, we had a very strong quarter. It's really based on our solid long-term strategic plan that we're executing on, an outstanding and dedicated team here at Farmer Mac, I'm very proud of them, and a proven track record now of very steady, strong financial results as further evidenced by our core earnings this quarter. We continue to believe that our mission helps focus us during agricultural economic cycles and the resiliency of American agriculture and the Farmer Mac business model are reflected in our financial results. Our capital base is strong and growing, providing plenty of capacity for further growth and creating more opportunities for us to enhance shareholder value. And so now with that, operator, I'd like to see if we have any questions from anyone on the line today.

Operator, Operator

Our first question will come from Gary Gordon, a Private Investor. Please go ahead.

Unidentified Analyst, Analyst

Hi, thank you. So a couple of things, if you don't mind. One, my calculation shows there were zero charge-offs for the quarter. Is that correct?

Brad Nordholm, President and CEO

Gary, Brad Nordholm here. Yes, great to have you on, Gary. Yes, that is correct, zero for the quarter.

Unidentified Analyst, Analyst

Two, you mentioned a few times the operating expense ratio of 30%. I know you've talked in the past about your targets, and I forgot what the number is. What's the sort of target long-term ratio you're aiming for?

Brad Nordholm, President and CEO

Yes. I think for the last 1.5 years, we've told you that our goal is to keep it at 30% or below. This quarter, we're at 30%. Year-to-date, we're slightly above that, Gary, but we're managing to track down the remainder of the year and hopefully get back to approximately 30% for the year, which, as I mentioned, we did achieve for the quarter.

Unidentified Analyst, Analyst

On loan growth, or if I just looked at assets right now and one year ago, it's up about 7%. And I'm wondering if that's a useful figure, or is there a better figure considering now the more active securitization program, which presumably pulls some of those assets off your balance sheet and then a mix issue of more loans less securities.

Brad Nordholm, President and CEO

Yes. Gary, I'm going to turn to Zach Carpenter to give you some color on loan growth, and what we're experiencing in this very volatile environment right now. But let me begin by just reacting to your statement about the impact of securitization. Over time, we expect that securitization may allow us to lower some pricing on some types of loans going into securitizations. That's really not the case yet. Until it becomes programmatic, we're being very prudent, we're being cautious about making that change. The second thing I'd like to note for disclosure purposes is that the second securitization is actually going to be an on-balance sheet versus an off-balance sheet. We could have gone either way on it, and it's really the rapid increase in the interest rate environment that caused us to choose to do this one on balance sheet. But the way we report out that asset growth, we're going to gross up for business that we do off balance sheet and are providing our metrics to you on how we're growing. Our assets are on balance sheet and off balance sheet. Our assets are really under management. And relative to that 7%, let me turn to Zach to give you a little bit of color on what we're seeing in the market right now. And I just noticed we do – as I turn to Zach, that if you look at Farmer Mac over the last couple of years, and you see this reflected in our business segment reporting, we are a more diversified company, and that diversification is benefiting us through these cycles. But with that, let me turn to Zach to give you some additional color.

Zach Carpenter, Analyst

Yes. Thanks, Gary, and Brad hit it on the head. I think the diversification of our business model is now showing more than ever. So year-to-date, we're up close to $900 million in net growth. As Brad indicated, it's coming from our loan purchase strategies, which we put a lot of focus on, both in the Agricultural Finance segment and the Rural Infrastructure. Our core Farm & Ranch loan purchase volume did grow again this quarter. We're thrilled to be able to deploy more capital to our key seller network, especially in this volatile rising interest rate environment, but also saw net growth in our AgVantage security product and tremendous growth in our Rural Infrastructure line of business as both rural utilities and telecommunication companies needed capital to continue to build their CapEx networks across the network. So I'd say a very diversified model and seeing solid loan growth across all of our operating segments.

Brad Nordholm, President and CEO

Gary, in terms of that 7%, additional guidance to you, we're really not prepared to give more specific guidance. I think that's a pretty good estimate of where we are, certainly. One thing I'd say is that because there is so much volatility among financial institutions as well as in the agricultural economy, which generally is very positive, I would note, very positive results in the agricultural economy. Oftentimes in this kind of period of volatility, new opportunities emerge. So the one thing I'd say is that we're going to be very opportunistic. It's hard to build a business plan around it, but very opportunistic to look for opportunities that could accelerate that growth further.

Unidentified Analyst, Analyst

And if you do one more question. Thinking about the preferred stocks, you've been an active issuer over the last few years. Is there a scenario, let's say, over the next year where looking at another issuance might make sense?

Brad Nordholm, President and CEO

Aparna, do you want to take that one?

Aparna Ramesh, Chief Financial Officer

Yes, sure. Gary, I think we wouldn't want to take anything off the table, but let me just help sort of position our capital a little bit more generally. I think we have three sources of capital: common stock, which is the bulk of our capital, retained earnings, and then preferred stock has been an excellent tool for us, especially over the last two years when, one, interest rates were pretty low, and Farmer Mac's performance was really good, and it was a sought-after instrument. So we were very, very opportunistic. We didn't need the capital, but we certainly have continued plans to grow. As we continue to diversify into these new segments that both Brad and Zach have mentioned, capital consumes a little bit more based on the type of assets that we're bringing on balance sheet. But I will note that securitization does offer us an opportunity for capital risk transfer as well. So when we look at securitization and we compare that to our preferred stock issuances, it's becoming an increasingly efficient source of capital consumption for us. So now we've got a fourth tool in our toolkit, which is securitization from the standpoint of capital. So maybe it's a long-winded way of saying if there's an opportunistic reason for us to raise preferred capital, we might do so. But it's really dependent on benchmark and nominal interest rates. So given all of that, over the next six to 12 months, I think it would be relatively unlikely that we want to do a preferred stock issuance, but we wouldn't necessarily want to take anything off the table.

Unidentified Analyst, Analyst

Okay, thanks for everybody's time.

Brad Nordholm, President and CEO

Thank you, Gary.

Operator, Operator

Our next question will come from Sloane Ortel with Invest Vegan. Please go ahead.

Sloane Ortel, Analyst

Hi, everyone. Congrats on a great quarter. I just - I see the renewed Farm Bill sort of living out there as a catalyst for you guys. I wonder if you could give us any color on how you see provisions that may or may not be in there affecting your business and whatever other commentary you want to give on the proposed, I guess, we're calling it the Inflation Reduction Act now? And how that might affect your infrastructure line of business?

Brad Nordholm, President and CEO

Yes, a couple of things. There are two big pieces of legislation, one, that everyone is reading about every day right now, the Inflation Reduction Act. What I can comment on that, Sloane, is that there are provisions in there that are favorable to American agriculture and rural electric cooperatives. We do business, as you know, with rural electric cooperatives; we also do renewable energy projects in rural America, some of which are contracted to or owned by rural electric cooperatives. There's a provision in there, it's not time to delay yet, but there's a provision that allows for the monetization of tax benefits by the U.S. Treasury, which simplifies the capital structure for doing renewable energy projects with rural electric cooperatives and other nonprofits. So we view that as favorable to renewable energy. We also see ITC tenure schedule for that. That will be a further stimulus to renewable energy projects and other details in that bill that will generally be bullish for our renewable energy project line of business. It also gets into American agriculture too because there are opportunities for this to extend into on-farm renewable natural gas, anaerobic digester capture, methane to gas, and other projects that have been happening at an accelerating rate. With this legislation, what should have passed will now happen at an even more accelerating rate. I also was wondering if you were beginning to ask your question about the Farm Bill, which happens every five years here in Washington, D.C. It's scheduled to happen in 2023, which would really reauthorize and potentially change, expand, or reduce different types of programs aimed at stabilizing pricing for major American commodities, agricultural commodities. On that, it’s really too premature to say exactly what that’s going to look like right now. But we have a very strong public affairs and government relations team here at Farmer Mac, led by a gentleman who worked at USDA and who has been involved in the formulation of policy associated with the Farm Bill in the past and is keeping a close eye on it right now and helping us decide if there are any things that we'd like to see in that Farm Bill that would be helpful to Farmer Mac. We've identified a few. We're not really at liberty to talk about those yet, but a few that have a fighting chance of finding their way into the next couple of years.

Sloane Ortel, Analyst

That's awesome. Well, you guys keep up the clip you've kept up for a while; you're well on your way to getting a food basket from us come Christmas time. So thank you.

Operator, Operator

Our next question will come from a Private Investor. Please go ahead.

Unidentified Analyst, Private Investor

Well, ladies and gentlemen, I am a private investor out here in Seattle. All I can say is God Bless America, and your company and team have been a part of this. Your company has been there since well before the dividend. Your earnings look like you will be continuing to increase your dividend, peers with your price. I guess the only thing that I find very sad about the whole thing is not enough people know about Farmer Mac, and the volume is so low on the stock that someone can come on and drop the stock by two points by selling 600 shares or something. So I know I've talked to you in the past about this. But I don't know that there's ever any solution to that other than becoming more well-known. So I have no question. That's more or less a comment.

Brad Nordholm, President and CEO

Carl, we actually agree with your comments. A couple of things. You may recall that in 2019 and '20, we had a very large investor, C-Class stock, a financial institution that over an extended period of time had to sell that position because of their regulatory situation. We're glad that's behind us because that was a situation, just as you described, where an investor could sell a stock and it just had a dampening effect, and we're now past that. We view that as a positive thing. We also have been working to increase market awareness of Farmer Mac. It's interesting, Carl, that the two times we've been marketing the securitizations for Farmer Mac have coincided with two times when our stock has significantly outperformed other indices for the same one- to two-week period. We view securitization as another small, but important way of expanding institutional investor awareness of who we are. We didn't set out to do securitizations to educate the market about Farmer Mac, but it is a good byproduct of that. The final point I would make is that we have really embarked on a branding initiative here at Farmer Mac. I think we may have mentioned that in one of the prior calls. We're thinking about how we describe and explain Farmer Mac in a more compelling and uniform way to all of our important stakeholders. That will play out over the next six to twelve months. This isn't a big advertising campaign. It's just a more concise and compelling way of explaining who we are to multiple stakeholders. We hope that will be another small thing that helps bring more attention to Farmer Mac.

Unidentified Analyst, Private Investor

Okay. Thank you very much. I was going to say one other comment, and that is another educational process maybe to the - I happened to deal with RBC. I'm now doing it myself through trade, but many of them, if you were to collateralize your stocks, are not giving Farmer Mac the typical 60% to 65% ratio on borrowing if you wanted to. So I was wondering for your own sake and other shareholders if there's some way around educating the financial institutions. Why would they - you are an awfully firm and solid company nowadays and have been, and yet they don't seem to give you credit for it.

Jalpa Nazareth, Director of Investor Relations and Finance Strategy

Carl, this is Jalpa. Maybe we can connect after this call, and we can find a way to connect with who you're working with because we agree we should reach and get in touch with you folks.

Unidentified Analyst, Private Investor

Yes. I don't typically need it, but the point is that other people would come across the same problem because this has happened at RBC. It was paying lever. It doesn't matter. They are not giving you the same status of many other companies that really are not nearest good quality as Farmer Mac. So that's more of an eye-opener for yourselves, I guess. But anyways, thank you and keep it up. I appreciate all your work.

Brad Nordholm, President and CEO

Thank you, Carl.

Jalpa Nazareth, Director of Investor Relations and Finance Strategy

Thanks, Carl.

Operator, Operator

With no remaining questions, we will conclude our question-and-answer session. I would now like to turn the conference back over to Brad Nordholm for any closing remarks.

Brad Nordholm, President and CEO

Great. Thank you, operator, and thank you all for joining us today. We really appreciate it. We're very proud of the story. We're proud of the results that we're able to deliver to you this quarter. We remain very, very optimistic about Farmer Mac, our business model, our positioning in this agricultural economy, and our ability to serve rural America and fulfill our mission. It's a time when we're feeling very, very good about what we're doing here. We appreciate your interest. As always, if you have follow-up questions or requests, get in touch with Jalpa, and she will make sure that the right people here at Farmer Mac are engaged with you in answering your questions. Thank you.

Operator, Operator

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