Federal Agricultural Mortgage Corporation (NYSE:AGM) Q3 2023 Earnings Call Transcript

Federal Agricultural Mortgage Corporation (NYSE:AGM) Q3 2023 Earnings Call Transcript November 6, 2023

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

Jalpa Nazareth: Good morning and thank you for joining us for our third 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 afternoon is our 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: Thanks Jalpa. Good morning everyone, and thank you for joining us. I’m pleased to report another record quarter for earnings, our sixth consecutive quarterly record. Our capital base remains strong, which along with our disciplined asset liability management and uninterrupted access to the capital markets enables our long-term strategic growth objectives while also providing a buffer against market volatility and changing credit market conditions. These results once again demonstrated the resiliency of our business model and the success of the strategic initiatives designed to grow our company profitably while and this is very important to us, while fulfilling our mission to rural America and also generating shareholder returns across changing market cycles.

In the third quarter, we recorded core earnings of $45.2 million, reflecting a 35% increase over the same period last year. We achieved gross new business volume of $2.3 billion during the quarter, resulting in total outstanding business volume of $27.7 billion as of September 30, 2023. Volume growth this quarter was driven by new AgVantage Securities with existing counterparties in the wholesale financing space. Specifically, we added a $500 million AgVantage Security in Rural Utilities segment and several AgVantage Securities in the Farm & Ranch segment, which more than offset maturing securities by a net $225 million. The overall growth in wholesale financing over the last six months primarily reflects many of our institutional counterparties utilizing our wholesale financing facilities that offer their counterparties a competitive cost of funds.

Also, these counterparties are layering in longer term, non-pre-payable AgVantage Securities to manage their asset liability maturity profile, given the current level of interest rates and the pricing of these securities as competitive instruments given their other market options. We entered the fourth with a strong pipeline of existing and new large financial institution counterparties. And we believe this renewed interest and wholesale financing which drives the AgVantage product, will continue well into 2024. Also contributing to our overall volume growth this quarter is an effective business development activity across more diverse business segment platforms. The agricultural finance line of business grew over $400 million in the third quarter, predominantly due to the previously mentioned AgVantage Securities growth, increases in longer-term stand by purchase commitments and incremental loan purchase volume in Corporate AgFinance.

Activity has been picking up in the Corporate AgFinance segment, reflecting our commitment to build a strong reputation in the marketplace with really a first class team of people. While volume tends to be lumpy on a quarter-to-quarter basis, opportunities in this segment are generally more accretive from a net effective spread standpoint. We remain focused on this segment, which 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 to flat as a result of higher interest rate environment. The prepayment rates also remain at historically low levels. The number of loan applications and approvals during the third quarter was relatively steady, reflecting borrowers’ adjustment to the new rate environment.

The agricultural mortgage market has seen a shift to primarily variable rate product as borrower sentiment generally expects rates to decrease over the next 5 to 10 years. Turning to our Rural Infrastructure line of business, we saw healthy loan purchase volume growth in our Rural Utilities and Renewable Energy segments. New Rural Utility loan purchase volume this quarter was the result of our borrowers’ normal course capital expenditures related to maintaining and upgrading utilities infrastructure as well as investments in broadband infrastructure and our continued focus on telecommunication investment in rural America. Our Renewable Energy portfolio grew over $100 million during the first nine months of the year, reflecting our robust efforts and investments to grow this portfolio, and our pipeline is strong heading into year-end.

Renewable Energy is both an important economic development opportunity for rural America and a business opportunity for us at Farmer Mac. As I’ve discussed in previous calls, we plan to invest additional resources that will help us further penetrate the Renewable Energy market as opportunities arise. In recent months, as the market stabilized following the regional banking crisis earlier this year. We’ve consistently presented our product offerings as a potential capital efficiency and liquidity conduit for our customers in agricultural finance and rural infrastructure lines of business. We believe that this is because of the relative value of Farmer Mac and what we bring to the agricultural and rural credit markets. We believe that it’s even greater when credit is a bit tighter, allowing us to further deliver upon our mission to build a trusted secondary market for credit to rural America.

For example, we have helped customers in the farm, F-A-R-M, the farm securitization program, to achieve their return objectives by utilizing the conduit that we have created to free up capital and manage their balance sheets more optimally. As we’ve said on previous calls, securitization is a tremendous opportunity for Farmer Mac. It is highly central to our mission, and we are committed being a regular issuer in the market with a set of securitization products that align with both our borrower and investor interests. The momentum and excitement that you heard today about our record results would not have been possible without our team’s continuing dedication and commitment to our long-term strategic plan and to the alignment across our organization and with our customers to bring even greater efficiencies the agriculture and rural infrastructure sectors.

Our business approach combined with a high caliber of talent across the organization is really paramount to continuing delivering consistent positive results. That is why we expanded our long-term incentive compensation program to all of our employees in the organization during the third quarter. This new incentive plan is intended to align all of our employees to the Company’s long-term performance and significant achievements, and also position each of our employees for their long-term financial success. Our underlying business model, strong capital position and uninterrupted access to the debt capital markets throughout the various market disruptions uniquely positions us to partner with our customers to help them achieve the growth of their businesses and manage 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 the changing credit environment and is expected to continue to create more opportunity enhance shareholder value and fulfill our mission. And so with that, 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. Good afternoon, everyone. Our record third quarter 2023 results highlight our balanced well measured approach, continued strong credit quality, and resiliency across market cycles. We achieved $2.3 billion of gross new volume this quarter. Some of the key components included $1 billion of wholesale financing in the agricultural finance line of business, the majority of which was refinancing of existing AgVantage Securities. $500 million of wholesale financing in the Rural Infrastructure segment, $204 million of long-term standby purchase commitments, $231 million in new Corporate AgFinance loan purchases and unfunded commitments, $205 million in Farm & Ranch loan purchases, $91 million in new Rural Utilities loan purchases, $44 million of which was telecommunication loans and $17 million in new Renewable Energy loan purchases.

Even after repayments and maturities, we grew approximately $900 million this quarter in our outstanding business volume and this speaks to the benefit of strategic decisions over the last few years that we have made to diversify our portfolio and create opportunities in all interest rate environments. Core earnings were $45.2 million of $4.13 per share in third quarter 2023 and this reflects a 35% year-over-year increase. This increase was driven by record net effective spread of $83.4 million in third quarter 2023 compared to $65.6 million in the same period last year. In percentage terms, our net effective spread in third quarter remained at 120 basis points and this was primarily driven by our low cost excess capital, debt funding strategies in previous low rate environments as well as our ability to redeploy both the excess capital and the lower cost debt into higher earning assets.

This phenomenon was further enhanced by the continued trend towards higher spread volume that is evident in our new segments like Corporate AgFinance and Renewable Energy. The capital that we raised opportunistically when rates were at historical lows in 2020 and 2021 has reduced the need for us to raise more expensive term and callable debt in this rising rate environment. We continue to defensively hold approximately $800 million in cash and other short-term instruments in our liquidity portfolio. Not only does this help us weather potential market disruptions, our excess and highly liquid capital generates immediate returns in a high nominal rate environment. This benefit is expected to continue to create a 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 a limited downside to earnings if rates decline in the future and this is due to our proactive equity capital allocation strategy where we are laddering and layering duration to minimize volatility. Specifically, we expect to retain some of this benefit over the medium-term if rates decline as we have started extending maturities in our investment portfolio. These are all practices that are consistent with our disciplined approach designed to help minimize early earnings volatility. Despite some macro headwinds, we continue to see strong access to debt capital markets and a flight to quality investments which allows us to be very well positioned to fund new asset opportunities as they arise.

As Brad highlighted in his comments, we have spent and will continue to spend a significant amount of time and resources to enhance our infrastructure and engage with our customers and investors to support a robust and liquid market for our farm securitization product. Securitization has many beneficial aspects for Farmer Mac. It allows us to diversify our funding, enhance and optimize the balance sheet by efficient deployment of capital and it also enables our growth strategy by targeting new asset opportunities into our conduit. While we are closely monitoring a changing market dynamic, we expect to return to the market in the first half of 2024 with another similar farm securitization transaction as the previous three transactions. As we highlighted last quarter, our fundamental asset liability management approach where we match fund the duration and convexity of our assets and liabilities in all rate environments remains unchanged.

As this practice has allowed us to successfully navigate changing market environments and contained earnings volatility. Our business has certain natural hedges that we described to you before and we have honed these over time to help insulate us from interest rate volatility. This is 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 on excess cash and capital would likely increase and we would continue to have strong market access as we do not rely on deposits as a source of funding. And conversely, when interest rates decline, loan purchase volume often increases, but prepayments also tend to increase and interest earned on our liquidity portfolio usually ends.

We are able to manage our interest rate risk by exercising callable issuances and maintaining our spreads, and this is the differentiator that I mentioned relative to depository institutions. Although, these natural business dynamics are not perfect offsets, they do counterbalance to mitigate volatility from changes in short-term interest rates. Our liquidity and capital positions also remain well in excess of all regulatory ratios and our projections show minimal change in our profitability and limited exposure to movement in interest rates whether market rates are projected to go up or down. As of September 30, 2023, Farmer Mac had 297 days of liquidity and this is another important data point as it validates our resiliency against short- and medium term market disruptions.

Turning to operating expenses, these increased by 24% year-over-year and this is primarily due to the expenditures that are associated with a multiyear technology investment in our treasury and cash management systems to enhance our trading, hedging and reporting platform. This modernization effort is expected to position us to more effectively defend against cyber and fraud threats while also allowing us to scale our portfolio and diversify our product offerings. I’ll note this effort is not a like-for-like, but is geared to the future and aligns with our business and funding strategy. We also plan to continue to make investments in strategic focus areas such as renewable energy and we intend to modern our asset infrastructure including our servicing and loan platforms to support our growth and strategic objectives.

As a result, we do expect our run rate operating expenses to increase at a pace above 2023 and historical averages and for this to continue over the next several years. Our operating efficiency was 27% through September 30th and is well below our strategic plan target of 30% primarily because revenue growth increased at a significantly higher rate than expenses. We will continue to closely monitor our efficiency ratio and manage it as we have done to stay within a band around 30%. As we make investments in our loan infrastructure and funding platforms and innovate our loan processes to accelerate growth, we may see temporary increases above the 30% level. Our credit profile remains very strong in aggregate despite economic headwinds. We saw a decrease in 90 day delinquencies from the Q2 which as of September 30 reflects 15 basis points across our entire portfolio.

The total allowance for losses decreased sequentially to $18.9 million in the third quarter and this reflects a $200,000 decrease from second quarter 2023. The modest decrease was primarily attributable to a $3.8 million release from the allowance for the agricultural finance portfolio to reflect the full payoff of a single ag storage and processing loan in the third quarter and this was partially offset by a $3.6 million provision to the allowance for the rural infrastructure portfolio due to a single telecommunications loan that was downgraded to substandard during the quarter. Turning to capital, Farmer Mac’s $1.4 billion of core capital as of September 30, 2023 exceeded our statutory requirement by $581 million or 69%. Core capital increased sequentially primarily due to an increase in retained earnings.

Our Tier 1 capital ratio as of September 30, 2023 improved to 16% 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. We are anticipating overall stress in credit markets from macro headwinds and we are proactively monitoring our exposures. However, we expect a strong capital position to allow us to remain resilient and be a source of low cost liquidity for our customers and borrowers even in difficult times. So in conclusion, our entire trade team delivered strong 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 is well positioned for uncertainty and we are 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: Thank you, Aparna. We are extremely proud of our third quarter results, and we believe our performance provides yet another example of the dynamic and enduring nature of Farmer Mac’s business model, which continues to be well positioned to deliver earnings growth and strong profitability for the remainder of 2023 and into 2024. Our high levels of capital enable us to continue to execute our solid long-term strategic plan and remain focused on our mission to increase the accessibility of financing for American agriculture and rural infrastructure. We’re aligned across our organization and with our customers to bring even greater efficiencies and lower costs in providing financing 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: We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Bose George with KBW. Please go ahead.

Bose George: I wanted to start with a question on spreads. So it sounds like spreads could stay closer to this elevated level at least in the medium term. In the past, you’ve discussed a normalized spread range. I think it’s 95 to 105. Is that still kind of the normalized level we should think about, and if so, how should we think of sort of the trajectory of spreads getting from here to there?

Brad Nordholm: Bose, I wish, I could provide a perfect answer to that because we have contributions to that positive variance coming from both our treasury operations and how we’re funding in this higher interest rate environment as well as the increasing diversification of our business into lines that have more accretive higher spreads. So let me first, ask Zack Carpenter, our Chief Business Officer, to give you a little bit of additional color on spreads on our different commercial lines of business, and then Aparna can kind of wrap it up with further comment on treasury.

Zack Carpenter: Thanks Brad. I think it’s been more apparent especially over the last 12 to 18 months, as our business lines have diversified in new areas of growth, as Brad said, are at much higher accretive spreads than our historical lines of business. Especially in this environment where our Farm & Ranch mortgages have slowed down given the interest rates, you’re seeing a much more, inclusion of volume from our Telecommunications, Renewable Energy and Corporate AgFinance lines of business, which by their nature have a larger spread, higher accretive spread than our historical overall portfolio. Those deals are lumpier in nature and larger, but also have tended to grow quicker especially in this environment where Farmer Mac has been a new and supportable use of capital, for these types of transactions.

So, as we grow in these new areas, as well as growing some of our historical segments, I think you see more of a weight to these higher accretive spread, I’m going forward. But I will say as Brad mentioned, it’s very hard to predict and some of these new lines of business are spotty at times in terms of pay downs and maturities. So, just in this environment, we’ve seen a significant growth in some of those new areas.

Brad Nordholm: Just to add a little bit to that. Bose, if for example, with some decline of rates, we saw a pickup in our Farm & Ranch origination activity. That, as an example, could have a slightly dilutive impact on our spreads. If we are successful accelerating the growth of Renewable Energy, it could have an accretive impact to our current spreads, which one will accelerate faster is quite difficult to predict. But I think we can confidently say that looking out a couple years, it is not our expectation that we would revert to a 90 to 95 basis point NES that we will be in north of that because of the composition of and growing diversification of the portfolio. But Aparna, can you add to that?

Aparna Ramesh: Yes, absolutely. And I just want to layer in one other comment around business composition. I think it absolutely has to do with business composition, but I will also say that and Zack alluded to this, our Rural Infrastructure portfolio, if you just go back several years, the spread on that portfolio was significantly lower than it is today and that’s been a huge contributor in addition to the new lines of business. So it’s just another example of the fact that we’ve been able to be a very consistent provider of liquidity and debt financing to our counterparties and we’ve been able to do that while not just maintaining but also increasing our spread. So I just want to add that one comment. And then in terms of treasury, I’ll just say that our funding strategy has really come to fruition in this rising rate environment.

And I made some of those comments, earlier on, which you likely heard both. But I’ll just note a couple of things, right? And I think a natural question is, will this sustain especially as the fed pauses or is likely to pause? We have some in book hedges within our funding strategy and one of them has to do with callable. So, we’ll actually layer in callable and we continue to do that. And that actually has the effect of being a little bit dilutive to spreads. But we do that deliberately because we do not want to be in a position where if rates dramatically trended downwards, we were caught in a situation where our funding costs outpaced our ability to put loans on. So, these callable spreads tend to come on at slightly wider margins relative to say bullet spreads.

We have consistently layered that in, but it is a hedging strategy. So that’s just one thing that I’ll note more to the positive, it’s going to help us maintain that spread band of north of about 100 basis points. The second piece that I will just highlight around our funding strategy has to do with how we manage our duration. So, as we anticipate being close to or at the peak of the rate cycle, we are very systematically and have very systematically ended some of our investment portfolio while maintaining our interest rate risk profile. And that again has the effect of providing a natural hedge if rates were to trend down. So, all of this is to say both that while we try to manage to a 95 to 105 basis point NES, I think given where we are headed both from a diversification of lines of business as well as our funding strategies, I think it would be fair to say that we’d be at the upper end of that as we look up into that.

Bose George: And then actually switching to the dividend, can you just remind us how you look at the dividend? Is it sort of a payout? And then just given that the returns are going are sort of above, sort of somewhat of a normalized level. Could that payout be a little bit lower just as the ROEs remain elevated to just yet philosophically how you’re looking at it?

Brad Nordholm: Yes. In terms of the dividend, that’s something that I’ll look at it very seriously, as we get into February of 2024 based on year-end results. We’re quite disciplined in revisiting it annually. You have seen what has happened each year for the last X number of years, consecutive increases in dividends. Given these results, it’s very reasonable to expect further increase in the dividend, but I really, I’m not going to provide any guidance on exactly how much that may be today. The factors that have gone into it in the past have been what is our growth rate and consumption of capital? What is the outlook for earnings? And the past years, that’s resulted in dividends that have been just inside of 35% of after tax earnings.