Federal Agricultural Mortgage Corporation

Good day and welcome to the FarmerMac third quarter 2022 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on a touch-tone phone. To withdraw your question, please press star then two. Please note, this event is being recorded. I would now like to turn the conference over to Jelpa Nazareth, Director of Investor Relations and Finance Strategy. Please go ahead.

Good afternoon, and thank you for joining us for our third quarter 2022 earnings conference call. I'm Jelpa Nazareth, Director of Investor Relations and Finance Strategy here at Armormac. 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 risks and uncertainties that could cause our actual results to differ materially from those projected. Please refer to PharmaMAC'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 10Q and earnings release posted on PharmaMac's website, PharmaMac.com, under the Financial Information portion of the Investors section. Joining us for management this afternoon are President and Chief Executive Officer Brad Nordholm, who will discuss third 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?

Thanks, Jalpa. Good afternoon, everyone, and thank you for joining us. I'm very pleased to announce that we've achieved another record quarter with all-time high net effective spread and earnings, and continued strong credit quality. Our results not only highlight the strength of our core business, our disciplined approach to interest rate risk management, and the resilience of the U.S. agricultural economy, but also the benefits from the investments in and the strategic management of our business, really in support of our long-term success. The diversity of our revenue streams, combined with our credit and asset liability management disciplines, have enabled us to deliver a very, very strong quarter. We provided a gross $2.7 billion in liquidity and lending capacity to lenders serving rural America during this last quarter, resulting in outstanding business volume of $25.3 billion at quarter end. The agricultural finance line of business grew $675 million during the third quarter, which is predominantly comprised of growth in the farm and ranch segment across multiple products, including egg batches securities, loan purchases, and long-term standby purchase commitments. The overall growth in the wholesale financing space primarily reflects many of our institutional counterparties leveraging our continued access to low cost of funds as they seek to add longer term AgVantage securities to manage their asset liability maturity profile given the recent increases in interest rates and the comparative competitiveness of PharmaMac AgVantage pricing relative to other market and Federal Reserve derived options. Here to date, we've added a net $580 million in new farm and ranch egg vantage securities compared to a net decline of $20 million in the same period last year. Looking ahead, we believe egg vantage volume will continue to increase as PharmaMac's relative value is viewed favorably by longstanding counterparties. This is the quarter for the harvest of many agricultural crops in rural America. Yet farm and ranch loan purchase volume growth this quarter has performed ahead of our expectations. Simply put, borrowers are adjusting to the higher rate environment and they're being opportunistic. Given the strength in the agricultural markets, we're optimistic about potential increases in loan purchase opportunities given the strong cash position of farmers and ranchers as they complete their harvests. In a reversal from prior years, we also saw new volume in our farm and ranch long-term standby purchase commitment product with one of our farm credit system customers. We see this as a testament to PharmaMac's product flexibility in providing credit solutions to farm credit system partners and relative value throughout market cycles. Our corporate ag finance segment saw net growth of $67.5 million during the third quarter, primarily due to our continued efforts to support loans to larger and more complex agribusinesses focused on businesses that span the food supply chain, as we say, outside the farm gate. We expect this relatively new area of business activity to enable FarmerMac to continue to strengthen and deliver on our mission. Turning to rural infrastructure, this line of business added $510 million of business year-to-date in renewable telecommunication and core rural utility sectors as a result of continued strong relationships with rural electric cooperative lenders. In the wholesale finance space, we successfully refinanced $400 million of outstanding advantage volume with rural utility counterparties. and we currently do not have any large rural infrastructure advantage maturities expected in the next three years. Loan purchase volume in the rural utility sector was consistent, with telecommunication loans a strong contributor in 2022. Farmer Mac has acquired $162 million in telecommunication loans year-to-date, holding a total balance of $243 million as of September 30th. While loans to telecommunication companies that provide wireless, cable, fiber, transport, and broadband services to rural America is a newer area for PharmaMac, we strive to increase investments and reduce the cost of capital for telecommunication providers as it is an area of growing importance to rural communities. Our renewable energy portfolio ended the quarter at nearly $200 million as of September 30th, reflecting $48 million in net growth in the third quarter, the largest quarterly increase to date. The pipeline remains strong in the near term as we continue to focus on upsizing existing deals and bringing on new renewable energy opportunities. As I've said on prior calls, Renewable energy is both an important economic development opportunity for rural America and a business opportunity for us at FarmerMac. During our last earnings call, we discussed the successful execution of our second $300 million securitization transaction in evolving and, quite frankly, a difficult market. We remain committed to being a regular issuer in the securitization marketplace with a set of securitization products that align with our borrower and investor interests. Developing this capital flow to agricultural producers exemplifies PharmaMac's core mission to lower costs for the environment and improve credit availability in rural America, while also creating a well-received new investment opportunity for leading institutional investors. While agricultural commodity prices have thus far outpaced the significant increase in input costs, the impact on global commodity markets from the Ukraine conflict creates further uncertainty for farmers and ranchers in terms of global production, prices, and input costs for the remainder of 2022 and into 2023. We believe our portfolio is sufficiently balanced to withstand the market volatility that could arise should the U.S. economy move into a recessionary period soon, as many fear as the agriculture, food, and infrastructure industries tend not to be directly correlated with the general economy. We believe these sectors are generally well positioned to withstand an economic downturn due to ample consumer demand and government support. Looking ahead, we'll strive to continue to be a source of stability to our customers by remaining adaptive, and flexible to our customer needs in this changing environment. The branding initiative we embarked on earlier this year, which is wrapping up in the next months, has helped us gain a deeper insight from each of our stakeholders and help determine how we describe Farmer Mac in more compelling ways. This, we hope, will continue to build on our strong reputation as the nation's trusted provider of low-cost credit to rural America. And now I'd like to turn the call over to Aparna Ramesh, our Chief Financial Officer, to discuss the financial results in more detail. Aparna.

Thank you, Brad, and good afternoon, everyone. Our record third quarter results highlight our balanced, well-measured approach, excellent credit quality, and resiliency throughout market cycles. Net new business volume growth was $847.2 million in third quarter, and it was driven by the healthy growth across all four of our segments. As we've discussed over the last few months, we have seen a slowdown in prepayments in the overall portfolio, as borrowers have less of an incentive to prepay in this higher-rate environment. As we look ahead, we believe our strong capital position really bodes us well as this trend continues and as we look to further our growth objectives. Turning to core earnings, our core earnings for third quarter 2022 were a record $33.4 million or $3.07 per diluted common share compared to $30.7 million or $2.83 per diluted common share in second quarter 2022 and $27.6 million or $2.55 per diluted common share for the same period last year. The sequential increase was due to a $3.7 million after tax increase in net effective spread and a $500,000 after tax decrease in operating expenses. The year-over-year increase in core earnings was primarily due to a $7.7 million after tax increase in net effective spread. And this was partially offset by a $1.8 million after-tax increase in operating expenses. Our net effective spread for third quarter 2022 was a record $65.6 million compared to $60.9 million in second quarter 2022 and $55.9 million in the same period last year. Both the sequential and year-over-year improvement in net effective spread was driven by a compositional shift in our program assets and generally wider spread across the board. We have seen upward pressure of pricing on corporate ag finance loans and advantage volume as a result of the higher rate environment. There's another evolving factor that I'd like to describe, and this has contributed to net effective spread as well. Over the past few years, we opportunistically raised low-cost debt and capital, and the excess capital essentially offsets our urgency to raise more expensive term and callable debt in a rising rate environment. This will 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. Our liability side of the balance sheet remains extremely strong, as we continue to benefit from this low-cost debt. The extension of debt has also strengthened our overall liquidity profile. We continue to maintain disciplined asset liability management, carefully analyzing our duration and convexity matches to minimize our interest rate risk as rates rise. Our forward-looking funding strategies and a prudent approach to hedging have also allowed us to maintain and enhance profitability despite an inversion in the yield curve. Operating expenses have increased 15% year-to-date compared to the same period last year. And this is primarily due to increased headcount, including 10 employees in connection with the strategic acquisition of loan servicing rights in the third quarter of 2021, increased stock compensation, and increased spending on software licenses and information technology, as well as the addition of consultants to support growth and strategic initiatives. Operating expenses decreased by 3% sequentially due to the deferral of certain large projects to 2023, voluntary employee turnover, and delays in hiring. This improvement reflects our proactive management of expenses as we continue to expand our investments in both headcount and technology over the next one to two years. We are currently in the process of evaluating a fairly large-scale investment to modernize both our treasury infrastructure and our front-end loan platform system to mitigate risk, increase efficiency, and enhance deal flow. In summary, operating efficiency was 29% through September and better than our strategic plan target of 30%. We're especially pleased with our efficiency ratio given the inflationary headwinds which are impacting the market as a whole. As we've always said, we will continue to closely monitor our efficiency ratio and we're committed to holding the run rate efficiency ratio at 30% or lower. However, as we make decisions to invest in infrastructure and funding platforms and scale for further growth, we may see some temporary increases above the 30% level. Turning to credit, our credit profile continues to be strong despite the economic headwinds. Ninety-eight delinquencies were $44 million, or 17 basis points of our entire portfolio, compared to $21 million in second quarter 2022 and $55 million in the same period last year. Our credit underwriting and policies have remained consistent and the sequential increase is consistent with the seasonal pattern of PharmaMax 90-day delinquencies that were observed at the end of the third quarter due to the July 1st payment date. As of September 30th, 2022, the total allowance for losses was $15.2 million, which reflects a half a million provision during third quarter. The $400,000 provision to the rural infrastructure portfolio was primarily driven by net new loan volume. The $100,000 provision in the agricultural finance portfolio was related to the deterioration of the single agricultural storage and processing loan. Now turning to capital, PharmaMax $1.3 billion of core capital as of September 30th, 2022 exceeded our statutory requirement by $514 million or 66%. Core capital increased from year-end, primarily due to an increase in retained earnings. Our Tier 1 capital ratio improved to 14.9% as of September 30, 2022, from 14.8% as of year-end 2021. And this is largely due to strong earnings results and capital release that we obtained through our second securitization transaction. And this was partially offset by growth in program assets. Maintaining consistent credit standards and strong levels of capital is a very fundamental part of our long-term strategy to support continued growth, deliver low costs, and ensure the steady execution of our business model. After the successful execution of our second farm series securitization transaction in August, we are encouraged by the demand for agricultural-backed securitized product opportunities. because these align very well with our mission and foster continued success. The Farm 2022-1 transaction was structured around two tranches, a senior guaranteed tranche and a subordinate unguaranteed tranche, both of which were very well received by the market, despite a volatile environment for structured products. The success of this transaction further demonstrates PharmaMax's capability to diversify long-term funding sources and we intend to use this conduit to perhaps generate additional revenue. 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 in the future to continue to build liquidity for our investors. In summary, our entire team delivered exceptional quarterly results while fulfilling several key strategic objectives, achieving record core earnings, ensuring continued strong credit performance, and resulting in a minimum 15% return on equity and an efficiency ratio at or below 30%, coupled with a dividend payout ratio of 35%. And with that, Brad, I'll turn it back to you.

Thanks, Aparna. We are extremely proud of our third quarter results and believe our performance provides yet another example of the dynamic and enduring nature of FarmerMac's business model, which continues to be well positioned for earnings growth going forward. We have a solid long-term strategic plan that we're executing on consistently and a proven track record of strong financial results as evidenced by record core earnings this quarter. We continue to deliver on our mission throughout agricultural economic cycles as reflected by our financial results over the last few years. Our capital base is strong and growing, providing plenty of capacity for future growth and creating more opportunities for us to enhance shareholder value. I also want to take a moment to recognize that our company earned four Culture Excellence Awards issued by Energage, a research company that conducts the National Top Workplaces Recognition Program. The four categories for which PharmaMac was recognized were innovation, employee appreciation, compensation of benefits, and leadership. These recognitions are important to me and to our company, especially in the context of our solid financial performance. It's important that we deliver results in fulfilling our mission while also providing a remarkable customer and employee experience. I thank our employees for their honest and enthusiastic participation in this survey and their dedication to PharmaMAC and our vitally important mission. And with that, operator, I'd like to see if we have any questions from anyone on the line today.

Thank you. We will now begin the question and answer session. If you'd like to ask a question, please press star then 1 on your touch-tone phone. If you're using a speakerphone, we ask that you please pick up your handset before pressing the keys. To withdraw your question, please press star then 2. Today's first question comes from Marla Backer with Sudoti. Please go ahead.

Thank you. A couple of questions following the strong results this quarter. Earlier in the year, you had been a little bit more cautious, I think, regarding prospects of business volume growth. You talked about that you expected prepayments to decline. given the rising interest rate environment. But it seems like there's an appetite now for new loan growth. And it's not just the payment side of the equation. Can you give us a little bit more color there? And you touched upon it in your prepared remarks about farmers getting used to perhaps higher expenses, higher interest rates. Can you talk a little bit about what you think has changed?

Hi, Marla. Brad here. I'd be happy to. And I'm also going to turn to Zach Carpenter, our chief business officer, to give you some additional color on this topic. But your observation is correct. Earlier in the year, we were cautious. You know, we're not feeling exuberant about business volumes right now, but they are a bit stronger than we did expect maybe six months ago or so. And while the prediction of much lower prepayments rates has certainly been borne out, it's the growth really across all lines of business that has been, well, it's required a lot of hard work, let me just say that. But it also, I think, as I said, exceeded our expectations of six months ago. And one point I'd like to make just before turning it to Zach is that Over the last year, you've seen us be much more deliberate in how we break out our segments of our line of business within Farmer Mac, how we originate, underwrite, administer, how we set up credit policies and credit administration for our different lines of business has really become clarified along those segment lines. And in addition to providing more insight for you into how those lines of businesses are doing, I think for us it also is a very good reminder of the benefits of the diversification that we have developed and really built into the business here at Farmer Mac over the last few years. But with that, let me turn to Zach to give you some good day-to-day color on what's going on.

Thanks, Brad. And Marla, great question. And I think really, Brad, is accurate in terms of volume growth, especially over the last couple quarters, and really the diversified nature of PharmaMAC. The rapid increase in interest rates earlier this year did cause us to take a more cautious tone, but now with our business model focused more in a diversified approach, we're able to leverage some of that new focus, especially in telecom and renewable energy, as well as our relative value, as Brad noted, in ag-managed securities. And having many different areas of opportunity and growth in this volatile market did create an opportunity for us to grow in all operating segments and lines of business this quarter. That being said, the environment does remain volatile. The interest rates continue to increase, especially in the short-term sector. So it is prudent for us to remain cautious as we go forward. However, in a much more diversified business model, we have a lot more opportunity to continue appropriate growth even in this volatile environment, and we're optimistic that with the numerous products and the segments that we have, we're able to take advantage even in this environment.

Okay. Thank you. That makes sense. I have one other question, and it's about the securitizations. You know, you launched that program last year, did another one in this past third quarter. Are you thinking now that this could be something more regular than an annual program? Could we see multiple issuances within a year?

The short answer is yes. I think if we look beyond 2023 to 2024, we are planning to be able to issue as frequently as quarterly. Now, whether we do that will depend on market conditions, but building this program takes a combination of educating the market, our investor base, and improving or not improving but changing our in-house systems for how quickly we can aggregate data that's needed for the securitization in the form the market expects in order to go to market. So, we've been doing a lot of that foundational work over the last year, and it's been one of the things that has paced our issuances to date. But, Aparna, do you want to shed some light on how they might increase and what it will take for it to increase?

Aparna Srinivasan Yeah, absolutely, Brad. I think you covered it really well. There are two factors, Marla. You know, one, you know, and Zach and Brad both alluded to this, obviously, with the rising rate environment. we've got to make sure that we've got a consistent deal flow coming in, especially with products that we think make sense to securitize the palm and branch in particular. A number of borrowers may have already locked in lower interest rates. So that's certainly one factor. And then the second factor is, I would say, the operational readiness that we are able to exhibit, both in terms of being able to predict that deal flow and then shortening the amount of time between what we would see as the You know, the coupon on the pool of securitized loans versus what the nominal rate environment is, I think that's a really important factor for us as well to consider as we think about the pace of issuances. That said, I think we were extremely encouraged by our second transaction, which was really a true test of the program because it was in the face of some really challenging and volatile market conditions, especially for fixed income products. And given the response that we did receive from the market, we are encouraged, and we do think that we'll be in a position to do another transaction. As things stabilize and as things normalize a little bit for the rate environment, we think, if not over the next 12 months, but certainly between the 12- to 24-month horizon, we could get to a point where we are doing more than two to three issuances per year and getting to that quarterly point that Brad noted.

Okay. Thank you.

And our next question today comes from Gary Gordon, a private investor. Please go ahead.

Okay, thank you. A couple of questions, if you don't mind. First, I ask this every quarter. As far as I can calculate, there were no charge-offs in the quarter. Is that correct?

That is correct.

Okay, terrific. I would personally highlight this. It's a terrific result. Second, two questions. on the hedging and the interest spread. This is apparently one of the worst bond markets ever in U.S. history. Did this change your need for hedging, or are there any necessary steps you had to take in the face of the drastic change in rates?

You know, Gary, I'm going to have to elaborate on what we're doing, but I'm just going to say out of the gate that the discipline that we've used over and over and over again, and I know we say this, you know, probably too much, but the discipline we use really doesn't change much in an up or down environment.

Yeah, exactly, Gary. I think you can see this, you know, maybe if you just look at our NES and see how it's changed quarter over quarter, you'll see a slight uptick in our NES, and a lot of this comes from the fact that You know, we have been extremely proactive when rates were low in really extending our debt terms as well as raising capital when we didn't need it. So that is something that's really paying off for us. It makes us or puts us in a position to be more opportunistic as we go out into the market. Now, one thing that we are doing, and, you know, speaking of hedging, and we've mentioned this before, when rates go down, we like to have a bank of callable debt that we can draw upon so we manage our interest rate risk when rates go back down. So we are doing some of that and perhaps scrubbing off a little bit of the NES that we could get if we just left it alone, but we think that's prudent. And it's really that dynamic of managing and toggling and keeping our interest rate risk within a band that allows us to be in a position where our NES remains very, very consistent. And the only other point I'll make is you know, we're very well positioned as a result of this. Both in a rising rate environment, you're certainly seeing that play out, even though there's a little bit of an inversion in the yield curve. We continue to benefit from that because we've got a bank of really equity that continues to price as Fed actions continue on.

Okay, good. Thanks. And last, Aparna, you mentioned or gave three reasons why the Fed The NES net effective spread was higher than normal. I know quarter to quarter there's some random error, but you pointed to a little less hedging because of your high capital ratio, better mix, more farm and ranch, and then I believe you said wider spreads available in the market. Those factors, are they sort of likely to keep this spread Is this 103 spread now more in the reasonable range or the high end of the range, and you've got some volatility, or are there prospects for a higher spread as these factors grow?

Yeah, I think that there are a couple of – you're exactly right on the three factors, and I would actually break them down specifically. a little bit further. One is just business composition and the work that Zach and his team are doing in really the pricing benefits that we're seeing on the loan side of the business and how those compositional shifts are playing out. That's a very significant part of this one and three. The other piece that I would say that we're really managing and hedging around is a relatively short-term benefit that we'd like to see extend out a bit, which has a function based on the nominal rate environment. As the Fed continues to raise rates and we see the short end of the curve go up and we have a bank of investable assets, those are certainly putting upward pressure on the NES that we are seeing. And that is a piece that will continue to hedge so it minimizes volatility. But those are the two significant dynamics that are really playing out. And then I'll just caveat that we try not to peg it to a single point, you know, 1% or 110, but we try to stay within a band. And you've always heard from us that you're seeing a shifting with this business compositional change as we move towards higher-priced assets. Instead of targeting an 85 to 95 basis point range, we're really targeting something that's more within the 90 to 100 basis point range, give or take. So that's really, again, you know, where we think, you know, is a good place for us to place some guardrails around us.

Is that based on what you're seeing in the market today and kind of the current mix? Do you have anything to add to that in terms of how it looks?

No, I think Aparna was right. I mean, we've seen this time and again in volatile markets. Credit spreads are going to widen for certain types of credits. We've seen that in Advantage, and we were able to be a relative value player versus the bond market out there. As credit reprices, we're able to take advantage on the loan side. Now, that being said, even in a more or less volatile interest rate environment, some of these new products and lines of business we are entering in have a higher net effective spread component than we've had in prior years. They are small, but they are growing. So over time, they will be more of a meaningful part. But in the short term, as they grow, they will contribute modestly to some of the growth.

Renewable Energy Project Finance, for example.

Correct. Yep. Okay. Thanks a lot.

And, ladies and gentlemen, this concludes today's question and answer session. I'd like to turn the conference back over to Brad Nordholm for any closing remarks.

Yes. Thank you very much, Rocco. You know, I mentioned a little while ago that we had recently received four awards for cultural excellence. and how much I appreciated our employees and their contribution to that. I'm sometimes asked by investors, well, isn't there inherent tension being a mission-driven organization with a clear mission, social purpose, if you will, of increasing the availability of credit for rural America? Isn't there an inherent tension between that and delivering great financial results? And I think that this recent award, just to point to it for a moment, helps provide some context that when you have great people and you have a very, very clear mission, a very clear purpose, which, by the way, is very motivating to those people, and when you have a very disciplined approach to your financial objectives, for example, around NES, and around efficiency ratios. We can consistently deliver 15% plus return on equity. We can consistently be a top quartile or even decile financial performer. We can have recognition for our employees and for PharmaMac as a great place to work. And we can everyday measure, quantify our progress in fulfilling our mission by showing this steady forward rate of growth in our business. And so, I really, you know, would love to challenge anyone back about whether that is an inherent tension. Because while it takes work to manage that, it's not just something that we're working to manage. This is actually a strength that we are trying to harness even more. Because when you get this all-line mission, the people, the financial construct, the disciplines, the consistency of all those things, it could become a very powerful engine. So when we talk about the resiliency of the PharmaMac business model, this really is what we're talking about. And I'm gonna spend more time talking about this in the future because I believe it is a clear source of differentiation from PharmaMac from many other companies in the public markets, in fact, most. And every time we get questions about whether there's tension or whether our results can be sustained, I think this is a very important part of the answer. So I look forward to talking more with you about that. Thank you, operator. Thank you, everyone.

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