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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good day, and welcome to the Farmer Mac Second Quarter 2023 Earnings Conference Call. All participants will be in listen-only-mode. [Operator Instructions] Please note, today's event is being recorded.
I would now like to turn the conference over to Jalpa Nazareth, Senior Director of Investor Relations and Finance Strategy. Please go ahead.
Good morning, and thank you for joining us for our second 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 morning are 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?
Thank you, Jalpa, and good morning, everyone. Thank you very much for joining us. I'm pleased to report that for the second quarter 2023, Farmer Mac once again surpassed previous records in revenues, core earnings and net effective spread, building on the strength of our performance.
Our capital base remains strong, which, along with our disciplined asset liability management and uninterrupted access to the capital markets supports our long-term strategic growth objectives and also serves as a buffer against market volatility and changing credit market conditions.
These results further demonstrate the resilience of our business model and the success of strategic initiatives designed to grow the company profitably while fulfilling our mission to rural America and generating shareholder returns across changing market cycles.
In the second quarter, we recorded core earnings of $42.2 million, reflecting a 37% increase over the same period last year. We achieved gross new business volume of $2.2 billion during the quarter, resulting in total outstanding business volume of $26.7 billion as of June 30, 2023. Included in the $2.2 billion of new volume was incremental volume in the form of an acquisition of mortgage servicing rights on $600 million of Farm & Ranch loans held by a third party.
Since the strategic acquisition and expansion of our loan servicing functions in the third quarter 2021, we have looked for opportunities such as this recent acquisition to scale this portfolio while creating more process transparency and greater efficiencies across our loan servicing platform. This capability gives us more direct oversight and governance of our portfolio, enhance security, more control over timely access to data and better visibility into loan performance from inception to maturity. We'll continue to work with our key partners to identify ways to capitalize on this initiative to create a more efficient process for our customers and their borrowers.
The volume growth we've seen in the last - first half of this year is largely attributable to the efforts we've made over the last few years to diversify our business model across several key markets. The agricultural finance line of business grew over $500 million in the second quarter, predominantly due to the previously mentioned acquisition of new loan servicing rights and growth in our corporate Ag Finance segment. There was good activity in corporate Ag Finance, reflecting our success in building our reputation in this market.
For example, during the second quarter, we were invited to participate in deals with very large well-known counterparties and have received more inquiries in recent months than we have ever seen before.
Opportunities in this segment are generally more accretive from a net effective spread standpoint, the volume tends to be lumpy on a quarter-to-quarter basis. We remain focused on this segment as it 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 as a result of the higher interest rate environment, but prepayment rates remained at historically low levels during the second quarter. We saw an increase in the number of loan applications and approvals during the second quarter, reflecting borrowers' adjustments to the new rate environment. The agricultural mortgage market has been - seen a shift to primarily variable rate products as borrower sentiment generally expects rates to decrease over the next 5 to 10 years.
Another key contributor to the increase in loan applications this past quarter was the enhancement of our scorecard underwriting product, AgXpress which allows more loans with up to 65% loan-to-value ratios, which is an increase from our previous criteria of 55% max loan to value.
The expansion of this criteria allows us to better support our customers with a product that aligns with other lenders in the marketplace today, and we can do this without increasing our credit risk appetite.
Turning to our rural infrastructure line of business. We saw continued healthy growth in the Renewable Energy segment during the second quarter. Our participation in syndicated renewable energy transactions has increased the number of opportunities we can participate in with key counterparties. The pipeline remains strong in the near term as we continue to focus on upsizing existing deals and bringing on new renewable energy opportunities.
We also continue to invest additional resources to further support this segment. Offsetting growth this quarter was the maturity of a single large AgVantage security in the Rural Utilities segment that resulted in a net decrease in the rural infrastructure line of business. During the disruptions in the banking industry in March, many of our counterparties opted to delay the refinancing of upcoming maturities to better navigate the market volatility and evaluate their capital and liquidity needs.
In recent months, as market has stabilized, we've seen many of those conversations resume, and we're having more discussions about our product offerings as potential capital efficiency and liquidity conduit for our customers. We anticipate that this will result in a growing volume pipeline as we look ahead to the second half of the year and into 2024.
Over the last few years, we have invested in our infrastructure by upgrading technology platforms, processes and product offerings to improve the customer experience. I'm pleased to announce today that we will be rolling out a pilot program to complete collateral valuations using technology, which, if successful, should reduce total loan processing times. This pilot will begin with many Midwestern properties with the goal of launching the program more broadly in the first quarter of 2024.
As we've mentioned previously, we are well into a significant upgrade of our treasury and cash management platforms and embarking on something similar with our loan purchase and processing platforms. Our commitment to incorporating innovation and modernizing existing technology is expected to continue to differentiate Farmer Mac and contribute to the transformation of the agricultural sector overall.
Our underlying business model, strong capital position and uninterrupted access to the debt capital markets through the various market disruptions, uniquely positions us to partner with our customers to help them manage their business and 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 changing credit environments and is expected to continue to create more opportunities to enhance shareholder value and fulfill our mission.
So now I'd like to turn the call over to Aparna Ramesh, our Chief Financial Officer, to discuss our financial results in more detail. Aparna?
Thank you, Brad, and good morning, everyone. Our record second quarter 2023 results highlight our balanced well-measured approach, continued strong credit quality and resiliency across market cycles. We achieved $2.2 billion of gross new business volume this quarter. Some of the key components included $675 million of wholesale financing from our large traditional counterparties in the Farm & Ranch segment, the majority of which was refinancing of existing advantage securities, $563 million of additional loans serviced for others, $199 million in Farm & Ranch loan purchases, $165 million in new corporate ag finance loan purchases and unfunded commitments, $135 million in new rural utilities loan purchases, $80 million of which was telecommunications loans and $72 million in new renewable energy loan purchases and purchase commitments.
Even after repayments, maturities and acquisition of servicing rights, we grew about $300 million this quarter in our outstanding business volume, and this speaks to the benefit of strategic decisions over the last few years that we've undertaken to diversify our portfolio.
Turning to core earnings. Core earnings was $42.2 million or $3.86 per share in second quarter 2023, and this reflects a 37% year-over-year increase. This increase was driven by record net effective spread of $81.8 million in second quarter 2023 compared to $60.9 million in the same period last year.
In percentage terms, our net effective spread in second quarter of 2023 increased to 120 basis points, and this was primarily driven by a low-cost excess capital and our ability to redeploy this excess capital into higher earning assets as well as the continued trend towards higher spread volumes.
The capital that we raised opportunistically when rates were at historical lows in 2020 and 2021 continues to reduce the need for us to raise more expensive term and callable debt in a rising refund [ph]. We continue to defensively hold about $600 million to $800 million of cash and other short-term instruments in our liquidity portfolio.
Not only does this help us weather potential market disruptions are excess and highly liquid capital generates immediate returns in a high nominal rate event. This benefit is expected to continue to create 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 limited downside to earnings if reached decline in the future due to our proactive equity capital allocation strategy. Specifically, we expect to retain some of the benefit over the medium term if rates decline as we have started extending maturities in our investment portfolio. Again, these are all practices that are highly consistent with our disciplined approach, which is designed to minimize earnings volatility.
Our fundamental asset liability management approach, where we match fund the duration and convexity of our assets and liability in all rate environments remains unchanged as it has allowed us to successfully navigate changing market environments and contain earnings volatility.
Our business has certain natural hedges that we have honed over time, and this helps us be insulated from interest rate volatility. We see this as 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 earned on excess cash and capital would likely increase, and we would continue to have strong market access as we're not reliant on deposits as a source of funding. Conversely, when interest rates decline, loan purchase volume often increases, but prepayments also tend to increase and interest on our liquidity portfolio usually ends, but we're able to manage our interest rate risk through exercising callable issuances and thereby, we're able to maintain our margins. Although these natural business dynamics are not perfect offset, they do counterbalance to mitigate volatility from changes in short-term interest rates.
Our liquidity and capital positions are well in excess of all regulatory ratios and our projections show minimal change in our profitability and market value, regardless of the direction and size of any rate shop that we apply to stress our balance sheet.
Let's move turn to operating expenses. Expenses increased by 21% year-over-year, and this is primarily due to the expenditures that are associated with a multiyear technology investment that we're making in our treasury and cash management systems to enhance our trading, hedging and reporting platforms. This modernization effort is expected to position us to be defensive against cyber and fraud threats and also allow us to scale our portfolio and diversify our product offerings.
We expect our run rate operating expenses to increase at a pace above historical averages over the next several years, given plans to continue to make investments in our team and our infrastructure to support our growth and strategic objectives.
Our operating efficiency is 27% year-to-date and below our strategic plan target of 30%. And this is primarily because revenue growth increased at a significantly higher rate than expenses. We will continue to closely monitor our efficiency ratio as we continue to make investments in our loan infrastructure and funding platform and innovate our loan processes to accelerate growth, we may see some temporary increases above the 30% level.
Our credit profile remains very strong in aggregate despite economic headwinds. We saw a seasonal decrease in 90-day delinquencies from the first quarter as well as a repayment from a single $16 million permanent planting loan that became delinquent in first quarter of 2023. As of June 30, 90-day delinquencies reflect 17 basis points of our entire portfolio.
As of June 30, 2023, the total allowance for losses was $19.1 million, reflecting a $1.1 million increase from first quarter of 2023. The increase was primarily attributable to new telecommunications business volume in the rural infrastructure portfolio and new agricultural storage and processing volumes in the agricultural finance portfolio.
Subsequent to quarter end, an entity purchased the assets and assume the liabilities of a single agricultural storage and processing loans that were subject to bankruptcy proceedings in the first half of the year. As a result of this, Farmer Mac has received proceeds from this bankruptcy field, and we, therefore, expect to release during the third quarter, the entire allowance for loan loss attributed to this loan, which was approximately $4.6 million as of June 30.
Now turning to capital. Farmer Mac $1.4 billion of core capital as of June 30, 2023 exceeded our statutory requirement by $566 million or 70%. Core capital increased sequentially, primarily due to an increase in retained earnings. Our Tier 1 capital ratio improved to 15.9% as of June 30, 2023, from 15.7% as of March 31, 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.
So in conclusion, our entire team delivered exceptional 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 has continued to be well positioned for uncertainty, and we're more optimistic than ever to deliver on our long-term strategic plan objectives.
And with that, Brad, let me turn it back to you.
Thanks, Aparna. Our business model is resilient and diversified and our balance sheet is very healthy. We operate with high capital levels and believe that we're well positioned to deliver earnings growth and strong profitability for the remainder of 2023 and into 2024.
We've emphasized that our ability to issue long-dated fixed rate debt in all rate environments and economic cycles is a core competitive advantage that when combined with our approach to asset liability management, helps to produce consistent spreads and provides forward visibility to future earnings.
I'm extremely proud of our team and the excellent progress that we're making on our multiyear strategic initiatives. We remain focused on our mission to increase the accessibility of financing for American agriculture and rural infrastructure. We are aligned across our organization and with our customers to bring even greater efficiencies and lower costs in providing financings 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.
Thank you. We will now begin the question-and-answer session. [Operator Instructions] Today’s first question comes from Bill Ryan with Seaport Research Partners. Please go ahead.
Good morning. Thanks for taking my questions and very nice quarter. Just kind of looking at your mix of business, obviously changed a little bit in the quarter. You talked about the acquisition of the servicing asset. Some acceleration in corporate AgFinance. I know we’ve got 6 months left to go in the year, but how do you see the mix of business kind of playing out through the rest of 2023? That’s the first question.
And it’s an important one as we’ve emphasized we're pleased with the increasing diversification of our business. We think it brings more stability through different economic cycles. And we tried to emphasize some of the reasons for that in the call today.
As we look out, Bill, to the rest of 2023, with increasing acceptance and, I guess, experience with higher interest rates, we're optimistic that we’ll see some increase in Farm & Ranch applications. We do expect to see more opportunity with corporate AgFinance, primarily because of our growing credibility in that market sector, including with leading syndicate banks. The overall credit demands are not necessarily increasing, but our presence is.
I think looking out to the rest of the year and then looking forward the next couple of years in terms of a percentage increase projection, but starting from a small notional base, we see probably the greatest growth in renewable energy.
So kind of looking out towards the end of the year, continued growth in renewable energy is still small, it’s just starting to move the needle, hopefully, some higher levels of both Corporate AgFinance and Farm & Ranch. And at the end of the year, the balance will probably shift slightly towards - ever so slightly towards Farm & Ranch and corporate agribusinesses, just because they’re larger books of business here at Farmer Mac.
I want to emphasize that the servicing is very strategic for us. It is not a huge driver of top line or bottom line earnings results. But it provides us with a way to create more opportunities for how we create valuable relationships with our seller servicers.
It gives us more immediate access to data that, for example, among other things, supports our securitization programs. And it allows us to focus more on operational excellence in servicing, not just for our own operation, but for our seller servicers too.
So you're going to continue to hear about that but it’s not going to be a large breakout number in our earnings for at least the next couple of years.
Okay, then...
Bill, I’m, go out, but Aparna I wanted to add something to that.
Just to augment with Brad said on the Farm & Ranch space. We're also seeing increased demand for our AgVantage facilities. So we expect that to be another area of, I would say, compositional shift as you look out through that.
That’s true, Bill. And Aparna makes a very good point, and AgVantage tends to be very lumpy. So one expected or unexpected new AgVantage facility in the back half of the year can move the needle by hundreds of millions of dollars.
Okay. And a follow-up question on the modernization efforts. Obviously, we saw the acceleration in expenses this quarter, as you’ve been broadcasting for the last couple of quarters. What is the kind of the time frame you're thinking for the modernization effort? Is this going to go through 2024 or 2025?
And the other part of that is, did you say the expense run rate you kind of expect it to return back to historical levels after this quarter? I just wanted to be clear on that.
Yes. I think a couple of points, Bill, let me just unpack your question into two places. One, the modernization effort that we're referring to that' begun, has to do with our treasury platforms. And what we're looking at and the good news here is that we expect to see an acceleration in the time line. It will run through 2024, but we’ll probably see some modest acceleration into this year.
And that is likely to put a little bit of upward pressure on operating expenses, but we expect to see that fully be completed by the end of 2024 at the latest. If anything, maybe by the middle of 2024, it should all be completed. So that’s probably going to create a little bit of lumpiness just in our operating expenses as we start to move forward some of that into this year.
And then we're also embarking on some other types of innovation that are a little bit more offensive in nature, some modernization, but things that we've done on our loan platform origination front. So that will probably get laddered in and staggered and some of those efforts are likely to spill well into 2024 and into 2025.
But it's too early to really ascertain what the magnitude of it is. But most of the modernization efforts are related to the treasury platform that we have a pretty good handle on.
So given all of that and thinking through just how the rate environment might shift, we think that we’ll still be able to maintain that efficiency ratio of 30%. But certainly, this quarter, you saw us at about 27%. So we expect to see a little bit of an uptick trending up towards that 30%, but still staying comfortably in that range.
Okay. Thanks for taking my questions. I'll hop back in the queue.
Thank you. And our next question today comes from Gary Gordon, a private investor. Please go ahead.
Thanks for taking my call. First, a few questions, if you don’t mind. First, my favorite one, what were your charge-offs for the quarter?
Zero.
Zero, once again. Two, I was looking at the interest margin, which was pretty remarkable at 120 basis points. I noticed there's something called fair value hedges on fair value hedge relationships, I have no idea what that is, that added about 7 basis points, and it looks volatile. This was an unusually good quarter. What is that? And is it basically nonrecurring or just volatile over time?
Yes. So Gary, this is just very fundamental to our business model because when we talk to you about core earnings and net effective spread, we really take out the effect of derivatives that we engage in purely for risk management reasons. So no volatility there. We're not running a prop trading work or anything like that. But what it does – do is as interest rates continue to fluctuate, there's an inverse proportion to those derivatives. And so you're naturally going to see some noise that really results from that.
So anything that's really a fair value hedge has the effect of impacting our P&L, but – and that’s really why we have this metric of core earnings and net effective spread because that gives you a little bit more of a pure look at what our true margins are.
So essentially, that's – again, since we're not really doing this for trading purposes or to make – do anything other than really manage our interest rate risk. All of this will really revert to the mean over time if we hold these assets to maturity, which is really how we look at it. So that’s really what I would say about that number that you’re looking at. There is some volatility, but it’s not really meaningful to us from a profitability side.
Okay. But as a run rate, maybe the 115 basis points might be a little more practical?
That's right. That's right. And we continue to anchor our expectations as a metric of somewhere between 90 to 100 basis points, maybe ticks up between 95 to 105 basis points because of the diversification of our revenue streams as well as some of the opportunistic issuances that we’ve done. That does not factor in any fluctuations from these types of hedging. That actually has the effect of really normalizing us or bringing us back to the mean.
So the 120 basis points, those continue to be the same reasons that we talked to you about before. Strong diversification from our revenue streams, compositional shift towards higher earning assets as well as the continued payoff of those opportunistic issuances that we’ve done, that’s brought down our overall cost of funds as the nominal rate environment that means to reprice upwards.
Okay, thanks. Last question is about the dividend. Obviously, that's a decision for early next year. But just looking at the numbers, so your current dividend of $4.40 is something like 30% of your current operating earnings run rate. My impression is your dividend payout target is about 40%. Even at 40%, if you're near or maintain your current ROE that leaves growth in capital of something like 10%, 11%, which I would think it will be a challenge to use, and you're sitting there with $700 million in excess capital.
It seems like there's a lot of excess capital on the books and being generated. How do I think about the dividend in this discussion?
Yes. First, Gary, I don't think I've ever mentioned 40%. I think we have mentioned mid-30s a number of times. And in some of these above expected return years that maybe has diluted it down into the low 30s or as you know now, 30%. You won't be surprised to hear that we will evaluate the actual dividend when we get our 2023 numbers kind of at year-end.
I, for one, am very hopeful that we can continue to execute on our strategic plan, and that means putting stronger growth on segments of business that will consume capital. And so I’m pleased that we have this cushion. It gives us credibility with our regulators. It also gives us a lot of leeway in being opportunistic to grow faster in some of these segments if the market opportunity presents itself.
That’s more contrast to a lot of commercial banks today, I’d now. So we’re in a great position. We’ll evaluate the dividend at year-end. We will take into consideration. Our Board will - all the things that we have in the past, growth rates, capital consumption and probably a gravitation towards that mid-30s target again. But we still have half the year left to go.
Okay, thank you.
Thank you. And our next question today comes from Brendan McCarthy with Sidoti. Please go ahead.
Great, good morning. And thank you for taking for taking my questions. I’m wondering if you can expand on the loan servicing growth in business volume and what the spread looks like on that business? It looks like the total widening in NES to 120 basis points was primarily driven by Farm & Ranch. I was just wondering if you could provide some insight on the spread on the loan servicing business volume.
Yes. The loan servicing spread and it’s really fee income is very similar to what you see in other loan servicing operations for different types of loan assets and other sectors, commercial loans, for example, commercial mortgage loans. And so we’re talking – think of it in the teens basis point range. It’s important to – and as I said earlier, it’s not something that has a huge impact on top line or bottom line revenue today, but it is strategic.
Doing our loan servicing, we have access to payment data on those loans almost instantaneously versus a 2- to 3-week delay with third-party servicers is an example. That gives us the ability to make more immediate decisions if there are and identify any potential issues. It also is very supportive of our securitization efforts, which require very, very tight reporting. So it’s very important in that regard. The $600 million approximately that was added this quarter was acquisition from one of our large seller servicers firm with whom we have a great relationship. And they just concluded that it wasn’t strategic for them.
But it is for us. And the other thing I’d note is that while the top line and bottom line revenue numbers don’t move the needle that much today, it is highly accretive. There are huge economies of scale in this business. And so for example, with our existing loan servicing operation, we were able to take on this additional $600 million with very, very minimal incremental expense. It almost all goes right to the bottom line.
So we’ll continue to look for opportunities in the future particularly when our interest and an existing seller servicers interests align and hope to grow further.
Great. Thank you. And then one more question in the Rural Utilities business, I know you mentioned there was one single maturity that drove the sequential decline there. What was the size of that loan?
So Brendan, yes, a lot of this tends to be a bit lumpy and this was around $500 million. But stay tuned because as we look out into Q3 and Q4, you’re going to probably see a renewing of some of that, which will probably recalibrate back up. So sometimes a Q-over-Q picture can be a little misleading. But as we said in response to one of the earlier questions, continue to see some lumpiness in the AgVantage maturities because we’re also actively renewing a number of them. That’s probably can have an offsetting side.
Great. Thank you. That’s helpful. And one final question. Just it looks like in the Farm & Ranch business, I guess, volume would have been down sequentially if it weren’t for that large loan servicing acquisition. What are the business trends like in that business now? Are higher interest rates really weighing on that business in the second quarter
Yes. Well, higher interest rates are. They significantly slow prepayments. But keep in mind that these loans are regularly advertising loans. And so it’s not that we’re getting prepaid on a bunch of loans because they’re refinancing with other people that they’re making regularly scheduled payments. And that’s what’s driving most of the net change in Farm & Ranch.
Farmer Mac hosted, it’s now annual Seller Summit in Des Moines [ph] in June. And it was anecdotal, but I think what we heard there was that for those who have the direct engagement with those farmers and ranchers, that there’s a bit more optimism that volumes are starting to come back. And as I mentioned in my opening comments, that may be largely attributable to just borrowers getting used to a higher interest rate environment and realizing that they do have opportunities to expand their Farm & Ranch operations and that maybe they want to borrow fixed rate or maybe variable rate given their outlook for interest rates.
And so that slightly more nuanced examination of borrowing opportunity that we’re hearing about amongst farmers and ranchers. We hope to see that show up in some incremental volume in the third and fourth quarters.
Great. Thank you. That's all from me.
Thank you. And our next question today comes from the [indiscernible] a retail investor. Please go ahead.
Hey. Thanks for thanks my questions And. I got a lot of comments and I have a lot of questions. Just I think you guys continue to be very humble in terms of how you guys have performed, but just absolutely phenomenal results. It’s showing up in the share price to some extent, but I don’t think it’s fully reflected. And I appreciate the fact you’re trying to highlight the growth opportunities, but they just seem really phenomenal. So that’s kind of where some of my comments and questions are going to go, but even the recent performance, just on a 6-month basis, very, very strong in light of – we’ve seen performance in the financial sector, especially banks doing a horrible job with duration matching, you guys are showing an ability to grow your loan book and actually have spreads improve. That is – it’s almost boring and amazing. That’s very, very good.
There was a previous question on the dividend, and this is something I talked to Jalpa,
I think Brad and Aparna in the past. Slide 15, there’s a change from second quarter to third quarter. As an investor, I appreciate that. And I think other investors need to look at
that as well. And I’m sure there’s some work that went into putting in this slide with this
dividend CAGR discussion .
So the first question is Farmer Mac, the fastest dividend grower, over the last 12 years within those cohorts, S&P 500, Russell 2000, is that – are we the fastest dividend CAGR,
the largest?
Yes, that is exactly a question I’ve been asking and we’re going to get to the bottom of that because I think we may be. And when you look at the absolute consistency on top of that, it is a remarkable story. And to your first point, I’d just like to note that we have always insisted that comparisons with banks as comparables are really not relevant. And the current situation the banks face with stagnant commercial loan notional rates and increasing deposit costs and the challenges that, that presents to them on maintaining margins in contrast to us is something that we are talking to investors more about because we think this current environment is a real opportunity for us not to compare ourselves to commercial banks, but to differentiate ourselves from commercial banks. Our asset liability model and practices are almost the exact opposite of banks and that we have the call option on the liabilities, not the issuer of the liability.
Okay. Brad, that’s helpful. I’ll say it publicly. But I’ve said this privately with you guys is the – you have a situation where the sell-side analysts are going to compare you to other financial companies. And I agree that’s not true. I’ve talked to you and said this in the past, rightly or wrongly, but I think that the company, as a GSE needs to be valued based on previous valuations of other GSEs predating the craziness of the financial crisis like Fannie & Freddie. And if that’s the case, then appropriate valuation, at least just on a PE basis, not even getting into the fact that there should be discussion on the dividend growth model from a valuation perspective, but a PE of 15 or higher given your performance seems to be more reasonable. That might be something you want to think about discussion and say, hey, look, Fannie & Freddie, pre-financial crisis trading at 15x PE for a number of years and certain dividend yield number. This is our benchmark because that’s what we are. Unfortunately, the peer group would only be a couple of companies, but you guys are in a very unique situation, and it’s not being – the company is not being valued in that way. The stock price should have a 2 in front of it. It’s severely undervalued. Once again, that’s just my opinion, but I’m always trying to help you guys and I know you’re trying to be humble in terms of how you’re performing, but it’s pretty phenomenal what you’ve been able to accomplish. So that’s just a comment.
I want another question on the hiring. You talked about continuing to grow. Can you give us an update on the current head count? And how many open positions are we looking to fill in the remainder of the year?
Yes. So thank you so much for those comments, and I think we really appreciate it. In terms of our headcount, we’ve certainly seen a much better picture in terms of – when we look at it on a relative basis. We want to be at full complement of about 185, and that includes some part timers and so on. I believe our current head count is closer to 172, but -at the end of the second quarter.
At the end of the second quarter. So – that’s not to say that we’ll be successful in really getting to that 185 number, but that’s really what we think of as full complement in terms of selling all of those positions. So we expect to see this 13 or so open positions start to get chipped away at, between now and year-end.
But as we get to that full complement number, I think you’ll see 2024 have some spillover as well. And that’s also another reason why we think our efficiency ratio is a little depressed right now. And as we start to get to that full complement, you’ll start to see it going back up to that 30%. So that’s really just to give you a handle on how we think about managing the business and in line with some of our revenue projections
I’ll just add to that, first, that 180-plus number is that’s full employment. You’ve always got some vacancies associated with turnover. Our turnover rates are well under 10%. In fact, they’re down this year compared to last year. I think last time I looked at the first half of the year on an annualized basis, it’s like 6%, 7%, which is extremely healthy, I think
But even when you apply that to the 180, you end up with something less. And we don’t discount our employment – budget employment number by the natural number of vacancies that we might have happened. So I don’t view the current head count as a weakness is not executing on plan. It’s – a couple of the positions are ones who have just decided to go slow on. A couple of them are because of turnover. So I think we’re in a very comfortable range here, certainly within 10% of our target employment.
Okay. And then on the Farm & Ranch book, we’ve had a number of transactions announced within California banks doing transactions. I think on a previous conference call there was a discussion about potentially seeing some loan books, shake loose. Is that still a possibility? Are there any ongoing discussions? And then would those loans potentially be able to be acquired at some type of a discount to outstanding balance?
It’s a great question. We’re keeping an eye on what’s happened with the failed California banks, namely Silicon Valley Bank. I think we have mentioned on our prior call that as an example, they have $750 million, something like that of vineyard loans. But those right now are held by the successor organization. So we’re keeping an eye on it.
There are other banks that last quarter had significant capital pressures attributable to their mark-to-market investment portfolios. And I think I speculated on the last call that maybe some of them would be in a position of having to do a bit more selling. There are a couple of financial institutions where we’re having discussions about maybe purchasing a larger portion of their agriculture mortgage loans than we have in the past. They maybe hold fewer on balance sheet and sell more to us, but nothing definitive on that.
Where we are seeing something that could result in some higher numbers during the remainder of the year is around AgVantage. From some of the institutional investors in agricultural mortgage loans, think insurance companies that do direct origination. They are showing some increased appetite for our AgVantage product. And so stay tuned on that because that’s something that could end up – could show up in our numbers towards the end of the year. Some of those facilities take a long time to put together. So we might put the facility together and it spills over into 2024. But that is an area where we’re seeing some unexpected additional demand.
Okay. That’s helpful. And then I think it’s worth spending some time talking more about the renewable energy book amounts Page 114 of the 10-Q. You got your June 30, 2022, outstanding balance, $148 million; June 30, 2023, $327 million. That’s 122% year-over- year growth in that loan book. And you didn’t say that, but that’s a really big number. The wheel is starting to spin. I think there was a comment in the past, that’s going to be $1 billion book at some point. Where does that book head at the end of this year? I mean that’s really impressive growth?
Yes. I think if you take the first half of the year and kind of use that rate of growth on a notional dollar basis for the second half, that’s probably baseline. It could exceed that. We are committing additional resources to this area. For example, we haven’t announced it yet, but we’ve just had an acceptance for a very senior experienced renewable energy executive who will be charged with bringing a bit more organization and both internal administration, but then more aggressive external outreach for those programs.
And that reflects our optimism about our opportunity to kind of double this book every year for the next couple of years with that $1 billion being in the sites just a few years out. And so – and we think it could double again after that. So you’re seeing a commitment of additional resources internally, and that reflects our – not just optimism, but our confidence in the depth of this market and the comparative advantages that Farmer Mac has from a funding and national reach standpoint, and being a player in that market.
Okay. That’s very helpful. I was hoping you would mention something like that under the hiring discussion. Building on the energy loan book comment, and I don’t want to get a better understanding how this business works, but I see some companies like Hannon Armstrong and Ameresco that are doing these renewable energy projects and funding. And Ameresco, I think it’s more of like a design build, but can you help people understand, is there a difference between like, let’s say, a Farm & Ranch loan, I’m a farmer, I want to do a project, I build a barn or something – that’s kind of – I don’t want to mischaracterize it all, but just to simplify it, maybe that’s more of a one and done. But from what I’ve seen with some of these renewable energy companies, maybe design, build, maybe more project oriented. If you can get kind of hooked in as a project financer on Project A, is there an opportunity to be funding on B, C, D projects that they’ve been lining up going forward?
Yes. So for individual projects, our sweet spot is probably the projects that require about $5 million to $25 million worth of debt, where we’re taking all of it. So that’s going to be – take 2x debt. That’s going to be a $10 million to $50 million solar project, that’s going to be somewhere in the range of 10 to 50-megawatt solar project covering somewhere between 50 and 250 acres. And so a lot of these are being done in rural America. Some are being done on warehouses, but we’re always looking for that connection to rural America. And it could be because the buyer of the electricity, is it electric co-op or corporation that is serving rural America? It could be because it’s located in rural America. So that’s one part of it.
Another part of it is the much larger deals where we may participate in the bank debt syndicate for that project. And you’ve seen that – we’ve done that in a couple of very, very large wind projects, again, set in rural America.
The credit metrics are pretty much always the same. These are low investment grade BBB- BB+ credit metrics, very well established, well used. We’re not doing anything very different or creative. It’s just the national outreach and focus on rural America.
The strategic the companies you mentioned as examples of potential strategic partners. Yes, we are talking with them and very current discussions. And you are correct in that if they are serial developers and there are many others out there, it provides an opportunity to – as long as we’re competitive and responsive to become really a preferred supplier of project finance debt and do project after project after project. And also provides an opportunity – and one of the names you mentioned is an example of this, to look at option is to do pools, fund pools of project finance loans that they may be doing. Very similar in a way to our AgVantage type bond underwriting. So yes, this is a real opportunity for us, and there is an opportunity to build relationships that can deliver recurring business opportunity.
Okay. And just to interject on your comments, those would have a power takeoff agreement as part of the financing structure?
They do. We don’t do speculative renewable energy projects where the power isn’t committed to be sold to someone. So that’s true for wind, that’s true for solar. We’re seeing a heightened opportunity with anaerobic digesters, where the output is really renewable natural gas, getting the hedges right, so we lock in a key margin – a predictable margin on those is key.
There – as we’ve said before, there’s a growing convergence between energy and American agriculture, and we want to be there.
Okay. Perfect. And then does that loan book reflect that balance to $327 million? Are there customers that we’ve done multiple projects was in that number, already?
On the for developer owners, I don’t know that there are - they’re sponsor owners in there that have multiple projects that we financed at the same time. But I don’t think that there are serial financings in there yet.
Okay. I mean I don’t want to put words in your mouth, but in theory, that we could see an acceleration of growth if those relationships start to develop.
Yes. The other recurring opportunity is on the large deals with syndicated banks. There are a handful of Japanese and European banks that lead to $200 million, $300 million $400 million, $500 million syndicates. And is – and we are beginning to do business with a number of them. And as we develop more of a reputation for them, that provides another opportunity to be a preferred partner with another financial institution in that case.
Okay, perfect. Thank you. Humoring me on all the renewable energy portfolio questions, but I just think there’s just a huge opportunity that needs to be discussed and needs to be understood by shareholders. And last question, maybe more for Aparna. You had talked about the securitization cadence. It seems like we’re getting to be doing something twice a year. So should we be expecting something in the back half of this year? And is that kind of what we’re thinking and messaging to the market as we look towards 2024? Thank you.
Yes. Absolutely. We were successful in doing one this year. We’ve sort of been on a cadence of one per year so far. I think the rate environment has certainly slowed down, as you can see in our numbers, the long-term fixed rate purchase of Farm & Ranch, which tend to be the best candidate for securitization. That said, the team is very actively contemplating when we might do another one. And if it’s not Q4, very likely – very early in Q1 of next year, we’d be targeting coming out with another issuance.
We’re also in active discussion about other assets, now that we have a good sense of the investor appetite for rural assets in the securitization space. We’re not moving out some of our assets within the rural infrastructure space. So that might be more of a longer-term slower maturing strategy, but that’s also at play.
Okay. Once again Thanks for taking my questions. Brad, Brad Aparna, for good work and the rest of team , you are doing a great job, which is – get people what you are doing. Thank you/
Thank you. And ladies and gentlemen this ends your question and answer session, I would like to turn the conference back over to Brad Nordholm for any closing remarks.
Good. Thank you all for the questions and after participation of this call, mean a lot to us. If we haven’t said it, let me just say it right now that we’re very pleased, but not at all surprised by the strong results of the second quarter. We’ve got a great business model. We have a crystal clear focus on our mission, our business purpose that goes from our Board to our – all of our employees to our executive team. We have, as a part of that, a very, very deep commitment to American agriculture and rural infrastructure. We emphasize that we’ve got a very well-honed asset liability management, credit, enterprise risk management disciplines across this organization. Our operations are getting tighter every day. I think that we have an outstanding team that’s just getting stronger, that’s getting better coordinated, that is getting more effective every day that we execute here. So in summary, the future is very bright. We appreciate your support. And as always, please reach back to us with any follow-on questions that you have. Thank you.
Thank you, sir. This concludes today’s conference call. We thank you all for attending today's presentation. You may now disconnect your lines. Have a wonderful day.+