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Good day, and welcome to the Farmer Mac’s Third Quarter 2021 Earnings Conference Call. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note today’s event is being recorded.
I would now like to turn the conference over to Jalpa Nazareth, Director of Investor Relations and Finance Strategy. Please go ahead.
Good afternoon and thank you for joining us for our Third Quarter 2021 Earnings Conference Call. I’m Jalpa Nazareth, Director of Investor Relations and Finance Strategy here at Farmer Mac.
As we begin, please note, that the information provided during this call may contain forward-looking statements about the company’s business, strategies and prospects which are based on management’s current expectations and assumptions. These statements are not a guarantee of future performance and are subject to the risks and uncertainties that could cause our actual results to differ materially from those projected. Please refer to Farmer Mac’s 2020 annual report and subsequent SEC filings for a full discussion of the company’s risk factors.
On today’s call, we will also be discussing certain non-GAAP financial measures. Disclosures and reconciliations of these non-GAAP measures can be found in the most recent Form 10-Q and earnings release posted on Farmer Mac’s website farmermac.com under the financial information portion of the Investors section.
Joining us from management this afternoon are our President and CEO, Brad Nordholm who will discuss third quarter business and financial highlights and strategic objectives; and our CFO, Aparna Ramesh who will provide greater detail on our financial performance. Select members of our management team will also be joining us for the question-and-answer period.
At this time, I’ll turn the call over to our President and CEO, Brad Nordholm. Brad?
Thanks, Jalpa and good afternoon, everyone and thank you for joining us. As you can see from this afternoon’s press release, we’re having another great year thus far, with many significant accomplishments, including the expansion of our internal loan servicing function in the third quarter, and more recently getting the fourth quarter a newly structured syndicated agriculture mortgage-backed securitization. These accomplishments combined with our consistent financial performance, and continued strong credit quality, reflect our alignment with and our execution on our multi-year strategic plan.
We delivered another quarter of strong core earnings and net effective spread, reflecting the discipline structure of our asset liability management and pricing policies and the consistency and durability of our business model. Our asset quality metrics remained strong with 90-day delinquencies and sub-standard asset ratios moving favorably on a quarter-by-quarter basis. We’re pleased with the overall portfolio performance and continue to see no material issues on the horizon. Expanding our internal loan servicing capabilities through this quarter’s strategic acquisition reflects an opportunity for Farmer Mac and will bring with it a myriad of benefits to our core customers, the lending institutions of rural America who are key parts of our seller servicer network. We will use this opportunity to create greater efficiencies across our loan servicing platforms and we will harness this opportunity for more direct oversight and governance of a large part of our portfolio, giving us enhanced security, more control over and timely access to data and better visibility into loan performance, from inception to maturity.
We’re also excited for the growth opportunities this strategic investment will enable as well as it will equip us with the talent and infrastructure to more effectively and efficiently service larger, more complex commercial loans, are a key driver in our long term growth strategy. This move is an important example of our dual strategies to broaden our business opportunities, while also deepening relationships with our existing customers. We believe that will ultimately enable us to provide increased capital to support rural America and to deliver better customer service to our lender network in support of our mission of increasing the access and competitive pricing for credit for the benefit of the country’s farmers, ranchers and rural residents.
I’m very proud of the $302 million newly structured and syndicated agricultural mortgage-backed securitization that we closed in early October. The success of this transaction is evidence of Farmer Mac’s high quality credit, our strong balance sheet, and our consistent financial performance, as well as the resilience of America’s farmers and ranchers. Developing this capital flow to agricultural producers strengthened the capital markets to them, exemplifies Farmer Mac’s core mission to lower costs for end borrowers and improve credit availability while creating a well-received new investment opportunity for leading institutional investors. Aparna will provide more details on this transaction in a few minutes. But looking ahead, we plan to build upon the securitization program over the next several years and eventually become a frequent issuer in the marketplace. The overall tone of the agricultural real estate market remains positive.
Farmland values are projected to remain flat to slightly higher, as we’re seeing an increase in the number of public auctions and sales with some of the highest values of the year. We provided a gross $2.5 billion in new credit to rural America in the third quarter, which resulted in outstanding business volume exceeding $23 billion at quarter end. Our success continues to be driven by our consistent customer-centric approach, which focuses on providing products and solutions that address funding needs through all agricultural economic cycles and that’s both existing as well as new markets.
Strong loan purchase growth in our Farm & Ranch line of business this quarter was largely attributable to our proactive customer outreach and retention strategies. We also added a net new $15 million commitment this quarter for a bower to acquire and improve the economics of farmland in a federally designated opportunity zone. This is our largest commitment to opportunity zones to date and we funded $21 million of this commitment in the third quarter. Farm & Ranch’s long-term standby purchase commitment product also exhibited healthy growth, reversing some of the general trends over the last years. Regional Farm Credit System Association’s growth within their core sectors resulted in some of these lenders exceeding commodity concentration limits, which provided an opportunity to Farmer Mac purchase commitment that provide relief from lending and concentration limits for these lenders.
Despite the ample supply of liquidity in the market from other sources, our institutional credit line of business grew over -- or just under actually $500 million, a reversal from prior quarters, largely driven by demand for short-term liquidity funding by two of our largest counterparties. This growth is a testament to Farmer Mac’s ability to be competitive in price, but also being effective in execution to meet the needs of these customers and I might add while also being flexible in recognizing that needs of customers can change very rapidly.
In our Rural Utilities line of business, we successfully added $50 million of unfunded telecommunication loan commitments with one of our key customers. This transaction reflects some of the positive momentum we’ve seen in broadband and renewable energy project finance. We view these growing sectors as significant opportunities for Farmer Mac over the next several years, given greater level of interest from rural electric cooperatives to develop and deploy broadband services and invest in renewable energy electric power generation.
As we look ahead to fourth quarter and build on the strategic plan and notable accomplishments of this quarter, we continue to see many opportunities. We’re confident with the strength of our underlying business model, our strong capital position, and our commitment to our customers will continue to support our ability to generate consistent returns throughout various market environments and across economic cycles, as we have done historically.
With that, I’d like to turn it over to Aparna to discuss our natural results in more detail.
Thank you, Brad and good afternoon, everyone. I’m pleased to share with you another quarter of consistent earnings results, reflecting focused execution throughout the organization. Farmer Mac’s third quarter 2021 earnings results were driven by higher spreads business volume and lower funding costs, given us strong access to debt capital markets. Our access to capital markets, as the previous quarters, remains extremely strong. We’ve issued debt daily and continue to maintain our disciplined asset liability management practices, including a methodical transition out of labor based insurance. Farmer Mac continues to increase this activity in the sector-based asset, debt and derivatives markets and we’ve seen a significant uptick in sector activity, especially true in the derivatives market, which should aid the LIBOR transition in the loan market.
The year-to-date average balance of spread earning assets was $22.4 billion, and this is comprised of $4.8 billion of cash and investments and $17.6 billion of loans and security. Farmer Mac’s net effective spread for third quarter 2021 was $55.9 million. This represents an 8% increase from $51.8 million in third quarter to 2020. In percentage terms, net effective spread was 0.99% compared to 0.96% in the same period last year. Year-to-date, our net effective spread has increased 7 basis point to 0.99% compared to the same period last year and this is a result of net new business volume, coupled with a decrease in funding costs. There was also an increase in the cash collection account from non-accrual loan payments.
By effectively extending our liabilities in a low-rate environment, we’re able to adequately prepare for a potential rising rate environment, while retaining attractive pricing levels. We’re also actively analyzing, as I mentioned before, our duration and convexity matches on our existing portfolio and looking at our pipeline to ensure that we minimize our interest rate risk in the event of a sustained rise in interest rates.
Core earnings for third quarter 2021 was $27.6 million or $2.55 per diluted common share compared to $27.7 million or $2.57 per diluted common share in the same period last year. The year-over-year results were in line with our expectations and were driven by strong revenue increases and core earnings were flat, despite the increase in our cost of capital that resulted from our recent preferred issuance in the second quarter that we told you about. We saw a $3.3 million after tax increase in net effective spread and $0.7 million after tax decrease in the provision for credit losses and these were partially offset by $2 million after tax increase in operating expenses, a $1.6 million increase in preferred stock dividends and the $0.3 million after tax decrease in guarantee fees.
Operating expenses increased by 17% year-over-year and this was primarily due to increased headcount, as well as higher spending on software licenses and information technology consultants that were brought on board to support various core and strategic initiatives. The increase in headcount in the third quarter was related to the expansion of our internal loan servicing function that Brad mentioned, as we welcomed 10 members of a talented loan servicing group to the Farmer Mac’s team in August. Their expertise will allow us to offer without interruption the same level of service and quality service that our customers deserve and expect whenever they interact with us or through any of our third-party central service. The additional loan servicing expenses are expected to be offset over a multi-year period by additional revenue that will be reflected in higher spreads in our Farm & Ranch and USDA lines of business, where we will not be paying a third party for servicing the loans that we will now serve, and this should make this initiative neutral in the short term to accretive for us.
We expect to see higher operating expenses for the foreseeable future. And this is primarily as we invest to modernize our infrastructure, enhance the technology platforms to support our revenue strategy, and add relevant talent across the organization. We expect these efforts to continue and increase over the next 12 to 18 months as we innovate and grow our business and we’ll continue to monitor the growth in operating expenses such that they remain commensurate with the growth in our revenue. We’ve instituted a very disciplined approach to controlling personnel and non-personnel costs and we monitor this closely through an operating efficiency ratio metric, and we do a rigorous review of our results every quarter.
Our efficiency ratio in the third quarter 2021 was a 27%, below are targeted 30% level. As we upgrade our platforms and invest strategically in multi-year technology commitments to improve customer service and enhance our competitive position, our efficiency ratios are projected to stabilize at historical levels and remain under 30%. Turning now to capital, Farmer Mac remains in a strong and well-capitalized regulatory capital position. Farmer Mac’s $1.2 billion of core capitals, as of September 30 2021, exceeded our statutory requirement by 480 million, or 69%. Our Tier 1 capital ratio was 15.1% at quarter end, remaining well-above regulatory threshold.
I also want to review our two recent accomplishments that Brad highlighted earlier on. First, the strategic servicing transaction. During this quarter, we acquired the loan servicing rights for a sizable portion of our Farm & Ranch loan and USDA portfolio. And we hired, as I mentioned, a talented team from the seller of the servicing rights and invested in a servicing platform that we are tailoring to unveil. This initiative will increase our interest income on the loan that we do service, as there will not be, as I mentioned, any third-party central service for retaining a servicing fee on those assets. This additional interest income is expected to be partially offset by the increase in our headcount-related operating expenses that I mentioned earlier.
The second transaction that Brad highlighted is a $302.7 million newly structured and syndicated agricultural mortgage backed securitization that took place on October 14. This deal was structured around two tranches, a senior guarantee tranche and a subordinated unguaranteed tranche. The transaction was very well received by the investment community and resulted in an oversubscription of up to 2.3 billion in total investor demand with repeated tightening of pricing levels. The success of this transaction has provided Farmer Mac with an opportunity to diversify funding sources and its revenue and fulfill our mission more effectively. We expect to return to the market in 2022 with another similar securitization, as we seek to make this a more programmatic effort for us in the future. An inaugural securitization transaction takes a great deal of work enterprise wide, and we are currently identifying ways to potentially execute these transactions more efficiently and thereby more frequently in the future. I’m looking forward to providing you more financial details on this transaction during our next earnings conference call, when we will discuss full year 2021
More complete information about Farmer Mac’s third quarter 2021 performance is in our 10-Q that we filed today with the SEC. And with that, Brad, I’ll turn it back to you.
Thanks, Aparna. Well, in summary, our third quarter results were strong, and continued to demonstrate the strong foundation for visibility and growth in earnings here at Farmer Mac into the future. We will continue to rely on the same principle of serving our mission of increasing access to and reducing the cost of capital for the benefit of agricultural and rural communities, and really the people who are there in the agricultural economies. We continue to manage our capital prudently focused on consistently building shareholder value for the long run, and delivering pure leading operating efficiency, while making investments to position this company for continued growth that we see over the next few years.
And now operator, I’d like to see if we have any questions from anyone on the line today.
Thank you. [Operator Instructions] Today’s first question comes from Gary Gordon, a
Private Investor and please go ahead.
Okay. Thanks for taking my question. A couple of things, if you don’t mind. One, my math hopefully I got it right says that there were no charge offs in the third quarter or actually looks like for the year-to-date. Is that correct? Am I missing something?
No, Gary, that is correct.
Okay, terrific. Second on the asset-backed securitization, at least my understanding is reasons for doing it are lower financing costs, or take some risk off the balance sheet and free up capital. Farmer Mac have had excellent access to the markets and local cost of funds and plenty of excess capital, so I guess I’m curious about why -- how that security securitization helps you.
Yeah, Gary, and I’m going to ask Aparna to jump in here in a minute and elaborate some of these points. But when we think about the benefits that you just mentioned, more financing costs, free up capital, risk transfer, that may be true, we haven’t fully realized lower financing cost yet but as systems [ph] programmatically expect to come down. But another very important objective here, Gary, is for us to be always diversifying and deepening our sources of the funding.
At the beginning of the pandemic, we had extraordinarily great access to debt capital in the markets but, you know, we’d never take that for granted. And by tapping into a different investor market for a different form of issuance by Farmer Mac, we can make sure that we have even further diversified and deepened our sources of liquidity. So let me just turn to Aparna to kind of elaborate on some of these different benefits, because they really are significant and over time, we expect them to become even more valuable to us.
Yeah, thank you, Gary. I think that’s a very good question. Certainly this allows us to better diversify both our funding sources, but especially on the long end, I want to maybe focus a little bit on the point that Brad just talked about. At the start of the pandemic, we didn’t see very good assets, especially at the short end of the curve but when we’re fully reliant on debt capital markets and only debt capital markets at the long end of the curve, especially in times of volatility that leaves us with only one source of funding. And so by diversifying our sources of funding, especially on the long end, to remind you, this securitization transaction really targets the 15 to 30 year sector, I think it’s important for us to continue to have that. So that’s one reason why we did that.
The second piece is this does allow us to also fulfill our mission more deeply by offering that lower cost of financing, but also add a tenner [ph], especially as rates are likely to rise, continue to be competitive in that long-end of the curve. So, that’s another point. And then finally, you talked about capital, absolutely, we are a very well capitalized institution. Our reason for doing this is not for reasons of capital efficiency but that said, a transaction like this is incredibly capital efficient, and allows us to continue to really deploy our capital in a way that makes a lot more sense, as we diversify our product line. So those, I think, are the primary reasons we entered into this transaction and I hope that helps.
Gary, I just hasten to add that if it sounds like we were concerned about something, and that motivated us to do this, that’s really not the case at all, we’ve been having fabulous access, over capitalized. But I think when you look to us as the leadership of Farmer Mac, you’ve entrusted us with your investments with your capital investments. When you look to us, you want us to be proactive and always looking for new and better ways of doing things that makes the organization stronger, even more resilient in the future, even more profitable in the future. That’s really what we’re trying to do here.
Okay, great. Quick question on the servicing business that you bought, were these business - are they servicing for others that you get fees on, one? And then two, you said there’s more long-term benefits and certain short term, the expectation of more and more of your portfolio is serviced by yourself as opposed to third party?
Yeah, well, we’ve been sitting here for this call, Aparna and Jalpa, I have been joined by our General Counsel, Steve Mullery; by our Chief Credit Officer, Marc Crady; and our Chief Business Officer, Zack Carpenter. And Zack, to put much of this transaction together along with Rob Maines, Head of Operations, and Mario was really a huge team effort. But in terms of the strategic intent and the near term as well as intermediate term business strategy and relationships, I’ll let Zack answer that question and give you some good color on that, Gary.
Thanks, Gary. Great question. You As Brad indicated, we see a lot of near-term immediate benefits as well as long-term benefits. And I say more on the immediate, and in prior calls we’ve talked about enhancing our infrastructure, predominantly as we enter new lines of business. As Brad indicated and Aparna commented on creating new products and services for our customers and solutions for farmers and ranchers, we need to continue to evaluate and enhance our infrastructure to be able to support those new products. And a key component that this new servicing function platform and team gives us the ability to execute on more complex and increasing loan products that we see in the market.
I’d say in the medium to longer term benefits, we do anticipate consolidating, I’d say, a fairly broad central servicing platform. That being said, we expect to fully work with a lot of our key central servicers to really make a more efficient process for their customers, our customers and the farmer and ranchers, and really what that means is getting more functionality with data, getting quicker access to data so, really, that we can make more access to capital for farmers and ranchers in a much more efficient way. We do anticipate an increasing portfolio that we will service and Aparna mentioned that the benefits that we will receive but overall, we plan to work more strategically with our key central servicing partners.
Okay, thanks. One last question; I haven’t seen anything, I’m no expert on this, but in the Infrastructure Bill that’s being proposed now or any other legislation by -- expected legislation by the new administration, is there anything that’s particularly relevant to Farmer Mac?
You bet. Let’s just talk about what is in there. A lot of emphasis on transportation and transportation infrastructure and you might say, well, what does that cuts to a Farmer Mac? Well, that has a lot to do with the farmers and ranchers and agribusinesses around the United States, Gary, because they are all very dependent on efficient truck, shipping, port facilities across this country. I mean, the portion of US agricultural crop commodities that are exported varies by crop, but in many cases over 50%. So, to the extent that we can improve transportation infrastructure, that is a big win for rural America. So, that’s a positive. We can’t quantify that for you but it’s a positive.
There is funds allocated for broadband, do that as an economic development matter for rural America, improving the ability for businesses to operate competitively again, and in competitive world economy for rural communities and rural businesses and farms, to continue to attract talented young people who expect great access to internet-based services. Frankly, there’s a very large portion of activity that goes on in farms and in production agriculture, today, increasing about around what we would generally call precision agriculture. We are using broadband and satellite-based technology to assess what’s going on in the fields to optimize decision making, for planting, for application of inputs, for harvesting, these all benefit -- these activities all benefit from improved rural broadband access.
So yes, there is renewable energy, we are financing renewable energy, specifically solar and wind projects in rural America. That’s an important economic development opportunity for rural America, it is important business opportunity for us. And then even with other aspects of proposed legislation, and even COP26, we see discussion about of all fuels, specifically biodiesel. We see discussion about methane capture and renewable gas. These are all things that are at the convergence of agriculture and energy in rural America. And so we follow these very closely and, frankly, see very little downside and quite a bit of upside, although difficult to quantify.
Okay, terrific. Thank you. Thanks for your time.
Thank you. We appreciate it.
[Operator Instructions] Ladies and gentlemen, concludes our question and answer session. I’d like to turn the conference back over to Brad Nordholm for any final -- any closing remarks.
Well, as always, we appreciate your interest. We’ve really had a number of calls over the last few weeks wondering what’s going on with stock performance. We’re going to continue to focus on the fundamentals of building this business here at Farmer Mac, and we see, actually, as I mentioned earlier in my comments, pretty good environment looking out over the next couple of quarters for doing just that. So, again, really appreciate your interest. Thanks for joining us today. If you do have any follow up questions, please reach out to us; reach out to Jalpa in particular. And thanks again.
Thank you. This concludes today’s conference call. We thank you all for attending today’s presentation. You may now disconnect your lines and have a wonderful day.