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Edited Transcript of AGM earnings conference call or presentation 9-Nov-17 4:00pm GMT

Q3 2017 Federal Agricultural Mortgage Corp Earnings Call

WASHINGTON Nov 9, 2017 (Thomson StreetEvents) -- Edited Transcript of Federal Agricultural Mortgage Corp earnings conference call or presentation Thursday, November 9, 2017 at 4:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Curt Covington

* R. Dale Lynch

Federal Agricultural Mortgage Corporation - CFO, EVP and Treasurer

* Stephen P. Mullery

Federal Agricultural Mortgage Corporation - SVP, General Counsel and Secretary

* Timothy L. Buzby

Federal Agricultural Mortgage Corporation - CEO and President

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Conference Call Participants

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* Brian Christopher Hollenden

Sidoti & Company, LLC - Research Analyst

* Eric J. Hagen

Keefe, Bruyette, & Woods, Inc., Research Division - Analyst

* Scott Jean Valentin

Compass Point Research & Trading, LLC, Research Division - MD & Research Analyst

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Presentation

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Operator [1]

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Good morning, and welcome to the Farmer Mac Third Quarter 2017 Investor Conference Call. (Operator Instructions) Please note this event is being recorded. I would now like to turn the conference over to Tim Buzby, CEO. Please go ahead.

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Timothy L. Buzby, Federal Agricultural Mortgage Corporation - CEO and President [2]

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Thank you. Good morning. I'm Tim Buzby, Farmer Mac's President and CEO. Farmer Mac is pleased to welcome you to our third quarter 2017 investor conference call. We have posted a slide deck to our website that we'll refer to throughout today's call. Information about where these slides can be found is included in this morning's press release.

Before I begin, I'd like to ask Steve Mullery, Farmer Mac's General Counsel, to comment on forward-looking statements that management may make today as well as Farmer Mac's use of non-GAAP financial measures.

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Stephen P. Mullery, Federal Agricultural Mortgage Corporation - SVP, General Counsel and Secretary [3]

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Thanks, Tim. Some of the statements made on this call may constitute forward-looking statements under the securities laws. We make these statements based on our current expectations and assumptions about future events and business performance. We do not undertake any obligation to update these statements after the date of this call.

We caution you that forward-looking statements are subject to risks and uncertainties. Actual results may differ materially from the results expressed or implied by the forward-looking statements. In evaluating Farmer Mac, you should consider these risks and uncertainties as well as those described in our 2016 annual report on Form 10-K, our subsequent quarterly reports on Form 10-Q and our other filings with the SEC.

In the analysis of its financial information, Farmer Mac sometimes uses measures of financial performance that are not presented in accordance with generally accepted accounting principles in the United States which we refer to as non-GAAP measures. The 3 non-GAAP measures that Farmer Mac uses are core earnings, core earnings per share and net effective spread. Farmer Mac uses these non-GAAP measures to measure corporate economic performance and to develop financial plans.

In management's view, they are useful alternative measures for understanding Farmer Mac's economic performance, transaction economics and business trends. These non-GAAP measures may not be comparable to similarly labeled non-GAAP measures disclosed by other companies. Farmer Mac's disclosure of non-GAAP measures is intended to be supplemental in nature and is not meant to be considered in isolation from, as a substitute for or more important than the related financial information prepared in accordance with GAAP.

Disclosures and reconciliations of Farmer Mac's non-GAAP measures can be found in the Form 10-Q and the earnings release posted on Farmer Mac's website, www.farmermac.com, under the financial information portion of the Investor section. A recording of this call will be available on our website for 2 weeks starting later today.

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Timothy L. Buzby, Federal Agricultural Mortgage Corporation - CEO and President [4]

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Thank you, Steve. Disciplined execution on our strategy, our success in business development efforts, and current industry dynamics that played to our strength continued to help produce strong results for Farmer Mac. This can be seen in our 15% year-over-year core earnings per share growth this quarter. Third quarter 2017 saw a strong business volume performance across all 4 of our lines of business.

Growth in the agricultural mortgage market has accelerated in 2017, due to an increase in borrower demand for long-term real estate financing as farmers have used equity in farmland assets to increase sources of operating capital. Also consolidation, expansion, and vertical integration occurring across virtually all sectors of the agriculture industry and agricultural banking coupled with Farmer Mac's new and expanded business relationships with large regional and national lenders has led to an increase in Farmer Mac's loan purchase volume within our Farm & Ranch line of business. This has taken our net growth in Farm & Ranch loans to nearly 22% year-over-year in third quarter.

Growth in our USDA and Rural Utilities loans is also strong, as we have seen an uptick in Rural Utilities loan purchase opportunities. Our Rural Utilities lending partner National Rural Utilities Cooperative Finance Corporation also known as CFC has increasingly used us as a partner in more competitive loan opportunities with larger Rural Utilities borrowers. We believe this represents an ongoing growth opportunity for Farmer Mac.

Within our Institutional Credit line of business, we continue to see solid growth trends with significant new business from Rabo AgriFinance and with the addition of 2 new counterparties for our Farm Equity AgVantage product.

The overall business climate for Farmer Mac remains positive even as some sectors of the agriculture economy remain under pressure from lower grain and oilseed prices and net farm income decreases for many producers. Some of Farmer Mac's credit metrics continued to show signs of normalization this quarter, but this was primarily due to borrower-specific factors and not necessarily related to macroeconomic factors in the agricultural economy.

While we expect that the agriculture economy will continue to adjust to lower commodity prices in some sectors, USDA now projects farm income to increase in the aggregate by approximately 3% in 2017. As Curt Covington will discuss shortly, land values in the Midwest seem to be stabilizing and land values in other areas of the country continue to increase. Against this backdrop, Farmer Mac has seen increased demand for its products and solutions, which has allowed us to help more rural borrowers and further deliver upon our mission.

Over our 29 years in agriculture, Farmer Mac has built a rich set of experience, knowledge and relationships as a diversified national secondary market for all kinds of rural lenders across approximately a 140 commodity types. More recently, we have begun to share our insights and perspectives on the agriculture economy through many speaking engagements, interviews, and our new publication, The Feed.

We also thought that providing an agricultural perspective on our quarterly calls would be a nice addition to our investor communications. So we plan to have a brief agricultural update during the earnings call every quarter from one of our agricultural experts. Today, I'd like to turn to Curt Covington, our Senior Vice President of Agricultural Finance to provide you with an update on the current agricultural environment. Curt.

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Curt Covington, [5]

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Tim, thanks. With the 2017 harvest in full swing, farmers and lenders alike are preparing for another year of unknowns. 2017 will likely go down as the year of the unexpected for U.S. agriculture, which is defined by its diversity, productivity and cyclicality. Farmer Mac has the privilege of serving rural lenders and their borrowers from coast to coast and as such the benefit of having a sweeping first-hand look across U.S. agriculture. I'd like to focus on just a few sectors today.

Growers in the Midwest continue to deal with over supply of corn, soybeans, and wheat and lower profits, with more of the same expected for 2018 as reported by the USDA. Cotton has had a surprising 2 year run with most growers showing good topline revenue and is a result of both above-average yields and favorable pricing.

The dairy sector profitability in 2017 has been highly dependent on the region of the country in which the dairy is operated and the size, the scale and the cost structure of the dairy. The beef cattle sector has rebounded somewhat in 2017 from a very tough 2016 marketing year. Industry experts predict 2018 will show continued improvement however.

The hog sector has seen some deterioration, but on average, marginally profitable conditions in 2017 with 2018 expected to be about the same. The Specialty Crop sector, which as a general rule, follows the coastline of this country, has done well so far in 2017, specifically the nut, fresh-market citrus, grapes, stone fruit, and most vegetable sectors have earned at or above average returns during the year. There of course remain pockets of concern, most notably for the citrus juice due to citrus greening disease, and the effects of hurricanes in the South, droughts in the Dakotas and fires in California.

Above all else, farmers came into this current cycle with relatively strong balance sheets, reasonably good liquidity, and leverage positions which have served them well. In general, 2017 is expected to go down as a year of marginal profitability and current USDA estimates imply only modest improvements in 2018.

Now let's turn to land values. Many agricultural industry experts have been expecting a decline in land values across the U.S. But a recent USDA land survey found that year-over-year land values are stable, slightly lower, or about 3% in Midwest with some areas of lower quality ground showing large declines and higher quality ground actually recording little to no decline. In other areas around the country, land values are either showing stable to modest increases along with pockets of noticeable increases in value year-over-year.

So the question that remains is, where do land values go from here? The answer is that, it's tied to the expectation for commodity prices, farm profitability and interest rates. Interestingly, recent lender survey suggests optimism about the state of the ag economy with fewer producers expecting profitability and land values to diminish further, and fewer lenders expecting farm land prices to fall over the coming year.

And with that, I'll turn it back to you. Tim.

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Timothy L. Buzby, Federal Agricultural Mortgage Corporation - CEO and President [6]

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Thank you, Curt. Against this market backdrop, our financial results this quarter were strong as business volumes, net effective spread and core earnings grew significantly. Year-over-year net effective spreads grew by more than $4 million and core earnings grew by over $2.5 million. As you can see on Slide 5, Farmer Mac ended third quarter 2017 with outstanding business volume of $18.6 billion.

We added more than $890 million of new business during the quarter, resulting in net growth of $385 million after maturities and prepayments. All 4 of our lines of business contributed to this increase. Our Farm & Ranch loan purchases were nearly $300 million in third quarter 2017, which resulted in net growth of $186 million. This was due to an increase in borrow demand for agricultural real estate financing and an increase in the average size of loans purchased, including several large loans to large borrowers.

In terms of our Institutional Credit line of business, we purchased approximately $290 million of AgVantage securities in the third quarter, which resulted in net growth of more than $190 million. This increase was mostly driven by new business from Rabo Agrifinance and counterparties within Farm Equity AgVantage. Our USDA Guarantees lines of business also saw significant growth in third quarter 2017. We purchased more than $130 million of USDA securities, which resulted in net growth of $62 million.

This is consistent with the trend of increased lender usage of USDA guaranteed loan programs due to available federal funding for those programs. For the first time in a while, we also saw significant net growth in our Rural Utilities line of business as we purchased 3 large loans totaling $70 million.

Farmer Mac's net effective spread for the third quarter 2017 grew significantly in dollars and as a percentage year-over-year due to growth in our business volumes and improved LIBOR-based funding costs this quarter. Dale Lynch, our CFO, will describe those changes in more detail in a few minutes.

In terms of credit; as we have expected, our 90-day delinquency rate has reverted to near its historical average. Our substandard asset rate also increased approximately 0.3% sequentially this quarter. However, the credit changes this quarter were primarily driven by factors specific to individual borrowers and not macroeconomic trends. Dale will also discuss this in more detail shortly.

With that as background, I'll ask Dale, our Chief Financial Officer to cover our financial results in more detail.

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R. Dale Lynch, Federal Agricultural Mortgage Corporation - CFO, EVP and Treasurer [7]

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Thanks, Tim. Our third quarter 2017 results reflect Farmer Mac's commitment to continue growing, developing new customers, innovating our product set, and delivering upon our mission throughout market cycles. As Tim mentioned, we grew to record outstanding business volume of $18.6 billion as of September 30, 2017; all 4 lines of business contributing to the growth.

Our spreads improved in both dollar and percentage terms year-over-year. Spreads on new assets generally remained stable although Farmer Mac has recently tightened some pricing for its Farm & Ranch loans because we believe there is an attractive growth opportunity for strong borrowers in this sector of the market.

As Curt mentioned earlier, we are seeing continued signs of stress in certain sectors of the ag economy, and while some of our credit metrics deteriorated modestly this quarter, this is primarily driven by borrower-specific factors and not macroeconomic trends that we've been discussing.

Turning to the financials. As you can see on Slide 6, core earnings for the third quarter '17 were $17 million or $1.57 per diluted common share compared to $14.4 million or $1.36 per share in third quarter of 2016 and $16 million or $1.48 per share in the second quarter of 2017.

The $2.6 million year-over-year increase in core earnings was due to a $3.2 million after-tax increase in total revenues, which is primarily driven by an increase in net effective spread. Partially offsetting the year-over-year increase was a $0.6 million after-tax increase in operating expenses, balance between increases in comp and benefits, and G&A expenses. The $1 million sequential increase in core earnings was primarily due to a $0.4 million after-tax increase in net effective spread and a $0.5 million after-tax decrease in comp and benefit expenses due to seasonal factors.

Turning to spreads on Slide 7. Farmer Mac's net effective spread for third quarter of 2017 was $36.2 million or 92 basis points compared to $32.2 million or 86 basis points in third quarter 2016 and $35.6 million or 92 basis points in the second quarter 2017. The $4 million year-over-year increase in net effective spread was due to growth in on-balance sheet AgVantage securities, Farm & Ranch loans, and other business volume, which increased net effective spread by about $4 million and changes in Farmer Mac's LIBOR-based funding strategies in a LIBOR market that remain favorable throughout most of third quarter 2017, which added another $0.8 million.

The increase was offset in part by a decrease in the amount of cash basis interest income recognized on nonaccrual Farm & Ranch loans which reduced net effective spread by $0.5 million. And the 6 basis point year-over-year increase in net effective spread was primarily due to a significant reduction in the average balance of cash and equivalents and lower earning investment securities, which added about 6 basis points to net effective spread.

The $0.6 million sequential increase in net effective spread in dollars was due to growth in on-balance sheet AgVantage securities, Farm & Ranch loans, and other business volume, which increased net effective spreads by $0.9 million. Net effective spread in percentage terms is flat between third and second quarters 2017.

Turning now to credit on Slide 8. As of September 30, 2017, the total allowance for losses was $8.5 million or 13 basis points of the $6.6 billion Farm & Ranch portfolio compared to $8.1 million or 13 basis points of the Farm & Ranch portfolio as of June 30, 2017. The $0.4 million sequential increase in total allowance for loss is primarily due to downgrades in risk ratings, which caused the net increase to the specific allowance for certain impaired on-balance sheet crop and permanent planting loans.

Net volume growth in on-balance sheet Farm & Ranch loans also contributed to the increase in the general allowance. There were no charge-offs recorded this quarter. As of September 30, 2017 Farmer Mac's 90-day delinquencies were $66.4 million or 1% of the Farm & Ranch portfolio compared to $41.9 million or 0.65% of the portfolio as of June 30, 2017, and $21 million or 0.34% of the portfolio as of December 31, 2016.

The 90-day delinquencies were comprised of 68 loans as of September 30 compared to 42 delinquent loans as of June 30, 2017 and 38 delinquent loans as of December 31, 2016. The increase in 90-day delinquencies from year-end is primarily due to several larger loans in certain crop and permanent planting loans, mostly driven by borrower-specific factors and not related to the macroeconomic factors in the ag economy. In particular, $15.3 million in permanent planting loans to a single borrower became delinquent in first quarter 2017 and accounted for 1/3 of the year-to-date increase in 90-day delinquencies.

Farmer Mac believes that it's adequately collateralized on this exposure. The increase is also consistent with the seasonal pattern of Farmer Mac's 90-day delinquencies, fluctuating from quarter-to-quarter, both in dollars and as a percentage of the outstanding Farm & Ranch portfolio, with higher levels generally observed at the end of first and third quarters and lower levels generally observed at the end of second and fourth quarters of each year. This is as a result of the January and July payment terms at most of our Farm & Ranch loans.

Farmer Mac believes that it remains adequately collateralized on all these exposures. As Farmer Mac has expected, its 90-day delinquency rate has reverted to and is in line with our 15-year historical average of approximately 1%. Although the vast majority of the year-to-date increase in 90-day delinquencies is due to borrower-specific factors. Other factors such as macroeconomic trends and the cyclical nature of the ag economy could contribute to an increase in 90-day delinquencies in the future.

The highest 90-day delinquency rate observed in the Farm & Ranch portfolio during the last 15 years occurred in 2009 at approximately 2%, which coincided with the increased delinquencies in loans within Farmer Mac's then-held ethanol portfolio that Farmer Mac no longer holds.

As of September 30, 2017 Farmer Mac's substandard assets were $219.6 million or 3.3% of the Farm & Ranch portfolio compared to $165.2 million or 2.7% of the Farm & Ranch portfolio as of December 31, 2016. Those substandard assets were comprised of 298 loans as of September 30, 2017; 287 loans as of December 31, 2016.

The $54.4 million increase from year-end 2016 was primarily driven by credit downgrades and on-balance sheet loans. The new substandard asset volume from year-end 2016 includes several large exposures and also represents a relatively diverse set of commodities. Farmer Mac expects that over time its substandard rate will eventually revert closer to impossibly exceed its historical average due to macroeconomic factors and the cyclical nature of the ag economy.

Farmer Mac's average substandard assets as a percent of its Farm & Ranch portfolio over the last 15 years is about 4%. The highest substandard rate over that period of time occurred in 2010 and was approximately 8%. This coincided with Farmer Mac's then-held ethanol portfolio, which again we no longer hold.

Although some credit losses are inherent to the business of ag lending, Farmer Mac believes that any losses associated with the current agricultural credit cycle will be moderated by the strength and diversity of its portfolio, which Farmer Mac believes is adequately collateralized.

Now turning to business volumes. As you can see on slide 9, we added $893 million in new business in third quarter 2017. Looking at the specifics for the quarter, we added the following the new business volume; purchased $298 million of Farm & Ranch loans, purchased $291 million of AgVantage securities, added a $013 million of Farm & Ranch loans under the purchase commitment product, purchased $90 million of USDA securities, purchased $70 million of Rural Utility loans, and issued $41 million of Farmer Mac Guaranteed USDA Securities. After maturities and repayments, our net outstanding business volume increased $385 million this quarter.

Turning now to capital on slide 10. Farmer Mac's [$652 million] of core capital as of September 30, 2017 exceeded the statutory minimum capital requirement of $516 million by $138 million or 27%. This compares to core capital of $610 million or $143 million of capital above the minimum requirement as of December 31, 2016.

The decrease in core capital in excess of our statutory minimums from year-end 2016 was due to an increase in the minimum capital required to support the growth in on-balance sheet assets including the $1 billion MetLife AgVantage security that was refinanced to an on-balance sheet assets in the second quarter of this year, which was offset in part by an increase in retained earnings.

More information about Farmer Mac's performance for third quarter 2017 is set forth in our 10-Q which we filed today with the SEC.

With that, Tim, I'll turn it back to you.

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Timothy L. Buzby, Federal Agricultural Mortgage Corporation - CEO and President [8]

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Thank you, Dale. Farmer Mac continues to deliver upon its mission throughout agricultural economic cycles and this has never been more true than throughout the last 2 years. Our capital base is strong and growing, providing plenty of capacity for future growth, and we believe our dividend policy has helped enhance stockholder value.

Farmer Mac continues to bring in new personnel to fill key positions, new positions and is expanding its investment in the technology and capacity to better grow our business. These investments will be evident overtime with increasing compensation and G&A expense.

Farmer Mac continues to broaden its customer base which is reflected in our results. More institutions are recognizing the value Farmer Mac can provide and more customers are choosing different products and solutions across our lines of business. We continue to sign up new lenders for our loan purchase and credit protection products, including new types of customers with these product types.

We see strong interest for our AgVantage family of products, including new business opportunities to provide wholesale funding to financial funds that originate and invest in agricultural mortgages. And we continue to grow Farm Equity AgVantage and look forward to working with new customers in that area.

Farmer Mac has been a champion for and an integral part of this nation's rural economy for nearly 30 years. Our mission is to help build a strong and vital rural America by increasing the availability and affordability of credit for the benefit of American agricultural and rural communities.

We provide our customers access to flexible low-cost financing and effective risk management tools. As a nationwide expert in agriculture and the premiere secondary markets provider for U.S. agricultural credit, Farmer Mac is in a unique position to deliver upon this mission.

We will now be happy to answer any questions you may have.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question comes from Eric Hagen of KBW.

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Eric J. Hagen, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [2]

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Can you comment on why you think the uptick in substandard assets is episodic and it's not some sort of trend that we should be aware of. And on top of that, how we should think about the level of credit-related expenses now that substandard assets have increased?

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Timothy L. Buzby, Federal Agricultural Mortgage Corporation - CEO and President [3]

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Well, I think the increase is -- we look at the portfolio and look at what has evolved into a substandard asset and where it was previously and try and draw conclusions as to whether we think that is commodity specific event or a regional event or if it's related to specific events related to individual borrowers. What we've seen so far has largely been just that, it's individual borrowers with specific stories or situations that they're going through as opposed to us seeing, for instance, general downgrade in our portfolio of corn loans, for instance. So we're not particularly concerned with what we see, both in substandard assets and 90-day delinquencies. Again, as a real estate lender with relatively low average LTVs, we're pretty comfortable with our collateralization, where we are. We do expect and have expected and had been signaling that we expected both substandard assets and 90 day delinquencies to increase. So it's not a surprise. It's not a particular concern and we're going to continue to monitor it and report to you what we see in the portfolio.

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R. Dale Lynch, Federal Agricultural Mortgage Corporation - CFO, EVP and Treasurer [4]

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Just to add to that too. Curt's team does a pretty detail dive every quarter of our credit metrics and we do full country review, region by region, commodity by commodity and the reality is this quarter, the degradation in substandard assets was primarily driven by the region that Curt referred to throughout the country, which is essentially the [smile], it's down the West Coast, down through the southern United States through the delta and up into the Southeast. Surprisingly, very little to do with grain and oilseeds in the Midwest. Almost -- I mean, very little degradation in those statistics in the Midwest. Again, it's somewhat surprising to us, but the numbers didn't bear out the macroeconomic theme this quarter at all. So to Tim's point, we feel very good about where we sit and these really are pretty idiosyncratic event so far.

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Eric J. Hagen, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [5]

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My second question, let's suppose that before the end of next year, there is a cut in corporate federal taxes, somewhere in the ballpark of what's been discussed in these last couple of weeks. The question for you guys, I think, then becomes whether you can generate the same return on a higher capital base, all else being held equal? In other words, can you just give us some color around what the environment needs to look like in order for you to grow your portfolio either on par or faster than the 8% or 9% that you're currently doing.

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R. Dale Lynch, Federal Agricultural Mortgage Corporation - CFO, EVP and Treasurer [6]

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So Eric, when we look at our capital, we look at it in a number of different ways. One is statutory, another is on sort of a Basel kind of a metric, right and we publish that Basel metric for you all to see, we're at about 13% this quarter. When you look at our -- when you model our business, our returns on equity can remain in that sort of mid-teens area pretty reliably, well past 13%. As you start to get to 14% area, you're still -- the ROEs on our current business model and current rate of growth and profitability remain pretty stable. If our core cap -- if our Tier 1 metric go substantially beyond 14%, then you're talking about a different prospect. But there is a lot of levers we can pull if growth slows and we can't consume enough capital with growth, which is a bit of rich man's problem, right. Other levers we can pull, we've got a series of preferred issuances out there that we could call beginning in first quarter of 2018 is the first, which would obviously then be directly accretive to common shareholders. So, lots of levers to push, way too early to even think about that, but certainly things we can do in response to it.

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Timothy L. Buzby, Federal Agricultural Mortgage Corporation - CEO and President [7]

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I'll just add too, Eric, related to tax reform, our current federal tax rate is 35%, as it is with almost virtually all corporations. The reality is, however, most corporations, if you look at their income statement, their percentage of their tax expense to their pre-tax income is usually much less than 35% or as you can see from our income statement, is almost exactly that, 35%. So if the corporate tax rate were reduced to 20% that is being talked about, that entire 15% goes right into net income for Farmer Mac as opposed to us having a lower corporate tax rate -- effective tax rate that then gets marginally reduced. So that -- if that would occur, that full 15% would definitely come right into earnings.

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Eric J. Hagen, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [8]

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Yes, I don't think it's a debate that it's a benefit. I think my question is a little more forward looking as far as what the environment would have to look like in order for you to generate that exact same ROE that you're doing now or better, given a higher capital base?

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R. Dale Lynch, Federal Agricultural Mortgage Corporation - CFO, EVP and Treasurer [9]

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Well then, it goes to back to the things that we just talked about Eric and some of the levers we can pull. But frankly right now our growth is running at -- if you annualize it, we're annualizing to [$1.5 billion] net on balance sheet growth which is substantial. So we are building capital. We're not building capital at a huge rate right now. In fact our Basel ratios are kind of stable because the rate of growth. So we added another 20% to our earnings, the immediate impact would be a significant increase in ROE. Over time those earnings will build to your point, growth may consume that or we may pull up levers around the capital structure of the company. We've got common dividends as a lever, we've got preferred issuances we could call. We're not worried about that. We have -- all of our targets internally are designed to produce significant profitability in and around where we are today, both on a GAAP basis and on a risk-adjusted basis. So a significant change in our profitability would not be something that company would want to let happen as a result of a change in tax policy.

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Eric J. Hagen, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [10]

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Yes. So would you guys consider a higher rate of capital return to shareholders if you did not have a use for that capital?

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Timothy L. Buzby, Federal Agricultural Mortgage Corporation - CEO and President [11]

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Sure.

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Operator [12]

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The next question comes from Scott Valentin of Compass Point.

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Scott Jean Valentin, Compass Point Research & Trading, LLC, Research Division - MD & Research Analyst [13]

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Just with regard to the -- I'm looking at the -- I guess it's Page 25 of the earnings release, the Farm & Ranch spreads are down a little bit. I know earlier in the call you referred to tightening some standards. I'm just wondering, does that decline in the spreads, the net spread reflect -- or sorry yield, does that reflect that tightening of standards, think it dropped 5 basis points from last quarter.

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R. Dale Lynch, Federal Agricultural Mortgage Corporation - CFO, EVP and Treasurer [14]

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No. I mean it's a combination of things. We had a decrease in cash basis interest income in Q3 compared to Q2 which was significant cash. We book cash basis interest income on non-accrual loans when we actually get paid, right and that's pretty volatile. That can swing up and down $300,000 to $500,000 quarter to quarter and that's the primary driver of that difference in basis points.

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Scott Jean Valentin, Compass Point Research & Trading, LLC, Research Division - MD & Research Analyst [15]

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Okay. So the increase in non-accruals would drove that, okay.

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R. Dale Lynch, Federal Agricultural Mortgage Corporation - CFO, EVP and Treasurer [16]

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Any decrease in cash payments on non-accrual loans is what drove that decrease.

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Scott Jean Valentin, Compass Point Research & Trading, LLC, Research Division - MD & Research Analyst [17]

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Okay, alright. And then, just bigger picture, in terms of over time, just looking at the net effective spread overall for the entire portfolio, it was flat linked-quarter, that should move up over time though, as you shift more and more into Farm & Ranch, correct?

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R. Dale Lynch, Federal Agricultural Mortgage Corporation - CFO, EVP and Treasurer [18]

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Yes. I mean a mix shift could definitely drive that kind of dynamic that you mentioned, sure.

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Timothy L. Buzby, Federal Agricultural Mortgage Corporation - CEO and President [19]

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Yes, we disclose all the different lines of business in the spreads there. That's really more important to look at the individual pieces as opposed to how it all piles in together.

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Scott Jean Valentin, Compass Point Research & Trading, LLC, Research Division - MD & Research Analyst [20]

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Okay. And then, just in terms of operating expenses, I think you've referenced making investments in the business, I'm just wondering how we should think about operating expense going forward, should we think it, may be as an efficiency ratio, as a percent of revenue, as a goal or a target that you guys have in mind?

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Timothy L. Buzby, Federal Agricultural Mortgage Corporation - CEO and President [21]

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I think in general I would maybe think of it in terms of the overall book of business. We're at $18.6 billion and you can look at compensation and G&A as a percentage of that and I would expect that over time as we get to $20 billion, $22 billion, $25 billion, you'll see G&A and compensation and our investment in technology move roughly in the same line; I think that percentage, not that it will be exactly the same over that time period. But as our business grows, we're certainly going to invest back in the company in terms of people and technology.

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Scott Jean Valentin, Compass Point Research & Trading, LLC, Research Division - MD & Research Analyst [22]

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Okay, then one final question. In terms of -- you mentioned seasonality in delinquencies, just wondering how powerful is that seasonality? Could you see or would you expect the DQs -- all else being equal DQs to come down next quarter given the seasonality of the business or it is not that powerful?

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Timothy L. Buzby, Federal Agricultural Mortgage Corporation - CEO and President [23]

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Well, from a seasonality standpoint, we do see generally delinquencies reduced from third quarter to fourth quarter. That being said, with the degradation in the portfolio that we've seen, it could offset that. I think if you look back historically, you can see that delinquencies are typically the highest at the end of the first quarter, next highest at the end of the third quarter, and then second and fourth quarters are lower than both of those. It's hard to say how things are going to progress as we get through this fourth quarter. That's something that we'll continue to monitor. If delinquencies are up at the end of fourth quarter, I would say that would probably be in -- you'd also see an increase in substandard assets corresponding with it. But it's hard to tell. Again, we've been signaling that we expect delinquencies to go up overtime here. We've seen that occur and so it wouldn't surprise me, quite frankly, if delinquencies were a little bit higher in fourth quarter.

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R. Dale Lynch, Federal Agricultural Mortgage Corporation - CFO, EVP and Treasurer [24]

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But if you go to the Q, I mean to Tim's point on Page 91, on table 16, you can see at least the last several years and the patterns. In the last several years, the trend has been pretty significant in terms of the seasonal -- largely seasonal impact between say Q1 and Q2 and then Q3 and Q4.

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Operator [25]

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The next question comes from Brian Hollenden of Sidoti.

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Brian Christopher Hollenden, Sidoti & Company, LLC - Research Analyst [26]

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Do you guys have any exposure to the California wildfires?

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Timothy L. Buzby, Federal Agricultural Mortgage Corporation - CEO and President [27]

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We actually -- we're concerned as we were watching things happen there. There was an article that I read just this week talking about how -- there were very few vineyards that were really impacted. Our overall view both in terms -- we talked a little bit about concerns that we had with hurricanes, drought and the fires, but from what we can tell and what we've heard from our servicers and customers in the field is that we're largely unscathed related to the wildfires in California. So that's a very fortunate outcome.

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Brian Christopher Hollenden, Sidoti & Company, LLC - Research Analyst [28]

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And can you talk a little bit about the $225 million AgVantage purchase from Rabo, what drove kind of their decision? And I guess, more importantly, do you expect to do more business with them?

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Timothy L. Buzby, Federal Agricultural Mortgage Corporation - CEO and President [29]

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Yes, I mean they've been a great customer of ours for a long period of time and more recently, I'd say the last 12 to 18 months, we've definitely seen more net growth from them, I think that's due to a couple of factors. One is more net growth within their portfolio. I think that they've been kind of astute in how they price the best credits; been very proactive in targeting the better credits in the market. I think additionally they've begun to adopt Farmer Mac a little bit more broadly in their funding portfolio. They've begun to use us not just for longer-term -- longest term fundings, but also to consider Farmer Mac an alternative on the shorter end of their funding spectrum. I think this quarter what drove a lot of the net growth was just that. It was funding on the shorter end of the funding spectrum which they otherwise would -- may get from say their parent source, right. So, I think that's a real positive sign for us. While the spreads are lower, it's great to have the business on a risk adjusted basis. AgVantage is probably the best product that we can do.

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Brian Christopher Hollenden, Sidoti & Company, LLC - Research Analyst [30]

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And then similarly, can you talk a little bit about your marketing initiatives that led to the 2 new counterparties and sort of what's the overall opportunity set there?

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Timothy L. Buzby, Federal Agricultural Mortgage Corporation - CEO and President [31]

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So that was our -- under our Farm Equity AgVantage product. We've grown a department here internally at Farmer Mac that is comprised of 3 people here in DC that travel the country and solicit business from, largely financial counterparties. And these 2 new counterparties this quarter were that financial counterparties that invest in agricultural assets. So it's really an institutionalized effort for us that has grown up in the past 24 months, I think is starting to gain critical mass. We'd love that half a dozen new counterparties a year. We're on track to do that this year. And again, I think with these 3 people in place and sort of the prominence in how we market ourselves at these various financial conferences within agriculture, I think we're starting to get a toehold. We're definitely a prominent face in financing for institutions -- financial institutions within ag. So our hope is that this is a meaningful contributor to growth going forward.

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Brian Christopher Hollenden, Sidoti & Company, LLC - Research Analyst [32]

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And do you expect net effect spread to continue to increase year-over-year once you lap the reduction of that lower earning cash?

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Timothy L. Buzby, Federal Agricultural Mortgage Corporation - CEO and President [33]

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We don't necessarily see it that way. I think there might be a slight mix shift. The fluctuations in the LIBOR market on a month-to-month basis can easily provide noise around that. So I think where we sit now, I think, is probably a good stable state level for us with, again, market forces driving things up or down a little bit. But the profitability that we're kicking off at these spreads is pretty good. I mean we were several years ago, we'd tick down to a [low tick], I think of 81 basis points or 82 basis points. So we're up, whatever that is, 11% or 12% since then. One note on the credit, you asked a question around, I think it was wildfires in California. Steve reminded me on page 84, which is in credit risk loans in our Q we have a discussion -- we added some new language around that if you're interested.

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Operator [34]

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This concludes our question-and-answer session. I would now like to turn the conference back over to Mr. Buzby for closing remarks.

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Timothy L. Buzby, Federal Agricultural Mortgage Corporation - CEO and President [35]

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I'd like to thank everyone for listening and participating in this morning. We look forward to our next call to report our fourth quarter 2017 results in March of 2018. Thank you.

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Operator [36]

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The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.