FEDERAL AGRICULTURAL MORTGAGE CORP annual report, FY2011

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Business context and reporting period

Federal Agricultural Mortgage Corporation (Farmer Mac) filed this Form 10-K on March 15, 2012, covering the fiscal year ended December 31, 2011. The federally chartered, stockholder-owned GSE provides a secondary market for rural credit through Farmer Mac I agricultural real estate loans, Farmer Mac II USDA-guaranteed loans, and Rural Utilities loans. Its obligations are not guaranteed by the U.S. government.

Financial and operating performance

  • Earnings: Net income was $38.9 million, versus $52.7 million in 2010. Net income attributable to common stockholders was $13.8 million, or $1.28 diluted EPS, compared with $22.1 million, or $2.08, in 2010. Management’s non-GAAP core earnings rose to $42.9 million ($3.97 diluted EPS) from $25.4 million ($2.39); core earnings exclude fair-value effects and specified unusual items.
  • Interest income and spread: Interest income was $274.7 million and net interest income was $121.3 million, up from $238.7 million and $96.0 million, respectively. Net interest yield declined to 1.20% from 1.30%; net effective spread increased to $89.4 million from $66.5 million, while its yield eased to 0.96% from 1.06%. Guarantee and commitment fees were $24.8 million, compared with $24.1 million.
  • Fair-value volatility: Derivative losses were $92.6 million, including $47.6 million of unrealized fair-value losses, largely reflecting falling long-term rates. Management said the unrealized swings are not expected to have a permanent effect if derivatives are held to maturity, but they materially affected GAAP results.
  • Assets, debt and equity: Total assets grew to $11.9 billion from $9.5 billion; total liabilities rose to $11.3 billion from $9.0 billion. Notes payable totaled $10.2 billion, including $6.1 billion due within one year. Total equity was $554.5 million, including $241.9 million of non-controlling preferred stock.
  • Liquidity and capital: Cash and cash equivalents were $817.0 million; cash plus investment securities totaled $3.0 billion. Farmer Mac reported 151 days of liquidity at year-end and an average of 169 days during 2011. Core capital of $475.2 million exceeded the $348.7 million statutory minimum by $126.5 million; regulatory capital exceeded the $52.9 million risk-based requirement by about $439.8 million. The corporation was in the highest regulatory compliance category.
  • Cash flow: Operating activities provided $26.8 million, investing activities used $2.0 billion, and financing activities provided $2.1 billion. Cash increased $87.1 million to $817.0 million. Comparisons of operating cash flow warrant care: the filing notes prior-period cash-flow classifications were restated, without changing net changes in cash.
  • Credit quality and business volume: Total program volume was $11.9 billion, down $303.4 million year over year despite $3.4 billion of new business. Farmer Mac I 90-day delinquencies fell to $40.6 million (0.93% of the relevant portfolio) from $70.2 million (1.63%); total-program 90-day delinquencies were 0.34%, versus 0.58%. Net credit losses were $0.2 million, and the allowance for losses declined to $17.5 million from $20.1 million.

Material changes versus 2010

  • Core earnings improved substantially, chiefly on higher net interest income and a release from the reserve for losses; GAAP common earnings declined because of derivative fair-value losses.
  • Assets and notes payable expanded, primarily as Farmer Mac purchased $1.8 billion of Farmer Mac I AgVantage securities. Total on- and off-balance-sheet program volume nevertheless decreased, principally after a $475 million AgVantage maturity was not replaced.
  • New business volume increased to $3.4 billion from $3.0 billion. Farmer Mac I LTSPC additions rose to $472.0 million from $263.7 million, while Rural Utilities additions fell to $206.6 million from $966.0 million.
  • Credit indicators improved, including lower delinquencies and non-performing assets. Allowance releases reflected lower estimated losses, including in ethanol and dairy exposures.

Outlook, risks and unusual items

Management sees potential for future growth in agricultural and rural utilities lending but gave no numerical earnings or volume guidance. Strong farm profitability, lender liquidity, low rates and reduced rural electricity demand constrained borrower and lender demand for Farmer Mac’s secondary-market products. Management expects demand could strengthen as financing needs, regulation and economic conditions change.

  • Risks include dependence on frequent debt-market access; interest-rate, spread, derivative-counterparty and credit risks; agricultural commodity, weather and land-value volatility; rural-utility policy and operating risks; and potential legislative or regulatory changes. The Dodd-Frank derivatives rules and proposed FCA changes to capital and liquidity/investment rules remained under development.
  • Farmer Mac’s off-balance-sheet LTSPCs and guarantees totaled $3.4 billion at year-end. The separate $1.5 billion U.S. Treasury borrowing authority is limited to fulfilling guarantee obligations after the required reserve is exhausted; it had never been used. The filing emphasizes that Farmer Mac securities and debt are not U.S.-government-guaranteed.
  • Valuation is a notable judgment area: $5.9 billion of fair-value instruments were Level 3, representing 49% of total assets and 72% of fair-value instruments. Auction-rate certificates remained illiquid; $60.2 million was carried at 81% of par.
  • Concentration matters: CFC accounted for all Rural Utilities program activity since launch and 19.7% of total outstanding program assets at year-end. Farmer Mac also reported related-party business relationships and associated servicing and investment exposures.
  • Other items: the corporation recorded $8.9 million of gains from reversing prior loan-held-for-sale valuation losses and $5.2 million of previously deferred Farmer Mac II gains in other income. The 2011 fourth quarter reported $13.3 million of net income attributable to common stockholders; the third quarter reported a $23.0 million loss, illustrating quarterly volatility. Management and the auditor concluded internal control over financial reporting was effective; the auditor issued an unqualified opinion. No legal proceedings were reported.

Important facts for investors to verify

  1. Reconcile GAAP common earnings with management’s core-earnings measure, including derivative marks, and assess whether the claimed non-permanent nature of unrealized derivative losses remains supportable.
  2. Review the debt maturity and refinancing profile, capital-market access, liquidity assumptions and the potential effects of new FCA or Dodd-Frank requirements.
  3. Monitor the $3.4 billion of off-balance-sheet program obligations, collateral and counterparty quality, and the availability and limits of the Treasury backstop.
  4. Test credit trends by portfolio segment and concentration, particularly permanent plantings, ethanol and other specialized collateral, as well as CFC and AgVantage exposures.
  5. Assess the sensitivity of reported asset values and capital to Level 3 assumptions, illiquid auction-rate securities and interest-rate movements.
  6. Confirm the sustainability of business volume, net effective spread, and the common dividend, which the board may restrict if capital requirements are not met.