Federal Agricultural Mortgage Corporation (Farmer Mac) — Q3 2011 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2011; filed November 9, 2011. Financial statements are unaudited and consolidated.
Business context and performance
Farmer Mac provides liquidity and credit support to rural lenders through its Farmer Mac I, Farmer Mac II and Rural Utilities programs. Its activities include purchasing loans and securities, guaranteeing securities and providing long-term standby purchase commitments (LTSPCs).
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Interest income | $71.1 million | $58.6 million | $202.0 million | $176.6 million |
| Net interest income | $31.7 million | $25.0 million | $87.9 million | $70.3 million |
| Net income (loss), consolidated | $(16.8) million | $12.3 million | $19.3 million | $33.9 million |
| Net income (loss) attributable to common stockholders | $(23.0) million | $6.0 million | $0.5 million | $9.6 million |
| Diluted earnings (loss) per common share | $(2.22) | $0.56 | $0.04 | $0.91 |
| Management’s non-GAAP core earnings | $11.2 million | $7.9 million | $30.3 million | $18.6 million |
Interest expense was $39.4 million in Q3 and $114.1 million for the nine months. Quarterly net interest income increased 27% year over year. The nine-month adjusted net interest yield was 1.20%, down from 1.33%; net effective spread was 0.94% for the nine months, compared with 1.05%. Quarterly net effective spread was 0.93%, versus 1.04%.
GAAP results were sharply affected by derivative fair-value volatility: derivative losses were $68.6 million in Q3 and $82.4 million for the nine months, including $55.2 million of unrealized losses in Q3. Management said the derivatives economically hedge interest-rate exposure, but are not designated for hedge accounting; it expects unrealized fluctuations not to have a permanent earnings or capital effect if held to maturity. Core earnings excludes specified fair-value and other items and is not a GAAP measure.
Balance sheet, cash flow and capital
- Total assets were $11.43 billion at September 30, up from $9.48 billion at December 31, 2010, principally reflecting increased on-balance-sheet AgVantage securities.
- Notes payable totaled $9.89 billion, versus $7.94 billion at year-end; $5.83 billion was due within one year. Total liabilities were $10.88 billion, and total equity was $547.1 million, including $241.9 million of non-controlling preferred equity.
- Cash and cash equivalents were $825.0 million, up from $729.9 million. Investment securities totaled $1.91 billion. Farmer Mac reported 174 days of liquidity at quarter-end and an average of 167 days during Q3; its regulatory target is 90 days, with a 60-day minimum.
- Nine-month cash flow: operating activities provided $8.8 million, investing activities used $1.71 billion, and financing activities provided $1.80 billion. Cash increased $95.1 million. The 2010 cash-flow comparison was restated for classification errors between operating and investing activities; the restatement did not affect reported cash balances or other financial statements.
- Core capital was $461.3 million, $124.7 million above the $336.6 million statutory minimum. Regulatory capital exceeded the $110.9 million risk-based requirement by approximately $368.1 million. The company reported compliance with applicable capital requirements.
Changes, outlook and principal risks
- Outstanding program volume was $11.84 billion, down from $12.22 billion at December 31, 2010, despite $3.03 billion of new volume in the first nine months. Management attributed the decrease mainly to maturities and paydowns, including a $475 million AgVantage maturity, and reduced lender demand amid a strong agricultural economy.
- Q3 new program volume was $1.46 billion. A $1.0 billion purchase of MetLife AgVantage securities replaced maturing off-balance-sheet guarantees; management expects the on-balance-sheet margin to exceed the prior guarantee fee, though the transaction did not increase total program volume.
- Credit indicators improved: Farmer Mac I 90-day delinquencies were $44.8 million, or 1.02%, versus $64.8 million, or 1.53%, a year earlier. Non-performing assets were $64.1 million, or 1.46%, versus $78.4 million, or 1.86%. Overall program delinquencies, including guaranteed and other program exposures, were 0.38%. The allowance for losses was $17.7 million, down from $20.1 million at year-end.
- Management sees potential for continued agricultural and rural-utilities business growth but said volumes depend on lender liquidity needs, borrower demand, concentration limits and financial-market stability. It noted feed-grain price volatility, potential pressure on protein-sector margins, continuing uncertainty for ethanol economics and federal support, and sensitivity of rural-utilities lending to economic conditions and regulation. No specific earnings or volume guidance was provided.
- Key exposures include interest-rate and funding-market risk, agricultural commodity and collateral concentration, and counterparty risk. A 100-basis-point rate increase was estimated to reduce net interest income by 6.1%; a 25-basis-point decrease by 6.5%. The company also disclosed $1.69 billion of off-balance-sheet guarantees and $1.81 billion of LTSPCs, before potential recourse, recoveries or collateral.
- Fair-value estimation is significant: $5.8 billion of assets and liabilities measured at fair value were Level 3 at quarter-end. Auction-rate certificates of $62.2 million had no active auction market and were carried at 84% of par. Derivative collateral arrangements could require an additional $88.2 million if specified contract provisions were breached.
- Regulatory changes remain under development, including possible derivatives margin and capital rules and proposed revisions to liquidity, investment and risk-based capital requirements. Management said the full effects were not yet assessable. The filing reported no legal proceedings and no material change in previously disclosed risk factors.
- Unusual or notable items included $9.9 million of Q3 gains from reversing prior lower-of-cost-or-fair-value adjustments on loans held for sale, a $0.9 million first-quarter expense for terminating a third-party servicing agreement, and recognition of previously deferred gains related to Farmer Mac II assets.
Important facts for investors to verify
- Reconcile GAAP losses to core earnings and assess the assumptions behind management’s view that derivative fair-value losses will reverse or have no permanent effect.
- Review debt maturities, continued access to capital markets, liquidity calculations and the potential cash or collateral demands under derivatives.
- Monitor Farmer Mac I delinquencies, non-performing assets, specific allowances and exposures to permanent plantings, ethanol and other stressed commodities.
- Evaluate AgVantage issuer concentrations, required collateralization and maturity timing, including related-party rural-utilities exposure.
- Track implementation of proposed regulatory changes and their potential effects on capital, liquidity, investment eligibility and hedging costs.
- Consider the cash-flow restatement and the substantial use of Level 3 fair-value estimates when assessing reported period-to-period results.