Good afternoon, and thank you for joining us for our Q1 2022 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 risks and uncertainties that could cause our actual results to differ materially from those projected. Please refer to Farmer Mac's 2021 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 Investor section. Joining us from management this afternoon are our President and CEO , Brad Nordholm, who will discuss first quarter business and financial highlights and strategic objectives. 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 President and CEO, Brad Nordholm. Brad?
Thanks, Jalpa, and good afternoon, everyone. I'm really pleased that you were able to join us today. I'm happy to report a very successful Q1 2022. Our financial results are strong, as we'll be discussing, and we also are working to build upon a solid foundation for our future growth. We provided a gross $3 billion in liquidity and lending capacity to lenders serving rural America in the Q1 2022. This resulted in outstanding business volume of $24.2 billion as of 31 March . We generated consistent core earnings, and most importantly, our portfolio remains strong and credit performance continued to be stable with 90-day delinquencies and substandard asset ratios improving relative to the same period last year.
The agricultural finance line of business, which is approximately 75% of our total outstanding business volume and comprises all products secured by first liens on agricultural real estate, plus all USDA guaranteed loans, grew approximately $500 million this quarter, or roughly 3%. This is primarily due to our AgVantage securities and Farm & Ranch loan purchase programs. We are pleased to see our strong institutional relationships and the overall dynamics of the macroeconomic environment that have resulted in our ability to return as an invaluable partner in the wholesale financing space. At the onset of the pandemic, opportunities for new business volume in our AgVantage securities program were limited as the liquidity support provided by the Federal Reserve Bank resulted in the tightening of investment-grade credit spreads to historically low levels and increased competition.
Net Farm & Ranch loan purchase volume was strong during the Q1 , despite its seasonally large number of payments. That's because most of our Farm & Ranch loans have annual and semiannual payment terms with January first payment dates. During the Q1 , markets experienced a disruption caused by a combination of factors, including inflation, a federal funds rate increase, expectations of future increases, as well as the conflict in Ukraine. Farm expenses are rising in nearly all categories, with higher grain, fertilizer, energy, and labor prices driving the trend, and the impacts of these increases will vary by operation and commodity type. We believe the sector's operating expense ratio is likely to increase back towards a historically high level. However, firm commodity and food prices do leave room for farm profits this year. The USDA is forecasting record net cash incomes for 2022.
While production expenses are forecast to increase and government payments are expected to fall, rising cash receipts should offset these changes, with recent commodity price data suggesting that even stronger incomes are possible. In terms of our portfolio, while we anticipate that future lower financings could result in lower levels of new loan purchases in some of our Farm & Ranch and USDA products, it could also result in lower portfolio prepayment speeds. Our pipeline in this line of business remains strong, and we will continue to be adaptive as we navigate through this environment that is characterized by significant uncertainty. Our Rural Infrastructure Finance line of business grew nearly $150 million this quarter, or 2%, primarily due to our loan purchase product.
This growth was fueled by a competitive but increasing interest rate environment, resulting in demand for long-term financing solutions for planned maintenance and capital expenditures. Also contributing to growth this quarter in rural infrastructure line of businesses was a $35 million commitment to a large solar project. As I've said on prior calls, renewable energy is both an important economic development opportunity for rural America, and it's a business opportunity for us. Another business opportunity for Farmer Mac is our securitization program. As mentioned in our last earnings call, over the last few months, we have been focused on enhancing our infrastructure to support a securitization program, and we are closely monitoring a changing market dynamic. The market for new issue securitizations was challenged during the Q1 as the volatility in the debt capital markets resulted in somewhat of a slowdown in securitization markets.
We remain committed to being a regular issuer in the market with a diverse set of securitized products that align with our investor interests. With that said, in the near term, our plan is to slowly ramp up the number of issuances each year as we focus on building a strong foundation for the program. Farmer Mac continues its measured and thoughtful investment in people, technology, and business infrastructure to improve our capacity and efficiency, and we believe these will help us deliver on our long-term goals. We set meaningful market share goals for ourselves in our strategic plan, and to achieve these goals over the long run, we're going to need to be able to achieve gross annual business volumes that represent a growth over our current asset levels.
As an example of our efforts to upgrade our technology platform, including doubling the eligible loan size for our AgXpress Scorecard products from $1.5 to $3 million. Upgrading and enhancing this underwriting solution to achieve this outcome will require appropriate investments. Another initiative currently underway at Farmer Mac is our rebranding efforts, which are currently in early stages. We recognize that we have grown significantly in size over the last few years, and as a result, we are reaching a larger set of audiences and stakeholders with different profiles, but all with a shared passion for rural America. We hope that through our rebranding initiative, we're able to better to gain deeper insight from each of our stakeholders in order to continue to build on our strong reputation as the nation's key trusted secondary market for credit to rural America.
The continuity of our culture and business model continues to deliver consistent, positive results. With the support of our board, we believe that our unified commitment to Farmer Mac's strategic plan, in conjunction with the organization's talented and committed employee base, is enabling us to take Farmer Mac to the next level. Now I'd like to turn the call over to Aparna, our CFO , to discuss our financial results in more detail. Aparna?
Thank you, Brad, and good afternoon, everyone. Core earnings for Q1 2022 were $25.8 million, or $2.37 per diluted common share, compared to $30 million or $2.75 per diluted common share in Q4 2021, and $25.9 million or $2.39 per diluted common share for the same period last year. The sequential decrease was due to the non-recurrence of the Q4 2021 $5.2 million after-tax gain on sale of mortgage loans, a net change in our total allowance for losses of $1.1 million after tax, and a $0.7 million after-tax increase in operating expenses. These factors were partially offset by a $2.8 million after-tax increase in net effective spread.
The year-over-year decrease in core earnings was primarily due to a $2 million after-tax increase in operating expenses and the $1.5 million increase in preferred stock dividends. These factors were partially offset by $3.1 million after-tax increase in net effective spread. Net effective spread for Q1 2022 was $57.8 million, an approximate 7% increase compared to Q4 2021 and the same period last year. The sequential and year-over-year improvement in net effective spread was primarily driven by net new business volume and cash-basis interest income. Also contributing to the year-over-year increase was an increase in net coupon yields related to the acquisition of loan servicing rights in Q3 2021.
Our liability side of the balance sheet remains strong as we continue to benefit from our dynamic funding strategies that we've outlined to you in the past as we continue to maintain our disciplined asset liability management. Additionally, we continue to very carefully analyze our duration and convexity matches, especially in this rising rate environment, to minimize our interest rate risk. Last quarter, we introduced operating segments to allow us to offer more transparency into the various contributing components of our portfolio's net effective spread. We've implemented a funds transfer pricing or FTP methodology. This process allows us to allocate interest expense much more accurately to each of the operating segments. Since funds transfer pricing or FTP assumes a match-funded asset liability management approach, it allocates both the benefits as well as the costs from the funding and hedging strategies to the funding segment.
This also allocates the results of the investment portfolio that we primarily hold for liquidity purposes. We believe that the new segment reporting construct provides shareholders and other stakeholders with clearer insight into the benefits of our disciplined ALM practices and dynamic funding strategies and how they ultimately contribute to enterprise profitability. Successful execution of a $299.4 million agricultural mortgage-backed securitization in October was a key contributor to our core earnings results in fourth quarter of 2021. While we have spent the last few months identifying ways to potentially execute these transactions more efficiently, and we hope to return to the market this year with another securitization transaction, we are taking a more measured approach in the short term, just as Brad mentioned, recognizing that current market dynamics are resetting credit market perspectives and rate outlooks.
Q1 2022 was extremely challenging for the securitization market as the evolving macro rate environment has contributed to spreads that are widening and interest rate volatility that is increasing throughout the quarter. We are, however, still committed to building a robust securitization program, which we believe will provide Farmer Mac with an opportunity to diversify its funding sources and fulfill our mission of delivering low-cost liquidity even more effectively. Our current focus, therefore, is strengthening the platform and remaining opportunistic in terms of timing and structure to ensure we are not issuing in the face of volatility and uncertainty, and that we continue to create value for our shareholders with these and other transactions.
Operating expenses increased by 13% in Q1 2022 compared to Q1 2021, and this was primarily due to increased headcount, including 10 new employees in connection with the strategic acquisition of loan servicing rights in Q3 2021. Increased stock compensation and increased spending on software licenses and information technology and other consultants to support growth and strategic initiatives, some of which Brad mentioned earlier. The increase in 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 segment, where we will not be paying a third party for servicing the loans that we will now service. This should make the initiative neutral to accretive for us in the midterm.
The remaining hires were brought on to drive additional volume growth and support our long-term technology strategy. We plan to continue our investments in both headcount and technology through 2022 and into 2023, and this will be primarily to modernize and mitigate risk in our infrastructure, enhance our technology platforms to support our revenue and hedging strategies, and add relevant talent across the organization, especially as we scale and enter into new areas of business such as renewable energy and telecom. Over the next 12 to 18 months, we'll continue, as we've done before, to closely monitor our efficiency ratio, which ended 31 March 2022 at 33%. Going forward, we expect operating expenses to increase commensurately with revenue growth.
As we've noted previously, we expect to stay within an annual range that is consistent with our historical averages and below a 30% operating efficiency level. Our credit profile continues to be strong. As of 31 March 2022, the total allowance for losses was $16.3 million, a modest decrease from year-end 2021. This decrease was primarily attributable to a risk rating upgrade on a single loan related to the borrower's successful securitization of a large payable that was incurred as a result of the Arctic freeze that struck Texas in February 2021. This was partially offset by new loan volume. Turning to capital now. Farmer Mac's $1.2 billion of core capital as of 31 March 2022 exceeded our statutory requirement by $489 million or 66%.
Core capital modestly increased from year-end, primarily due to an increase in retained earnings. Our Tier 1 capital ratio improved to 15% from 14.7% as of 31 December 2021. Subsequent to our February earnings call, the outlook for interest rates has changed materially. Low levels of unemployment and continued supply chain disruptions exacerbated by the situation in Ukraine have pushed inflation to levels not seen since the early 1980s. Interest rates began to rise even before the Federal Reserve raised its fed funds target in late March. Rate hikes are predicted to occur more quickly than we anticipated in the beginning of the year. We locked in low fixed rate funding over the past two years, and that has positioned us extremely well to withstand either a rising or flattening rate environment.
Despite rising rates and higher input costs that are experienced by our borrowers, credit quality remains strong given the increase in commodity prices that has outpaced the increase in input costs. We're managing expense growth thoughtfully, as mentioned before, and commensurately with revenue growth as we navigate this volatile rate environment and our opportunities. We are, however, overall very well positioned for the future and excited about the opportunities ahead of us. With that, Brad, I'll turn it back to you.
Thank you, Aparna. We experienced a strong start to 2022. We are delivering well on all of our initiatives, and we believe we're well positioned to deliver strong financial performance and consistent returns to shareholders over the rest of 2022. Farmer Mac has significantly increased its profile and name recognition over the last few years, and we believe this will help us as we bring new capital to agriculture and to rural communities of America. Now, operator, I'd like to see if we have any questions from anyone on the line today.
We will now begin the question-and-answer session. To ask a question, you may press star then one on your touch-tone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. At this time, we'll pause momentarily to assemble our roster. The first question will come from Marla Backer with Sidoti. Please go ahead.
Thank you. So could you give us a little bit more color on, you know, how you see the impact of current geopolitical situation and the general, you know, economic situation, how you see that impacting grain prices in terms of, you mentioned in your prepared remarks, having an impact on the credit quality of your overall portfolio. Is there any, expectation that that will filter down into, increased business volumes for you down the road?
Yeah. Marla, thanks so much for that question. Obviously this is an extremely volatile environment which we're operating. Not only are we dealing with increases in interest rates, but the global events which are having a significant impact on commodity prices, including agricultural prices and the inputs into agricultural production. I'm going to ask Zach Carpenter to comment on the business outlook and how we're seeing the combination of rising interest rates and volatility and generally good conditions in American agriculture impact originations. I'm also going to ask Marc Crady to comment a little bit on credit quality. Let me begin by saying that the overall condition of American agriculture, while these price changes are unnerving, the outlook, as I said, remains generally quite positive, with anticipated record levels of earnings in American agriculture in 2022.
If you look at the commodity sheets, you know, we're seeing corn approaching $8 a bushel. We're seeing wheat over $10 a bushel. But at the same time, we're seeing natural gas at $7.50. We're seeing global oil at over $100 a barrel. You know, agriculture has the effect of rising cost of inputs. But it also is seeing really a level of commodity, agricultural commodity prices that we haven't seen, frankly, for about 10 years.T hat's both on a real as well as nominal basis. Let me turn to Zach and let him add some color on how we're seeing that translate into ebbs and flows and demand for credit.
We'll carefully distinguish between demand for short-term operating credit, which may be a function of commodity prices for inventories and longer term trends as it relates to land. Zach.
Yeah. Thanks, Brad. Marla, great question. I think Brad summed it up, very nicely. It's when you have all these numerous components coming into the market, it creates, I would say, a lot of pause. Record grain prices are continuing to help with the economics of the farmer. We are seeing farmers continuing to, you know, execute on real estate transactions. That being said, we have seen the fastest increase in interest rates for our products in many years. You do get that sticker shock in terms of severity of increase in rates, and that creates a little pause, coupled with all the uncertainties going on in the market.
You know, when you look in the food and agribusiness space, in those transactions, we've had a pretty quick drop off in volume compared to Q1 2021. Again, that goes back to just uncertainty and trying to understand what's happening in the market and making sure transactions come at the appropriate time. You know, overall, our borrowers are in a very strong position. From a historical perspective, debt is still relatively cheap, even though you've had a significant increase in interest rates. You know, as Brad mentioned in the remarks and Aparna Ramesh said, we had a strong quarter in Farm & Ranch loan purchases in Q1 2021.
We're assessing the market, and we're looking to be flexible and competitive in our rates and support the sellers and the lenders and their borrowers as they navigate this uneasy time. You know, again, assessing the market, assessing the uncertainty, and being able to support the customers in a very strong economic environment from a commodity and ag space with our products and services.
Marc, could you add anything relative to credit quality and what we're actually seeing in the numbers right now?
Yeah. Thanks. Let me start out by saying that current credit quality is very strong, as evidenced by strong farm incomes over the last year. Going forward, as mentioned, volatility has been very high. Input costs have been very high. We expect farm incomes to continue to be strong in 2022. From an overall credit quality perspective in the portfolio, we expect to see continued strong performance. That doesn't mean that there may be some operators, some producers, some farmers and ranchers, in some commodity sectors that won't experience some level of distress. Generally speaking, you know, we're optimistic in terms of continued high-quality credit performance.
Okay. Thank you for that comprehensive answer or those comprehensive answers. Just one follow on, which is a lot of the factors that you noted, we're seeing obviously, uncertainty impact a lot of factors and a lot of , general demand for financing and for transactions. Given where you sit and how, you have access to capital that, certain other institutions don't. How do you see this playing out in terms of perhaps, providing some opportunity for market share gains? Or, do you see it playing out that way?
Yeah. There are opportunities, and they're in different corners of our portfolio in our lines of business, I think, Marla. For example, right now, one of the impacts that the rapid run-up in commodity prices is happening is that farmers are drawing on their operating lines of credit very heavily. That is resulting in banks that have an agricultural concentration, including Farm Credit Banks, experiencing rapid and, in fact, quite unexpected run-ups in asset levels. That, in some cases, is putting some pressure on capital. One, not the only driver, but one of the drivers of the increase in AgVantage activity at the very end of the quarter was because of just that. So, interesting to think about how it translates into new opportunity.
With the steepening of the yield curve, it actually is a bit distracting from one of our real core competitive advantages, which is at the long end of the curve, very long-term fixed rate mortgages. But we have the ability and in fact, our rate sheets publish offerings across the full curve, and we do short-term variable rate financing as well. You know, we may see some pickup there, and that may be a second example of the kind of opportunity that you're alluding to. The third thing I just mentioned is that, you know, we are extremely disciplined in how we price our loans, our asset liability management.
We've talked about that on numerous occasions before, but we pretty much match all of our business activity to current, meaning real time, this minute, this hour, this day, debt capital market conditions. When we first saw the rapid run-up in interest rates, that was reflected immediately in our rate sheet. Some of our competitors lagged the market a bit. That was a little bit of a disadvantage to us. As they catch up, it then begins translating more into an AgVantage for us. Those are three specific ways that we could see some increasing demand per product amidst this unprecedented volatility that you're referring to.
Okay. Thank you very much.
The next question will come from Gary Gordon, investor. Please go ahead.
Okay. Thanks a lot. Appreciate your taking my questions. A couple about interest rates. First, on your existing portfolio, obviously, you've got a variety of hedges to limit interest rate risk. Due to obviously dramatic market shifts in Q1, did that cause any adjustments to the hedges? Was there anything needed to be done to maintain the stability in the portfolio?
Gary, one of the benefits of having this kind of volatility is that we are going to prove to you what we've been talking about for years, and that is the discipline of our asset liability management. I think the short answer is no, but let me turn to Aparna to give you some real color on just exactly why that is.
Yeah, absolutely, Gary. Y ou can see some of this volatility play out actually to the positive when you look at our net income profile. Essentially, we don't hold derivatives on our balance sheet for speculative reasons as you know. We really hold this much more to manage our asset liability management. So pivoting to what Brad said, and actually really even responding to the first question, that Marla had, which you know which comes back to, how we price. We have some tremendous advantages because we really don't take on any basis risk or underlying interest rate risk, and we're able to do that through managing our derivatives activities. S o we can actually match funds.
We can also issue and take positions, offset positions that allow us to almost completely eliminate our interest rate risk. When you add all of that together, maybe it's a slightly complicated way of looking at it. We essentially have really the benefit, especially in this rising rate environment, some of the positions that we've taken on in the last two years that are really coming out in our favor. There's probably a lot to unpack there, but you know, maybe the short answer to that is, it continues to be an advantage for us in terms of how we fund and manage our balance sheet through our.
Okay. Thanks. Second one is, typically in volatile markets, spreads widen out. You can discuss a minute, your own funding costs versus treasuries, and then maybe more important, available spreads for new investment.
Sure. Let me take that, that first part of your question in terms of our funding costs. We are seeing definitely a widening of our funding. I will say that when we look at where we are relative to our competitors, you know, and by that I mean the Federal Farm Credit Banks Funding Corporation or other GSEs. We typically on the long end of the curve maybe been somewhere between five to 10 basis points, you know, on top of them. Everyone is seeing widening across the board relative to, you know, what's happening.
I think also as a GSE, maybe from a credit standpoint, credit spreads widening out, we're not seeing as much, you know, relative to maybe, you know, other issuers. We are seeing same dynamics that we've seen in the past two years relative to other GSEs. We're not seeing anything very different. As far as it relates to us specifically, this, again, you know, I'll just reiterate this, and you know this, Gary, but over the last two years we've really been very opportunistic, whether it's on our capital stack, through preferred issuances or whether it's been through extending our debt funding. I think the treasury team has done a very, very good job of really extending our liabilities.
Now we can be very opportunistic in terms of, you know, when we want to go out there and fund at the long end of the curve. We have a little bit of a bias not to do that until the volatility settles down. We have an abundant amount of really debt funding at all points on the curve. We can really manage our interest rate profile and our end debt profile pretty opportunistically.
Okay, good. One last question on the net interest margin. You said it was 97 basis points operating basis this year, same as last year. The servicing business, obviously the expenses of it run through operating expense. The revenue, is there a way to estimate how much of an impact it had or benefit to the net interest margin?
Yeah. You know, we can actually come back to you on it. It's still early days in terms of really being able to give you a sense of that. I would say about a third of the Farm & Ranch portfolio is likely to be funneled back into the servicing business. If you look at our incremental volume, and again, Q1, we had some dynamics, shifting dynamics going on with additional prepayments and so on in Farm & Ranch. It was probably a little bit of a wash, and you wouldn't have seen much of a benefit on that 97 basis points. Over time, really you should see, you know, an incremental volume anywhere between 18 to 25 basis points of a pickup on about a third of our net incremental volume.
I mean, that's probably the way to think about it.
Thanks. One last question on operating expenses. You said your efficiency ratio is 33% today, and you've got spending plans for the next, let's say, four to six quarters. Ultimately you want below 30% efficiency ratio, which is a fairly big move. Is this, gee, we hope one day or there's a three-year plan to get it back to the 30%? How should I think about that?
Let me jump in, and you know, I'm sure Brad or others might wanna add to this. You know, the Q1 , typically, when you think about revenue, and this is not unusual. Go back to the Q1 of last year and the previous quarter in 2020. Q1 tends to be north of 30%. One dynamic that we have additionally seen playing out. In fact, you know, when you look at why that's the reason, compensation tends to be something that really pops up. We've really done, I think, a fairly good job of managing just the run rate of compensation and keeping that down. It's not really out of line with, you know, last year and the year before.
Y ou see some of that normalizing towards historical averages over the rest of the year. What you're likely going to see this year is that continued investment in technology and headcount that we talked about. That'll keep that efficiency ratio at a highly elevated level. We will see additional loan pickup, loan activity, because typically in Q1 you do see more seasonality in terms of prepayment. That also has a tendency of making that efficiency ratio go up. W e know, our sense is that will likely come down, and it's not going to be a huge move because we can see some pretty big swings. The second point here is just that seasonality around compensation. That goes away in the remaining quarters.
One dynamic is obviously the servicing acquisition that does have, I would say, a higher efficiency ratio relative to the rest of our business. That trend is likely to persist. You know, back to your earlier question on seeing those spreads play out as we continue to service some of that volume and that additional spread pickup, all that will start to really help with respect to the denominator of that efficiency ratio. We feel pretty optimistic that we can manage our efficiency ratio at under that 30% on an annualized basis.
Yeah. Yeah, Gary, just to elaborate on that. If you go back to Q1 2021, we were between 32% and 33%. If you go back to Q1 2020, we were between 22% and 23%. This is not really an outlier, although it is slightly higher. But to be also specific, our goal is to get that efficiency ratio for fiscal 2022 down to that 30% or below level.
Okay. Terrific. Thank you.
This concludes our question and answer session. I would like to turn the conference back over to Brad Nordholm for any closing remarks. Please go ahead, sir.
No. Well, thank you, operator, and thank you all for participating in the call. As always, with follow-up questions or things that you'd like to have clarified, please get in touch with Jalpa. We'll put together the right people to answer your questions. This is a time of great volatility, but you know, I think you've heard optimism on this call today, and you also heard confidence. The real confidence comes from Farmer Mac's business model. It is designed from an asset liability standpoint, from an origination standpoint to be highly resilient.
While we don't know exactly where commodity prices and interest rates will be six months from now, we do know that the way we're structured, we're very well positioned to continue to deliver very steady results and to continue to fulfill our mission of serving American agriculture. I'll just leave you with that thought. Thank you very much for participating. Look forward to talking to you all soon.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.