Welcome to the Farmer Mac first quarter 2018 investor conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your touch-tone phone. To withdraw your question, please press star then two. Please note, this event is being recorded. I would now like to turn the conference over to Lowell Junkins, Acting President and Chief Executive Officer. Please go ahead.
Good morning. I'm Lowell Junkins, Farmer Mac's Acting President and CEO. Farmer Mac is pleased to welcome you to our first quarter 2018 investor conference call. We posted a slide deck on 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.
Thanks, Lowell. Some of the statements made on this conference 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 may not be obligated to update these statements after 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 2017 annual report on Form 10-K and our subsequent quarterly report on Form 10-Q, which was filed with the SEC this morning.
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 three 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 performance and to develop financial plans. In management's view, they are useful alternative measures for understanding Farmer Mac's business. 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. These measures are not meant to be considered in isolation from, as a substitute for, or as 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 most recent Form 10-Q and 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 two weeks starting later today.
Thank you, Steve, and thanks for all of you that joined us this morning. Our first quarter 2018 results largely reflect the continuation of strong trends that developed over the course of the last few years. From business volume growth to continued favorable credit quality to double-digit core earnings growth, Farmer Mac's performance hasn't skipped a beat. Our business volume grew by $19.4 billion. Our substandard assets remained unchanged as a percentage of our portfolio, and our core earnings per share grew 46% year over year. Even without the benefit of the lower federal corporate tax rate that became effective at the beginning of 2018, our core earnings per share still grew 19% year over year. These results demonstrate the talent and commitment that Farmer Mac's leadership team and employees bring to their jobs every day.
As you can see in the morning's press release, the new lower federal corporate income tax rate had a positive effect on Farmer Mac's first quarter earnings results. We expect to see a significant increase in core earnings per share related to the tax benefit, which was an important factor in why we increased our quarterly dividend 61% to $0.58 per share on all classes of our common stock beginning this past quarter. We believe that our strong earnings potential and overall capital position will continue to support our dividends going forward as we approach our targeted core earnings payout ratio of approximately 30%. Farmer Mac continues to execute on the strategic initiatives to increase capacity and efficiency, which includes investing in our people, enhancing our technology, improving our infrastructure, and maintaining a leadership position in financing rural America.
The benefit from the new lower federal corporate tax rate has allowed us to further these initiatives while also increasing returns to our common stockholders. As guided by our mission, Farmer Mac is committed to finding innovative ways to reach customers to increase the access to capital and to reduce the cost of credit for rural America. Farmer Mac's business model is performing well and may even be more valuable in tighter credit markets, as demonstrated by our strong first quarter performance. Now I'd like to ask Dale Lynch, our Chief Financial Officer, to cover the financial results in more detail. Dale?
Thanks, Lowell. Farmer Mac is a one-of-a-kind financial services company with a compelling mission to provide a unique combination of high-quality assets and a GSE funding advantage that is designed to generate benefits for rural America.
We're positioned within an industry that also provides attractive growth opportunities, we efficiently serve this market as a $19 billion company through our 92 hardworking employees. Farmer Mac is able to generate high teens return on equity while growing its earnings by double digits and maintaining a Tier 1 capital ratio similar to that of a well-capitalized money center bank and a cumulative loss rate that is unique for a commercial credit company, only 14 basis points. The combination of these fundamental and financial factors has led to significant benefits for rural America in the form of increased credit availability and lower cost of financing, as well as for our stockholders, as reflected in the stock and the strong performance of our common stock over the past several years. Turning to first quarter, our first quarter 2018 results reflect the ongoing strength of Farmer Mac's business model throughout market cycles.
As business volume increased to $0.4 billion, core earnings exceeded $21 million and credit quality remained favorable. In terms of business volume, as you can see on slide six, outstanding volume grew to a record $19.4 billion as of March 31, 2018. We completed more than $1.4 billion of new business during the quarter, resulting in net growth of approximately $400 million after maturities and repayments. This increase in outstanding business volume was driven by net growth in our institutional credit, Farm & Ranch, and USDA lines of business. We purchased $813 million of AgVantage securities in the first quarter, which resulted in net growth of $421 million. The increase was driven by two of our longstanding counterparties, National Rural Utilities Cooperative Finance Corporation, also known as CFC, and Rabobank.
During first quarter 2018, CFC completed a new $325 million funding, and Rabobank increased its AgVantage business volume by $100 million. Also contributing to growth was $32 million of new business with five other institutional counterparties in a series of smaller transactions with our newer AgVantage products, such as Farm Equity AgVantage and AgVantage for Funds. As you can see in our financial results, more of our institutional customers are recognizing the value Farmer Mac can provide as we continuously innovate our product set to meet our customers' needs. Our Farm & Ranch loan purchases were $259 million in the first quarter, which was modestly lower year-over-year, primarily due to a combination of reduced borrower demand resulting from rising interest rates and the lower average size of loans purchased.
During first quarter 2018, Farmer Mac purchased 456 Farm & Ranch loans with an average principal balance of $570,000, compared to 440 Farm & Ranch loans purchased with an average principal balance of $714,000 in the first quarter in the previous year. We also added $159 million of Farm & Ranch loans under standby purchase commitments during first quarter 2018, which was a 40% increase over the same period last year. We purchased $124 million of USDA guarantees in first quarter 2018, compared to $131 million in first quarter a year ago. Our rural utilities line of business decreased to $153 million, primarily due to partial termination of $120 million of rural utilities loans under standby purchase commitments. Also contributing to the decrease was a paydown of $41 million of rural utility loans, which was modestly offset by the purchase of $8.6 million in new rural utility loans.
The decrease in rural utility loans purchased in first quarter 2018 compared to last year was primarily due to a lack of loan purchase opportunities for larger, more competitive loans to rural utilities borrowers. Now turning to the financials. As you can see on slide seven, core earnings for first quarter 2018 were $21.8 million, or $2.03 per diluted common share, compared to $15 million, or $1.39 per share in first quarter 2017, and $17.9 million, or $1.65 per share in fourth quarter 2017. The $6.8 million year-over-year increase in core earnings was primarily due to a $3.6 million after-tax increase in net effective spread. Also contributing to the increase was a $2.6 million decrease in tax expense due to the lower federal corporate tax rate and a $0.7 million after-tax decrease in credit related expenses.
The increase was offset in part by a $0.7 million after-tax increase in operating expenses, driven by higher compensation in employee benefits as Farmer Mac continues to invest in its people. As Lowell Junkins mentioned earlier, we plan to continue to invest in our human capital and our technology and business infrastructure to increase our capacity and efficiency as we work to achieve our longer-term strategic objectives. Accordingly, Farmer Mac expects the annual increases in its aggregate comp and benefits and G&A expenses to be above historical averages over the next several years. Specifically, management believes that the aggregate comp and benefits and G&A expenses will increase approximately 15% in 2018 relative to 2017, with increases likely to remain elevated in 2019.
The $3.9 million sequential increase in core earnings was primarily due to a decrease in income tax expense of $5.5 million in first quarter 2018, again related to the lower federal corporate tax rate, and a $0.7 million after-tax decrease in credit related expenses. The increase was offset in part by a $1.1 million after-tax increase in operating expenses. Now turning to spreads on slide eight. Farmer Mac's net effective spread for first quarter 2018 was $37.1 million or 91 basis points, compared to $32.5 million or 90 basis points in first quarter 2017, and $37.5 million or 93 basis points in fourth quarter 2017. The $4.6 million year-over-year increase in net effective spread in dollars was primarily due to the growth of outstanding business volume, which increased net effective spread by approximately $3.9 million.
The one basis point year-over-year increase in net effective spread in percentage terms was primarily due to changes in Farmer Mac funding strategies and improvements in LIBOR-based short-term funding costs for floating rate assets indexed to LIBOR, as well as a reduction in the average balance of lower earning interest investment securities in our investment portfolio. The $0.4 million or two basis point sequential decrease in net effective spread was primarily due to two fewer days of interest in Q1 2018 compared to Q4 2017 in our USDA lines of business. Turning to credit on slide nine. As of March 31st, 2018, the total allowance for losses was $8.5 million or 12 basis points of the $6.9 billion Farm & Ranch portfolio, compared to $8.9 million or 13 basis points of the Farm & Ranch portfolio as of year-end 2017.
The $0.4 million release in Q1 2018 from the total allowance for losses was due to payoffs and pay downs of loans with an existing allowance that exceeded the increase in the allowance associated with net growth in Farm & Ranch loans this quarter. Also contributing to the release were changes in credit quality that reduced the proportion of substandard assets rated in the lowest credit quality tier. As of March 31st, 2018, Farmer Mac 90-day delinquency is for $47.6 million or 0.69% of the Farm & Ranch portfolio, compared to $48.4 million or 0.71% of the Farm & Ranch portfolio as of December 31st, 2017. Those 90-day delinquencies were comprised of 65 loans as of March 31st, 2018 and 51 loans as of year-end 2017.
The modest decline in delinquencies from year-end 2017 was primarily due to lower expected seasonal delinquencies associated with the loans that have January 1st payment terms, which account for most loans in the Farm & Ranch portfolio, as well as the pay down on $15.3 million in permanent planting loans to a single borrower that resulted in those loans becoming current. Farmer Mac 90-day delinquencies have historically fluctuated from quarter to quarter, both in dollars and as a percent of the portfolio. We generally observe higher levels at the end of first and third quarters, and lower levels at the end of second and fourth quarters of each year, which is related to the annual and semi-annual payment terms of most of our Farm & Ranch loans.
Farmer Mac expects that over time, its 90-day delinquency rate will eventually revert closer to and possibly exceed Farmer Mac's historical average of approximately 1% due to macroeconomic factors and the cyclical nature of the ag economy. Now, with regard to substandard assets, due to a relative balance between newly substandard assets and upgrades and payoffs and pay downs of existing substandard assets, the overall portfolio substandard volume was little changed this quarter. As of March 31st, 2018, Farmer Mac substandard assets were $221.2 million, or 3.2% of the Farm & Ranch portfolio, compared to $221.3 million, or again, 3.2% of the Farm & Ranch portfolio as of prior year-end. Those substandard assets were comprised of 318 loans as of Q1 2018, compared to 307 loans as of Q4 2017.
Farmer Mac expects that over time, its substandard asset rate will eventually revert closer to and possibly exceed Farmer Mac's historical average of approximately 4% due to macroeconomic factors and the cyclical nature of the ag economy. If Farmer Mac's substandard asset rate continues to increase in current levels, it is likely that Farmer Mac's provision fee allowance for loan losses and reserve for losses will also increase. Although some credit losses are inherent to the business of ag lending, Farmer Mac believes that any losses associated with the current ag credit cycle will be moderated by the strength and diversity of our portfolio, which Farmer Mac believes is adequately collateralized. Turning to capital on slide 10. Farmer Mac's $673 million of core capital as of March 31st, 2018 exceeded the statutory minimum capital requirement of $536 million by $137 million or 26%.
This compares to core capital of $657 million or $137 million of capital above the minimum requirement as of year-end 2017. An increase in retained earnings this quarter was mostly offset by an increase in minimum capital required to support the growth of our on-balance sheet assets this quarter. More complete information about Farmer Mac's Q1 2018 performance is set forth in our 10-Q, which we filed today with the SEC. With that, Lowell, I'll turn it back to you.
Thanks, Dale. Farmer Mac's business model is thriving as we continue to deliver upon the mission throughout agricultural economic cycles. Our capital base is strong and growing, providing capacity for future growth, and we believe our dividend policy has helped enhance stockholder value. We continue to bring in new personnel to fill key positions and to expand our investment in the technology and the capacity to better grow our business. Farmer Mac has been a champion for and an integral part of this nation's real economy now for 30 years and look forward to the decades that are ahead. As discussed earlier in our last earnings call, we established a subcommittee of the board to lead our CEO search efforts and are actively conducting a search for a new CEO.
Since that last update, the search committee has continued to solicit stakeholder feedback and has developed a CEO profile and position description and engaged an executive search firm. The CEO search committee will seek to recommend to the board for its approval a new President and CEO with the appropriate qualifications and expertise in a timely manner.
Farmer Mac deserves a world-class CEO to help us lead into this bright future that's ahead of us. We look forward to being able to provide you with more information on our next earnings call. We'd be happy now to answer any questions that you may have.
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 are 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 will pause momentarily to assemble our roster. The first question comes from Scott Valentin with Compass Point. Please go ahead.
Good morning, everyone. Thanks for taking my question. Just with regard to the originations this quarter, I noticed the AgVantage product was active. Is that a reflection of any shift in strategy versus Farm & Ranch, or just kind of what the market was giving you during the quarter?
Scott, it's mostly what the market was giving us in the first quarter. We have several large counterparties, and the business that they do with us can be very, I guess, lumpy is the best way to say it. CFC, our utilities partner, tends to do a financing early in the year. This year they did it in the first quarter. It was $325 million. That was a huge lift to our business in the quarter. Rabobank also contributed another $100 million. They tend to be more granular in how they fund. It's just a little bit random depending on who comes in what quarter.
Still, I know in the past, Farm & Ranch has been a category that you guys have been somewhat focused on growing. It's still the case going forward?
Yes. Look, our Farm & Ranch loan business has been a growth driver for five years. I guess it's been growing 20%-25% year-over-year for at least five years. Our AgVantage business has also been growing in that sort of seven percent-ish range, which on a big base is pretty healthy growth. The strategies that you're referring to remain intact around wholesale funding and trying to push that out to more counterparties. We did over $30 million this quarter with five other smaller counterparties. That reflects sort of the financial universe that we have spoken with you in the past on. Again, more granular business, but good from the breadth of counterparties that we did business with this quarter, and we certainly hope to do more of that this year and in the future.
Okay. Thanks. That helps. Just a question on credit. It was very stable this quarter. Obviously, there's concerns around potential tariffs and any impact on agriculture. Just wondering, as you reach out to different credit providers and borrowers, how are they reacting, or are they reacting to potential tariffs, and what kind of contingency plans would they have?
Yeah, this is Curt Covington. We do reach out to and have been reaching out to many of our counterparties across the U.S. We have a nationwide reach, and talking to most of the sellers, I think the biggest concern obviously is in the soybean sector when it comes to China. When it comes to NAFTA, there's kind of differences of opinions, depending on the bank and the commodity that you're talking about. Because for certain, Mexico takes a wider array of commodities offtake from the U.S. In general, most of the banks we talk to and most of the actual growers and those that are involved in the processing and sale of this have been actually fairly optimistic. What we've been hearing is that the volume of activity in those countries right now continues to be pretty strong.
Okay. All right. I'll get back in the queue. Thanks very much.
The next question comes from Eric Hagen with KBW. Please go ahead.
Thanks. Good morning, gentlemen. Dale, you mentioned the newer counterparties that you're exploring through AgVantage. Just to follow up on that, I guess just how sensitive is the growth in that segment to the overall health and profitability of the ag economy? Is there even a correlation that we should be looking at? I guess just from our perspective, since we can't see the loans on an inter-quarter basis, is there anything that we can sort of track or follow that would provide some indication about the drivers of that growth in that segment? Thanks.
Sure. Thanks, Eric. I think the counterparties in that space are financials, and at some level, they're not immune from the ag economy at all. Having said that, their incentives are somewhat different than farmers. I think farmers, to Curt's point earlier, we've seen a very modest decrease in our farmer and ranch loan purchase volume this year versus first quarter last year. Smaller loan size contributed to that, there's also a bit of an influence on higher rates, right? Financials at some level may be more immune to that from the standpoint that their investors require them to deploy the capital. The capital has to be deployed. The interest rate environment will be what it will be. They do need a level of leverage within their capital structure to generate the level of returns that their equity investors demand.
The terms of their funding may change a bit. They may go shorter on the curve. They may choose floating rate. That's sort of their choice. In terms of volume, I think it's a little bit less sensitive than, say, an individual farmer's volume would be.
Right.
We're less concerned. The issue for us is really pushing the Farmer Mac message deeper and deeper and deeper within that universe of customers. There's dozens and dozens of those counterparties that we can do business with, and that's our challenge, and we're starting to gain some real traction, I think.
Yep. No doubt that that's really positive. I guess just one more. What's the difference in spread that we can expect to see between those sort of newer counterparties versus, I guess you could call them the core counterparties that have been in that segment for a while?
Sure. The difference in spread is we haven't disclosed what it is the short answer, but it's higher. It's significantly higher. These counterparties are smaller. They're not rated. They may have a profile of BB-, I don't know, but they're not all that different from a Farm & Ranch portfolio in terms of the spreads that we charge. As compared to MetLife, the spreads may be 40, 50, 60, 70 basis points, depending on maturity. Spreads on the smaller county counterparties may more closely approximate a Farm & Ranch portfolio.
Yep. That's a helpful answer, Dale. Forgive me for just a slight technical question, the move that we saw in three-month LIBOR was somewhat late in the quarter, and I know that, I think in your opening remarks, you mentioned that you guys benefited from that. Is there any sort of, I guess, timing difference between what you might see on the funding side with respect to short-term interest rates and I guess what you're obviously able to capture on the asset side?
Yeah.
I guess you kind of get where I'm going with that question.
Yeah, no, it's a good question. The three-month LIBOR dynamic, especially relative to the one-month LIBOR dynamic, is striking. It's a stark difference. On the three-month side, it's a huge advantage for us in terms of where we can fund. At some level, we're taking this opportunity to push our funding on these types of assets further out the curve. We're not necessarily trying to monetize and grab all the money we can today, but rather sort of term it out further and reduce the amount of basis risk presumably that we're taking on that population of assets. It's safe to assume we're probably picking up something, though, net on the balance on the threes, but on the ones we're probably giving it up.
Over the course of this year, we've kind of indicated that we don't see a real opportunity as things play out right now for a significant improvement in our net refinancing rate over the course of the year. Certainly not like we saw last year. That's just one area of caution. I'm not sure that I would be thinking that Farmer Mac's funding spreads are going to necessarily improve dramatically just because of what's going on in three-month LIBOR.
Okay. Fair enough that they don't improve, but we shouldn't expect any sort of tightening or reversal due to timing in 2Q or anything like that?
No. We're doing our best to kind of keep a pretty coherent funding strategy quarter to quarter to quarter, and the volatility, frankly, in the last, I'd say, 24 months on our funding, on our refinancing business, has been far less. Even though the LIBOR markets have been more volatile, I'd say that our refinance rates that we're achieving have been more stable.
Yep. Great. Thanks for that response. Appreciate it.
Again, if you have a question, please press star then one. The next question comes from James Sidoti with Sidoti. Please go ahead.
Hi. Thanks for taking my question. Was the amount of repayments in Farm & Ranch in line with your expectations? What was the big driver of the repayments in your view?
Yeah. I would say it was in line with the expectations. Some of the repayments have slowed down a bit. Most of that's because in certain sectors of the economy, we've seen obviously some stress, particularly corn and bean sector, a little bit in the cattle sector and certainly in the hog sector we've seen some of that as well. We don't have a lot of exposure to those last two, but I would say that those were pretty much in line with what we had expected.
All right. Are you surprised at all about how long 90-day delinquencies have persisted below the historical average?
Yeah. Here's what I would say. We all kind of view this as potentially issues arising just because we see the stress in the economy. We pay very close attention to our delinquencies, and inside the Farmer Mac world we have a lot of discussions with our seller banks, and our seller banks are telling us the exact same thing that we're seeing, and that is their delinquencies just haven't materialized to any great extent.
A lot of this is because we're beginning to find out many of these farmers, while we hear that there's stress out in the economy, there's still a good bulk of customers out there, many of whom those loans are sold to us, that even at prices of where corn and beans are today, they're eking out a small profit, and/or they've taken on second jobs, many of them, in order to make sure their mortgage payments get made. While we're pleasantly surprised, again, I would just say that we talked to many of our seller banks who are also telling us the exact same thing.
Sorry if I missed this, is there any change in your net effective spread outlook? Is it kind of safe to assume flattish, up one or two basis points year-over-year for 2018?
Yeah. Unless there's some major change in the market on our refinancing business, our goal for the year is to maintain the status quo. The funding that's coming off this year is actually very attractive funding, it's going to be a challenge to achieve that. We think we can come close to that, I think spreads on new business are largely stable. Ironically, there might be a little bit of pressure to tighter spreads in some sectors in the Farm & Ranch business just to a pretty strong bid for the best credit quality business out there. When markets get tighter, you might pay up for the best business. There might be that dynamic. By and large, our spread on most of our asset classes are pretty stable.
Our outlook is that there's no big change either on the refinancing or on the new business side.
All right. Last one from me, just on the expense side. G&A rose kind of in line with your previous guidance. I guess just on the comp expense, is 5%-6% kind of the right way to look at that? I guess that came in a little bit lower than what we had forecasted.
You mean in terms of % growth?
Yes.
We really haven't broken it out between the two. If you kind of look in aggregate, just add the numbers together, 2018 versus 2017 should be approximately 15% higher year-over-year. We really haven't gotten into the dissecting between the two. I will say if you're looking optically at the dollars, fourth quarter versus first quarter, keep in mind that the fourth quarter was a little bit anomalous from the standpoint that we had a reversal of compensation associated with the termination of our prior CEO in that quarter, which made that quarter look lower than it fundamentally is.
Yep. Okay. Got it. Thank you.
This concludes our question and answer session. I would like to turn the conference back over to Lowell Junkins for any closing remarks.
Seeing no more questions, I'd like to thank you for listening and participating this morning. Look forward to our next call to report our second quarter 2018 results in August of 2018. Thank you very much, everyone.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.