Farmer Mac

Moat: 2/5

Understandability: 4/5

Balance Sheet Health: 3/5

Farmer Mac is a federally chartered instrumentality of the US Government, designed to provide liquidity and capital to lenders serving rural America, acting as a secondary market for agricultural real estate and rural infrastructure loans.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Farmer Mac’s business is straightforward: it buys loans made to farmers from smaller lenders, packaging them into securities, and selling them on the secondary markets to investors. This provides liquidity to rural lenders and supports the agriculture industry.

Business Overview

Revenue Distribution

Farmer Mac’s revenue streams are primarily driven by:

  • Net interest income: Earned from the difference between the interest it receives on loans and the interest it pays on debt and securities.

  • Guarantee and commitment fee income: Fees charged for assuming the credit risk and guaranteeing the repayment of loans.

  • Other income: Primarily comprised of the gains and losses on financial derivatives, and the fair value of securities

Net interest income and effective spread constitute the main revenue source.

  • Increased scrutiny of government-sponsored entities (GSEs): Heightened scrutiny and regulatory attention on GSEs like Farmer Mac are an ongoing trend.
  • The Farm Bill: The Farm Bill is a comprehensive legislation that impacts the agriculture industry, its passage or changes to it can have a significant impact on Farmer Mac’s business.
  • Interest Rate and Credit cycles: The agriculture industry is sensitive to these cycles, especially with the recent higher interest rates, potentially affecting farmers’ ability to repay loans.
  • Consolidation: The agricultural industry is seeing consolidation and increasing farm size, but at the same time this reduces the overall number of borrowers.

Competitive Landscape

Farmer Mac’s main purpose is to provide a secondary market for agriculture loans. It generally does not compete with private lenders, but rather partners with them. So, the company’s main competition is not from those who can be better than them in lending but rather from those who can create similar products and take up the market share of the debt that is sold to investors.

Farmer Mac has some advantages as a GSE. As an authorized government-sponsored entity, it receives certain preferential treatment, while also being backed by the US government’s financial assurances.

Financials

  • Revenue: Farmer Mac’s revenue is largely determined by interest rates and loan volume which can cause some fluctuations, specifically with the recent rate hikes and a decrease in new business volume.
  • Margins: Farmer Mac’s operating margins have been affected by shifts in the mix of new business volume between Ag and Rural Infrastructure, and a changing credit environment and higher reserves.
  • Financial Health: Farmer Mac is structured in a way that its operations are generally low risk, as most of its credit risks are backed by guarantees from other agencies. However, a decrease in new business volume may still prove to be harmful.

Moat Analysis: 2/5

Farmer Mac’s economic moat is weak. It lacks strong sustainable competitive advantages, with only a few differentiators:

  • Government Sponsorship: Farmer Mac’s status as a government-sponsored enterprise (GSE) provides a layer of implicit backing, lower cost of capital, and access to favorable regulatory treatment. However, this is not a strong moat by itself, as other companies in the industry can also obtain funding with government support.
  • Specialized Knowledge: Farmer Mac’s understanding of the agriculture sector, and its ability to underwrite, sell, and manage agricultural debt is a unique trait, though this can be acquired or mimicked by other sophisticated private lenders and debt underwriters.

Although these traits provide some protection against the most reckless competition, they don’t provide it with any major advantage. Farmer Mac can be easily replaced, and most of its profits come not from its innovation or better products but from its government status and the size of its operations.

Moat Risks and Business Resilience

The following are legitimate risks that could harm Farmer Mac’s moat:

  • Political and Regulatory Changes: Because of its GSE status, Farmer Mac is heavily influenced by government actions, including amendments or withdrawal of GSE status, as well as changes in regulations. These can affect their financial standing, the volume they are allowed to trade in, and their credit quality. A new Congress might lead to more restrictions on GSE’s, which could harm Farmer Mac.
  • Interest Rate and Credit Cycles: Farmers and rural America are heavily reliant on the federal government for financial security. They are very susceptible to interest rate fluctuations and credit cycles. The credit environment may deteriorate and the borrower’s ability to repay might be negatively affected. This would force Farmer Mac to account for higher credit losses on its books.
  • Market Disruptions: As evidenced by the company’s 2023 annual report, large declines in credit markets can reduce its ability to engage in new business and/or affect the fair value of certain assets it owns. This could severely disrupt their profits and margins.
  • Competition: Private capital and lenders may increase competition by offering lower cost of capital, better services, or better terms. While unlikely to topple Farmer Mac, this will pressure profits.
  • Technological Disruption: Although not as applicable in the short-term, technological advances in agricultural lending, as well as the broader market of financing tools, may erode a part of Farmer Mac’s business.

The business is resilient to some of these risks. For instance, its GSE status would mean that it would be bailed out in the case of a large financial crisis. And, they have had a long time in business to develop relationships to navigate the agriculture industry, its complexity, and its cycles. However, they also don’t have a strong position in their markets without their government-sponsored status, making them vulnerable to any change in their legislative/regulatory environment.

Understandability Rating: 4/5

Farmer Mac’s business model is relatively easy to understand, but its financial reports tend to be complex.

  • Straightforward Concept: The fundamental idea of facilitating loans in rural areas, and then repackaging and reselling these loans on the market is not complex and easy to grasp.
  • Financial Complexity: On the other hand, their financial reports, their accounting methods, their financial instruments, and their various funding mechanisms and swaps are complex, which requires detailed understanding to value properly.
  • Regulatory and Economic Factors: A full understanding requires a strong grasp of the regulatory environment, government oversight, and the specific economic conditions within the agriculture sector. These elements add layers of complexity.

Balance Sheet Health Rating: 3 / 5

Farmer Mac’s balance sheet has some strengths, but is susceptible to potential vulnerabilities:

  • Leverage: Farmer Mac operates with substantial leverage and off balance sheet obligations to create profitability. However, their high leverage adds risk and makes it difficult to predict the true financial strength of the company.
  • Liquidity: Farmer Mac has access to substantial liquidity from capital markets, and through their GSE status.
  • Assets & Liability Matching: Farmer Mac’s assets have long-maturity but their funding requirements are dependent on short-term obligations, which makes it vulnerable to interest rate movements and duration mismatch.
  • Interest Rate Risk: Farmer Mac is exposed to significant risks due to potential changes in interest rates because of its dependence on short term funding and long term lending.

One should be careful with Farmer Mac because of the complexity of the organization itself, as well as the risks that it is susceptible to. Although its overall financial health is not in the ‘danger’ zone, its debt makes its valuation more risky.

Recent Concerns and Controversies

Farmer Mac’s management is aware of concerns and is working on measures to increase the company’s strength.

  • Declining revenues: Farmer Mac’s revenue has been negatively affected in the short term because of rate hikes, as well as a change in portfolio mix. This is something that has been highlighted by the company.
  • Regulatory and political risks: Farmer Mac has to operate in accordance with government mandates, and hence, they are vulnerable to political changes. Their GSE status means that they are not wholly independent, which has implications on their overall financial prospects.

While some of these concerns might seem like red-flags, the company remains a solid investment.