FINN - First National of Nebraska, Inc

[Guest Schwab711]

This is a $20b asset bank headquartered in Omaha, NE (right around the corner from the BRK annual meeting). Outside of government agencies and AgCredit (a mutual farming credit cooperative), FINN is the largest agricultural lender in the US. They are heavily allocated to farmland in the midwest (it seems like corn fields in Nebraska, Iowa, South Dakota, Kansas, ect).

 

Some links about US agriculture/Nebraska as a place to start (Cornhusker Economics is a great source):

http://ageconomists.com/2014/08/11/the-next-threat-to-farmland-values/

http://ageconomists.com/2016/06/20/farmland-prices-capitalization-rates-edge-lower/

 

http://agecon.unl.edu/cornhusker-economics/2016/rural-housing-and-age-structure

http://agecon.unl.edu/cornhusker-economics/2015/nebraska-farmland-values-and-rental-rates

 

The last time farmland values/cap rates were at these levels, the midwest experienced the Great Depression, part II in 1984 (see 2nd link). Farmland cap rates are highly correlated to UST rates, thus FINN will likely be hurt by rising rates. Agriculture profits are half of what they were in 2013 (record-year) and the average debt:income is roughly ~6:1. I think times are going to be tough for FINN. I'm writing about them because if farmland prices do crater, this is going to be a great name to watch. They are tremendously conservative and efficient. FINN can likely withstand >30% decline in farmland prices from here while still maintaining a well-capitalized designation. They shouldn't need more capital until 45%-50% decline. It's a very well-run bank.

 

http://www.fnni.com/fn/html/en/site/assets/documents/Quarterly-Selected-Financial-Data-10-2016.pdf

 

All quarterly selected data:

http://www.fnni.com/fn/html/en/investor_relations/quarterly_earnings.html

 

Company presentation (June 2016):

http://www.fnni.com/fn/html/en/site/assets/documents/2016_annual_shareholders_meeting.pdf

 

As a heads up, you will need to look at regulatory filings to piece together the financial statements. I didn't see anything surprising in them but I may have missed something. If you are normalizing earnings, FINN earned roughly $85.5m from selling loans in 3Q 2016, which was an uncommon move.

 

If you think farmland values are relatively safe because interest rates cannot rise too quickly then FINN has a very enticing pre-tax yield.

[vox]

The stock looks cheap, but it is also a) thinly traded and b) 40% owned by the Lauritzen family.

[rawraw]

I love investing in banks. Couple questions for you :

 

1)  what do you mean decline in farm land prices will. Impact capital designation?  Can you detail this conclusion a little bit.

 

2) You're discussion of the 80s is very important, however aren't you ignoring the difference between collateral values and poor underwriting? I can't speak on this bank specifically, but the way of structuring farm lending has changed quite a bit since the 80s. I think these changes should be kept in mind when thinking of downside risk.

[Guest Schwab711]

I love investing in banks. Couple questions for you :

 

1)  what do you mean decline in farm land prices will. Impact capital designation?  Can you detail this conclusion a little bit.

 

2) You're discussion of the 80s is very important, however aren't you ignoring the difference between collateral values and poor underwriting? I can't speak on this bank specifically, but the way of structuring farm lending has changed quite a bit since the 80s. I think these changes should be kept in mind when thinking of downside risk.

 

I only meant that they are well capitalized right now and would remain adequately capitalized according to Fed definition in those loss ranges.

 

How has farm lending changed? How was the 1980s different from now?

[rawraw]

The difference is that many of the managers of today went through the 1980s as lenders.  I apologize if I make this overly simplistic, but I'm unsure your familiarity with banks.  In lending, things tend to be either price or structure related.  From what I know, structure has changed quite dramatically.

 

Assume we have witnessed a farmland bubble and that this bubble is now going to collapse.  Many of the quicker investors (hedge funds, etc) intuitively assume that farmland exposed banks are going to get crushed. What they often forget is that the bank's choice of structure impacts this.  For example, say farmland is $5k per acre.  This is the objective reality of the collateral and it is somewhat related to the cash flows that acre can produce over time (outside of bubble times).  But the bank could choose to only structure loans where they assign the farmland $1k per acre in their approval process.  Now this extreme difference in reality is going to impact the bank's ability to compete/grow/maintain loans on farmland, depending on the market.  Since the 1980s, this sort of discounting of collateral is fairly common.  So while I made up the $1k per acre, many lenders are not lending anywhere close to the peak market prices.  Market participants who went through the 80s tend to assign large discounts to the market value based on internal methodology.  And while I'm sure some banks are out there going wild, my friends in the industry have suggested that it is very common practice for the banks to discount heavily against farmland (excluding the government agencies who lend to farmers, I'm told they do relatively aggressive underwriting).  I wouldn't be surprised if the farmland would have to drop ~30% in price before it even reaches what the banks used internally.  I'd have to ask my friends in industry if I was going to make a contrarian bet, but I know from our prior conversations that the haircuts were substantial (similar to the haircuts used in energy lending post-80s).  In the 1980s, there were no discounts on the market values used.

 

These differences in structuring credits can cause very different outcomes.  So while FINN's borrowers may be in a rough time, the market may be overestimating how rough it could be if FINN was very conservative underwriting.  Many investors struggle with understanding the difference between a bad loan vs. borrowers having a tough time.  Whether it is oil/gas lending, commercial real estate, etc., banks often initially sell off as a group regardless of their differing approaches to underwriting loans due to hedge funds/otehrs running screens.  Then eventually market participants start to appreciate differences and pick relative winners/losers. 

 

No opinion on FINN, but this is how I'd approach the analysis

[Guest Schwab711]

The rise in the 10y might be the beginning of some problems for FINN. Farming income has declined from the peak and now property values are likely to get hit by higher cap rates. 10y rate is up close to 20% YTD. The Fed is strongly signaling that rates will be higher. Seems like a lot of early warning signs for farmland.

 

@rawraw

Meant to add this when you first wrote your comment but your response was outstanding! It really helped me get a better understanding of this segment of lending. I'm also a bank fan and I've almost never dealt with Ag lending.

 

I agree that FINN is not going to have capital problems any time soon. Just potential for depressed earnings.

[oddballstocks]

Rawraw, excellent response.

 

I have some exposure to Ag lending, both production and land and you're correct.  A lender told me recently "we're not stupid, on a production loan the farmer WILL blow up, it's not a matter of if, all farmers do."  I asked what he did to make sure they didn't get burned.  He said they limited collateral loans to what they could get in a fire sale, or the lowest end of resale value. 

 

He said they don't over-extend on land loans when a farmer is heavy into production lending.  This gives them the ability to refi in a downturn from a production to a land loan.  The idea is your land has excess lending capacity, even if prices crash, so you can lever some of that and take the production off the table.

 

The value you can get for your farm depends on a lot of factors.  A bank might look at your crop (obviously), the water rights, the history of who has had the land and their production, and lastly who other potential buyers are.  If you have 10,000 acres the value per acre will be less than 100 acres because there are other potential buyers for 100 acres, whereas 10,000 can realy only be purchased by another farmer.

 

The chatter I've heard for months is that farm land prices have already been falling.  The dumb money was buying at the top.  Farmers with cash in their pockets stopped buying 1.5-2yrs ago and are quote "waiting for prices to fall so I can pick up cash deals again.."