Low Payout Ratio and Plenty of Cash Hint at Dividend Boost for Federal Agricultural Mortgage Corporation

Submitted by Investing Daily as part of our contributors program.

By: Benjamin Shepherd, Investing Daily

Many unfortunate analysts have been burned trying to predict a de­cisive turn in the housing market over the past few years, as perpet­ually falling real estate values and weak consumer confidence foreclose on a meaningful recovery.

However, home prices appear to have stabilized, giving the industry a shot of confidence. The S&P/Case- Shiller Index of prices in 20 metro­politan areas rose 0.7 percent in April, beating expectations. Prices in all 20 cities were above their recent lows.

The rise in home prices has boost­ed three important housing mar­ket indicators (see “Signs of Recov­ery”). New home starts and sales of both new and existing homes are posting a marked recovery so far this year. After a long period of pessimism, most analysts are final­ly upgrading their ratings on a wide swath of housing-related stocks.

At the same time, government ef­forts to help homeowners are accel­erating, allowing more borrowers to refinance or avoid foreclosure.

Uniformity of opinion doesn’t necessarily mean a real recovery is in the offing. Millions of people are still “underwater,” owing more on their homes than their homes are worth. And a major economic set­back could reverse the recent uptick in housing prices.

However, as my colleague Chad Fraser pointed out in 3 Stocks That Will Benefit From a Housing Market Rebound, fundamentals of the real estate market are now the best they’ve been in almost four years, with momentum clearly shifting for the better. I’m taking this oppor­tunity to highlight housing stocks that will benefit from any rebound in the market.

While you are probably famil­iar with the government-sponsored enterprises (GSE) Fannie Mae and Freddie Mac, you may never have heard of Federal Agricultural Mortgage Corporation (NYSE: AGM), otherwise known as Farm­er Mac.

Just as Fannie and Freddie exist to create a robust secondary mar­ket for residential real estate loans, Farmer Mac exists to help ensure that reasonably priced financing is available to America’s farmers and rural communities as well as to ru­ral utility companies.

Farmer Mac achieves this goal primarily by purchasing agricultur­al loans from lenders and packaging those loans into mortgage-backed securities, many of which are guar­anteed by the US Department of Agriculture (USDA).

The fact that it didn’t require federal bailout money during the fi­nancial crisis is another key differ­ence between Farmer Mac and its cousins. That’s not to say it didn’t require some assistance. In 2008, souring loans forced it to raise capi­tal by selling $65 million in pre­ferred stock to a network of private banks that rely on its services to offer affordable agricultural loans. This help was a far cry from the billions of dollars the government sank into the other GSEs.

While Fannie Mae and Freddie Mac continue to struggle, Farm­er Mac has made a strong recov­ery over the past few years. In the first quarter of 2012, EPS surged by 18.6 percent over the same pe­riod last year, rising to $2.04 as net interest income bounced up by al­most a third.

Loan loss provisions have also been on the decline at Farmer Mac, as credit quality steadily improves. The 90-day delinquency rate in its core Farmer Mac I Portfolio of loans has fallen to just 1.2 percent of assets, while its overall 90-day rate across all of its assets has de­clined to just 0.44 percent.

Asset quality improvement has been largely driven by elevated ag­ricultural commodity prices—corn and wheat are currently trading near post-recession highs—and im­proving farmland valuations. Ac­cording to USDA data, the aver­age cost of farmland has shot up by more than 30 percent over the past five years.

However, even as farmers’ fun­damentals have improved, Farmer Mac largely has failed to keep up. The lender is currently trading at just half its book value per share and just 7.2 times its forward 2012 earnings. As of the first quarter, it had $975 million in cash despite a market capitalization of only $272 million.

In addition to its attractive valu­ation, Farmer Mac also pays out a 10-cent quarterly dividend. With a payout ratio of just 15.2 percent and plenty of cash on the books, the company is likely to be a rising dividend payer in the coming quarters.