form10q.htm


As filed with the Securities and Exchange Commission on
November 10, 2008

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549


FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2008

Commission File Number 001-14951
 
Logo
FEDERAL AGRICULTURAL MORTGAGE CORPORATION
(Exact name of registrant as specified in its charter)


Federally chartered instrumentality of the United States
52-1578738
(State or other jurisdiction of incorporation or organization)
(I.R.S. employer identification number)
   
1133 Twenty-First Street, N.W., Suite 600
Washington, D.C.
20036
(Address of principal executive offices)
(Zip code)


(202) 872-7700
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes           T
No           £

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer   £
Accelerated filer   T
   
Non-accelerated filer   £
Smaller reporting company   £

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes           £
No           T

As of November 1, 2008, the registrant had 1,030,780 shares of Class A Voting Common Stock, 500,301 shares of Class B Voting Common Stock and 8,601,352 shares of Class C Non-Voting Common Stock outstanding.
 


 
 

 

PART I - FINANCIAL INFORMATION

Item 1.
Condensed Consolidated Financial Statements

The following information concerning Farmer Mac’s interim unaudited condensed consolidated financial statements is included in this report beginning on the pages listed below:

Condensed Consolidated Balance Sheets as of September 30, 2008 and December 31, 2007
3
Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2008 and 2007
4
Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2008 and 2007
5
Notes to Condensed Consolidated Financial Statements
6

 
-2-

 

FEDERAL AGRICULTURAL MORTGAGE CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)

   
September 30, 2008
   
December 31, 2007
 
   
(in thousands)
 
Assets:
           
Cash and cash equivalents
  $ 50,661     $ 101,445  
Investment securities:
               
Available-for-sale, at fair value (includes securities pledged to counterparties of $16.6 million and $7.2 million as of September 30, 2008 and December 31, 2007, respectively)
    1,297,255       2,616,187  
Trading, at fair value
    171,046       8,179  
Total investment securities
    1,468,301       2,624,366  
Farmer Mac Guaranteed Securities:
               
Held-to-maturity, at amortized cost
    -       959,865  
Available-for-sale, at fair value
    1,250,194       338,958  
Trading, at fair value
    913,211       -  
Total Farmer Mac Guaranteed Securities
    2,163,405       1,298,823  
Loans:
               
Loans held for sale, at lower of cost or fair value
    63,202       118,629  
Loans held for investment, at amortized cost
    630,615       649,280  
Allowance for loan losses
    (2,329 )     (1,690 )
Total loans, net of allowance
    691,488       766,219  
                 
Real estate owned, at lower of cost or fair value
    590       590  
Financial derivatives, at fair value
    3,395       2,288  
Interest receivable
    57,701       91,939  
Guarantee and commitment fees receivable
    60,385       57,804  
Deferred tax asset, net
    55,073       30,239  
Prepaid expenses and other assets
    107,689       3,900  
Total Assets
  $ 4,658,688     $ 4,977,613  
                 
Liabilities, Mezzanine Equity and Stockholders' Equity:
               
Liabilities:
               
Notes payable:
               
Due within one year
  $ 3,642,228     $ 3,829,698  
Due after one year
    664,874       744,649  
Total notes payable
    4,307,102       4,574,347  
                 
Financial derivatives, at fair value
    65,670       55,273  
Accrued interest payable
    32,520       50,004  
Guarantee and commitment obligation
    55,582       52,130  
Accounts payable and accrued expenses
    24,780       20,069  
Reserve for losses
    2,106       2,197  
Total Liabilities
    4,487,760       4,754,020  
                 
Mezzanine Equity:
               
Series B redeemable preferred stock, redemption/liquidation value of $1,000 per share, 65,000 shares authorized, issued and outstanding
    61,039       -  
                 
Stockholders' Equity:
               
Preferred stock:
               
Series A, stated at redemption/liquidation value, $50 per share, 700,000 shares authorized, issued and outstanding
    35,000       35,000  
Common stock:
               
Class A Voting, $1 par value, no maximum authorization
    1,031       1,031  
Class B Voting, $1 par value, no maximum authorization
    500       500  
Class C Non-Voting, $1 par value, no maximum authorization
    8,598       8,364  
Additional paid-in capital
    96,194       87,134  
Accumulated other comprehensive loss
    (41,421 )     (2,793 )
Retained earnings
    9,987       94,357  
Total Stockholders' Equity
    109,889       223,593  
                 
Total Liabilities, Mezzanine Equity and Stockholders' Equity
  $ 4,658,688     $ 4,977,613  

See accompanying notes to condensed consolidated financial statements.

 
-3-

 

FEDERAL AGRICULTURAL MORTGAGE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(in thousands, except per share amounts)

   
Three Months Ended
   
Nine Months Ended
 
   
September 30, 2008
   
September 30, 2007
   
September 30, 2008
   
September 30, 2007
 
Interest income:
                       
Investments and cash equivalents
  $ 20,395     $ 46,621     $ 97,305     $ 127,143  
Farmer Mac Guaranteed Securities
    28,470       18,437       67,007       56,622  
Loans
    11,718       11,636       35,192       34,154  
Total interest income
    60,583       76,694       199,504       217,919  
                                 
Total interest expense
    39,260       66,177       135,885       189,841  
                                 
Net interest income
    21,323       10,517       63,619       28,078  
(Provision)/recovery for loan losses
    (731 )     -       (731 )     215  
Net interest income after (provision)/recovery for loan losses
    20,592       10,517       62,888       28,293  
                                 
Non-interest (loss)/income:
                               
Guarantee and commitment fees
    7,281       6,421       20,574       18,633  
Losses on financial derivatives
    (19,021 )     (24,906 )     (29,691 )     (9,040 )
Losses on trading assets
    (14,507 )     -       (21,664 )     (74 )
Impairment losses on available-for-sale investment securities
    (97,108 )     -       (102,452 )     -  
(Losses)/gains on sale of available-for-sale investment securities
    (85 )     87       65       108  
Gains on sale of Farmer Mac Guaranteed Securities
    1,531       -       1,531       -  
Gains on the repurchase of debt
    840       -       840       -  
Gains on the sale of real estate owned
    -       98       -       130  
Other income
    192       712       1,315       1,163  
Non-interest (loss)/income
    (120,877 )     (17,588 )     (129,482 )     10,920  
                                 
Non-interest expense:
                               
Compensation and employee benefits
    3,748       3,459       11,327       10,315  
General and administrative
    4,061       1,982       8,331       6,556  
Regulatory fees
    513       550       1,538       1,650  
Real estate owned operating costs, net
    15       (31 )     102       (31 )
(Recovery)/provision for losses
    (91 )     386       (91 )     73  
Non-interest expense
    8,246       6,346       21,207       18,563  
                                 
(Loss)/income before income taxes
    (108,531 )     (13,417 )     (87,801 )     20,650  
                                 
Income tax (benefit)/expense
    (2,973 )     (5,407 )     3,463       5,249  
Net (loss)/income
    (105,558 )     (8,010 )     (91,264 )     15,401  
Preferred stock dividends
    (578 )     (560 )     (1,698 )     (1,680 )
Net (loss)/income available to common stockholders
  $ (106,136 )   $ (8,570 )   $ (92,962 )   $ 13,721  
                                 
(Loss)/earnings per common share and dividends:
                               
Basic (loss)/earnings per common share
  $ (10.55 )   $ (0.82 )   $ (9.33 )   $ 1.32  
Diluted (loss)/earnings per common share
  $ (10.55 )   $ (0.82 )   $ (9.33 )   $ 1.29  
Common stock dividends per common share
  $ 0.10     $ 0.10     $ 0.30     $ 0.30  

See accompanying notes to condensed consolidated financial statements.

 
-4-

 

FEDERAL AGRICULTURAL MORTGAGE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)

   
Nine Months Ended
 
   
September 30, 2008
   
September  30, 2007
 
   
(in thousands)
 
Cash flows from operating activities:
           
Net (loss) income
  $ (91,264 )   $ 15,401  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Net amortization of premiums and discounts on loans and investments
    3,752       (1,530 )
Amortization of debt premiums, discounts and issuance costs
    66,790       98,154  
Purchases of trading investment securities
    -       (9,090 )
Proceeds from repayment of trading investment securities
    6,507       5,417  
Purchases of loans held for sale
    (38,461 )     (36,021 )
Proceeds from repayment of loans held for sale
    14,747       5,744  
Net change in fair value of trading securities and financial derivatives
    30,954       8,692  
Amortization of SFAS 133 transition adjustment on financial derivatives
    222       297  
Impairment losses on available-for-sale investment securities
    102,452       -  
Gains on sale of Farmer Mac Guaranteed Securities
    (1,531 )     -  
Gains on sale of available-for-sale investment securities
    (65 )     (108 )
Gains on repurchase of debt
    (840 )     -  
Gains on the sale of real estate owned
    -       (130 )
Total provision/(recovery) for losses
    640       (142 )
Deferred income taxes
    (11,316 )     (5,588 )
Stock-based compensation expense
    3,389       2,452  
Decrease in interest receivable
    34,238       13,474  
Increase in guarantee and commitment fees receivable
    (2,581 )     (14,544 )
Increase in other assets
    (41,561 )     (2,276 )
(Decrease)/increase in accrued interest payable
    (17,484 )     3,376  
Increase in other liabilities
    8,911       11,199  
Net cash provided by operating activities
    67,499       94,777  
Cash flows from investing activities:
               
Purchases of available-for-sale investment securities (1)
    (1,160,501 )     (3,211,435 )
Purchases of Farmer Mac II Guaranteed Securities and
               
AgVantage Farmer Mac Guaranteed Securities
    (305,584 )     (172,503 )
Purchases of loans held for investment
    (86,024 )     (51,025 )
Purchases of defaulted loans
    (1,746 )     (3,911 )
Proceeds from repayment of investment securities (2)
    445,154       2,314,070  
Proceeds from repayment of Farmer Mac Guaranteed Securities
    219,341       201,667  
Proceeds from repayment of loans held for investment
    101,964       121,261  
Proceeds from sale of available-for-sale investment securities
    351,256       58,383  
Proceeds from sale of real estate owned
    -       1,523  
Proceeds from sale of Farmer Mac Guaranteed Securities
    649,723       2,538  
Net cash provided by/(used in) investing activities
    213,583       (739,432 )
Cash flows from financing activities:
               
Proceeds from issuance of discount notes
    105,086,822       88,500,039  
Proceeds from issuance of medium-term notes
    1,486,903       1,261,000  
Payments to redeem discount notes
    (104,926,504 )     (88,604,301 )
Payments to redeem medium-term notes
    (1,979,660 )     (805,665 )
Tax benefit from tax deductions in excess of compensation cost recognized
    381       593  
Proceeds from common stock issuance
    5,722       7,531  
Purchases of common stock
    (830 )     (15,041 )
Dividends paid on common and preferred stock
    (4,700 )     (4,789 )
Net cash (used in)/provided by financing activities
    (331,866 )     339,367  
Net decrease in cash and cash equivalents
    (50,784 )     (305,288 )
                 
Cash and cash equivalents at beginning of period
    101,445       877,714  
Cash and cash equivalents at end of period
  $ 50,661     $ 572,426  

(1)
Includes purchases of $349.0 million and $2.0 billion related to auction-rate certificates for the nine months ended September 30, 2008 and 2007, respectively.  See Note 2 to the condensed consolidated financial statements.
(2)
Includes proceeds, through the normal auction process, of $268.0 million and $1.9 billion related to auction-rate certificates for the nine months ended September 30, 2008 and 2007, respectively.  See Note 2 to the condensed consolidated financial statements.

See accompanying notes to condensed consolidated financial statements.

 
-5-

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 1.
Accounting Policies

The interim unaudited condensed consolidated financial statements of the Federal Agricultural Mortgage Corporation (“Farmer Mac” or the “Corporation”) have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”).  These interim unaudited condensed consolidated financial statements reflect all normal and recurring adjustments that are, in the opinion of management, necessary to present a fair statement of the financial condition and the results of operations and cash flows of Farmer Mac for the interim periods presented.  Certain information and footnote disclosures normally included in the annual consolidated financial statements have been condensed or omitted as permitted by SEC rules and regulations.  The December 31, 2007 consolidated balance sheet presented in this report has been derived from the Corporation’s audited 2007 consolidated financial statements.  Management believes that the disclosures are adequate to present fairly the condensed consolidated financial position, condensed consolidated results of operations and condensed consolidated cash flows as of the dates and for the periods presented.  These interim unaudited condensed consolidated financial statements should be read in conjunction with the audited 2007 consolidated financial statements of Farmer Mac included in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2007.  Results for interim periods are not necessarily indicative of those that may be expected for the fiscal year.  Below is a summary of Farmer Mac’s significant accounting policies.

 
(a)
Cash and Cash Equivalents and Statements of Cash Flows

Farmer Mac considers highly liquid investment securities with original maturities of three months or less at the time of purchase to be cash equivalents.  Changes in the balance of cash and cash equivalents are reported in the condensed consolidated statements of cash flows.  The following table sets forth information regarding certain cash and non-cash transactions for the nine months ended September 30, 2008 and 2007.

 
-6-

 
 
   
Nine Months Ended
 
   
September 30, 2008
   
September 30, 2007
 
   
(in thousands)
 
Cash paid for:
           
Interest
  $ 88,012     $ 93,345  
Income taxes
    25,069       8,000  
Non-cash activity:
               
Loans acquired and securitized as Farmer Mac Guaranteed Securities
    79,757       1,324  
Issuance of Series B redeemable preferred stock (net of deferred offering costs)
    61,039       -  
Reclassification of unsettled trades with The Reserve Primary Fund from Cash and cash equivalents to Prepaid expenses and other assets
    42,489       -  
Transfers of investment securities from available-for-sale to trading from the effect of adopting SFAS 159
    600,468       -  
Transfers of Farmer Mac II Guaranteed Securities from held-to-maturity to trading from the effect of adopting SFAS 159
    428,670       -  
Transfers of Farmer Mac II Guaranteed Securities from held-to-maturity to available-for-sale
    493,997       -  
Transfers of Farmer Mac I Guaranteed Securities from held-to-maturity to available-for-sale
    25,458       -  
Transfers of available-for-sale investment securities to available-for-sale Farmer Mac Guaranteed Securities - Rural Utilities
    902,420       -  
Transfers of trading investment securities to trading Farmer Mac Guaranteed Securities - Rural Utilities
    459,026       -  


 
(b)
Allowance for Losses

As of September 30, 2008, Farmer Mac maintained an allowance for losses to cover estimated probable losses on loans held, real estate owned, and loans underlying long-term standby purchase commitments (“LTSPCs”) and Farmer Mac I Guaranteed Securities issued after the Farm Credit System Reform Act of 1996 (the “1996 Act”) in accordance with Statement of Financial Accounting Standards No. 5, Accounting for Contingencies (“SFAS 5”), and Statement of Financial Accounting Standards No. 114, Accounting by Creditors for Impairment of a Loan, as amended (“SFAS 114”).

The allowance for losses is increased through periodic provisions for loan losses that are charged against net interest income and provisions for losses that are charged to non-interest expense and is reduced by charge-offs for actual losses, net of recoveries.  Negative provisions for loan losses or negative provisions for losses are recorded in the event that the estimate of probable losses as of the end of a period is lower than the estimate at the beginning of the period.

 
-7-

 

Farmer Mac’s methodology for determining its allowance for losses incorporates the Corporation’s proprietary automated loan classification system.  That system scores loans based on criteria such as historical repayment performance, loan seasoning, loan size and loan-to-value ratio.  For the purposes of the loss allowance methodology, the loans in Farmer Mac’s portfolio of loans and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs have been scored and classified for each calendar quarter since first quarter 2000.  The allowance methodology captures the migration of loan scores across concurrent and overlapping three-year time horizons and calculates loss rates separately within each loan classification for (1) loans underlying LTSPCs and (2) loans held and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities.  The calculated loss rates are applied to the current classification distribution of Farmer Mac’s portfolio to estimate inherent losses, on the assumption that the historical credit losses and trends used to calculate loss rates will continue in the future.  Management evaluates this assumption by taking into consideration factors including:

 
·
economic conditions;
 
·
geographic and agricultural commodity/product concentrations in the portfolio;
 
·
the credit profile of the portfolio;
 
·
delinquency trends of the portfolio;
 
·
historical charge-off and recovery activities of the portfolio; and
 
·
other factors to capture current portfolio trends and characteristics that differ from historical experience.

Management believes that its use of this methodology produces a reliable estimate of probable losses, as of the balance sheet date, for all loans held, real estate owned and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs in accordance with SFAS 5 and SFAS 114.

 
-8-

 

The following table summarizes the changes in the components of Farmer Mac’s allowance for losses for the three and nine months ended September 30, 2008 and 2007:
 
 
   
September 30, 2008
 
   
Allowance for Loan Losses
   
REO Valuation Allowance
   
Reserve for Losses
   
Total Allowance for Losses
 
   
(in thousands)
 
Three Months Ended:
                       
Beginning balance
  $ 1,592     $ -     $ 2,197     $ 3,789  
Provision/(recovery) for losses
    731       -       (91 )     640  
Charge-offs
    -       -       -       -  
Recoveries
    6       -       -       6  
Ending balance
  $ 2,329     $ -     $ 2,106     $ 4,435  
                                 
Nine Months Ended:
                               
Beginning balance
  $ 1,690     $ -     $ 2,197     $ 3,887  
Provision/(recovery) for losses
    731       -       (91 )     640  
Charge-offs
    (108 )     -       -       (108 )
Recoveries
    16       -       -       16  
Ending balance
  $ 2,329     $ -     $ 2,106     $ 4,435  


   
September 30, 2007
 
   
Allowance for Loan Losses
   
REO Valuation Allowance
   
Reserve for Losses
   
Total Allowance for Losses
 
   
(in thousands)
 
Three Months Ended:
                       
Beginning balance
  $ 1,681     $ -     $ 2,197     $ 3,878  
Provision/(recovery) for losses
    -       -       386       386  
Charge-offs
    -       -       (386 )     (386 )
Recoveries
    20       -       -       20  
Ending balance
  $ 1,701     $ -     $ 2,197     $ 3,898  
                                 
Nine Months Ended:
                               
Beginning balance
  $ 1,945     $ -     $ 2,610     $ 4,555  
Provision/(recovery) for losses
    (215 )     100       (27 )     (142 )
Charge-offs
    (49 )     (100 )     (386 )     (535 )
Recoveries
    20       -       -       20  
Ending balance
  $ 1,701     $ -     $ 2,197     $ 3,898  


Prior to third quarter 2007, no allowance for losses had been made for loans underlying Farmer Mac I Guaranteed Securities issued prior to the 1996 Act (“Pre-1996 Act Farmer Mac I Guaranteed Securities”), AgVantage securities or securities issued under the Farmer Mac II program (“Farmer Mac II Guaranteed Securities”).  Pre-1996 Act Farmer Mac I Guaranteed Securities are supported by unguaranteed first loss subordinated interests, which are expected to exceed the estimated credit losses on those loans.  Through September 30, 2008, Farmer Mac had charged off $0.4 million related to one loan underlying Pre-1996 Act Farmer Mac I Guaranteed Securities.  The remaining $1.7 million of Pre-1996 Act Farmer Mac I Guaranteed Securities represent interests in seasoned performing loans with low loan-to-value ratios.  Farmer Mac does not expect to incur any further losses on the remaining Pre-1996 Act Farmer Mac I Guaranteed Securities in the future.  Each AgVantage security is a general obligation of an issuing institution approved by Farmer Mac and is collateralized by eligible mortgage loans.  As of September 30, 2008, there were no probable losses inherent in Farmer Mac’s AgVantage securities due to the high credit quality of the obligors, as well as the underlying collateral.  As of September 30, 2008, Farmer Mac had not experienced any credit losses on any AgVantage securities and does not expect to incur any such losses in the future.  The guaranteed portions collateralizing Farmer Mac II Guaranteed Securities are guaranteed by the United States Department of Agriculture (“USDA”).  Each USDA guarantee is an obligation backed by the full faith and credit of the United States.  As of September 30, 2008, Farmer Mac had not experienced any credit losses on any Farmer Mac II Guaranteed Securities and does not expect to incur any such losses in the future.

 
-9-

 

On May 22, 2008, Congress enacted into law the Food, Conservation and Energy Act of 2008 (the “Farm Bill”), which expanded Farmer Mac’s authorities to include providing a secondary market for rural electric and telephone loans made by cooperative lenders.  During second quarter 2008, Farmer Mac placed its guarantee on $430.7 million of securities representing interests in rural electric cooperative loans and $900.0 million principal amount of obligations collateralized by rural electric cooperative loans previously held as mission-related investments under authority granted by the Farm Credit Administration (“FCA”).  During third quarter 2008, $500.0 million of the obligations collateralized by rural electric cooperative loans matured and was repaid and $5.7 million of the securities representing interests in rural electric cooperative loans was repaid.  Farmer Mac evaluated the remaining $825.0 million Farmer Mac Guaranteed Securities – Rural Utilities outstanding as of September 30, 2008 and determined that there were no probable losses inherent in the securities or the underlying rural utilities loans.  Accordingly, no allowance for losses was recorded as of September 30, 2008 with respect to those securities.

The table below summarizes the components of Farmer Mac’s allowance for losses as of September 30, 2008 and December 31, 2007:
 
 
   
September 30, 2008
   
December 31, 2007
 
   
(in thousands)
 
Allowance for loan losses
  $ 2,329     $ 1,690  
Real estate owned valuation allowance
    -       -  
Reserve for losses:
               
On-balance sheet Farmer Mac I Guaranteed Securities
    868       857  
Off-balance sheet Farmer Mac I Guaranteed Securities
    895       655  
LTSPCs
    343       685  
Farmer Mac Guaranteed Securities - Rural Utilities
    -       -  
Total
  $ 4,435     $ 3,887  

 
-10-

 

As of September 30, 2008, Farmer Mac individually analyzed $3.7 million of its $47.8 million of impaired assets for collateral shortfalls against updated appraised values, other updated collateral valuations or discounted values.  Farmer Mac evaluated the remaining $44.1 million of impaired assets, for which updated valuations were not available, in the aggregate in consideration of their similar risk characteristics and historical statistics.  All of the $3.7 million of assets analyzed individually were adequately collateralized.  Accordingly, Farmer Mac did not record any specific allowances for any of its impaired assets as of September 30, 2008.  Similarly, as of December 31, 2007, Farmer Mac did not record any specific allowances related to its $36.6 million of impaired assets as of that date.

Farmer Mac recognized interest income of approximately $1.0 million and $3.1 million on impaired loans during the three and nine months ended September 30, 2008, respectively, compared to $1.1 million and $2.9 million, respectively, during the same periods in 2007.  During the three and nine months ended September 30, 2008, Farmer Mac’s average investment in impaired loans was $46.9 million and $42.2 million, respectively, compared to $44.5 million and $50.1 million, respectively, for the same periods in 2007.


 
(c)
Adoption of Fair Value Accounting Standards

Effective January 1, 2008, Farmer Mac adopted Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“SFAS 157”) and Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities – Including an amendment of FASB Statement No. 115 (“SFAS 159”).  These standards require disclosures about financial assets and liabilities that are measured at fair value and provide an election option to report financial instruments at fair value with changes in fair value recorded in earnings as they occur.

Fair Value Measurements

SFAS 157 defines fair value, establishes a framework for measuring fair value under other accounting pronouncements that permit or require fair value measurements, and expands disclosures about fair value measurements.  In particular, disclosures are required to provide information on the extent to which fair value is used to measure assets and liabilities, the inputs used to develop measurements and the effects of certain of the measurements on earnings or changes in net assets.

The principal impact of SFAS 157 to Farmer Mac is to require expanded disclosures regarding fair value measurements.  SFAS 157 establishes a fair value hierarchy that prioritizes inputs to valuation techniques used to measure fair value.  The hierarchy gives highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements).  Farmer Mac’s assets and liabilities recorded at fair value have been categorized based upon a fair value hierarchy in accordance with SFAS 157.  The levels of fair value hierarchy are described below:

 
-11-

 

Basis of Fair Value Measurement

 
Level 1
Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.  Farmer Mac has classified exchange-traded Treasury futures as Level 1 measurements.

 
Level 2
Quoted prices in markets that are not active or financial instruments for which all significant inputs are observable, either directly or indirectly.  Level 2 inputs include inputs other than quoted prices that are observable for the financial instrument, such as interest rates and yield curves that are observable at commonly quoted intervals.  Farmer Mac has classified financial instruments for which there are continuous and verifiable pricing sources as Level 2 inputs, including certificates of deposit, commercial paper, asset-backed securities, corporate debt securities, mortgage-backed securities, preferred stock issued by Fannie Mae, and most financial derivatives.

 
Level 3
Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable.  Level 3 inputs include situations where there is little, if any, market activity for the financial instrument.  For financial instruments that are thinly traded, Farmer Mac uses as its primary fair value source analytical models that project cash flows based on internal and external inputs, including transaction terms, yield curves, benchmark data, volatility data, prepayment assumptions and default assumptions.  Financial instruments requiring Level 3 inputs include available-for-sale Farmer Mac I Guaranteed Securities, available-for-sale and trading Farmer Mac II Guaranteed Securities, available-for-sale and trading Farmer Mac Guaranteed Securities – Rural Utilities, auction-rate certificates, basis swaps, preferred stock issued by institutions of the Farm Credit System and loans held for sale.

In some cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy.  In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety.  Farmer Mac’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the financial instrument.

Both observable and unobservable inputs may be used to determine the fair value of positions that Farmer Mac has classified within the Level 3 category.  As a result, the unrealized gains and losses for assets and liabilities within the Level 3 category presented in the following tables may include changes in fair value that were attributable to both observable (e.g., changes in market interest rates) and unobservable (e.g., changes in long-dated volatilities) inputs.

 
-12-

 

The following table presents information about Farmer Mac’s assets and liabilities measured at fair value on a recurring and nonrecurring basis as of September 30, 2008, and indicates the fair value hierarchy of the valuation techniques utilized by Farmer Mac to determine such fair value.

Assets and Liabilities Measured at Fair Value as of September 30, 2008
                         
   
Level 1
   
Level 2
   
Level 3
   
Total
 
Recurring:
 
(in thousands)
 
Assets:
                       
Investment Securities:
                       
Available-for-sale:
                       
Fixed rate certificates of deposit
  $ -     $ 60,000     $ -     $ 60,000  
Fixed rate commercial paper
    -       84,571       -       84,571  
Floating rate auction-rate certificates backed by Government guaranteed student loans
    -       -       192,010       192,010  
Floating rate asset-backed securities
    -       94,437       -       94,437  
Floating rate corporate debt securities
    -       448,950       -       448,950  
Floating rate Government/GSE guaranteed mortgage-backed securities
    -       355,748       -       355,748  
Fixed rate GSE guaranteed mortgage-backed securities
    -       7,508       -       7,508  
Floating rate GSE subordinated debt
    -       51,562       -       51,562  
Floating rate GSE preferred stock
    -       2,469       -       2,469  
Total available-for-sale investment securities
    -       1,105,245       192,010       1,297,255  
                                 
Trading:
                               
Floating rate asset-backed securities
    -       -       4,357       4,357  
Fixed rate GSE preferred stock
    -       -       166,689       166,689  
Total trading investment securities
    -       -       171,046       171,046  
Total investment securities
    -       1,105,245       363,056       1,468,301  
                                 
Farmer Mac Guaranteed Securities:
                               
Available-for-sale:
                               
Farmer Mac I
    -       -       354,712       354,712  
Farmer Mac II
    -       -       493,997       493,997  
Rural Utilities
    -       -       401,485       401,485  
Total available-for-sale guaranteed securities
    -       -       1,250,194       1,250,194  
                                 
Trading:
                               
Farmer Mac II
    -       -       476,880       476,880  
Rural Utilities
    -       -       436,331       436,331  
Total trading guaranteed securities
    -       -       913,211       913,211  
Total Farmer Mac guaranteed securities
    -       -       2,163,405       2,163,405  
                                 
Financial Derivatives
    238       3,157       -       3,395  
Total Assets at fair value
  $ 238     $ 1,108,402     $ 2,526,461     $ 3,635,101  
                                 
Liabilities:
                               
Financial Derivatives
  $ -     $ 64,461     $ 1,209     $ 65,670  
                                 
Total Liabilities at fair value
  $ -     $ 64,461     $ 1,209     $ 65,670  
                                 
Nonrecurring:
                               
Loans held for sale
  $ -     $ -     $ 63,202     $ 63,202  

 
-13-

 

The following tables present additional information about assets and liabilities measured at fair value on a recurring and nonrecurring basis for which Farmer Mac has used significant Level 3 inputs to determine fair value for the three and nine months ended September 30, 2008.

Level 3 Assets and Liabilities Measured at Fair Value for the Three Months Ended September 30, 2008
   
Beginning Balance
   
Purchases, Sales, Issuances and Settlements, Net
   
Realized and Unrealized Gains/(Losses) included in Income
   
Unrealized Gains/(Losses) included in Other Comprehensive Income
   
Net Transfers In and/or Out
   
Ending Balance
 
Recurring:
 
(in thousands)
 
Assets:
                                   
Investment Securities:
                                   
Available-for-sale:
                                   
Floating rate auction-rate certificates backed by Government guaranteed student loans
  $ 209,360     $ (17,525 )   $ -     $ 175     $ -     $ 192,010  
Floating rate corporate debt securities
    -       -       -       -       -       -  
Fixed rate corporate debt securities
    -       -       -       -       -       -  
Total available-for-sale
    209,360       (17,525 )     -       175       -       192,010  
                                                 
Trading:
                                               
Floating rate asset-backed securities (1)
    7,414       (143 )     (2,914 )     -       -       4,357  
Fixed rate mortgage-backed securities
    -       -       -       -       -       -  
Fixed rate GSE preferred stock(1)
    -       (338 )     (12,073 )     -       179,100       166,689  
Total trading
    7,414       (481 )     (14,987 )     -       179,100       171,046  
Total investment securities
    216,774       (18,006 )     (14,987 )     175       179,100       363,056  
                                                 
Farmer Mac Guaranteed Securities:
                                               
Available-for-sale:
                                               
Farmer Mac I
    391,904       (64,387 )     -       2,203       24,992       354,712  
Farmer Mac II
    -       -       -       419       493,578       493,997  
Rural Utilities
    901,639       (500,000 )     -       (154 )     -       401,485  
Total available-for-sale
    1,293,543       (564,387 )     -       2,468       518,570       1,250,194  
                                                 
Trading:
                                               
Farmer Mac II (2)
    450,562       26,218       100       -       -       476,880  
Rural Utilities (1)
    441,685       (5,735 )     381       -       -       436,331  
Total trading
    892,247       20,483       481       -       -       913,211  
Total Farmer Mac Guaranteed Securities
    2,185,790       (543,904 )     481       2,468       518,570       2,163,405  
                                                 
Total Assets at fair value
  $ 2,402,564     $ (561,910 )   $ (14,506 )   $ 2,643     $ 697,670     $ 2,526,461  
Liabilities:
                                               
Financial Derivatives (3)
  $ (1,457 )   $ -     $ 248     $ -     $ -     $ (1,209 )
Total Liabilities at fair value
  $ (1,457 )   $ -     $ 248     $ -     $ -     $ (1,209 )
                                                 
Nonrecurring:
                                               
Loans held for sale
  $ 142,695     $ (79,534 )   $ 41     $ -     $ -     $ 63,202  

(1)
Unrealized gains/(losses) are attributable to assets still held as of September 30, 2008 and are recorded in losses on trading assets.
(2)
Includes unrealized gains of approximately $455,000 attributable to assets still held as of September 30, 2008 that are recorded in losses on trading assets.
(3)
Unrealized gains are attributable to liabilities still held as of September 30, 2008 and are recorded in losses on financial derivatives.

 
-14-

 

Level 3 Assets and Liabilities Measured at Fair Value for the Nine Months Ended September 30, 2008
   
Beginning Balance
   
Purchases, Sales, Issuances and Settlements, Net
   
Realized and Unrealized Gains/(Losses) included in Income
   
Unrealized Gains/(Losses) included in Other Comprehensive Income
   
Net Transfers In and/or Out
   
Ending Balance
 
Recurring:
 
(in thousands)
 
Assets:
                                   
Investment Securities:
                                   
Available-for-sale:
                                   
Floating rate auction-rate certificates backed by Government guaranteed student loans
  $ -     $ 62,406     $ -     $ (1,940 )   $ 131,544     $ 192,010  
Floating rate corporate debt securities
    -       400,000       -       (669 )     (399,331 )     -  
Fixed rate corporate debt securities
    500,138       -       -       2,951       (503,089 )     -  
Total available-for-sale
    500,138       462,406       -       342       (770,876 )     192,010  
                                                 
Trading:
                                               
Floating rate asset-backed securities (1)
    8,179       (771 )     (3,051 )     -       -       4,357  
Fixed rate mortgage-backed securities
    415,813       29,367       13,846       -       (459,026 )     -  
Fixed rate GSE preferred stock(1)
    -       (338 )     (12,073 )     -       179,100       166,689  
Total trading
    423,992       28,258       (1,278 )     -       (279,926 )     171,046  
Total investment securities
    924,130       490,664       (1,278 )     342       (1,050,802 )     363,056  
Farmer Mac Guaranteed Securities:
                                               
Available-for-sale:
                                               
Farmer Mac I
    338,958       (15,161 )     -       5,923       24,992       354,712  
Farmer Mac II
    -       -       -       419       493,578       493,997  
Rural Utilities
    -       (500,000 )     -       (935 )     902,420       401,485  
Total available-for-sale
    338,958       (515,161 )     -       5,407       1,420,990       1,250,194  
                                                 
Trading:
                                               
Farmer Mac II (2)
    428,670       46,715       1,495       -       -       476,880  
Rural Utilities (1)
    -       (5,735 )     (16,960 )     -       459,026       436,331  
Total trading
    428,670       40,980       (15,465 )     -       459,026       913,211  
Total Farmer Mac Guaranteed Securities
    767,628       (474,181 )     (15,465 )     5,407       1,880,016       2,163,405  
                                                 
Total Assets at fair value
  $ 1,691,758     $ 16,483     $ (16,743 )   $ 5,749     $ 829,214     $ 2,526,461  
Liabilities:
                                               
Financial Derivatives (3)
  $ (1,106 )   $ -     $ (103 )   $ -     $ -     $ (1,209 )
Total Liabilities at fair value
  $ (1,106 )   $ -     $ (103 )   $ -     $ -     $ (1,209 )
                                                 
Nonrecurring:
                                               
Loans held for sale
  $ -     $ (79,534 )   $ (20 )   $ -     $ 142,756     $ 63,202  


(1)
Unrealized losses are attributable to assets still held as of September 30, 2008 and are recorded in losses on trading assets.
(2)
Includes unrealized gains of approximately $2.3 million attributable to assets still held as of September 30, 2008 that are recorded in losses on trading assets.
(3)
Unrealized losses are attributable to liabilities still held as of September 30, 2008 and are recorded in losses on financial derivatives.

 
-15-

 

Fair Value Option

SFAS 159 permits entities to make a one-time election to report financial instruments at fair value with changes in fair value recorded in earnings as they occur.  The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions.

Farmer Mac adopted the provisions of SFAS 159 on January 1, 2008 and recorded a cumulative effect of adoption adjustment of $12.1 million, net of tax, as an increase to the beginning balance of retained earnings.  The fair value option election was made for certain available-for-sale investment securities and certain Farmer Mac II Guaranteed Securities that were classified as held-to-maturity on January 1, 2008.  These assets were selected for the fair value option under SFAS 159 because they were funded or hedged principally with financial derivatives and, therefore, it was expected that the changes in fair value of the assets would provide partial economic and financial reporting offsets to the related financial derivatives.


Impact of Adopting SFAS 159 to Retained Earnings as of January 1, 2008
   
Carrying Value as of January 1, 2008 Prior to Adoption of Fair Value Option
   
Transition Gain
   
Fair Value as of January 1, 2008 After Adoption of Fair Value Option
 
   
(in thousands)
 
Available-for-sale Investment Securities:
                 
Fixed rate GSE preferred stock (1)
  $ 184,655     $ 2,783     $ 184,655  
Fixed rate mortgage-backed securities (1)
    415,813       14,504       415,813  
                         
Held-to-maturity Farmer Mac Guaranteed Securities:
                       
Farmer Mac II Guaranteed Securities
    427,330       1,340       428,670  
                         
Pre-tax cumulative effect of adoption
            18,627          
Tax effect
            6,519          
                         
Cumulative effect of adoption to beginning retained earnings
          $ 12,108          

(1) Farmer Mac adopted the fair value option for certain securities classified within its investment portfolio previously classified as available-for-sale.  These securities are presented in the condensed consolidated balance sheet at fair value in accordance with Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities and the amount of the transition gain was recognized in accumulated other comprehensive loss prior to the adoption of SFAS 159.

 
(d)
Financial Derivatives

Farmer Mac enters into financial derivative transactions principally to protect against risk from the effects of market price or interest rate movements on the value of certain assets, future cash flows or debt issuance, not for trading or speculative purposes.  Principally, Farmer Mac enters into interest rate swap contracts to adjust the characteristics of its short-term debt to match more closely the cash flow and duration characteristics of its longer-term mortgage and other assets, and also to adjust the characteristics of its long-term debt to match more closely the cash flow and duration characteristics of its short-term assets, thereby reducing interest rate risk and also to derive an overall lower effective cost of borrowing than would otherwise be available to Farmer Mac in the conventional debt market.  During third quarter 2008, Farmer Mac, for the first time, purchased pay-fixed swaptions, which provide the option of entering into pay-fixed swaps, as part of its overall strategy in managing interest rate risk.  Farmer Mac is required also to recognize certain contracts and commitments as derivatives when the characteristics of those contracts and commitments meet the definition of a derivative as promulgated by Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended (“SFAS 133”).

 
-16-

 

Farmer Mac manages the interest rate risk related to loans it has committed to acquire, but has not yet purchased and permanently funded, through the use of forward sale contracts on mortgage-backed securities and the debt of other government-sponsored enterprises (“GSEs”), futures contracts involving U.S. Treasury securities and interest rate swaps.  Farmer Mac uses forward sale contracts on GSE securities to reduce its interest rate exposure to changes in both Treasury rates and spreads on Farmer Mac debt and Farmer Mac Guaranteed Securities.  The notional amounts of these contracts are determined based on a duration-matched hedge ratio between the hedged item and the hedge instrument.  Gains or losses generated by these hedge transactions should offset changes in funding costs or Farmer Mac Guaranteed Securities sale prices that occur during the hedge period.

All financial derivatives are recorded on the balance sheet at fair value as a freestanding asset or liability in accordance with SFAS 133.  Farmer Mac does not designate its financial derivatives as fair value hedges or cash flow hedges; therefore, the changes in the fair values of financial derivatives are reported as gains or losses on financial derivatives in the condensed consolidated statements of operations.

The following table summarizes information related to Farmer Mac’s financial derivatives as of September 30, 2008 and December 31, 2007:
 
 
   
September 30, 2008
   
December 31, 2007
 
   
Notional Amount
   
Fair Value
   
Notional Amount
   
Fair Value
 
   
(in thousands)
 
Interest rate swaps:
                   <