AGM-9.30.2012-10Q
Table of Contents

As filed with the Securities and Exchange Commission on November 8, 2012
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, 2012
Commission File Number 001-14951 
 ____________________________________________________________
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)
 
 
1999 K Street, N.W., 4th Floor,
Washington, D.C.
20006
(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        x                               No           o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes        x                                No          o
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 the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. 
Large accelerated filer
o
Accelerated filer
x
Non-accelerated filer
o
Smaller reporting company
o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes        o                                No           x
As of November 1, 2012, the registrant had outstanding 1,030,780 shares of Class A voting common stock, 500,301 shares of Class B voting common stock and 8,977,818 shares of Class C non-voting common stock.

Table of Contents

Table of Contents

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2
Table of Contents

PART I - FINANCIAL INFORMATION

Item 1.
Consolidated Financial Statements

FEDERAL AGRICULTURAL MORTGAGE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(unaudited) 
 
September 30,
2012
 
December 31,
2011
 
(in thousands)
Assets:
 
 
 
Cash and cash equivalents
$
870,040

 
$
817,046

Investment securities:
 

 
 

Available-for-sale, at fair value
2,634,984

 
2,182,694

Trading, at fair value
1,344

 
1,796

Total investment securities
2,636,328

 
2,184,490

Farmer Mac Guaranteed Securities:
 

 
 

Available-for-sale, at fair value
4,648,507

 
4,289,272

USDA Guaranteed Securities:
 

 
 

Available-for-sale, at fair value
1,468,041

 
1,279,546

Trading, at fair value
122,587

 
212,359

Total USDA Guaranteed Securities
1,590,628

 
1,491,905

Loans:
 

 
 

Loans held for sale, at lower of cost or fair value
622,330

 
541,447

Loans held for investment, at amortized cost
1,367,948

 
1,241,311

Loans held for investment in consolidated trusts, at amortized cost
568,307

 
1,121,559

Allowance for loan losses
(9,050
)
 
(10,161
)
Total loans, net of allowance
2,549,535

 
2,894,156

Real estate owned, at lower of cost or fair value
3,453

 
3,136

Financial derivatives, at fair value
36,190

 
40,250

Interest receivable (includes $3,643 and $15,578, respectively, related to consolidated trusts)
70,128

 
110,339

Guarantee and commitment fees receivable
37,740

 
31,384

Prepaid expenses and other assets
59,932

 
21,530

Total Assets
$
12,502,481

 
$
11,883,508


 
 
 
Liabilities and Equity:
 

 
 

Liabilities:
 

 
 

Notes payable:
 

 
 

Due within one year
$
6,775,226

 
$
6,087,879

Due after one year
4,700,680

 
4,104,882

Total notes payable
11,475,906

 
10,192,761

Debt securities of consolidated trusts held by third parties
163,909

 
701,583

Financial derivatives, at fair value
164,949

 
160,024

Accrued interest payable (includes $1,583 and $7,659, respectively, related to consolidated trusts)
35,487

 
60,854

Guarantee and commitment obligation
34,393

 
27,440

Accounts payable and accrued expenses
12,915

 
178,708

Deferred tax liability, net
5,873

 
250

Reserve for losses
8,736

 
7,355

Total Liabilities
11,902,168

 
11,328,975

Commitments and Contingencies (Note 6)


 


Equity:
 

 
 

Preferred stock:
 

 
 

Series C, par value $1,000 per share, 100,000 shares authorized, 57,578 shares issued and outstanding
57,578

 
57,578

Common stock:
 

 
 

Class A Voting, $1 par value, no maximum authorization, 1,030,780 shares outstanding
1,031

 
1,031

Class B Voting, $1 par value, no maximum authorization, 500,301 shares outstanding
500

 
500

Class C Non-Voting, $1 par value, no maximum authorization, 8,964,819 shares and 8,825,794 shares outstanding, respectively
8,965

 
8,826

Additional paid-in capital
104,869

 
102,821

Accumulated other comprehensive income, net of tax, related to available-for-sale securities
91,805

 
79,370

Retained earnings
93,712

 
62,554

Total Stockholders' Equity
358,460

 
312,680

Non-controlling interest - preferred stock
241,853

 
241,853

Total Equity
600,313

 
554,533

Total Liabilities and Equity
$
12,502,481

 
$
11,883,508

See accompanying notes to consolidated financial statements.

3
Table of Contents

FEDERAL AGRICULTURAL MORTGAGE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
 
For the Three Months Ended
 
For the Nine Months Ended
 
September 30,
2012
 
September 30,
2011
 
September 30,
2012
 
September 30,
2011
 
(in thousands, except per share amounts)
Interest income:
 
 
 
 
 
 
 
Investments and cash equivalents
$
6,437

 
$
6,880

 
$
18,693

 
$
21,100

Farmer Mac Guaranteed Securities and USDA Guaranteed Securities
33,261

 
34,398

 
108,530

 
91,531

Loans
24,112

 
29,843

 
81,296

 
89,414

Total interest income
63,810

 
71,121

 
208,519

 
202,045

Total interest expense
33,448

 
39,412

 
109,332

 
114,105

Net interest income
30,362

 
31,709

 
99,187

 
87,940

(Provision for)/release of loan losses
(137
)
 
349

 
663

 
(1,092
)
Net interest income after (provision for)/release of loan losses
30,225

 
32,058

 
99,850

 
86,848

Non-interest income/(loss):
 

 
 

 
 

 
 

Guarantee and commitment fees
6,401

 
6,148

 
18,395

 
18,855

Gains/(losses) on financial derivatives and hedging activities
1,558

 
(68,567
)
 
(23,334
)
 
(82,368
)
Losses on trading assets
(441
)
 
(3,633
)
 
(2,428
)
 
(354
)
Gains on sale of available-for-sale investment securities
—


74

 
28

 
269

(Losses)/gains on sale of real estate owned
(13
)
 
(4
)
 
249

 
720

Lower of cost or fair value adjustment on loans held for sale
—

 
9,851

 
—

 
8,887

Other income
959

 
726

 
2,451

 
5,748

Non-interest income/(loss)
8,464

 
(55,405
)
 
(4,639
)
 
(48,243
)
Non-interest expense:
 

 
 

 
 

 
 

Compensation and employee benefits
4,375

 
4,805

 
13,434

 
13,968

General and administrative
2,788

 
2,505

 
8,210

 
7,417

Regulatory fees
562

 
550

 
1,687

 
1,714

Real estate owned operating costs, net
66

 
142

 
87

 
741

(Release of)/provision for losses
(43
)
 
(452
)
 
1,381

 
(3,321
)
Other expense
—

 
—

 
—

 
900

Non-interest expense
7,748

 
7,550

 
24,799

 
21,419

Income/(loss) before income taxes
30,941

 
(30,897
)
 
70,412

 
17,186

Income tax expense/(benefit)
8,294

 
(14,131
)
 
17,319

 
(2,075
)
Net income/(loss)
22,647

 
(16,766
)
 
53,093

 
19,261

Less: Net income attributable to non-controlling interest - preferred stock dividends
(5,547
)
 
(5,547
)
 
(16,641
)
 
(16,641
)
Net income/(loss) attributable to Farmer Mac
17,100

 
(22,313
)
 
36,452

 
2,620

Preferred stock dividends
(719
)
 
(719
)
 
(2,159
)
 
(2,159
)
Net income/(loss) attributable to common stockholders
$
16,381

 
$
(23,032
)
 
$
34,293

 
$
461

 
 
 
 
 
 
 
 
Earnings/(loss) per common share and dividends:
 

 
 

 
 

 
 

Basic earnings/(loss) per common share
$
1.56

 
$
(2.22
)
 
$
3.28

 
$
0.04

Diluted earnings/(loss) per common share
$
1.49

 
$
(2.22
)
 
$
3.12

 
$
0.04

Common stock dividends per common share
$
0.10

 
$
0.05

 
$
0.30

 
$
0.15

See accompanying notes to consolidated financial statements.

4
Table of Contents

FEDERAL AGRICULTURAL MORTGAGE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(unaudited)

 
For the Three Months Ended
 
For the Nine Months Ended
 
September 30,
2012
 
September 30,
2011
 
September 30,
2012
 
September 30,
2011
 
(in thousands)
Net income/(loss)
$
22,647

 
$
(16,766
)
 
$
53,093

 
$
19,261

Other comprehensive income, net of tax:
 
 
 
 
 
 
 
Unrealized holding gains on securities (1)
5,507

 
49,661

 
16,370

 
70,573

Less: Reclassification adjustment for gains included in net income (2)
(3,415
)
 
(383
)
 
(3,935
)
 
(3,133
)
Other comprehensive income
2,092

 
49,278

 
12,435

 
67,440

Comprehensive income
24,739

 
32,512

 
65,528

 
86,701

Less: Comprehensive income attributable to noncontrolling interest - preferred stock dividends
(5,547
)
 
(5,547
)
 
(16,641
)
 
(16,641
)
Comprehensive income attributable to Farmer Mac
$
19,192

 
$
26,965

 
$
48,887

 
$
70,060


(1)
Presented net of income tax expense of $3.0 million and $26.7 million for the three months ended September 30, 2012 and 2011, respectively, and income tax expense of $8.8 million and $38.0 million for the nine months ended September 30, 2012 and 2011, respectively.
(2)
Presented net of income tax benefit of $1.8 million and $0.2 million for the three months ended September 30, 2012 and 2011, respectively, and income tax benefit of $2.1 million and $1.7 million for the nine months ended September 30, 2012 and 2011, respectively.

See accompanying notes to consolidated financial statements.

5
Table of Contents

FEDERAL AGRICULTURAL MORTGAGE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EQUITY
(unaudited)
  
For the Nine Months Ended
 
September 30, 2012
 
September 30, 2011
 
Shares
 
Amount
 
Shares
 
Amount
 
(in thousands)
Preferred stock:
 
 
 
 
 
 
 
Balance, beginning of period
58

 
$
57,578

 
58

 
$
57,578

Issuance of Series C preferred stock
—

 
—

 
—

 
—

Balance, end of period
58

 
$
57,578

 
58

 
$
57,578

Common stock:
 

 
 

 
 

 
 

Balance, beginning of period
10,357

 
$
10,357

 
10,284

 
$
10,284

Issuance of Class C common stock
43

 
43

 
59

 
59

Exercise of stock options and SARs
96

 
96

 
14

 
14

Balance, end of period
10,496

 
$
10,496

 
10,357

 
$
10,357

Additional paid-in capital:
 

 
 

 
 

 
 

Balance, beginning of period
 

 
$
102,821

 
 

 
$
100,050

Stock-based compensation expense
 

 
2,721

 
 

 
2,254

Issuance of Class C common stock
 

 
11

 
 

 
19

Tax effect of stock-based awards
 

 
(684
)
 
 

 
(514
)
Balance, end of period
  

 
$
104,869

 
  

 
$
101,809

Retained earnings:
 

 
 

 
 

 
 

Balance, beginning of period
 

 
$
62,554

 
 

 
$
50,837

Net income attributable to Farmer Mac
 

 
36,452

 
 

 
2,620

Cash dividends:
 

 
 

 
 

 
 

Preferred stock, Series C ($37.50 per share)
 

 
(2,159
)
 
 

 
(2,159
)
Common stock ($0.30 per share and $0.15 per share, respectively)
 

 
(3,135
)
 
 

 
(1,549
)
Balance, end of period
 

 
$
93,712

 
 

 
$
49,749

Accumulated other comprehensive income:
 

 
 

 
 

 
 

Balance, beginning of period
 

 
$
79,370

 
 

 
$
18,275

Other comprehensive income, net of tax
 

 
12,435

 
 

 
67,440

Balance, end of period
 

 
$
91,805

 
 

 
$
85,715

Total Stockholders' Equity
 

 
$
358,460

 
 

 
$
305,208

Non-controlling interest - preferred stock:
 

 
 

 
 

 
 

Balance, beginning of period
 

 
$
241,853

 
 

 
$
241,853

Issuance of Preferred stock - Farmer Mac II LLC
 

 
—

 
 

 
—

Balance, end of period
 

 
$
241,853

 
 

 
$
241,853

Total Equity
 
 
$
600,313

 
 

 
$
547,061

See accompanying notes to consolidated financial statements.



6
Table of Contents

FEDERAL AGRICULTURAL MORTGAGE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited) 
 
For the Nine Months Ended
 
September 30,
2012
 
September 30,
2011
 
(in thousands)
Cash flows from operating activities:
 
 
 
Net income
$
53,093

 
$
19,261

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 

Net amortization of deferred gains, premiums and discounts on loans, investments, Farmer Mac Guaranteed Securities and USDA Guaranteed Securities
10,109

 
9,707

Amortization of debt premiums, discounts and issuance costs
10,653

 
8,822

Net change in fair value of trading securities, hedged assets, financial derivatives and loans held for sale
3,035

 
48,538

Gains on the sale of available-for-sale investment securities
(28
)
 
(269
)
Gains on the sale of real estate owned
(249
)
 
(720
)
Total provision for/(release of) losses
718

 
(2,229
)
Deferred income taxes
(1,885
)
 
(20,734
)
Stock-based compensation expense
2,721

 
2,254

Proceeds from repayment and sale of trading investment securities
663

 
686

Purchases of loans held for sale
(114,299
)
 
(152,117
)
Proceeds from repayment of loans purchased as held for sale
143,915

 
83,361

Net change in:
 
 
 

Interest receivable
40,603

 
10,778

Guarantee and commitment fees receivable
(6,356
)
 
4,505

Other assets
(37,388
)
 
2,269

Accrued interest payable
(25,367
)
 
(8,133
)
Other liabilities
3,853

 
2,838

Net cash provided by operating activities
83,791

 
8,817

Cash flows from investing activities:
 

 
 

Purchases of available-for-sale investment securities
(1,524,618
)
 
(1,276,131
)
Purchases of Farmer Mac Guaranteed Securities and USDA Guaranteed Securities
(1,233,312
)
 
(2,105,473
)
Purchases of loans held for investment
(383,684
)
 
(398,050
)
Purchases of defaulted loans
(11,031
)
 
(21,266
)
Proceeds from repayment of available-for-sale investment securities
910,313

 
675,566

Proceeds from repayment of Farmer Mac Guaranteed Securities and USDA Guaranteed Securities
780,643

 
699,263

Proceeds from repayment of loans purchased as held for investment
244,577

 
251,471

Proceeds from sale of available-for-sale investment securities
5,028


447,864

Proceeds from sale of Farmer Mac Guaranteed Securities
29,334

 
13,869

Proceeds from sale of real estate owned
1,062

 
1,361

Net cash used in investing activities
(1,181,688
)
 
(1,711,526
)
Cash flows from financing activities:
 

 
 

Proceeds from issuance of discount notes
51,844,862

 
52,174,214

Proceeds from issuance of medium-term notes
2,148,051

 
1,981,109

Payments to redeem discount notes
(51,328,421
)
 
(51,185,913
)
Payments to redeem medium-term notes
(1,392,000
)
 
(1,027,000
)
Excess tax benefits related to stock-based awards
994

 
243

Payments to third parties on debt securities of consolidated trusts
(101,421
)
 
(124,521
)
Proceeds from common stock issuance
41

 
20

Dividends paid - Non-controlling interest - preferred stock
(16,641
)
 
(16,641
)
Dividends paid on common and preferred stock
(4,574
)
 
(3,708
)
Net cash provided by financing activities
1,150,891

 
1,797,803

Net increase in cash and cash equivalents
52,994

 
95,094

Cash and cash equivalents at beginning of period
817,046

 
729,920

Cash and cash equivalents at end of period
$
870,040

 
$
825,014

 See accompanying notes to consolidated financial statements.

7
Table of Contents

FEDERAL AGRICULTURAL MORTGAGE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

1.
ACCOUNTING POLICIES

The interim unaudited consolidated financial statements of the Federal Agricultural Mortgage Corporation ("Farmer Mac" or the "Corporation") and subsidiaries have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the "SEC"). These interim unaudited 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 position and the results of operations and cash flows of Farmer Mac and subsidiaries for the interim periods presented. Certain information and footnote disclosures normally included in the annual consolidated financial statements have been omitted as permitted by SEC rules and regulations. The December 31, 2011 consolidated balance sheet presented in this report has been derived from the Corporation's audited 2011 consolidated financial statements. Management believes that the disclosures are adequate to present fairly the consolidated financial statements as of the dates and for the periods presented. These interim unaudited consolidated financial statements should be read in conjunction with the 2011 consolidated financial statements of Farmer Mac and subsidiaries included in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2011 filed with the SEC on March 15, 2012. 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.

Principles of Consolidation

The consolidated financial statements include the accounts of Farmer Mac and its two subsidiaries: (1) Farmer Mac Mortgage Securities Corporation ("FMMSC"), whose principal activities are to facilitate the purchase and issuance of Farmer Mac Guaranteed Securities and (2) Farmer Mac II LLC, whose principal activity is the operation of substantially all of the business related to the Farmer Mac II program – primarily the acquisition of USDA-guaranteed portions.  The consolidated financial statements also include the accounts of variable interest entities ("VIEs") in which Farmer Mac determined itself to be the primary beneficiary.  See Note 1(f) for more information on consolidated VIEs.

A Farmer Mac guarantee of timely payment of principal and interest is an explicit element of the terms of all Farmer Mac Guaranteed Securities.  When Farmer Mac retains such securities in its portfolio, that guarantee is not extinguished.  For Farmer Mac Guaranteed Securities in the Corporation's portfolio, Farmer Mac has entered into guarantee arrangements with FMMSC.  The guarantee fee rate established between Farmer Mac and FMMSC is an element in determining the fair value of these Farmer Mac Guaranteed Securities, and guarantee fees related to these securities are reflected in guarantee and commitment fees in the consolidated statements of operations.  These guarantee fees totaled $2.6 million and $7.7 million for the three and nine months ended September 30, 2012, respectively, compared to $2.4 million and $6.5 million for the same periods in 2011. The corresponding expense of FMMSC has been eliminated against interest income in consolidation.  All other inter-company balances and transactions have been eliminated in consolidation.


8
Table of Contents

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

Farmer Mac considers highly liquid investment securities with maturities at the time of purchase of three months or less to be cash equivalents.  The carrying value of cash and cash equivalents is a reasonable estimate of their approximate fair value.  Changes in the balance of cash and cash equivalents are reported in the 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, 2012 and 2011:

 
For the Nine Months Ended
 
September 30, 2012
 
September 30, 2011
 
(in thousands)
Cash paid during the period for:
 
 
 
Interest
$
90,588

 
$
78,598

Income taxes
16,500

 
20,568

Non-cash activity:
 

 
 

Real estate owned acquired through loan liquidation
1,130

 
2,723

Loans acquired and securitized as Farmer Mac Guaranteed Securities
24,008

 
10,656

Consolidation of Farmer Mac I Guaranteed Securities from off-balance sheet to loans held for investment in consolidated trusts and to debt securities of consolidated trusts held by third parties
24,008

 
10,656

Deconsolidation of loans held for investment in consolidated trusts and debt securities of consolidated trusts held by third parties - transferred to off-balance sheet Farmer Mac I Guaranteed Securities
460,261

 
—

Transfers of loans held for sale to loans held for investment
—

 
878,798


During second quarter 2012, Farmer Mac deconsolidated $460.3 million of Farmer Mac I Guaranteed Securities owned by Farm Credit West ("FCW") from loans held for investment in consolidated trusts and debt securities of consolidated trusts held by third parties to off-balance sheet Farmer Mac I Guaranteed Securities because FCW was no longer a related party as of June 30, 2012.

Effective January 1, 2011, Farmer Mac transferred $878.8 million of loans in the Farmer Mac I program from held for sale to held for investment because Farmer Mac no longer has the intent to securitize or sell these loans in the foreseeable future. Farmer Mac transferred these loans at their cost, which was lower than the estimated fair value at the time of transfer. At the time of purchase, loans are classified as either held for sale or held for investment depending upon management's intent and ability to hold the loans for the foreseeable future. Cash receipts from the repayment of loans are classified within the statements of cash flows based on management's intent upon purchase of the loan, as prescribed by accounting guidance related to the statement of cash flows.


9
Table of Contents

(b)
Allowance for Losses

Farmer Mac maintains an allowance for losses to cover estimated probable losses incurred as of the balance sheet date on loans held ("allowance for loan losses") and loans underlying LTSPCs and Farmer Mac Guaranteed Securities ("reserve for losses") based on available information.  Farmer Mac's methodology for determining the allowance for losses separately considers its portfolio segments – Farmer Mac I, Farmer Mac II, and Rural Utilities, and disaggregates its analysis, where relevant, into classes of financing receivables, which currently include loans and AgVantage securities.  Further
disaggregation by commodity type is performed, where appropriate, in analyzing the need for an allowance for losses.

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, or releases of allowance for losses, generally 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.

The total allowance for losses consists of a general allowance for losses and a specific allowance for impaired loans.

General Allowance for Losses

Farmer Mac I
 
Farmer Mac's methodology for determining its allowance for losses incorporates the Corporation's automated loan classification system.  That system scores loans based on criteria such as historical repayment performance, indicators of current financial condition, loan seasoning, loan size and loan-to-value ratio.  For purposes of the loss allowance methodology, the loans in Farmer Mac's portfolio of loans and loans underlying 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 Farmer Mac I Guaranteed Securities.  The calculated loss rates are applied to the current classification distribution of unimpaired loans in 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 several 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 reasonable estimate of probable losses, as of the balance sheet date, for all loans held in the Farmer Mac I portfolio and loans underlying Farmer Mac I Guaranteed Securities and LTSPCs. There were no purchases or sales during the first nine

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months of 2012 that materially affected the credit profile of the Farmer Mac I portfolio.

Farmer Mac has not provided an allowance for losses for loans underlying Farmer Mac I AgVantage securities.  Each AgVantage security is a general obligation of an issuing institution approved by Farmer Mac and is secured by eligible loans in an amount at least equal to the outstanding principal amount of the security, with some level of overcollateralization required for Farmer Mac I AgVantage securities. Farmer Mac excludes the loans that secure AgVantage securities from the credit risk metrics it discloses because of the credit quality of the issuing institutions, the collateralization level for the securities, and because delinquent loans are required to be removed from the pool of pledged loans and replaced with current eligible loans. AgVantage® is a registered trademark of Farmer Mac.

Farmer Mac II

No allowance for losses has been provided for USDA Guaranteed Securities or Farmer Mac II Guaranteed Securities.  The USDA-guaranteed portions presented as "USDA Guaranteed Securities" on the consolidated balance sheets, as well as those that collateralize Farmer Mac II Guaranteed Securities, are guaranteed by the United States Department of Agriculture.  Each USDA guarantee is an obligation backed by the full faith and credit of the United States.  Farmer Mac excludes these guaranteed portions from the credit risk metrics it discloses because of the USDA guarantee.

Rural Utilities

Farmer Mac separately evaluates the rural utilities loans it owns, as well as the lender obligations and loans underlying or securing its Farmer Mac Guaranteed Securities – Rural Utilities, including AgVantage securities, to determine if there are any probable losses inherent in those assets.  Each AgVantage security is a general obligation of an issuing institution approved by Farmer Mac and is secured by eligible loans in an amount at least equal to the outstanding principal amount of the security.  No allowance for losses has been provided for this portfolio segment based on the credit quality of the collateral supporting rural utilities assets and Farmer Mac's counterparty risk analysis. As of September 30, 2012, there were no delinquencies and no probable losses inherent in Farmer Mac's rural utilities loans held or in any Farmer Mac Guaranteed Securities – Rural Utilities.

Specific Allowance for Impaired Loans

Farmer Mac also analyzes certain loans in its portfolio for impairment in accordance with accounting guidance on measuring individual impairment of a loan.  Farmer Mac's impaired loans generally include loans 90 days or more past due, in foreclosure, restructured, in bankruptcy and certain performing loans that have previously been delinquent or are secured by real estate that produces agricultural commodities or products currently under stress.

For loans with an updated appraised value, other updated collateral valuation or management's estimate of discounted collateral value, this analysis includes the measurement of the fair value of the underlying collateral for individual loans relative to the total recorded investment, including principal, interest and advances and net of any charge-offs.  In the event that the collateral value does not support the total recorded investment, Farmer Mac specifically provides an allowance for the loan for the difference between the recorded investment and its fair value, less estimated costs to liquidate the collateral. Estimated selling costs are based on historical selling costs incurred by Farmer Mac or management's best estimate of selling costs for a particular property.  For the remaining impaired assets without updated

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valuations, this analysis is performed in the aggregate in consideration of the similar risk characteristics of the assets and historical statistics.

A modification to the contractual terms of a loan that results in granting a concession to a borrower experiencing financial difficulties is considered a troubled debt restructuring ("TDR"). Farmer Mac has granted a concession when, as a result of the restructuring, it does not expect to collect all amounts due, including interest accrued at the original contract rate. In making its determination of whether a borrower is experiencing financial difficulties, Farmer Mac considers several factors, including whether (1) the borrower has declared or is in the process of declaring bankruptcy, (2) there is substantial doubt as to whether the borrower will continue to be a going concern, and (3) the borrower can obtain funds from other sources at an effective interest rate at or near a current market interest rate for debt with similar risk characteristics. Farmer Mac evaluates TDRs similarly to other impaired loans for purposes of the allowance for losses. For the three and nine months ended September 30, 2012, the recorded investment of loans determined to be TDRs was $0.4 million and $1.5 million, respectively, before restructuring and $0.4 million and $1.7 million, respectively, after restructuring. As of September 30, 2012, there was one TDR identified during the previous 12 months that was in default, under the modified terms, with a recorded investment of $0.1 million. The impact of TDRs on Farmer Mac's allowance for loan losses for the three and nine months ended September 30, 2012 was partial releases of $46,000 and $0.2 million, respectively. See Note 5 for more information related to the allowance for losses.

(c)
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. Farmer Mac enters into interest rate swap contracts
principally to adjust the characteristics of its short-term debt to match more closely the cash flow and
duration characteristics of its longer-term loans 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 often times deriving an overall lower effective cost of borrowing
than would otherwise be available to Farmer Mac in the conventional debt market. Farmer Mac is
required to recognize certain contracts and commitments as derivatives when the characteristics of those
contracts and commitments meet the definition of a derivative.

Accounting for financial derivatives differs significantly depending on whether a derivative is designated as a hedge. Derivative instruments designated in hedging relationships that mitigate exposure to changes in the fair value of assets or liabilities are considered fair value hedges. Derivative instruments designated in hedging relationships that mitigate exposure to the variability in expected future cash flows or other forecasted transactions are considered cash flow hedges. In order to qualify for hedge accounting treatment, documentation must indicate the intention to designate the derivative as a hedge of a specific asset or liability or a future cash flow. Effectiveness of the hedge must be monitored over the life of the derivative instrument.

Financial derivatives are recorded on the consolidated balance sheets at fair value as a freestanding asset or liability. Fair value hedges are accounted for by recording the fair value of the financial derivative and the change in fair value of the hedged item attributable to the risk being hedged on the consolidated balance sheets with the net difference reported as gains/(losses) on financial derivatives and hedging activities in the consolidated statements of operations. The accrual of the contractual amounts due on the financial derivative is included as an adjustment to the yield of the hedged item and is reported in net

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interest income. Cash flow hedges are accounted for by recording the fair value of the financial derivative as either a freestanding asset or a freestanding liability on the consolidated balance sheets, with the effective portion of the change in fair value of the financial derivative recorded in accumulated other comprehensive income within stockholders' equity, net of tax. Amounts are reclassified from accumulated other comprehensive income to interest income or expense in the consolidated statements of operations in the period the hedged transaction affects earnings. Any ineffective portion of the change in fair value of the financial derivative is reported as gains/(losses) on financial derivatives and hedging activities in the consolidated statements of operations. If it becomes probable that a hedged forecasted transaction will not occur, any amounts included in accumulated other comprehensive income related to the specific hedging relationship are reclassified from accumulated other comprehensive income to the consolidated statements of operations and reported as gains/(losses) on financial derivatives and hedging activities.

Through second quarter 2012, Farmer Mac did not designate its financial derivatives as fair value hedges or cash flow hedges; therefore, the changes in the fair values of financial derivatives were reported as gains/(losses) on financial derivatives and hedging activities in the consolidated statements of operations, without offsetting fair value adjustments on the hedged items. Effective July 1, 2012, Farmer Mac designated $950.0 million notional amount of interest rate swaps in fair value hedge relationships. These interest rate swaps are used to hedge against the risk of changes in fair values of certain fixed rate AgVantage securities due to changes in the designated benchmark interest rate (i.e., LIBOR). Beginning in third quarter 2012, Farmer Mac recorded in earnings offsetting fair value adjustments on the hedged items attributable to the risk being hedged. Any differences arising from fair value changes that are not offset will result in hedge ineffectiveness and affect GAAP earnings.

In accordance with applicable fair value measurement guidance, Farmer Mac made an accounting policy election to measure the credit risk of its derivative financial instruments that are subject to master netting agreements on a net basis by counterparty portfolio, consistent with how the Corporation previously has been measuring credit risk for these instruments. See Notes 4 and 8 for more information on financial derivatives.


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(d)
Earnings/Loss Per Common Share

Basic earnings/loss per common share ("EPS") is based on the weighted-average number of shares of common stock outstanding.  Diluted earnings per common share is based on the weighted-average number of shares of common stock outstanding adjusted to include all potentially dilutive common stock options, stock appreciation rights ("SARs") and non-vested restricted stock awards.  The following schedules reconcile basic and diluted EPS for the three and nine months ended September 30, 2012 and 2011:

 
For the Three Months Ended
 
September 30, 2012
 
September 30, 2011
 
Net Income
 
Weighted-Average Shares
 
$ per
Share
 
Net Loss
 
Weighted-Average Shares
 
$ per
Share
 
(in thousands, except per share amounts)
Basic EPS
 
 
 
 
 
 
 
 
 
 
 
Net income/(loss) attributable to common stockholders
$
16,381

 
10,492

 
$
1.56

 
$
(23,032
)
 
10,354

 
$
(2.22
)
Effect of dilutive securities(1):
 

 
 

 
 

 
 

 
 

 
 

Stock options, SARs and restricted stock
 
 
504

 
(0.07
)
 
 
 
—

 
—

Diluted EPS
$
16,381

 
10,996

 
$
1.49

 
$
(23,032
)
 
10,354

 
$
(2.22
)

(1)
For the three months ended September 30, 2012 and 2011, stock options and SARs of 296,873 and 1,294,066, respectively, were outstanding but not included in the computation of diluted earnings per share of common stock because they were anti-dilutive. For the three months ended September 30, 2012 and 2011, contingent shares of non-vested restricted stock of 106,300 and 196,076, respectively, were outstanding but not included in the computation of diluted earnings per share of common stock because performance conditions were not met.

 
For the Nine Months Ended
 
September 30, 2012
 
September 30, 2011
 
Net
Income
 
Weighted-Average Shares
 
$ per
Share
 
Net
Income
 
Weighted-Average Shares
 
$ per
Share
 
(in thousands, except per share amounts)
Basic EPS
 
 
 
 
 
 
 
 
 
 
 
Net income attributable to common stockholders
$
34,293

 
10,442

 
$
3.28

 
$
461

 
10,328

 
$
0.04

Effect of dilutive securities(1):
 

 
 

 
 

 
 

 
 

 
 

Stock options, SARs and restricted stock
 
 
532

 
(0.16
)
 


 
387

 
—

Diluted EPS
$
34,293

 
10,974

 
$
3.12

 
$
461

 
10,715

 
$
0.04


(1)
For the nine months ended September 30, 2012 and 2011, stock options and SARs of 412,009 and 685,921, respectively, were outstanding but not included in the computation of diluted earnings per share of common stock because they were anti-dilutive. For the nine months ended September 30, 2012 and 2011, contingent shares of non-vested restricted stock of 97,300 and 150,353, respectively, were outstanding but not included in the computation of diluted earnings per share of common stock because performance conditions were not met.


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(e)
Fair Value Measurement

Farmer Mac follows accounting guidance for fair value measurements that defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date and establishes a fair value hierarchy that ranks the quality and reliability of the inputs to valuation techniques used to measure fair value.  The hierarchy gives highest rank to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest rank to unobservable inputs (level 3 measurements).

Farmer Mac's assessment of the significance of the input to the fair value measurement requires judgment and considers factors specific to the financial instrument.  Both observable and unobservable inputs may be used to determine the fair value of financial instruments 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 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 projected prepayment rates) inputs. See Note 8 for more information regarding fair value measurement.

(f)
Consolidation of Variable Interest Entities

Farmer Mac has interests in various entities that are considered to be VIEs.  These interests include investments in securities issued by VIEs, such as Farmer Mac agricultural mortgage-backed securities created pursuant to Farmer Mac's securitization transactions and mortgage and asset-backed trusts that Farmer Mac did not create.  The consolidation model uses a qualitative evaluation that requires consolidation of an entity when the reporting enterprise both (1) has the power to direct matters which significantly impact the activities and success of the entity, and (2) has exposure to benefits and/or losses that could potentially be significant to the entity.  The reporting enterprise that meets both these conditions is deemed the primary beneficiary of the VIE.

The VIEs in which Farmer Mac has a variable interest are limited to securitization trusts.  The major judgment in determining if Farmer Mac is the primary beneficiary is whether Farmer Mac has the power to direct the activities of the trust that potentially have the most significant impact on the economic performance of the trust.  Generally, the ability to make decisions regarding default mitigation is evidence of that power.  Farmer Mac determined that it is the primary beneficiary for the securitization trusts related to most Farmer Mac I and all Rural Utilities securitization transactions because of its rights as guarantor under both programs to control the default mitigation activities of the trusts.  For certain securitization trusts created when loans subject to LTSPCs were converted to Farmer Mac I Guaranteed Securities, Farmer Mac determined that it is not the primary beneficiary since the power to make decisions regarding default mitigation was shared among unrelated parties.  For similar securitization transactions where the power to make decisions regarding default mitigation is shared with a related party, Farmer Mac determined that it is the primary beneficiary because the applicable accounting guidance does not permit parties within a related party group to conclude that the power is shared. In the event that a related party status changes, consolidation or deconsolidation of these securitization trusts could occur.

For those trusts that Farmer Mac is the primary beneficiary, the assets and liabilities are presented on the consolidated balance sheets as "Loans held for investment in consolidated trusts" and "Debt securities of consolidated trusts held by third parties," respectively.  These assets can only be used to satisfy the obligations of the related trust.


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For those trusts where Farmer Mac has a variable interest but has not been determined to be the primary beneficiary, Farmer Mac's interests are presented as either "Farmer Mac Guaranteed Securities" or "Investment securities" on the consolidated balance sheets.  Farmer Mac's involvement in VIEs classified as Farmer Mac Guaranteed Securities include securitization trusts under the Farmer Mac II program and trusts related to AgVantage securities.  In the case of Farmer Mac II trusts, Farmer Mac is not determined to be the primary beneficiary because it does not have the decision-making power over default mitigation activities.  For the AgVantage trusts, Farmer Mac currently does not have the power to direct the activities that have the most significant economic impact to the trust unless, as guarantor, there is a default by the issuer of the trust securities.  Should there be a default, Farmer Mac would reassess whether it is the primary beneficiary of those trusts.  For VIEs classified as investment securities, which include auction-rate certificates, asset-backed securities and government-sponsored enterprise ("GSE")-guaranteed mortgage-backed securities, Farmer Mac is determined not to be the primary beneficiary because of the lack of voting rights or other powers to direct the activities of the trust.  As of September 30, 2012, the Farmer Mac Guaranteed Securities trusts and investment securities trusts have carrying amounts on the consolidated balance sheets totaling $61.4 million and $0.8 billion, respectively, and Farmer Mac's maximum exposure to loss, based on principal outstanding, was $59.0 million and $0.8 billion, respectively.  As of December 31, 2011, the Farmer Mac Guaranteed Securities trusts and investment securities trusts had carrying amounts on the consolidated balance sheets totaling $66.6 million and $0.8 billion, respectively, and Farmer Mac's maximum exposure to loss was $65.4 million and $0.8 billion, respectively.  In addition, Farmer Mac had a variable interest in unconsolidated VIEs, which include a guarantee of timely payment of principal and interest, totaling $2.0 billion and $1.6 billion, respectively, as of September 30, 2012 and December 31, 2011.

(g)
New Accounting Standards

Offsetting Assets and Liabilities

On December 16, 2011, the FASB issued ASU 2011-11, Disclosures about Offsetting Assets and Liabilities, which creates new disclosure requirements designed to make financial statements prepared under U.S. GAAP more comparable to those prepared under International Financial Reporting Standards. The new guidance requires entities to disclose net and gross information for certain derivative instruments and financial instruments and information about the impact of collateral on offsetting arrangements and other amounts subject to a master netting agreement that are not offset on the balance sheet. ASU 2011-11 will be effective in first quarter 2013. Farmer Mac does not expect the adoption of the new guidance to have a material effect on its financial position, results or operations or cash flows.

(h)
Reclassifications

Certain reclassifications of prior period information were made to conform to the current period presentation.


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2.
INVESTMENT SECURITIES

The following tables present the amortized cost and fair values of Farmer Mac's investment securities as of September 30, 2012 and December 31, 2011:
 
 
September 30, 2012
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair Value
 
(in thousands)
Available-for-sale:
 
 
 
 
 
 
 
Floating rate auction-rate certificates backed by Government guaranteed student loans
$
74,100

 
$
—

 
$
(14,066
)
 
$
60,034

Floating rate asset-backed securities
166,483

 
596

 
(34
)
 
167,045

Fixed rate asset-backed securities
9,735

 
—

 
—

 
9,735

Floating rate corporate debt securities
78,308

 
511

 
—

 
78,819

Fixed rate corporate debt securities
52,462

 
219

 
—

 
52,681

Floating rate Government/GSE guaranteed mortgage-backed securities
734,406

 
9,168

 
(130
)
 
743,444

Fixed rate GSE guaranteed mortgage-backed securities
2,331

 
206

 
—

 
2,537

Floating rate GSE subordinated debt
70,000

 
—

 
(12,830
)
 
57,170

Fixed rate commercial paper
19,995

 
2

 
—

 
19,997

Fixed rate GSE preferred stock
79,382

 
6,477

 
—

 
85,859

Floating rate senior agency debt
49,992

 
64

 
—

 
50,056

Fixed rate senior agency debt
127,572

 
143

 
—

 
127,715

Fixed rate U.S. Treasuries
1,179,754

 
139

 
(1
)
 
1,179,892

Total available-for-sale
2,644,520

 
17,525

 
(27,061
)
 
2,634,984

Trading:
 

 
 

 
 

 
 

Floating rate asset-backed securities
4,474

 
—

 
(3,130
)
 
1,344

Total investment securities
$
2,648,994

 
$
17,525

 
$
(30,191
)
 
$
2,636,328


 
December 31, 2011
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair Value
 
(in thousands)
Available-for-sale:
 
 
 
 
 
 
 
Floating rate auction-rate certificates backed by Government guaranteed student loans
$
74,100

 
$
—

 
$
(13,887
)
 
$
60,213

Floating rate asset-backed securities
178,443

 
219

 
(102
)
 
178,560

Floating rate corporate debt securities
74,152

 
69

 
(388
)
 
73,833

Fixed rate corporate debt securities
38,678

 
27

 
(6
)
 
38,699

Floating rate Government/GSE guaranteed mortgage-backed securities
759,567

 
4,852

 
(381
)
 
764,038

Fixed rate GSE guaranteed mortgage-backed securities
3,106

 
254

 
—

 
3,360

Floating rate GSE subordinated debt
70,000

 
—

 
(17,438
)
 
52,562

Fixed rate commercial paper
9,999

 
1

 
—

 
10,000

Fixed rate GSE preferred stock
79,662

 
5,216

 
—

 
84,878

Floating rate senior agency debt
38,000

 
32

 
—

 
38,032

Fixed rate senior agency debt
79,255

 
19

 
(21
)
 
79,253

Fixed rate U.S. Treasuries
798,966

 
304

 
(4
)
 
799,266

Total available-for-sale
2,203,928

 
10,993

 
(32,227
)
 
2,182,694

Trading:
 

 
 

 
 

 
 

Floating rate asset-backed securities
5,138

 
—

 
(3,342
)
 
1,796

Total investment securities
$
2,209,066

 
$
10,993

 
$
(35,569
)
 
$
2,184,490


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During the three months ended September 30, 2012, Farmer Mac did not sell any securities from its available-for-sale investment portfolio, compared to the same period in 2011, when Farmer Mac received proceeds of $294.7 million from the sale of securities from its available-for-sale investment portfolio, resulting in gross realized gains of $84,000 and gross realized losses of $10,000. During the nine months ended September 30, 2012, Farmer Mac received proceeds of $5.0 million from the sale of securities from its available-for-sale investment portfolio, resulting in gross realized gains of $28,000, compared to proceeds of $447.9 million, for the same period in 2011, resulting in gross realized gains of $279,000 and gross realized losses of $10,000.

As of September 30, 2012 and December 31, 2011, unrealized losses on available-for-sale investment securities were as follows:

 
September 30, 2012
 
Available-for-Sale Securities
 
Unrealized loss position for
less than 12 months
 
Unrealized loss position for
more than 12 months
 
Fair Value
 
Unrealized
Loss
 
Fair Value
 
Unrealized
Loss
 
(in thousands)
Floating rate auction-rate certificates backed by Government guaranteed student loans
$
—

 
$
—

 
$
60,034

 
$
(14,066
)
Floating rate asset-backed securities
20,480

 
(34
)
 
—

 
—

Floating rate Government/GSE guaranteed mortgage-backed securities
22,715

 
(126
)
 
840

 
(4
)
Floating rate GSE subordinated debt
—

 
—

 
57,170

 
(12,830
)
Fixed rate U.S. Treasuries
101,118

 
(1
)
 
—

 
—

Total
$
144,313

 
$
(161
)
 
$
118,044

 
$
(26,900
)

 
December 31, 2011
 
Available-for-Sale Securities
 
Unrealized loss position for
less than 12 months
 
Unrealized loss position for
more than 12 months
 
Fair Value
 
Unrealized
Loss
 
Fair Value
 
Unrealized
Loss
 
(in thousands)
Floating rate auction-rate certificates backed by Government guaranteed student loans
$
—

 
$
—

 
$
60,213

 
$
(13,887
)
Floating rate asset-backed securities
63,496

 
(102
)
 
—

 
—

Floating rate corporate debt securities
41,061

 
(388
)
 
—

 
—

Fixed rate corporate debt securities
18,189

 
(6
)
 
—

 
—

Floating rate Government/GSE guaranteed mortgage-backed securities
235,454

 
(359
)
 
17,409

 
(22
)
Floating rate GSE subordinated debt
—

 
—

 
52,562

 
(17,438
)
Fixed rate senior agency debt
44,976

 
(21
)
 
—

 
—

Fixed rate U.S. Treasuries
50,160

 
(4
)
 
—

 
—

Total
$
453,336

 
$
(880
)
 
$
130,184

 
$
(31,347
)
 
The unrealized losses presented above are principally due to a general widening of credit spreads from the dates of acquisition to September 30, 2012 and December 31, 2011, as applicable.  The resulting decreases in fair values reflect an increase in the perceived risk by the financial markets related to those securities. As of September 30, 2012, all of the investment securities in an unrealized loss position had credit ratings of at least "AA+" except one that was rated "A-". As of December 31, 2011, all of the investment

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Table of Contents

securities in an unrealized loss position had credit ratings of at least "A" except one that was rated "A- " and two that were rated "BBB+".  The unrealized losses were on 13 and 44 individual investment securities, respectively, as of September 30, 2012 and December 31, 2011.

As of September 30, 2012, 8 of the securities in loss positions had been in loss positions for more than 12 months and had a total unrealized loss of $26.9 million.  As of December 31, 2011, 10 of the securities in loss positions had been in loss positions for more than 12 months and had a total unrealized loss of $31.3 million.  The unrealized losses on those securities are principally due to a general widening of credit spreads from the dates of acquisition.  Securities in unrealized loss positions 12 months or more have a fair value as of September 30, 2012 that is, on average, approximately 81.4 percent of their amortized cost basis.  Farmer Mac believes that all of these unrealized losses are recoverable within a reasonable period of time by way of changes in credit spreads or maturity.  Accordingly, Farmer Mac has concluded that none of the unrealized losses on these available-for-sale investment securities represent other-than-temporary impairment as of September 30, 2012 and December 31, 2011.  Farmer Mac does not intend to sell these securities and it is not more likely than not that Farmer Mac will be required to sell the securities before recovery of the amortized cost basis.

Farmer Mac did not own any held-to-maturity investment securities as of September 30, 2012 and December 31, 2011. As of September 30, 2012, Farmer Mac owned trading investment securities with an amortized cost of $4.5 million, a fair value of $1.3 million and a weighted average yield of 4.30 percent.  As of December 31, 2011, Farmer Mac owned trading investment securities with an amortized cost of $5.1 million, a fair value of $1.8 million and a weighted average yield of 4.36 percent.

The amortized cost, fair value and weighted average yield of available-for-sale investment securities by remaining contractual maturity as of September 30, 2012 are set forth below.  Asset-backed and mortgage-backed securities are included based on their final maturities, although the actual maturities may differ due to prepayments of the underlying assets or mortgages.

 
Investment Securities Available-for-Sale as of
 
September 30, 2012
 
Amortized
Cost
 
Fair Value
 
Weighted-
Average
Yield
 
(dollars in thousands)
Due within one year
$
1,370,334

 
$
1,370,517

 
0.63%
Due after one year through five years
168,249

 
169,159

 
0.90%
Due after five years through ten years
435,609

 
425,640

 
1.13%
Due after ten years
670,328

 
669,668

 
2.54%
Total
$
2,644,520

 
$
2,634,984

 
1.21%


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3.
FARMER MAC GUARANTEED SECURITIES AND USDA GUARANTEED SECURITIES

The following table sets forth information about on-balance sheet Farmer Mac Guaranteed Securities and USDA Guaranteed Securities as of September 30, 2012 and December 31, 2011:

 
September 30, 2012
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair Value
 
(in thousands)
Available-for-sale:
 
 
 
 
 
 
 
Farmer Mac I
$
3,339,368

 
$
98,532

 
$
(6,312
)
 
$
3,431,588

Farmer Mac II
28,342

 
1,639

 
(6
)
 
29,975

Rural Utilities
1,165,100

 
21,844

 
—

 
1,186,944

USDA Guaranteed Securities
1,429,196

 
38,989

 
(144
)
 
1,468,041

Total available-for-sale
5,962,006

 
161,004

 
(6,462
)
 
6,116,548

Trading:
 

 
 

 
 

 
 

USDA Guaranteed Securities
125,998

 
830

 
(4,241
)
 
122,587

Total Farmer Mac Guaranteed Securities and USDA Guaranteed Securities
$
6,088,004

 
$
161,834

 
$
(10,703
)
 
$
6,239,135


 
December 31, 2011
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair Value
 
(in thousands)
Available-for-sale:
 
 
 
 
 
 
 
Farmer Mac I
$
2,741,192

 
$
67,895

 
$
(1,460
)
 
$
2,807,627

Farmer Mac II
34,692

 
924

 
(17
)
 
35,599

Rural Utilities
1,410,800

 
35,246

 
—

 
1,446,046

USDA Guaranteed Securities
1,244,519

 
35,149

 
(122
)
 
1,279,546

Total available-for-sale
5,431,203

 
139,214

 
(1,599
)
 
5,568,818

Trading:
 

 
 

 
 

 
 

USDA Guaranteed Securities
213,130

 
1,804

 
(2,575
)
 
212,359

Total Farmer Mac Guaranteed Securities and USDA Guaranteed Securities
$
5,644,333

 
$
141,018

 
$
(4,174
)
 
$
5,781,177


The unrealized losses presented above are principally due to higher interest rates and wider spreads on mortgage securities from the date of acquisition to September 30, 2012 and December 31, 2011, as applicable.  As of September 30, 2012 and December 31, 2011, the unrealized losses presented above are related to Farmer Mac I, Farmer Mac II Guaranteed Securities, which are USDA-guaranteed portions of loans backed by the full faith and credit of the United States, and USDA Guaranteed Securities.  None of the Farmer Mac I Guaranteed Securities has been in an unrealized loss position for greater than 12 months. Farmer Mac has concluded that none of the unrealized losses on its available-for-sale Farmer Mac Guaranteed Securities and USDA Guaranteed Securities represents an other-than-temporary impairment as of September 30, 2012 and December 31, 2011.  Farmer Mac does not intend to sell these securities and it is not more likely than not that Farmer Mac will be required to sell the securities before recovery of the amortized cost basis.

Farmer Mac realized no gains or losses from the sale of Farmer Mac Guaranteed Securities and USDA Guaranteed Securities for the three and nine months ended September 30, 2012 and September 30, 2011.


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Table of Contents

The amortized cost, fair value and weighted average yield of available-for-sale Farmer Mac Guaranteed Securities and USDA Guaranteed Securities by remaining contractual maturity as of September 30, 2012 are set forth below. The balances presented are based on their final maturities, although the actual maturities may differ due to prepayments of the underlying assets.

 
Farmer Mac Guaranteed Securities and USDA Guaranteed Securities Available-for-Sale as of September 30, 2012
 
Amortized
Cost
 
Fair Value
 
Weighted-
Average
Yield
 
(dollars in thousands)
Due within one year
$
536,528

 
$
539,070

 
1.13
%
Due after one year through five years
3,409,024

 
3,510,665

 
2.50
%
Due after five years through ten years
769,631

 
784,685

 
2.61
%
Due after ten years
1,246,823

 
1,282,128

 
3.53
%
Total
$
5,962,006

 
$
6,116,548

 
2.61
%

Farmer Mac did not own any held-to-maturity Farmer Mac Guaranteed and USDA Guaranteed Securities as of September 30, 2012 and December 31, 2011. As of September 30, 2012, Farmer Mac owned trading USDA Guaranteed Securities with an amortized cost of $126.0 million, a fair value of $122.6 million and a weighted average yield of 5.76 percent.  As of December 31, 2011, Farmer Mac owned trading USDA Guaranteed Securities with an amortized cost of $213.1 million, a fair value of $212.4 million and a weighted average yield of 5.83 percent.

4.
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.  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 loans 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 often times deriving an overall lower effective cost of borrowing than would otherwise be available to Farmer Mac in the conventional debt market.  Certain financial derivatives are designated as fair value hedges of fixed rate assets classified as available-for-sale to protect against fair value changes in the assets related to a benchmark interest rate (i.e., LIBOR).

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 the debt of other 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.  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 are expected to offset changes in funding costs.

All financial derivatives are recorded on the balance sheet at fair value as a freestanding asset or liability. Changes in the fair values of financial derivatives are reported in gains/(losses) on financial derivatives and hedging activities in the consolidated statements of operations. For financial derivatives designated in fair value hedging relationships, changes in the fair values of the hedged items related to the risk being

21
Table of Contents

hedged are also reported in gains/(losses) on financial derivatives and hedging activities in the consolidated statements of operations. Farmer Mac currently has no financial derivatives designated in cash flow hedging relationships.

The following tables summarize information related to Farmer Mac's financial derivatives as of September 30, 2012 and December 31, 2011 and the effects of financial derivatives on the consolidated statements of operations for the three and nine months ended September 30, 2012 and 2011:

  
September 30, 2012
  

 
Fair Value
 
Weighted-
Average
Pay Rate
 
Weighted-
Average Receive Rate
 
Weighted-
Average
Forward
Price
 
Weighted-
Average
Remaining
Life (in years)
  
Notional Amount
 
Asset
 
(Liability)
 
 
 
 
  
(dollars in thousands)
Fair value hedges:
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps:
 
 
 
 
 
 
 
 
 
 
 
 
 
Pay fixed non-callable
$
950,000

 
$
—

 
$
(63,496
)
 
2.20%
 
0.44%
 
 
 
4.33

No hedge designation:
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps:
 
 
 
 
 
 
 
 
 
 
 
 
 
Pay fixed non-callable
807,606

 
47

 
(100,814
)
 
4.85%
 
0.41%
 
 
 
4.31

Receive fixed non-callable
3,668,717

 
35,632

 
—

 
0.36%
 
0.95%
 
 
 
0.77

Receive fixed callable
90,000

 
7

 
(21
)
 
0.17%
 
0.60%
 
 
 
3.99

Basis swaps
564,262

 
508

 
(945
)
 
0.53%
 
0.38%
 
 
 
1.19

Agency forwards
20,048

 
—

 
(58
)
 
 
 
 
 
101.17

 
 
Treasury futures
6,400

 
—

 
(3
)
 
 
 
 
 
133.44

 
 
Credit valuation adjustment
 
 
(4
)
 
388

 
 
 
 
 
 
 
 

Total financial derivatives
$
6,107,033

 
$
36,190

 
$
(164,949
)
 
  
 
  
 
 
 
  


  
December 31, 2011
  
 
 
Fair Value
 
Weighted-
Average
Pay Rate
 
Weighted-
Average Receive Rate
 
Weighted-
Average
Remaining
Life (in years)
  
Notional Amount
 
Asset
 
(Liability)
 
 
 
  
(dollars in thousands)
No hedge designation:
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps:
 
 
 
 
 
 
 
 
 
 
 
Pay fixed non-callable
$
1,906,123

 
$
—

 
$
(157,520
)
 
3.65
%
 
0.46
%
 
4.48
Receive fixed non-callable
4,212,713

 
41,006

 
(1,302
)
 
0.41
%
 
0.96
%
 
0.97
Basis swaps
457,694

 
—

 
(2,137
)
 
0.80
%
 
0.38
%
 
1.30
Credit default swaps
10,000

 
17

 
—

 
1.00
%
 
—

 
0.72
Credit valuation adjustment
 
 
(773
)
 
935

 
 

 
 

 
 
Total financial derivatives
$
6,586,530

 
$
40,250

 
$
(160,024
)
 
  

 
  

 
  



22
Table of Contents

 
Gains/(Losses) on Financial Derivatives and Hedging Activities
  
For the Three Months Ended
 
For the Nine Months Ended
  
September 30, 2012
 
September 30, 2011
 
September 30, 2012
 
September 30, 2011
  
(in thousands)
Fair value hedges:
 
 
 
 
 
 
 
Interest rate swaps
$
(5,142
)
 
$
—

 
$
(5,142
)
 
$
—

Hedged items
8,378

 
—

 
8,378

 
—

Gains on hedging activities (1)
3,236

 
—

 
3,236

 
—

No hedge designation:
 
 
 
 
 
 
 
Interest rate swaps
(1,970
)
 
(65,136
)
 
(25,853
)
 
(76,857
)
Agency forwards
452

 
(3,052
)
 
(153
)
 
(5,053
)
Treasury futures
(142
)
 
(512
)
 
(471
)
 
(538
)
Credit default swaps
(18
)
 
133

 
(93
)
 
80

Losses on financial derivatives not designated in hedging relationships
(1,678
)
 
(68,567
)
 
(26,570
)
 
(82,368
)
Gains/(losses) on financial derivatives and hedging activities
$
1,558

 
$
(68,567
)
 
$
(23,334
)
 
$
(82,368
)
 
(1) Includes gains of $3.0 million that are excluded from the assessment of hedge effectiveness and gains of $0.2 million due to hedge ineffectiveness for the three and nine months ended September 30, 2012.

In the normal course of business, collateral requirements contained in Farmer Mac's derivative contracts are enforced by Farmer Mac and its counterparties.  Upon enforcement of the collateral requirements, the amount of collateral posted is typically based on the net fair value of all derivative contracts with the counterparty, i.e., derivative assets net of derivative liabilities at the counterparty level.  If Farmer Mac were to be in violation of certain provisions of the derivative contracts, the related counterparty could request payment or full collateralization on the derivative contracts.  As of September 30, 2012, the fair value of Farmer Mac's derivatives in a net liability position at the counterparty level, which includes accrued interest but excludes any adjustment for nonperformance risk, was $130.6 million.  As of September 30, 2012, Farmer Mac posted cash of $55.2 million as collateral for its derivatives in net liability positions.  Farmer Mac records posted cash as a reduction in the outstanding balance of cash and cash equivalents and an increase in the balance of prepaid expenses and other assets.  If Farmer Mac had breached certain provisions of the derivative contracts as of September 30, 2012, it could have been required to settle its obligations under the agreements or post additional collateral of $75.4 million.

As of September 30, 2012, Farmer Mac had outstanding basis swaps with Zions First National Bank, a related party, with a total notional amount of $49.3 million and a fair value of $(0.9) million, compared to $72.7 million and $(1.3) million, respectively, as of December 31, 2011.  Under the terms of those basis swaps, Farmer Mac pays Constant Maturity Treasury-based rates and receives LIBOR.  Those swaps hedge most of the interest rate basis risk related to loans Farmer Mac purchases that pay a Constant Maturity Treasury based-rate and the discount notes Farmer Mac issues to fund the loan purchases.  The pricing of discount notes is closely correlated to LIBOR rates.  Farmer Mac recorded unrealized gains on those outstanding basis swaps for the three and nine months ended September 30, 2012 of $0.1 million and $0.5 million, respectively, compared to unrealized losses of $0.2 million and unrealized gains of $1.4 million, respectively, for the same periods in 2011.


23
Table of Contents

5.
ALLOWANCE FOR LOSSES AND CONCENTRATIONS OF CREDIT RISK

Allowance for Losses

Farmer Mac maintains an allowance for losses to cover estimated probable losses on loans held and loans underlying LTSPCs and Farmer Mac Guaranteed Securities.  As of September 30, 2012 and December 31, 2011, Farmer Mac recorded specific allowances for losses of $8.0 million and $7.3 million, respectively. No allowance for losses has been provided for the Farmer Mac II and Rural Utilities programs and Farmer Mac I AgVantage securities as of September 30, 2012 or December 31, 2011.  See Note 2(b), Note 3 and Note 6 for more information about Farmer Mac Guaranteed Securities.  Farmer Mac's allowance for losses is presented in two components on its consolidated balance sheets:
 
•
an "Allowance for loan losses" on loans held; and
•
a "Reserve for losses" on loans underlying LTSPCs and Farmer Mac Guaranteed Securities.
 
The following is a summary of the changes in the allowance for losses for the three and nine months ended September 30, 2012 and 2011:

 
September 30, 2012
 
September 30, 2011
 
Allowance
for Loan
Losses
 
Reserve
for Losses
 
Total
Allowance
for Losses
 
Allowance
for Loan
Losses
 
Reserve
for Losses
 
Total
Allowance
for Losses
  
(in thousands)
For the Three Months Ended:
 
 
 
 
 
 
 
 
 
 
 
Beginning Balance
$
9,361

 
$
8,779

 
$
18,140

 
$
11,053

 
$
7,443

 
$
18,496

Provision for/(release of) losses
137

 
(43
)
 
94

 
(349
)
 
(452
)
 
(801
)
Charge-offs
(448
)
 
—

 
(448
)
 
(5
)
 
—

 
(5
)
Ending Balance
$
9,050

 
$
8,736

 
$
17,786

 
$
10,699

 
$
6,991

 
$
17,690

 
 
 
 
 
 
 
 
 
 
 
 
For the Nine Months Ended:
 
 
 
 
 
 
 
 
 
 
 
Beginning Balance
$
10,161

 
$
7,355

 
$
17,516

 
$
9,803

 
$
10,312

 
$
20,115

(Release of)/provision for losses
(663
)
 
1,381

 
718

 
1,092

 
(3,321
)
 
(2,229
)
Charge-offs
(448
)
 
—

 
(448
)
 
(196
)
 
—

 
(196
)
Ending Balance
$
9,050

 
$
8,736

 
$
17,786

 
$
10,699

 
$
6,991

 
$
17,690

 
During third quarter 2012, Farmer Mac recorded provisions to its allowance for loan losses of $0.1 million, releases from its reserve for losses of $43,000, and charged off $0.4 million of losses upon acquisition of real estate owned ("REO") or upon loan liquidation. For the nine months ended September 30, 2012, Farmer Mac recorded releases from its allowance for loan losses of $0.7 million, provisions to its reserve for losses of $1.4 million and charged off $0.4 million of losses. The releases recorded for the nine months ended September 30, 2012 were driven primarily by reductions in specific allowances for certain loans due to principal payments received and updated appraisal information and the reclassification of approximately $0.3 million from the allowance for loan losses to the reserve for losses due to the deconsolidation of certain VIEs resulting from a change in related party status. The provision for losses recorded for the nine months ended September 30, 2012 primarily resulted from an increase in a specific allowance related to an ethanol loan underlying an LTSPC.


24
Table of Contents

During third quarter 2011, Farmer Mac recorded releases from its allowance for loan losses and its reserve for losses of $0.3 million and $0.5 million, respectively, and charged off $5,000 of losses. The releases from the allowance for losses in third quarter 2011 were primarily due to a decline in estimated probable losses related to Farmer Mac's exposure to the dairy industry. For the nine months ended September 30, 2011, Farmer Mac recorded provisions to its allowance for loan losses of $1.1 million, releases from its reserve for losses of $3.3 million, and charged off $0.2 million of losses. In first quarter 2011, Farmer Mac purchased two defaulted loans pursuant to the terms of an LTSPC agreement. This resulted in the reclassification of $1.8 million of specific allowance, which had been recorded in 2010, from the reserve for losses to allowance for loan losses. The (release of)/provision for losses for the first nine months of 2011 reflects this reclassification as well as a decline in estimated probable losses related to Farmer Mac's exposure to the ethanol and dairy industries.

The following tables present the changes in the allowance for losses for the three and nine months ended September 30, 2012 and 2011 by commodity type:

 
September 30, 2012
 
Crops
 
Permanent
Plantings
 
Livestock
 
Part-time
Farm
 
Ag. Storage and
Processing
(including ethanol
facilities)
 
Other
 
Total
 
(in thousands)
For the Three Months Ended:
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning Balance
$
4,281

 
$
2,522

 
$
1,471

 
$
557

 
$
9,302

 
$
7

 
$
18,140

(Release of)/provision for losses
(305
)
 
176

 
(129
)
 
192

 
161

 
(1
)
 
94

Charge-offs
—

 
(375
)
 
—

 
(73
)
 
—

 
—

 
(448
)
Ending Balance
$
3,976

 
$
2,323

 
$
1,342

 
$
676

 
$
9,463

 
$
6

 
$
17,786

 
 
 
 
 
 
 
 
 
 
 
 
 
 
For the Nine Months Ended:
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning Balance
$
4,133

 
$
3,099

 
$
1,697

 
$
477

 
$
8,106

 
$
4

 
$
17,516

(Release of)/provision for losses
(157
)
 
(401
)
 
(355
)
 
272

 
1,357

 
2

 
718

Charge-offs
—

 
(375
)
 
—

 
(73
)
 
—

 
—

 
(448
)
Ending Balance
$
3,976

 
$
2,323

 
$
1,342

 
$
676

 
$
9,463

 
$
6

 
$
17,786


 
September 30, 2011
 
Crops
 
Permanent
Plantings
 
Livestock
 
Part-time
Farm
 
Ag. Storage and
Processing
(including ethanol
facilities)
 
Other
 
Total
 
(in thousands)
For the Three Months Ended:
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning Balance
$
3,715

 
$
3,582

 
$
2,688

 
$
402

 
$
8,100

 
$
9

 
$
18,496

Provision for/(release of) losses
144

 
(27
)
 
(891
)
 
(28
)
 
2

 
(1
)
 
(801
)
Charge-offs
—

 
—

 
—

 
(5
)
 
—

 
—

 
(5
)
Ending Balance
$
3,859

 
$
3,555

 
$
1,797

 
$
369

 
$
8,102

 
$
8

 
$
17,690

 
 
 
 
 
 
 
 
 
 
 
 
 
 
For the Nine Months Ended:
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning Balance
$
3,572

 
$
3,537

 
$
2,749

 
$
445

 
$
9,797

 
$
15

 
$
20,115

Provision for/(release of) losses
463

 
25

 
(944
)
 
(71
)
 
(1,695
)
 
(7
)
 
(2,229
)
Charge-offs
(176
)
 
(7
)
 
(8
)
 
(5
)
 
—

 
—

 
(196
)
Ending Balance
$
3,859

 
$
3,555

 
$
1,797

 
$
369

 
$
8,102

 
$
8

 
$
17,690


25
Table of Contents

The following tables present the ending balances of loans held and loans underlying LTSPCs and Farmer Mac Guaranteed Securities and the related allowance for losses by impairment method and commodity type as of September 30, 2012 and December 31, 2011:

  
As of September 30, 2012
 
Crops
 
Permanent
Plantings
 
Livestock
 
Part-time
Farm
 
Ag. Storage and
Processing
(including ethanol
facilities)
 
Other
 
Total
  
(in thousands)
Ending Balance
 
 
 
 
 
 
 
 
 
 
 
 
 
Evaluated collectively for impairment
$
1,925,509

 
$
795,516

 
$
1,169,443

 
$
198,175

 
$
193,769

 
$
12,041

 
$
4,294,453

Evaluated individually for impairment
31,786

 
37,939

 
17,034

 
16,391

 
4,337

 
1,017

 
108,504

 
$
1,957,295

 
$
833,455

 
$
1,186,477

 
$
214,566

 
$
198,106

 
$
13,058

 
$
4,402,957

Allowance for Losses
 

 
 

 
 

 
 

 
 

 
 

 
 

Evaluated collectively for impairment
$
1,626

 
$
643

 
$
1,131

 
$
107

 
$
6,263

 
$
5

 
$
9,775

Evaluated individually for impairment
2,350

 
1,680

 
211

 
569

 
3,200

 
1

 
8,011

 
$
3,976

 
$
2,323

 
$
1,342

 
$
676

 
$
9,463

 
$
6

 
$
17,786


  
As of December 31, 2011
 
Crops
 
Permanent
Plantings
 
Livestock
 
Part-time
Farm
 
Ag. Storage and
Processing
(including ethanol
facilities)
 
Other
 
Total
  
(in thousands)
Ending Balance
 
 
 
 
 
 
 
 
 
 
 
 
 
Evaluated collectively for impairment
$
1,835,439

 
$
796,100

 
$
1,213,227

 
$
232,607

 
$
167,850

 
$
15,914

 
$
4,261,137

Evaluated individually for impairment
29,520

 
28,245

 
10,884

 
12,513

 
5,842

 
1,022

 
88,026

 
$
1,864,959

 
$
824,345

 
$
1,224,111

 
$
245,120

 
$
173,692

 
$
16,936

 
$
4,349,163

Allowance for Losses
 

 
 

 
 

 
 

 
 

 
 

 
 

Evaluated collectively for impairment
$
1,723

 
$
775

 
$
1,290

 
$
172

 
$
6,256

 
$
4

 
$
10,220

Evaluated individually for impairment
2,410

 
2,324

 
407

 
305

 
1,850

 
—

 
7,296

 
$
4,133

 
$
3,099

 
$
1,697

 
$
477

 
$
8,106

 
$
4

 
$
17,516



26
Table of Contents

The following tables present by commodity type the unpaid principal balances, recorded investment and specific allowance for losses related to impaired loans and the recorded investment in loans on nonaccrual status as of September 30, 2012 and December 31, 2011:

  
As of September 30, 2012
 
Crops
 
Permanent
Plantings
 
Livestock
 
Part-time
Farm
 
Ag. Storage and
Processing
(including 
ethanol
facilities)
 
Other
 
Total
  
(in thousands)
Impaired Loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
With no specific allowance:
 
 
 
 
 
 
 
 
 
 
 
 
 
Recorded investment
$
7,863

 
$
10,060

 
$
6,007

 
$
3,377

 
$
—

 
$
907

 
$
28,214

Unpaid principal balance
7,752

 
10,038

 
5,686

 
3,323

 
—

 
902

 
27,701

With a specific allowance:
 

 
 

 
 

 
 

 
 

 
 

 
 

Recorded investment
24,905

 
28,302

 
11,529

 
13,156

 
4,498

 
117

 
82,507

Unpaid principal balance
24,034

 
27,901

 
11,348

 
13,068

 
4,337

 
115

 
80,803

Associated allowance
2,350

 
1,680

 
211

 
569

 
3,200

 
1

 
8,011

Total:
 

 
 

 
 

 
 

 
 

 
 

 
 

Recorded investment
32,768

 
38,362

 
17,536

 
16,533

 
4,498

 
1,024

 
110,721

Unpaid principal balance
31,786

 
37,939

 
17,034

 
16,391

 
4,337

 
1,017

 
108,504

Associated allowance
2,350

 
1,680

 
211

 
569

 
3,200

 
1

 
8,011

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Recorded investment of loans on nonaccrual status:
$
13,533

 
$
22,601

 
$
5,219

 
$
8,420

 
$
—

 
$
—

 
$
49,773


  
As of December 31, 2011
 
Crops
 
Permanent
Plantings
 
Livestock
 
Part-time
Farm
 
Ag. Storage and
Processing
(including 
ethanol
facilities)
 
Other
 
Total
  
(in thousands)
Impaired Loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
With no specific allowance:
 
 
 
 
 
 
 
 
 
 
 
 
 
Recorded investment
$
6,809

 
$
10,083

 
$
3,248

 
$
3,241

 
$
—

 
$
914

 
$
24,295

Unpaid principal balance
7,446

 
9,957

 
4,088

 
3,298

 
—

 
902

 
25,691

With a specific allowance:
 

 
 

 
 

 
 

 
 

 
 

 
 

Recorded investment
23,009

 
18,668

 
7,036

 
9,392

 
5,842

 
121

 
64,068

Unpaid principal balance
22,074

 
18,288

 
6,796

 
9,215

 
5,842

 
120

 
62,335

Associated allowance
2,410

 
2,324

 
407

 
305

 
1,850

 
—

 
7,296

Total:
 

 
 

 
 

 
 

 
 

 
 

 
 

Recorded investment
29,818

 
28,751

 
10,284

 
12,633

 
5,842

 
1,035

 
88,363

Unpaid principal balance
29,520

 
28,245

 
10,884

 
12,513

 
5,842

 
1,022

 
88,026

Associated allowance
2,410

 
2,324

 
407

 
305

 
1,850

 
—

 
7,296

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Recorded investment of loans on nonaccrual status:
$
9,214

 
$
25,710

 
$
3,483

 
$
6,931

 
$
—

 
$
—

 
$
45,338



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The following table presents by commodity type the average recorded investment and interest income recognized on impaired loans for the three and nine months ended September 30, 2012 and 2011:

 
September 30, 2012
 
Crops
 
Permanent
Plantings
 
Livestock
 
Part-time
Farm
 
Ag. Storage and
Processing
(including 
ethanol
facilities)
 
Other
 
Total
  
(in thousands)
For the Three Months Ended:
 
 
 
 
 
 
 
 
 
 
 
 
 
Average recorded investment in impaired loans
$
31,490

 
$
34,566

 
$
17,643

 
$
16,526

 
$
4,449

 
$
1,033

 
$
105,707

Income recognized on impaired loans
72

 
1,015

 
94

 
76

 
—

 
—

 
1,257

 
 
 
 
 
 
 
 
 
 
 
 
 
 
For the Nine Months Ended:
 
 
 
 
 
 
 
 
 
 
 
 
 
Average recorded investment in impaired loans
29,583

 
34,284

 
14,973

 
16,127

 
4,785

 
1,035

 
100,787

Income recognized on impaired loans
213

 
1,691

 
210

 
250

 
—

 
—

 
2,364


 
September 30, 2011
 
Crops
 
Permanent
Plantings
 
Livestock
 
Part-time
Farm
 
Ag. Storage and
Processing
(including 
ethanol
facilities)
 
Other
 
Total
  
(in thousands)
For the Three Months Ended:
 
 
 
 
 
 
 
 
 
 
 
 
 
Average recorded investment in impaired loans
$
31,639

 
$
31,299

 
$
12,371

 
$
11,511

 
$
6,158

 
$
1,207

 
$
94,185

Income recognized on impaired loans
120

 
480

 
42

 
63

 
—

 
—

 
705

 
 
 
 
 
 
 
 
 
 
 
 
 
 
For the Nine Months Ended:
 
 
 
 
 
 
 
 
 
 
 
 
 
Average recorded investment in impaired loans
30,546

 
30,070

 
13,344

 
9,753

 
6,439

 
771

 
90,923

Income recognized on impaired loans
432

 
857

 
343

 
125

 
382

 
—

 
2,139



When particular criteria are met, such as the default of the borrower, Farmer Mac becomes entitled to purchase the defaulted loans underlying Farmer Mac Guaranteed Securities (commonly referred to as "removal-of-account" provisions).  Farmer Mac records all such defaulted loans at their unpaid principal balance during the period in which Farmer Mac becomes entitled to purchase the loans and therefore regains effective control over the transferred loans. In accordance with the terms of all LTSPCs, Farmer Mac acquires loans that are either 90 days or 120 days (depending on the provisions of the applicable agreement) delinquent upon the request of the counterparty. Subsequent to the purchase, such defaulted loans are treated as nonaccrual loans and, therefore, interest is accounted for on the cash basis.  Any decreases in expected cash flows are recognized as impairment.


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Table of Contents

During the three and nine months ended September 30, 2012, Farmer Mac purchased 7 defaulted loans having an unpaid principal balance of $7.2 million and 12 defaulted loans having an unpaid principal balance of $11.0 million, respectively, from pools underlying Farmer Mac I Guaranteed Securities and LTSPCs.  During the three and nine months ended September 30, 2011, Farmer Mac purchased 5 defaulted loans having an unpaid principal balance of $2.9 million and 18 defaulted loans having an unpaid principal balance of $21.3 million, respectively, from pools underlying Farmer Mac I Guaranteed Securities and LTSPCs. The following tables present information related to Farmer Mac's acquisition of defaulted loans for the three and nine months ended September 30, 2012 and 2011 and the outstanding balances and carrying amounts of all such loans as of September 30, 2012 and December 31, 2011:

 
For the Three Months Ended
 
For the Nine Months Ended
 
September 30,
2012
 
September 30,
2011
 
September 30,
2012
 
September 30,
2011
 
(in thousands)
Unpaid principal balance at acquisition date:
 
 
 
 
 
 
 
  Loans underlying LTSPCs
$
432

 
$
—

 
$
2,962

 
$
13,974

  Loans underlying Farmer Mac Guaranteed Securities
6,742

 
2,921

 
8,069

 
7,292

    Total unpaid principal balance at acquisition date
7,174

 
2,921

 
11,031

 
21,266

Contractually required payments receivable
7,373

 
2,922

 
11,230

 
21,314

Impairment recognized subsequent to acquisition
367

 
42

 
382

 
3,812

Recovery/release of allowance for defaulted loans
46

 
5

 
979

 
19


 
September 30,
2012
 
December 31,
2011
 
(in thousands)
Outstanding balance
$
40,715

 
$
35,773

Carrying amount
35,046

 
29,461


Net credit losses and 90-day delinquencies as of and for the periods indicated for loans held and loans underlying Farmer Mac I Guaranteed Securities and LTSPCs are presented in the table below. Information is not presented for loans underlying AgVantage securities, USDA Guaranteed Securities, Farmer Mac II Guaranteed Securities, or rural utilities loans or underlying Farmer Mac Guaranteed Securities – Rural Utilities.  Each AgVantage security is a general obligation of an issuing institution approved by Farmer Mac and is secured by eligible loans in an amount at least equal to the outstanding principal amount of the security.  Farmer Mac excludes the loans that secure AgVantage securities from the credit risk metrics it discloses because of the credit quality of the issuing institutions, the collateralization level for the securities, and because delinquent loans are required to be removed from the pool of pledged loans and replaced with current eligible loans.  As of September 30, 2012, there were no probable losses inherent in Farmer Mac's AgVantage securities due to the credit quality of the obligors, as well as the underlying collateral.  To date, Farmer Mac has not experienced any credit losses on any Farmer Mac I AgVantage securities. The USDA-guaranteed portions presented as USDA Guaranteed Securities, as well as those that collateralize Farmer Mac II Guaranteed Securities, are guaranteed by the USDA. Each USDA guarantee is an obligation backed by the full faith and credit of the United States. As of September 30, 2012, neither Farmer Mac nor Farmer Mac II LLC had experienced any credit losses on any USDA Guaranteed Securities or Farmer Mac II Guaranteed Securities. As of September 30, 2012, there were no delinquencies and no probable losses inherent in the Farmer Mac's rural utilities loans held or in any Farmer Mac Guaranteed Securities – Rural Utilities.  As of September 30, 2012, Farmer Mac has not experienced any credit losses on any of those loans or securities.

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Table of Contents

 
90-Day Delinquencies (1)
 
Net Credit Losses
 
As of
 
For the Nine Months Ended
 
September 30,
2012
 
December 31,
2011
 
September 30,
2011
 
September 30,
2012
 
September 30,
2011
 
(in thousands)
On-balance sheet assets:
 
 
 
 
 
 
 
 
 
Farmer Mac I:
 
 
 
 
 
 
 
 
 
Loans
$
29,120

 
$
33,243

 
$
35,860

 
$
199

 
$
334

Total on-balance sheet
$
29,120

 
$
33,243

 
$
35,860

 
$
199

 
$
334

Off-balance sheet assets:
 

 
 
 
 

 
 

 
 

Farmer Mac I:
 

 
 
 
 

 
 

 
 

LTSPCs
$
11,677

 
$
7,379

 
$
8,988

 
$
—

 
$
—

Total off-balance sheet
$
11,677

 
$
7,379

 
$
8,988

 
$
—

 
$
—

Total
$
40,797

 
$
40,622

 
$
44,848

 
$
199

 
$
334


(1)
Includes loans and loans underlying Farmer Mac I Guaranteed Securities and LTSPCs that are 90 days or more past due, in foreclosure, restructured after delinquency, and in bankruptcy, excluding loans performing under either their original loan terms or a court-approved bankruptcy plan.

Of the $29.1 million, $33.2 million and $35.9 million of on-balance sheet loans reported as 90 days delinquent as of September 30, 2012, December 31, 2011 and September 30, 2011, respectively, $2.6 million, $5.6 million and $6.2 million, respectively, are loans subject to "removal-of-account" provisions.

Credit Quality Indicators

Farmer Mac analyzes credit risk related to loans held and loans underlying LTSPCs and Farmer Mac I Guaranteed Securities (excluding AgVantage securities) based on internally assigned loan scores (i.e., risk ratings) that are derived by taking into consideration such factors as historical repayment performance, indicators of current financial condition, loan seasoning, loan size and loan-to-value ratio. Loans are then classified into one of the following asset categories based on their underlying risk rating: acceptable; other assets especially mentioned; and substandard. Farmer Mac believes this analysis provides meaningful information regarding the credit risk profile of its Farmer Mac I portfolio as of each quarterly reporting period end date.

Farmer Mac also uses 90-day delinquency information to evaluate its credit risk exposure on these program assets because historically it has been the best measure of borrower credit quality deterioration. Most of the loans held and underlying LTSPCs and Farmer Mac I Guaranteed Securities have annual (January 1) or semi-annual (January 1 and July 1) payment dates and are supported by less frequent and less predictable revenue sources, such as the cash flows generated from the maturation of crops, sales of livestock and government farm support programs.  Taking into account the reduced frequency of payment due dates and revenue sources, Farmer Mac considers the 90-day delinquency point to be the most significant observation point when evaluating delinquency information.


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The following tables present credit quality indicators related to loans held and loans underlying LTSPCs and Farmer Mac I Guaranteed Securities (excluding AgVantage securities) as of September 30, 2012 and December 31, 2011.  
  
As of September 30, 2012
 
Crops
 
Permanent
Plantings
 
Livestock
 
Part-time
Farm
 
Ag. Storage and
Processing
(including ethanol
facilities)
 
Other
 
Total
  
(in thousands)
Credit risk profile by internally assigned grade (1)
 
 
 
 
 
 
 
 
 
 
 
 
 
Grade:
 
 
 
 
 
 
 
 
 
 
 
 
 
Acceptable
$
1,881,406

 
$
764,097

 
$
1,084,277

 
$
188,445

 
$
130,902

 
$
11,319

 
$
4,060,446

Other assets especially mentioned ("OAEM") (2)
34,118

 
16,025

 
45,158

 
6,241

 
44,754

 
599

 
146,895

Substandard (2)
41,771

 
53,333

 
57,042

 
19,880

 
22,450

 
1,140

 
195,616

Total
$
1,957,295

 
$
833,455

 
$
1,186,477

 
$
214,566

 
$
198,106

 
$
13,058

 
$
4,402,957

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commodity analysis of past due loans (1)
 

 
 

 
 

 
 

 
 

 
 

 
 

90 days or more past due
$
13,414

 
$
11,861

 
$
4,899

 
$
6,125

 
$
4,498

 
$
—

 
$
40,797


(1)
Amounts represent unpaid principal balance of risk-rated loans, which is the basis Farmer Mac uses to analyze its portfolio, and recorded investment of past due loans. 
(2)
Assets in the OAEM category generally have potential weaknesses due to performance issues but are currently considered to be adequately secured.  Substandard assets have a well-defined weakness or weaknesses and there is a distinct possibility that some loss will be sustained if deficiencies are not corrected.

  
As of December 31, 2011
 
Crops
 
Permanent
Plantings
 
Livestock
 
Part-time
Farm
 
Ag. Storage and
Processing
(including ethanol
facilities)
 
Other
 
Total
  
(in thousands)
Credit risk profile by internally assigned grade (1)
 
 
 
 
 
 
 
 
 
 
 
 
 
Grade:
 
 
 
 
 
 
 
 
 
 
 
 
 
Acceptable
$
1,769,768

 
$
748,558

 
$
1,097,184

 
$
215,525

 
$
96,532

 
$
15,158

 
$
3,942,725

Other assets especially mentioned ("OAEM") (2)
60,076

 
20,442

 
74,959

 
7,103

 
45,673

 
641

 
208,894

Substandard (2)
35,115

 
55,345

 
51,968

 
22,492

 
31,487

 
1,137

 
197,544

Total
$
1,864,959

 
$
824,345

 
$
1,224,111

 
$
245,120

 
$
173,692

 
$
16,936

 
$
4,349,163

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commodity analysis of past due loans (1)
 

 
 

 
 

 
 

 
 

 
 

 
 

90 days or more past due
$
11,605

 
$
19,227

 
$
2,475

 
$
7,315

 
$
—

 
$
—

 
$
40,622


(1)
Amounts represent unpaid principal balance of risk-rated loans, which is the basis Farmer Mac uses to analyze its portfolio, and recorded investment of past due loans.  
(2)
Assets in the OAEM category generally have potential weaknesses due to performance issues but are currently considered to be adequately secured.  Substandard assets have a well-defined weakness or weaknesses and there is a distinct possibility that some loss will be sustained if deficiencies are not corrected.


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Table of Contents

Concentrations of Credit Risk

The following table sets forth the geographic and commodity/collateral diversification, as well as the range of original loan-to-value ratios, for all loans held and loans underlying Farmer Mac I Guaranteed Securities (excluding AgVantage securities) and LTSPCs as of September 30, 2012 and December 31, 2011:

  
September 30, 2012
 
December 31, 2011
  
(in thousands)
By commodity/collateral type:
 
 
 
Crops
$
1,957,295

 
$
1,864,959

Permanent plantings
833,455

 
824,345

Livestock
1,186,477

 
1,224,111

Part-time farm
214,566

 
245,120

Ag. Storage and processing (including ethanol facilities)
198,106

 
173,692

Other
13,058

 
16,936

Total
$
4,402,957

 
$
4,349,163

By geographic region (1):
 

 
 

Northwest
$
785,454

 
$
761,078

Southwest
1,555,368

 
1,597,369

Mid-North
897,453

 
857,659

Mid-South
512,628

 
484,176

Northeast
273,420

 
294,854

Southeast
378,634

 
354,027

Total
$
4,402,957

 
$
4,349,163

By original loan-to-value ratio:
 

 
 

0.00% to 40.00%
$
1,119,814

 
$
1,104,617

40.01% to 50.00%
802,204

 
769,618

50.01% to 60.00%
1,216,706

 
1,225,939

60.01% to 70.00%
1,097,884

 
1,062,061

70.01% to 80.00%
126,297

 
135,985

80.01% to 90.00%
40,052

 
50,943

Total
$
4,402,957

 
$
4,349,163


(1)
Geographic regions:  Northwest (AK, ID, MT, ND, NE, OR, SD, WA, WY); Southwest (AZ, CA, CO, HI, NM, NV, UT); Mid-North (IA, IL, IN, MI, MN, MO, WI); Mid-South (KS, OK, TX); Northeast (CT, DE, KY, MA, MD, ME, NC, NH, NJ, NY, OH, PA, RI, TN, VA, VT, WV); Southeast (AL, AR, FL, GA, LA, MS, SC).

The original loan-to-value ratio is calculated by dividing the loan principal balance at the time of guarantee, purchase or commitment by the appraised value at the date of loan origination or, when available, the updated appraised value at the time of guarantee, purchase or commitment.  Current loan-to-value ratios may be higher or lower than the original loan-to-value ratios.


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Table of Contents

6.
OFF-BALANCE SHEET GUARANTEES AND LONG TERM STANDBY PURCHASE COMMITMENTS

Farmer Mac offers approved lenders two credit enhancement alternatives to increase their liquidity or lending capacity while retaining the cash flow benefits of their loans: (1) Farmer Mac Guaranteed Securities, which are available through the Farmer Mac I program, the Farmer Mac II program or the Rural Utilities program, and (2) LTSPCs, which are available through the Farmer Mac I program or the Rural Utilities program. For securitization trusts where Farmer Mac is the primary beneficiary, as described in Note 1(f), the trust assets and liabilities are included on Farmer Mac's consolidated balance sheet. Upon consolidation, Farmer Mac eliminates the portion of the guarantee and commitment fees receivable and guarantee and commitment obligations related to the consolidated trusts. For the remainder of these transactions, or in the event of deconsolidation, both of these alternatives result in the creation of off-balance sheet obligations for Farmer Mac. Farmer Mac accounts for these transactions and other financial guarantees in accordance with accounting guidance on accounting for guarantees. Farmer Mac records, at the inception of a guarantee, a liability for the fair value of its obligation to stand ready to perform under the terms of each guarantee and an asset that is equal to the fair value of the fees that will be received over the life of each guarantee. The fair values of the guarantee obligation and asset at inception are based on the present value of expected cash flows using management's best estimate of certain key assumptions, which include prepayment speeds, forward yield curves and discount rates commensurate with the risks involved. Because the cash flows of these instruments may be interest rate path dependent, these values and projected discount rates are derived using a Monte Carlo simulation model. The guarantee obligation and corresponding asset are subsequently amortized into guarantee and commitment fee income in relation to the decline in the unpaid principal balance on the underlying agricultural real estate mortgage and rural utilities loans.

Off-Balance Sheet Farmer Mac Guaranteed Securities

Eligible loans and other eligible assets may be placed into trusts that are used as vehicles for the securitization of the transferred assets and the Farmer Mac-guaranteed beneficial interests in the trusts are sold to investors.  The following table summarizes the significant cash flows received from and paid to trusts used for Farmer Mac securitizations:

 
For the Nine Months Ended
  
September 30, 2012
 
September 30, 2011
  
(in thousands)
Proceeds from new securitizations
$
29,334

 
$
13,869

Guarantee fees received
3,344

 
6,042

Purchases of assets from the trusts
(8,069
)
 
(7,292
)
 

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The following table presents the maximum principal amount of potential undiscounted future payments that Farmer Mac could be required to make under all off-balance sheet Farmer Mac Guaranteed Securities as of September 30, 2012 and December 31, 2011, not including offsets provided by any recourse provisions, recoveries from third parties or collateral for the underlying loans:
Outstanding Balance of Off-Balance Sheet Farmer Mac Guaranteed Securities
  
September 30, 2012
 
December 31, 2011
  
(in thousands)
Farmer Mac I:
 
 
 
Farmer Mac Guaranteed Securities - AgVantage
$
970,000

 
$
970,000

Farmer Mac Guaranteed Securities
975,720

 
621,871

Farmer Mac II:
 

 
 

Farmer Mac Guaranteed Securities
33,295

 
42,088

Rural Utilities:
 

 
 

Farmer Mac Guaranteed Securities - AgVantage
16,269

 
16,271

Total off-balance sheet Farmer Mac Guaranteed Securities
$
1,995,284

 
$
1,650,230

 
Farmer Mac has recorded a liability for its obligation to stand ready under the guarantee in the guarantee and commitment obligation on the consolidated balance sheets.  This liability approximated $16.8 million as of September 30, 2012 and $12.3 million as of December 31, 2011.  During second quarter 2012, Farmer Mac deconsolidated $460.3 million of certain securitization trusts created when loans subject to LTSPCs were converted to Farmer Mac I Guaranteed Securities because Farmer Mac was no longer determined to be the primary beneficiary when the counterparty to the transaction ceased being a related party as a result of changes to the membership of Farmer Mac's board of directors. This deconsolidation resulted in an increase to the guarantee and commitment obligation of $5.9 million as of June 30, 2012. There were no such deconsolidation in the third quarter 2012. As of September 30, 2012, the weighted-average remaining maturity of all loans underlying off-balance sheet Farmer Mac Guaranteed Securities, excluding AgVantage securities, was 13.5 years.  As of September 30, 2012, the weighted-average remaining maturity of the off-balance sheet AgVantage securities was 4.6 years.

Long-Term Standby Purchase Commitments

An LTSPC is a commitment by Farmer Mac to purchase eligible loans from an identified pool of loans under enumerated circumstances, either for cash or in exchange for Farmer Mac I Guaranteed Securities, on one or more undetermined future dates.  As consideration for its assumption of the credit risk on loans underlying an LTSPC, Farmer Mac receives a commitment fee payable monthly in arrears in an amount approximating what would have been the guarantee fee if the transaction were structured as a swap for Farmer Mac Guaranteed Securities.

The maximum principal amount of potential undiscounted future payments that Farmer Mac could be requested to make under all LTSPCs, not including offsets provided by any recourse provisions, recoveries from third parties or collateral for the underlying loans, was $1.9 billion as of September 30, 2012 and $1.8 billion as of December 31, 2011.

As of September 30, 2012, the weighted-average remaining maturity of all loans underlying LTSPCs was 13.1 years.  For those LTSPCs issued or modified on or after January 1, 2003, Farmer Mac has recorded a liability for its obligation to stand ready under the commitment in the guarantee and commitment obligation on the consolidated balance sheet.  This liability approximated $17.6 million as of September 30, 2012 and $15.1 million as of December 31, 2011.

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7.
EQUITY

Common Stock

Farmer Mac has three classes of common stock outstanding:
 
•
Class A voting common stock, which may be held only by banks, insurance companies and other financial institutions or similar entities that are not institutions of the FCS.  By federal statute, no holder of Class A voting common stock may directly or indirectly be a beneficial owner of more than 33 percent of the outstanding shares of Class A voting common stock;
•
Class B voting common stock, which may be held only by institutions of the FCS.  There are no restrictions on the maximum holdings of Class B voting common stock; and
•
Class C non-voting common stock, which has no ownership restrictions.

During each of the first three quarters of 2012, Farmer Mac paid a quarterly dividend of $0.10 per share on the Corporation's common stock. During 2011, Farmer Mac paid quarterly dividends of $0.05 per share, in each quarter, on all classes of the Corporation's common stock.  Farmer Mac's ability to declare and pay a dividend could be restricted if it failed to comply with regulatory capital requirements.

Preferred Stock

As of September 30, 2012 and December 31, 2011, Farmer Mac had 57,578 shares of Series C Preferred Stock outstanding. The Series C preferred stock is a component of Stockholder's Equity on the consolidated balance sheets. All of the Series C Preferred Stock outstanding as of September 30, 2012 and December 31, 2011 were held by National Rural Utilities Cooperative Finance Corporation ("CFC"), a related party.

Farmer Mac's ability to declare and pay dividends on outstanding preferred stock could be restricted if it failed to comply with regulatory capital requirements. Farmer Mac's preferred stock is included as a component of core capital for regulatory and statutory capital compliance measurements.

Non-Controlling Interest in Farmer Mac II LLC

On January 25, 2010, Farmer Mac completed a private offering of $250.0 million of securities issued by a newly formed Delaware statutory trust.  The trust securities represent undivided beneficial ownership interests in 250,000 shares of non-cumulative perpetual preferred stock (the "Farmer Mac II LLC Preferred Stock") of Farmer Mac's subsidiary, Farmer Mac II LLC, a Delaware limited liability company.  The Farmer Mac II LLC Preferred Stock has a liquidation preference of $1,000 per share.

Dividends on the Farmer Mac II LLC Preferred Stock will be payable if, when and as declared by Farmer Mac II LLC's board of directors, quarterly, on a non-cumulative basis, on March 30, June 30, September 30, and December 30 of each year.  For each quarterly period from the date of issuance to but excluding the payment date occurring on March 30, 2015, the dividend rate on the Farmer Mac II LLC Preferred Stock will be 8.875 percent per annum.  For each quarterly period from March 30, 2015 to but excluding the payment date occurring on March 30, 2020, the dividend rate on the Farmer Mac II LLC Preferred Stock will be 10.875 percent per annum.  For each quarterly period beginning on March 30, 2020, the dividend rate on the Farmer Mac II LLC Preferred Stock will be an annual rate equal to three-month LIBOR plus 8.211 percent.  Dividends on the Farmer Mac II LLC Preferred Stock are non-

35
Table of Contents

cumulative, so dividends that are not declared for a payment date will not accrue.  The Farmer Mac II LLC Preferred Stock is permanent equity of Farmer Mac II LLC and is presented as "Non-controlling interest – preferred stock" within permanent equity on the consolidated balance sheets of Farmer Mac. Farmer Mac II LLC incurred $8.1 million of direct costs related to the issuance of the Farmer Mac II LLC Preferred Stock, which reduced the amount of non-controlling interest – preferred stock.  The accrual of declared dividends is presented as "Net income attributable to non-controlling interest – preferred stock dividends" on the consolidated statements of operations on a pre-tax basis.  The consolidated tax benefit is included in income tax expense.

Statutory and Regulatory Capital Requirements

Farmer Mac is subject to three statutory and regulatory capital requirements:
 
•
Statutory minimum capital requirement – Farmer Mac's statutory minimum capital level is an amount of core capital (stockholders' equity less accumulated other comprehensive income plus non-controlling interest - preferred stock) equal to the sum of 2.75 percent of Farmer Mac's aggregate on-balance sheet assets, as calculated for regulatory purposes, plus 0.75 percent of the aggregate off-balance sheet obligations of Farmer Mac, specifically including:   
◦
the unpaid principal balance of outstanding Farmer Mac Guaranteed Securities;
◦
instruments issued or guaranteed by Farmer Mac that are substantially equivalent to Farmer Mac Guaranteed Securities, including LTSPCs; and
◦
other off-balance sheet obligations of Farmer Mac.
•
Statutory critical capital requirement – Farmer Mac's critical capital level is an amount of core capital equal to 50 percent of the total minimum capital requirement at that time.
•
Risk-based capital requirement – Farmer Mac's charter directs the Farm Credit Administration ("FCA") to establish a risk-based capital stress test for Farmer Mac, using specified stress-test parameters.

Farmer Mac is required to comply with the higher of the minimum capital requirement and the risk-based capital requirement.

As of September 30, 2012, Farmer Mac's minimum and critical capital requirements were $368.4 million and $184.2 million, respectively, and its actual core capital level was $508.5 million, which was $140.1 million above the minimum capital requirement and $324.3 million above the critical capital requirement as of that date.  As of December 31, 2011, Farmer Mac's minimum and critical capital requirements were $348.7 million and $174.3 million, respectively, and its actual core capital level was $475.2 million, which was $126.5 million above the minimum capital requirement and $300.9 million above the critical capital requirement as of that date.

Based on the risk-based capital stress test, Farmer Mac's risk-based capital requirement as of September 30, 2012 was $42.0 million, and Farmer Mac's regulatory capital (core capital plus the allowance for losses) of $526.3 million exceeded that amount by approximately $484.3 million.  As of December 31, 2011, Farmer Mac's risk-based capital requirement was $52.9 million, and Farmer Mac's regulatory capital of $492.7 million exceeded that amount by approximately $439.8 million.


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Table of Contents

8.
FAIR VALUE DISCLOSURES

Fair Value Measurement

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (also referred to as an exit price).
In determining fair value, Farmer Mac uses various valuation approaches, including market and income approaches.  The fair value hierarchy requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.  When available, the fair value of Farmer Mac's financial instruments is based on quoted market prices, valuation techniques that use observable market-based inputs or unobservable inputs that are corroborated by market data.  Pricing information obtained from third parties is internally validated for reasonableness prior to use in the consolidated financial statements.

When observable market prices are not readily available, Farmer Mac estimates fair value using techniques that rely on alternate market data or internally-developed models using significant inputs that are generally less readily observable.  Market data includes prices of financial instruments with similar maturities and characteristics, interest rate yield curves, measures of volatility and prepayment rates.  If market data needed to estimate fair value is not available, Farmer Mac estimates fair value using internally-developed models that employ a discounted cash flow approach.  Even when market assumptions are not readily available, Farmer Mac's assumptions reflect those that market participants would likely use in pricing the asset or liability at the measurement date.

The fair value hierarchy ranks the quality and reliability of the information used to determine fair values.  The hierarchy gives highest priority to unadjusted quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs.  The standard describes the following three levels used to classify fair value measurements:

Level 1
Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.
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 3
Prices or valuations that require unobservable inputs that are significant to the fair value measurement.


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Table of Contents

Farmer Mac performs a detailed analysis of the assets and liabilities carried at fair value to determine the appropriate level based on the transparency of the inputs used in the valuation techniques.  In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy.  In such cases, an instrument's level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.  Farmer Mac's assessment of the significance of a particular input to the fair value measurement of an instrument requires judgment and consideration of factors specific to the instrument.  While Farmer Mac believes its valuation methods are appropriate and consistent with those of other market participants, using different methodologies or assumptions to determine fair value could result in a materially different estimate of fair value for some financial instruments.

The following is a description of the fair value techniques used for instruments measured at fair value as well as the general classification of such instruments pursuant to the valuation hierarchy described above.  Fair value measurements related to financial instruments that are reported at fair value in the consolidated financial statements each period are referred to as recurring fair value measurements.  Fair value measurements related to financial instruments that are not reported at fair value each period but are subject to fair value adjustments in certain circumstances are referred to as nonrecurring fair value measurements.

Recurring Fair Value Measurements and Classification

Available-for-Sale and Trading Investment Securities

The fair value of investments in U.S. Treasuries is based on unadjusted quoted prices in active markets.  Farmer Mac classifies these fair value measurements as level 1.

For a significant portion of Farmer Mac's investment portfolio, including most asset-backed securities, corporate debt securities, senior agency debt securities, Government/GSE guaranteed mortgage-backed securities, commercial paper and preferred stock issued by GSEs, fair value is primarily determined using a reputable and nationally recognized third party pricing service.  The prices obtained are non-binding and generally representative of recent market trades.  The fair value of certain asset-backed and Government guaranteed mortgage-backed securities are estimated based on quotations from brokers or dealers. Farmer Mac corroborates its primary valuation source by obtaining a secondary price from another independent third party pricing service.  Farmer Mac classifies these fair value measurements as level 2.

For certain investment securities that are thinly traded or not quoted, Farmer Mac estimates fair value using internally-developed models that employ a discounted cash flow approach.  Farmer Mac maximizes the use of observable market data, including prices of financial instruments with similar maturities and characteristics, interest rate yield curves, measures of volatility and prepayment rates.  Farmer Mac generally considers a market to be thinly traded or not quoted if the following conditions exist: (1) there are few transactions for the financial instruments; (2) the prices in the market are not current; (3) the price quotes vary significantly either over time or among independent pricing services or dealers; or (4) there is limited availability of public market information.  Farmer Mac classifies these fair value measurements as level 3.


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Table of Contents

Farmer Mac's investment securities include callable, highly rated auction-rate certificates ("ARCs"), the interest rates on which are reset through an auction process, most commonly at intervals of 28 days, or at formula-based floating rates as set forth in the related transaction documents in the event of a failed auction.  These formula-based floating rates, which may at times reset to zero, are intended to preserve the underlying principal balance of the securities and avoid overall cash shortfalls.  Accordingly, payments of accrued interest may also be delayed and are ultimately subject to cash availability. Beginning in mid-February 2008, there were widespread failures of the auction mechanism designed to provide regular liquidity to these types of securities.  Consequently, Farmer Mac has not sold any of its ARCs into the auctions since that time.  All ARCs held by Farmer Mac are collateralized entirely by pools of Federal Family Education Loan Program ("FFELP") guaranteed student loans that are backed by the full faith and credit of the United States.  Farmer Mac continues to believe that the credit quality of these securities is high, based on the underlying collateralization and the securities' ratings.  To date, Farmer Mac has received all interest due on ARCs it holds and expects to continue to do so. 

Farmer Mac classifies its estimates of fair value for ARCs as level 3 measurements. During 2012 and 2011, Farmer Mac used unadjusted quotes from a broker specializing in these types of securities to determine the estimated fair value of these investments as of each quarter end. Through discussions with the broker, Farmer Mac gained an understanding of the assumptions underlying the broker quotes and independently benchmarked those quotes against other dealer price indications. Farmer Mac believes the broker quotes are the best indication of fair value as of the measurement date although there is uncertainty regarding the ability to transact at such levels. Considering there is no active secondary market for these securities, although limited observable transactions do occasionally occur, price quotes vary significantly among dealers or independent pricing services, if provided at all, and there is little transparency in the price determination, Farmer Mac believes these measurements are appropriately classified as level 3.
 
Net transfers in and/or out of the different levels within the fair value hierarchy are based on the fair values of the assets and liabilities as of the beginning of the reporting period.  There were no transfers within the fair value hierarchy for fair value measurements of Farmer Mac's investment securities during the first nine months of 2012 and 2011.

Available-for-Sale and Trading Farmer Mac Guaranteed Securities and USDA Guaranteed Securities

Farmer Mac estimates the fair value of its Farmer Mac Guaranteed Securities and USDA Guaranteed Securities by discounting the projected cash flows of these instruments at projected interest rates.  The fair values are based on the present value of expected cash flows using management's best estimate of certain key assumptions, which include prepayment speeds, forward yield curves and discount rates commensurate with the risks involved.  Farmer Mac classifies these fair value measurements as level 3 because there is limited market activity and therefore little or no price transparency.  On a sample basis, Farmer Mac corroborates the fair value of its Farmer Mac Guaranteed Securities and USDA Guaranteed Securities by obtaining a secondary valuation from an independent third party service.

Farmer Mac made no transfers within the fair value hierarchy for fair value measurements of Farmer Mac Guaranteed Securities and USDA Guaranteed Securities during the first nine months of 2012 and 2011.


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Table of Contents

Financial Derivatives

The fair value of exchange-traded U.S. Treasury futures is based on unadjusted quoted prices for identical financial instruments.  Farmer Mac classifies these fair value measurements as level 1.

Farmer Mac's derivative portfolio consists primarily of interest rate swaps, credit default swaps and forward sales contracts on the debt of other GSEs.  Farmer Mac estimates the fair value of these financial instruments primarily based upon the counterparty valuations.  Farmer Mac internally values its derivative portfolio using a discounted cash flow valuation technique and obtains a secondary valuation for certain interest rate swaps to corroborate the counterparty valuations.  Farmer Mac also regularly reviews the counterparty valuations as part of the collateral exchange process.  Farmer Mac classifies these fair value measurements as level 2.

Certain basis swaps are nonstandard interest rate swap structures and are therefore internally modeled using significant assumptions and unobservable inputs, resulting in level 3 classification.  Farmer Mac uses a discounted cash flow valuation technique, using management's best estimate of certain key assumptions, which include prepayment speeds, forward yield curves and discount rates commensurate with the risks involved.

As of September 30, 2012, the consideration of credit risk, Farmer Mac's and the counterparties, resulted in an adjustment of $0.4 million to the valuations of Farmer Mac's derivative portfolio. As of December 31, 2011, the consideration of credit risk, Farmer Mac's and the counterparties, resulted in an adjustment of $0.2 million to the valuations of Farmer Mac's derivative portfolio. See Note 1(c) and Note 4 for further information regarding Farmer Mac's derivative portfolio.

Nonrecurring Fair Value Measurements and Classification

Loans Held-for-Sale

Loans held for sale are reported at the lower of cost or fair value in the consolidated balance sheets. Farmer Mac internally models the fair value of loans by discounting the projected cash flows of these instruments at projected interest rates.  The fair values are based on the present value of expected cash flows using management's best estimate of certain key assumptions, which include prepayment speeds, forward yield curves and discount rates commensurate with the risks involved.  The fair values of these instruments are classified as level 3 measurements.  As of September 30, 2012 and December 31, 2011, the fair values of loans held for sale exceeded their cost amounts. Accordingly, Farmer Mac recorded no adjustment to report these loans at the lower of cost or fair value. 


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Table of Contents

Loans Held for Investment

Certain loans in Farmer Mac's held for investment loan portfolio are measured at fair value when they are determined to be impaired. Impaired loans are reported at net realizable value (fair value less estimated cost to sell). The fair value of the loan generally is based on the fair value of the underlying property, which is determined by third-party appraisals when available. When third-party appraisals are not available, fair value is estimated based on factors such as prices for comparable properties in similar geographical areas and/or assessment through observation of such properties. Farmer Mac classifies these fair values as level 3 measurements. Farmer Mac uses net realizable value as a reasonable estimate of fair value in the tables below.

Real Estate Owned

Farmer Mac initially records REO properties at net realizable value and subsequently records them at the lower of carrying value or net realizable value. The fair value of REO is determined by third-party appraisals when available. When third-party appraisals are not available, fair value is estimated based on factors such as prices for comparable properties in similar geographical areas and/or assessment through observation of such properties. Farmer Mac classifies the REO fair values as level 3 measurements. Farmer Mac uses net realizable value as a reasonable estimate of fair value in the tables below.

Fair Value Classification and Transfers

As of September 30, 2012, Farmer Mac's assets and liabilities recorded at fair value included financial instruments valued at $6.3 billion whose fair values were estimated by management in the absence of readily determinable fair values (i.e., level 3).  These financial instruments measured as level 3 represented 50 percent of total assets and 69 percent of financial instruments measured at fair value as of September 30, 2012.  As of December 31, 2011, Farmer Mac's assets and liabilities recorded at fair value included financial instruments valued at $5.9 billion whose fair values were estimated by management in the absence of readily determinable fair values.  These financial instruments measured as level 3
represented 49 percent of total assets and 72 percent of financial instruments measured at fair value as of December 31, 2011.


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Table of Contents

The following tables present information about Farmer Mac's assets and liabilities measured at fair value on a recurring and nonrecurring basis as of September 30, 2012 and December 31, 2011, respectively, and indicate the fair value hierarchy of the valuation techniques used by Farmer Mac to determine such fair value:

Assets and Liabilities Measured at Fair Value as of September 30, 2012
 
Level 1
 
Level 2
 
Level 3
 
Total
 
(in thousands)
Recurring:
 
Assets:
 
 
 
 
 
 
 
Investment Securities:
 
 
 
 
 
 
 
Available-for-sale:
 
 
 
 
 
 
 
Floating rate auction-rate certificates backed by Government guaranteed student loans
$
—

 
$
—

 
$
60,034

 
$
60,034

Floating rate asset-backed securities
—

 
167,045

 
—

 
167,045

Fixed rate asset-backed securities
—

 
9,735

 
—

 
9,735

Floating rate corporate debt securities
—

 
78,819

 
—

 
78,819

Fixed rate corporate debt
—

 
52,681

 
—

 
52,681

Floating rate Government/GSE guaranteed mortgage-backed securities
—

 
743,444

 
—

 
743,444

Fixed rate GSE guaranteed mortgage-backed securities
—

 
2,537

 
—

 
2,537

Floating rate GSE subordinated debt
—

 
57,170

 
—

 
57,170

Fixed rate commercial paper
—

 
19,997

 
—

 
19,997

Fixed rate GSE preferred stock
—

 
85,859

 
—

 
85,859

Floating rate senior agency debt
—

 
50,056

 
—

 
50,056

Fixed rate senior agency debt
—

 
127,715

 
—

 
127,715

Fixed rate U.S. Treasuries
1,179,892

 
—

 
—

 
1,179,892

Total available-for-sale
1,179,892

 
1,395,058

 
60,034

 
2,634,984

Trading:
 

 
 

 
 

 
 

Floating rate asset-backed securities
—

 
—

 
1,344

 
1,344

Total trading
—

 
—

 
1,344

 
1,344

Total Investment Securities
1,179,892

 
1,395,058

 
61,378

 
2,636,328

Farmer Mac Guaranteed Securities:
 

 
 

 
 

 
 

Available-for-sale:
 

 
 

 
 

 
 

Farmer Mac I
—

 
—

 
3,431,588

 
3,431,588

Farmer Mac II
—

 
—

 
29,975

 
29,975

Rural Utilities
—

 
—

 
1,186,944

 
1,186,944

Total Farmer Mac Guaranteed Securities
—

 
—

 
4,648,507

 
4,648,507

USDA Guaranteed Securities:
 

 
 

 
 

 
 

Available-for-sale
—

 
—

 
1,468,041

 
1,468,041

Trading
—

 
—

 
122,587

 
122,587

Total USDA Guaranteed Securities
—

 
—

 
1,590,628

 
1,590,628

Financial derivatives
—

 
36,190

 
—

 
36,190

Total Assets at fair value
$
1,179,892

 
$
1,431,248

 
$
6,300,513

 
$
8,911,653

Liabilities:
 

 
 

 
 

 
 

Financial derivatives
$
3

 
$
164,066

 
$
880

 
$
164,949

Total Liabilities at fair value
$
3

 
$
164,066

 
$
880

 
$
164,949

Nonrecurring:
 

 
 

 
 

 
 

Assets:
 

 
 

 
 

 
 

Loans held for investment
$
—

 
$
—

 
$
7,822

 
$
7,822

REO
—

 
—

 
1,159

 
1,159

Total Nonrecurring Assets at fair value
$
—

 
$
—

 
$
8,981

 
$
8,981


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Table of Contents

Assets and Liabilities Measured at Fair Value as of December 31, 2011
 
Level 1
 
Level 2
 
Level 3
 
Total
 
(in thousands)
Recurring:
 
Assets:
 
 
 
 
 
 
 
Investment Securities:
 
 
 
 
 
 
 
Available-for-sale:
 
 
 
 
 
 
 
Floating rate auction-rate certificates backed by Government guaranteed student loans
$
—

 
$
—

 
$
60,213

 
$
60,213

Floating rate asset-backed securities
—

 
178,560

 
—

 
178,560

Floating rate corporate debt securities
—

 
73,833

 
—

 
73,833

Floating rate Government/GSE guaranteed mortgage-backed securities
—

 
764,038

 
—

 
764,038

Fixed rate GSE guaranteed mortgage-backed securities
—

 
3,360

 
—

 
3,360

Floating rate GSE subordinated debt
—

 
52,562

 
—

 
52,562

Fixed rate GSE preferred stock
—

 
84,878

 
—

 
84,878

Fixed rate corporate debt
—

 
38,699

 
—

 
38,699

Fixed rate commercial paper
—

 
10,000

 
—

 
10,000

Fixed rate U.S. Treasuries
799,266

 
—

 
—

 
799,266

Senior agency debt
—

 
117,285

 
—

 
117,285

Total available-for-sale
799,266

 
1,323,215

 
60,213

 
2,182,694

Trading:
 

 
 

 
 

 
 

Floating rate asset-backed securities
—

 
—

 
1,796

 
1,796

Total trading
—

 
—

 
1,796

 
1,796

Total Investment Securities
799,266

 
1,323,215

 
62,009

 
2,184,490

Farmer Mac Guaranteed Securities:
 

 
 

 
 

 
 

Available-for-sale:
 

 
 

 
 

 
 

Farmer Mac I
—

 
—

 
2,807,627

 
2,807,627

Farmer Mac II
—

 
—

 
35,599

 
35,599

Rural Utilities
—

 
—

 
1,446,046

 
1,446,046

Total Farmer Mac Guaranteed Securities
—

 
—

 
4,289,272

 
4,289,272

USDA Guaranteed Securities:
 

 
 

 
 

 
 

Available-for-sale
—

 
—

 
1,279,546

 
1,279,546

Trading
—

 
—

 
212,359

 
212,359

Total USDA Guaranteed Securities
—

 
—

 
1,491,905

 
1,491,905

Financial derivatives
—

 
40,250

 
—

 
40,250

Total Assets at fair value
$
799,266

 
$
1,363,465

 
$
5,843,186

 
$
8,005,917

Liabilities:
 

 
 

 
 

 
 

Financial derivatives
$
—

 
$
158,689

 
$
1,335

 
$
160,024

Total Liabilities at fair value
$
—

 
$
158,689

 
$
1,335

 
$
160,024

Nonrecurring:
 

 
 

 
 

 
 

Assets:
 

 
 

 
 

 
 

Loans held for investment
$
—

 
$
—

 
$
10,118

 
$
10,118

REO
—

 
—

 
1,296

 
1,296

Total Nonrecurring Assets at fair value
$
—

 
$
—

 
$
11,414

 
$
11,414




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Table of Contents

The following tables present additional information about assets and liabilities measured at fair value on a recurring basis for which Farmer Mac has used significant unobservable inputs to determine fair value. Net transfers in and/or out of level 3 are based on the fair values of the assets and liabilities as of the beginning of the reporting period.
 
Level 3 Assets and Liabilities Measured at Fair Value for the Three Months Ended September 30, 2012
  
Beginning
Balance
 
Purchases
 
Sales
 
Settlements
 
Realized and
Unrealized Gains/
(Losses) included
in Income
 
Unrealized
Gains/(Losses)
included in Other
Comprehensive
Income
 
Ending
Balance
 
(in thousands)
Recurring:
 
 
 
 
 
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
Investment Securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
Available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
 
 
Floating rate auction-rate certificates backed by Government guaranteed student loans
$
59,707

 
$
—

 
$
—

 
$
—

 
$
—

 
$
327

 
$
60,034

Total available-for-sale
59,707

 
—

 
—

 
—

 
—

 
327

 
60,034

Trading:
 

 
 

 
 

 
 
 
 

 
 
 
 

Floating rate asset-backed securities(1)
1,430

 
—

 
—

 
(137
)
 
51

 
—

 
1,344

Total trading
1,430

 
—

 
—

 
(137
)
 
51

 
—

 
1,344

Total Investment Securities
61,137

 
—

 
—

 
(137
)
 
51

 
327

 
61,378

Farmer Mac Guaranteed Securities:
 

 
 

 
 

 
 
 
 

 
 
 
 

Available-for-sale:
 

 
 

 
 

 
 
 
 

 
 
 
 

Farmer Mac I
3,223,332

 
201,000

 
—

 
(1,809
)
 
8,378

 
687

 
3,431,588

Farmer Mac II
29,899

 
—

 
—

 
(335
)
 
—

 
411

 
29,975

Rural Utilities
1,191,236

 
250,000

 
—

 
(250,000
)
 
—

 
(4,292
)
 
1,186,944

Total Farmer Mac Guaranteed Securities
4,444,467

 
451,000

 
—

 
(252,144
)
 
8,378

 
(3,194
)
 
4,648,507

USDA Guaranteed Securities:
 

 
 

 
 

 
 
 
 

 
 
 
 

Available-for-sale
1,418,638

 
114,974

 
—

 
(68,516
)
 
—

 
2,945

 
1,468,041

Trading(2)
146,825

 
—

 
—

 
(23,746
)
 
(492
)
 
—

 
122,587

Total USDA Guaranteed Securities
1,565,463

 
114,974

 
—

 
(92,262
)
 
(492
)
 
2,945

 
1,590,628

Total Assets at fair value
$
6,071,067

 
$
565,974

 
$
—

 
$
(344,543
)
 
$
7,937

 
$
78

 
$
6,300,513

Liabilities:
 

 
 

 
 

 
 
 
 

 
 
 
 

Financial derivatives(3)
$
(967
)
 
$
—

 
$
—

 
$
—

 
$
87

 
$
—

 
$
(880
)
Total Liabilities at fair value
$
(967
)
 
$
—

 
$
—

 
$
—

 
$
87

 
$
—

 
$
(880
)

(1)
Unrealized gains are attributable to assets still held as of September 30, 2012 and are recorded in Losses on trading assets.
(2)
Includes unrealized losses of $0.4 million attributable to assets still held as of September 30, 2012 that are recorded in Losses on trading assets.
(3)
Unrealized gains are attributable to liabilities still held as of September 30, 2012 and are recorded in Gains/(losses) on financial derivatives and hedging activities.


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Table of Contents

Level 3 Assets and Liabilities Measured at Fair Value for the Three Months Ended September 30, 2011
  
Beginning
Balance
 
Purchases
 
Sales
 
Settlements
 
Realized and
Unrealized Gains/
(Losses) included
in Income
 
Unrealized
Gains/(Losses)
included in Other
Comprehensive
Income
 
Ending
Balance
 
(in thousands)
Recurring:
 
 
 
 
 
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
Investment Securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
Available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
 
 
Floating rate auction-rate certificates backed by Government guaranteed student loans
$
64,682

 
$
—

 
$
—

 
$
—

 
$
—

 
$
(2,439
)
 
$
62,243

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Trading:
 

 
 

 
 

 
 
 
 

 
 
 
 

Floating rate asset-backed securities(1)
2,209

 
—

 
—

 
(136
)
 
(310
)
 
—

 
1,763

Total Investment Securities
66,891

 
—


—


(136
)

(310
)

(2,439
)

64,006

Farmer Mac Guaranteed Securities:
 

 
 

 
 

 
 
 
 

 
 
 
 

Available-for-sale:
 

 
 

 
 

 
 
 
 

 
 
 
 

Farmer Mac I
1,759,205

 
1,001,500

 
—

 
(2,009
)
 
—

 
56,771

 
2,815,467

Farmer Mac II
36,530

 
1,264

 
(1,208
)
 
(990
)
 
—

 
1,003

 
36,599

Rural Utilities
1,448,230

 
—

 
—

 
—

 
—

 
(296
)
 
1,447,934

Total Farmer Mac Guaranteed Securities
3,243,965

 
1,002,764

 
(1,208
)
 
(2,999
)
 
—

 
57,478

 
4,300,000

USDA Guaranteed Securities:
 

 
 

 
 

 
 
 
 

 
 
 
 

Available-for-sale
1,120,397

 
85,894

 
—

 
(33,179
)
 
—

 
19,903

 
1,193,015

Trading(2)
249,074

 
—

 
—

 
(17,124
)
 
1,433

 
—

 
233,383

Total USDA Guaranteed Securities
1,369,471

 
85,894

 
—

 
(50,303
)
 
1,433

 
19,903

 
1,426,398

Total Assets at fair value
$
4,680,327

 
$
1,088,658

 
$
(1,208
)
 
$
(53,438
)
 
$
1,123

 
$
74,942

 
$
5,790,404

Liabilities:
 

 
 

 
 

 
 
 
 

 
 
 
 

Financial derivatives(3)
$
(1,755
)
 
$
—

 
$
—

 
$
—

 
$
(232
)
 
$
—

 
$
(1,987
)
Total Liabilities at fair value
$
(1,755
)
 
$
—

 
$
—

 
$
—

 
$
(232
)
 
$
—

 
$
(1,987
)

(1)
Unrealized losses are attributable to assets still held as of September 30, 2011 and are recorded in Losses on trading assets.
(2)
Includes unrealized gains of $0.6 million attributable to assets still held as of September 30, 2011 that are recorded in Losses on trading assets.
(3)
Unrealized losses are attributable to liabilities still held as of September 30, 2011 and are recorded in Gains/(losses) on financial derivatives and hedging activities.


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Table of Contents

Level 3 Assets and Liabilities Measured at Fair Value for the Nine Months Ended September 30, 2012
  
Beginning
Balance
 
Purchases
 
Sales
 
Settlements
 
Realized and
Unrealized Gains/
(Losses) included
in Income
 
Unrealized
Gains/(Losses)
included in Other
Comprehensive
Income
 
Ending
Balance
 
(in thousands)
Recurring:
 
 
 
 
 
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
Investment Securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
Available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
 
 
Floating rate auction-rate certificates backed by Government guaranteed student loans
$
60,213

 
$
—

 
$
—

 
$
—

 
$
—

 
$
(179
)
 
$
60,034

Total available-for-sale
60,213

 
—

 
—

 
—

 
—

 
(179
)
 
60,034

Trading:
 

 
 

 
 

 
 
 
 

 
 
 
 

Floating rate asset-backed securities(1)
1,796

 
—

 
—

 
(664
)
 
212

 
—

 
1,344

Total trading
1,796

 
—

 
—

 
(664
)
 
212

 
—

 
1,344

Total Investment Securities
62,009

 
—

 
—

 
(664
)
 
212

 
(179
)
 
61,378

Farmer Mac Guaranteed Securities:
 

 
 

 
 

 
 
 
 

 
 
 
 

Available-for-sale:
 

 
 

 
 

 
 
 
 

 
 
 
 

Farmer Mac I
2,807,627

 
601,000

 
—

 
(2,824
)
 
8,378

 
17,407

 
3,431,588

Farmer Mac II
35,599

 
5,327

 
(5,327
)
 
(6,350
)
 
—

 
726

 
29,975

Rural Utilities
1,446,046

 
250,000

 
—

 
(495,701
)
 
—

 
(13,401
)
 
1,186,944

Total Farmer Mac Guaranteed Securities
4,289,272

 
856,327

 
(5,327
)
 
(504,875
)
 
8,378

 
4,732

 
4,648,507

USDA Guaranteed Securities:
 

 
 

 
 

 
 
 
 

 
 
 
 

Available-for-sale
1,279,546

 
376,985

 
—

 
(192,309
)
 
—

 
3,819

 
1,468,041

Trading(2)
212,359

 
—

 
—

 
(87,132
)
 
(2,640
)
 
—

 
122,587

Total USDA Guaranteed Securities
1,491,905

 
376,985

 
—

 
(279,441
)
 
(2,640
)
 
3,819

 
1,590,628

Total Assets at fair value
$
5,843,186

 
$
1,233,312

 
$
(5,327
)
 
$
(784,980
)
 
$
5,950

 
$
8,372

 
$
6,300,513

Liabilities:
 

 
 

 
 

 
 
 
 

 
 
 
 

Financial derivatives(3)
$
(1,335
)
 
$
—

 
$
—

 
$
—

 
$
455

 
$
—

 
$
(880
)
Total Liabilities at fair value
$
(1,335
)
 
$
—

 
$
—

 
$
—

 
$
455

 
$
—

 
$
(880
)

(1)
Unrealized gains are attributable to assets still held as of September 30, 2012 and are recorded in Losses on trading assets.
(2)
Includes unrealized losses of $2.0 million attributable to assets still held as of September 30, 2012 that are recorded in Losses on trading assets.
(3)
Unrealized gains are attributable to liabilities still held as of September 30, 2012 and are recorded in Gains/(losses) on financial derivatives and hedging activities.



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Level 3 Assets and Liabilities Measured at Fair Value for the Nine Months Ended September 30, 2011
  
Beginning
Balance
 
Purchases
 
Sales
 
Settlements
 
Realized and
Unrealized Gains/
(Losses) included
in Income
 
Unrealized
Gains/(Losses)
included in Other
Comprehensive
Income
 
Ending
Balance
 
(in thousands)
Recurring:
 
 
 
 
 
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
Investment Securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
Available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
 
 
Floating rate auction-rate certificates backed by Government guaranteed student loans
$
64,335

 
$
—

 
$
—

 
$
—

 
$
—

 
$
(2,092
)
 
$
62,243

Total available-for-sale
64,335

 
—

 
—

 
—

 
—

 
(2,092
)
 
62,243

Trading:
 

 
 

 
 

 
 
 
 

 
 
 
 

Floating rate asset-backed securities(1)
1,400

 
—

 
—

 
(686
)
 
1,049

 
—

 
1,763

Total Trading
1,400

 
—

 
—

 
(686
)
 
1,049

 
—

 
1,763

Total Investment Securities
65,735

 
—


—


(686
)

1,049


(2,092
)

64,006

Farmer Mac Guaranteed Securities:
 

 
 

 
 

 
 
 
 

 
 
 
 

Available-for-sale:
 

 
 

 
 

 
 
 
 

 
 
 
 

Farmer Mac I
942,809

 
1,801,500

 
—

 
(2,023
)
 
—

 
73,181

 
2,815,467

Farmer Mac II
37,637

 
3,268

 
(3,213
)
 
(3,484
)
 
—

 
2,391

 
36,599

Rural Utilities
1,926,818

 
—

 
—

 
(476,401
)
 
—

 
(2,483
)
 
1,447,934

Total Farmer Mac Guaranteed Securities
2,907,264

 
1,804,768

 
(3,213
)
 
(481,908
)
 
—

 
73,089

 
4,300,000

USDA Guaranteed Securities:
 

 
 

 
 

 
 
 
 

 
 
 
 

Available-for-sale
1,005,679

 
300,705

 
—

 
(142,965
)
 
—

 
29,596

 
1,193,015

Trading(2)
311,765

 
—

 
—

 
(80,082
)
 
1,700

 
—

 
233,383

Total USDA Guaranteed Securities
1,317,444

 
300,705

 
—

 
(223,047
)
 
1,700

 
29,596

 
1,426,398

Total Assets at fair value
$
4,290,443

 
$
2,105,473

 
$
(3,213
)
 
$
(705,641
)
 
$
2,749

 
$
100,593

 
$
5,790,404

Liabilities:
 

 
 

 
 

 
 
 
 

 
 
 
 

Financial derivatives(3)
$
(3,390
)
 
$
—

 
$
—

 
$
—

 
$
1,403

 
$
—

 
$
(1,987
)
Total Liabilities at fair value
$
(3,390
)
 
$
—

 
$
—

 
$
—

 
$
1,403

 
$
—

 
$
(1,987
)

(1)
Unrealized gains are attributable to assets still held as of September 30, 2011 and are recorded in Losses on trading assets.
(2)
Includes unrealized losses of $2.0 million attributable to assets still held as of September 30, 2011 that are recorded in Losses on trading assets.
(3)
Unrealized gains are attributable to liabilities still held as of September 30, 2011 and are recorded in Gains/(losses) on financial derivatives and hedging activities.
    

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The following table presents additional information about the significant unobservable inputs used in the fair value measurements categorized in level 3 of the fair value hierarchy:

 
 
Fair Value as of
 
 
 
Unobservable
 
Range
Financial Instruments
 
September 30, 2012
 
Valuation Technique
 
Input
 
(Weighted-Average)
 
 
(in thousands)
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
Investment securities:
 
 
 
 
 
 
 
 
Floating rate auction-rate certificates backed by Government guaranteed student loans
 
$
60,034

 
Indicative bids
 
Range of broker quotes
 
70.0% - 92.0% (81.0%)
 
 
 
 
 
 
 
 
 
Floating rate asset-backed securities
 
$
1,344

 
Discounted cash flow
 
Discount rate
 
12.0% - 19.0% (15.7%)
 
 
 
 
 
 
Constant prepayment rate
 
10%
 
 
 
 
 
 
 
 
 
Farmer Mac Guaranteed Securities:
 
 
 
 
 
 
 
 
  Farmer Mac I
 
$
3,431,588

 
Discounted cash flow
 
Discount rate
 
1.1% - 3.2% (1.6%)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Farmer Mac II
 
$
29,975

 
Discounted cash flow
 
Discount rate
 
0.9% - 3.4% (2.0%)
 
 
 
 
 
 
Constant prepayment rate
 
9% - 18% (15%)
 
 
 
 
 
 
 
 
 
  Rural Utilities
 
$
1,186,944

 
Discounted cash flow
 
Discount rate
 
1.0% - 2.7% (1.6%)
 
 
 
 
 
 
 
 
 
USDA Guaranteed Securities
 
$
1,590,628

 
Discounted cash flow
 
Discount rate
 
1.4% - 5.3% (3.4%)
 
 
 
 
 
 
Constant prepayment rate
 
0% - 24% (11%)
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
Financial Derivatives:
 
 
 
 
 
 
 
 
Basis swaps
 
$
880

 
Discounted cash flow
 
Discount rate
 
1.0% - 2.7% (1.6%)
 
 
 
 
 
 
Constant prepayment rate
 
11% - 19% (17%)

The significant unobservable inputs used in the fair value measurements of Farmer Mac Guaranteed Securities and USDA Guaranteed Securities are prepayment rates and discount rates commensurate with the risks involved. Typically, significant increases (decreases) in any of these inputs in isolation may result in materially lower (higher) fair value measurements. Generally, in a rising interest rate environment, Farmer Mac would expect average discount rates to increase and would likely expect a corresponding decrease in forecasted prepayment rates. Conversely, in a declining interest rate environment, Farmer Mac would expect average discount rates to decrease and would likely expect a corresponding increase in forecasted prepayment rates. Prepayment rates are not presented in the table above for the Farmer Mac I and Rural Utilities securities structured as AgVantage securities because they do not pay down principal based on amortization schedules but instead have fixed maturity dates when the secured general obligations are due.

Fair Value Option

Accounting guidance on the fair value option for financial instruments permits entities to make a one-time irrevocable election to report financial instruments at fair value with changes in fair value recorded in

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earnings as they occur.  This guidance provides 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 made no fair value option elections for the nine months ended September 30, 2012 and 2011. For the three and nine months ended September 30, 2012, Farmer Mac recorded net losses of $0.5 million and $2.6 million, respectively, for changes in fair value of assets previously selected for the fair value option, compared to net losses of $3.3 million and $1.4 million, respectively, for the same periods ended September 30, 2011.  These changes in fair value are presented in "Losses on trading assets" in the consolidated statements of operations.

Disclosures on Fair Value of Financial Instruments

The following table sets forth the estimated fair values and carrying values for financial assets, liabilities and guarantees and commitments as of September 30, 2012 and December 31, 2011:

 
September 30, 2012
 
December 31, 2011
 
Fair Value
 
Carrying
Amount
 
Fair Value
 
Carrying
Amount
 
(in thousands)
Financial assets:
 
 
 
 
 
 
 
Cash and cash equivalents
$
870,040

 
$
870,040

 
$
817,046

 
$
817,046

Investment securities
2,636,328

 
2,636,328

 
2,184,490

 
2,184,490

Farmer Mac Guaranteed Securities
4,648,507

 
4,648,507

 
4,289,272

 
4,289,272

USDA Guaranteed Securities
1,590,628

 
1,590,628

 
1,491,905

 
1,491,905

Loans
2,589,006

 
2,549,535

 
2,971,187

 
2,894,156

Financial derivatives
36,190

 
36,190

 
40,250

 
40,250

Guarantee and commitment fees receivable:
 
 
 
 
 
 
 
LTSPCs
23,769

 
18,461

 
22,802

 
15,886

Farmer Mac Guaranteed Securities
20,731

 
19,279

 
17,960

 
15,498

Financial liabilities:
 
 
 
 
 
 
 
Notes payable:
 
 
 
 
 
 
 
Due within one year
6,775,228

 
6,775,226

 
6,091,573

 
6,087,879

Due after one year
4,898,122

 
4,700,680

 
4,288,670

 
4,104,882

Debt securities of consolidated trusts held by third parties
170,462

 
163,909

 
726,826

 
701,583

Financial derivatives
164,949

 
164,949

 
160,024

 
160,024

Guarantee and commitment obligations:
 
 
 
 
 
 
 
LTSPCs
22,947

 
17,639

 
22,047

 
15,131

Farmer Mac Guaranteed Securities
18,206

 
16,754

 
14,771

 
12,309


The carrying value of cash and cash equivalents is a reasonable estimate of their approximate fair value. This line item is categorized as Level 1 within the fair value hierarchy. Farmer Mac estimates the fair value of its loans, guarantee and commitment fees receivable/obligation, notes payable and debt securities of consolidated trusts held by third parties by discounting the projected cash flows of these instruments at projected interest rates.  The fair values are based on the present value of expected cash flows using management's best estimate of certain key assumptions, which include prepayment speeds, forward yield curves and discount rates commensurate with the risks involved.  Because the cash flows of these instruments may be interest rate path dependent, these values and projected discount rates are derived using a Monte Carlo simulation model. Different market assumptions and estimation methodologies

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Table of Contents

could significantly affect estimated fair value amounts. These line items are categorized as Level 3 within the fair value hierarchy.

9.
BUSINESS SEGMENT REPORTING

Management has determined that the Corporation's operations consist of three reportable segments – Farmer Mac I, Farmer Mac II and Rural Utilities.  Farmer Mac uses these three segments to generate revenue and manage business risk, and each segment is based on distinct products and distinct business activities.  In addition to these three program operating segments, a corporate segment is presented.  That segment represents activity in Farmer Mac's non-program investment portfolio and other corporate activities.  The segment financial results include directly attributable revenues and expenses.  Corporate charges for administrative expenses that are not directly attributable to an operating segment are allocated based on headcount.

Farmer Mac uses core earnings to measure corporate economic performance and develop financial plans because, in management's view, core earnings is a useful alternative measure in understanding Farmer Mac's economic performance, transaction economics and business trends.  Core earnings differs from GAAP net income by excluding the effects of fair value accounting guidance, which are not expected to have a permanent effect on capital. Core earnings also differs from GAAP net income by excluding specified infrequent or unusual transactions that Farmer Mac believes are not indicative of future operating results and that may not reflect the trends and economic financial performance of the Corporation's core business. This non-GAAP financial measure may not be comparable to similarly labeled non-GAAP financial measures disclosed by other companies.

The financial information presented below reflects the accounts of Farmer Mac and its subsidiaries on a consolidated basis.  Accordingly, the core earnings for Farmer Mac's reportable operating segments will differ from the stand-alone financial statements of Farmer Mac's subsidiaries.  These differences will be due to various factors, including the reversal of unrealized gains and losses related to fair value changes of trading assets and financial derivatives, as well as the allocation of certain expenses such as dividends and interest expense related to the issuance of capital and the incurrence of indebtedness managed at the corporate level.  The allocation of general and administrative expenses that are not directly attributable to an operating segment may also result in differences.  The assets of Farmer Mac's subsidiary, Farmer Mac II LLC, will only be available to creditors of Farmer Mac after all obligations owed to creditors of and equity holders in Farmer Mac II LLC have been satisfied.  As of September 30, 2012, Farmer Mac II LLC held assets with a fair value of $1.6 billion, had debt outstanding of $293.0 million, had preferred stock outstanding with a liquidation preference of $250.0 million, and had $1.0 billion of common stock outstanding held by Farmer Mac.


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Table of Contents

The following tables present core earnings for Farmer Mac's reportable operating segments and a reconciliation to GAAP net (loss)/income for the three and nine months ended September 30, 2012 and 2011: 

Core Earnings by Business Segment
For the Three Months Ended September 30, 2012
 
Farmer Mac I
 
Farmer Mac II
 
Rural Utilities
 
Corporate
 
Reconciling
Adjustments
 
GAAP
Amounts
 
(in thousands)
Interest income (1)
$
28,887

 
$
14,299

 
$
15,401

 
$
6,437

 
$
(1,214
)
 
$
63,810

Interest income related to consolidated trusts owned by third parties reclassified to guarantee fee income
(190
)
 
—

 
—

 
—

 
190

 
—

Interest expense (2)
(11,858
)
 
(11,469
)
 
(12,292
)
 
(1,959
)
 
4,130

 
(33,448
)
Net effective spread
16,839

 
2,830

 
3,109

 
4,478

 
3,106

 
30,362

Guarantee and commitment fees
5,551

 
38

 
1,002

 
—

 
(190
)
 
6,401

Other income/(expense) (3)
519

 
251

 
300

 
(699
)
 
1,692

 
2,063

Non-interest income/(loss)
6,070

 
289

 
1,302

 
(699
)
 
1,502

 
8,464

 
 
 
 
 
 
 
 
 
 
 
 
Release of loan losses
(137
)
 
—

 
—

 
—

 
—

 
(137
)
 
 
 
 
 
 
 
 
 
 
 
 
Provision for losses
43

 
—

 
—

 
—

 
—

 
43

Other non-interest expense
(3,582
)
 
(757
)
 
(1,368
)
 
(2,084
)
 
—

 
(7,791
)
Non-interest expense (4)
(3,539
)
 
(757
)
 
(1,368
)
 
(2,084
)
 
—

 
(7,748
)
Core earnings before income taxes
19,233

 
2,362

 
3,043

 
1,695

 
4,608

(5)
30,941

Income tax (expense)/benefit
(6,731
)
 
(827
)
 
(1,065
)
 
1,941

 
(1,612
)
 
(8,294
)
Core earnings before preferred stock dividends and attribution of income to non-controlling interest - preferred stock dividends
12,502

 
1,535

 
1,978

 
3,636

 
2,996

(5)
22,647

Preferred stock dividends
—

 
—

 
—

 
(719
)
 
—

 
(719
)
Non-controlling interest - preferred stock dividends
—

 
—

 
—

 
(5,547
)
 
—

 
(5,547
)
Segment core earnings
$
12,502

 
$
1,535

 
$
1,978

 
$
(2,630
)
 
$
2,996

(5)
$
16,381

 
 
 
 
 
 
 
 
 
 
 
 
Total assets at carrying value
$
5,046,716

 
$
1,640,940

 
$
2,206,529

 
$
3,608,296

 
$
—

 
$
12,502,481

Total on- and off-balance sheet program assets at principal balance
8,712,157

 
1,599,226

 
2,156,676

 
—

 
—

 
12,468,059


(1)
Includes reconciling adjustments for yield maintenance income and amortization of premiums on assets consolidated at fair value to reflect core earnings amounts.
(2)
Based on effective funding cost determined for each operating segment, including expenses related to interest rate swaps not designated as hedges, which are included in Gains/(losses) on financial derivatives and hedging activities on the GAAP financial statements.
(3)
Includes reconciling adjustments for the reclassification of yield maintenance income and expenses related to interest rate swaps not designated as hedges and fair value adjustments on financial derivatives and trading assets. Also includes a reconciling adjustment related to the recognition of deferred gains over the estimated lives of certain Farmer Mac II Guaranteed Securities and USDA Guaranteed Securities.
(4)
Includes directly attributable costs and an allocation of indirectly attributable costs based on headcount.
(5)
Net  adjustments to reconcile core earnings before income taxes; core earnings before preferred stock dividends and attribution of income to non-controlling interest - preferred stock dividends; and segment core earnings to corresponding GAAP measures: (loss)/income before income taxes, net income, and net (loss)/income attributable to common stockholders, respectively.


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Table of Contents

Core Earnings by Business Segment
For the Three Months Ended September 30, 2011
 
Farmer Mac I
 
Farmer Mac II
 
Rural Utilities
 
Corporate
 
Reconciling
Adjustments
 
GAAP
Amounts
 
(in thousands)
Interest income (1)
$
38,949

 
$
14,370

 
$
13,135

 
$
6,880

 
$
(2,213
)
 
$
71,121

Interest income related to consolidated trusts owned by third parties reclassified to guarantee fee income
(782
)
 
—

 
—

 
—

 
782

 
—

Interest expense (2)
(24,625
)
 
(11,665
)
 
(10,089
)
 
(3,408
)
 
10,375

 
(39,412
)
Net effective spread
13,542

 
2,705

 
3,046

 
3,472

 
8,944

 
31,709

Guarantee and commitment fees
5,562

 
51

 
1,317

 
—

 
(782
)
 
6,148

Other income/(expense) (3)
236

 
26

 
—

 
(946
)
 
(60,869
)
 
(61,553
)
Non-interest income/(loss)
5,798

 
77

 
1,317

 
(946
)
 
(61,651
)
 
(55,405
)
 
 
 
 
 
 
 
 
 
 
 
 
Release of loan losses
349

 
—

 
—

 
—

 
—

 
349

 
 
 
 
 
 
 
 
 
 
 
 
Release of losses
452

 
—

 
—

 
—

 
—

 
452

Other non-interest expense
(3,891
)
 
(710
)
 
(1,319
)
 
(2,082
)
 
—

 
(8,002
)
Non-interest expense (4)
(3,439
)
 
(710
)
 
(1,319
)
 
(2,082
)
 
—

 
(7,550
)
Core earnings before income taxes
16,250

 
2,072

 
3,044

 
444

 
(52,707
)
(5)
(30,897
)
Income tax (expense)/benefit
(5,687
)
 
(725
)
 
(1,065
)
 
3,161

 
18,447

 
14,131

Core earnings before preferred stock dividends and attribution of income to non-controlling interest - preferred stock dividends
10,563

 
1,347

 
1,979

 
3,605

 
(34,260
)
(5)
(16,766
)
Preferred stock dividends
—

 
—

 
—

 
(719
)
 
—

 
(719
)
Non-controlling interest - preferred stock dividends
—

 
—

 
—

 
(5,547
)
 
—

 
(5,547
)
Segment core earnings
$
10,563

 
$
1,347

 
$
1,979

 
$
(2,661
)
 
$
(34,260
)
(5)
$
(23,032
)
 
 
 
 
 
 
 
 
 
 
 
 
Total assets at carrying value
$
4,790,409

 
$
1,483,750

 
$
2,356,590

 
$
2,799,758

 
$
—

 
$
11,430,507

Total on- and off-balance sheet program assets at principal balance
8,088,365

 
1,463,129

 
2,289,899

 
—

 
—

 
11,841,393


(1)
Includes reconciling adjustments for yield maintenance income and amortization of premiums on assets consolidated at fair value to reflect core earnings amounts.
(2)
Based on effective funding cost determined for each operating segment, including expenses related to interest rate swaps, which are included in Gains/(losses) on financial derivatives and hedging activities on the GAAP financial statements.
(3)
Includes reconciling adjustments for the reclassification of yield maintenance income, expenses related to interest rate swaps and fair value adjustments on loans held for sale, financial derivatives and trading assets. Also includes a reconciling adjustment related to the recognition of deferred gains over the estimated lives of certain Farmer Mac II Guaranteed Securities and USDA Guaranteed Securities.
(4)
Includes directly attributable costs and an allocation of indirectly attributable costs based on headcount.
(5)
Net  adjustments to reconcile core earnings before income taxes; core earnings before preferred stock dividends and attribution of income to non-controlling interest - preferred stock dividends; and segment core earnings to corresponding GAAP measures: income before income taxes, net income, and net income attributable to common stockholders, respectively.



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Table of Contents

Core Earnings by Business Segment
For the Nine Months Ended September 30, 2012
 
Farmer Mac I
 
Farmer Mac II
 
Rural Utilities
 
Corporate
 
Reconciling
Adjustments
 
GAAP
Amounts
 
(in thousands)
Interest income (1)
$
103,328

 
$
42,811

 
$
48,223

 
$
18,693

 
$
(4,536
)
 
$
208,519

Interest income related to consolidated trusts owned by third parties reclassified to guarantee fee income
(1,463
)
 
—

 
—

 
—

 
1,463

 
—

Interest expense (2)
(53,403
)
 
(34,425
)
 
(38,931
)
 
(4,736
)
 
22,163

 
(109,332
)
Net effective spread
48,462

 
8,386

 
9,292

 
13,957

 
19,090

 
99,187

Guarantee and commitment fees
16,340

 
126

 
3,392

 
—

 
(1,463
)
 
18,395

Other income/(expense) (3)
1,470

 
525

 
301

 
(1,939
)
 
(23,391
)
 
(23,034
)
Non-interest income/(loss)
17,810

 
651

 
3,693

 
(1,939
)
 
(24,854
)
 
(4,639
)
 
 
 
 
 
 
 
 
 
 
 
 
Release of loan losses
663

 
—

 
—

 
—

 
—

 
663

 
 
 
 
 
 
 
 
 
 
 
 
Provision for losses
(1,381
)
 
—

 
—

 
—

 
—

 
(1,381
)
Other non-interest expense
(10,650
)
 
(2,265
)
 
(4,135
)
 
(6,368
)
 
—

 
(23,418
)
Non-interest expense (4)
(12,031
)
 
(2,265
)
 
(4,135
)
 
(6,368
)
 
—

 
(24,799
)
Core earnings before income taxes
54,904

 
6,772

 
8,850

 
5,650

 
(5,764
)
(5)
70,412

Income tax (expense)/benefit
(19,216
)
 
(2,371
)
 
(3,097
)
 
5,347

 
2,018

 
(17,319
)
Core earnings before preferred stock dividends and attribution of income to non-controlling interest - preferred stock dividends
35,688

 
4,401

 
5,753

 
10,997

 
(3,746
)
(5)
53,093

Preferred stock dividends
—

 
—

 
—

 
(2,159
)
 
—

 
(2,159
)
Non-controlling interest - preferred stock dividends
—

 
—

 
—

 
(16,641
)
 
—

 
(16,641
)
Segment core earnings
$
35,688

 
$
4,401

 
$
5,753

 
$
(7,803
)
 
$
(3,746
)
(5)
$
34,293

 
 
 
 
 
 
 
 
 
 
 
 
Total assets at carrying value
$
5,046,716

 
$
1,640,940

 
$
2,206,529

 
$
3,608,296

 
$
—

 
$
12,502,481

Total on- and off-balance sheet program assets at principal balance
8,712,157

 
1,599,226

 
2,156,676

 
—

 
—

 
12,468,059


(1)
Includes reconciling adjustments for yield maintenance income and amortization of premiums on assets consolidated at fair value to reflect core earnings amounts.
(2)
Based on effective funding cost determined for each operating segment, including expenses related to interest rate swaps not designated as hedges, which are included in Gains/(losses) on financial derivatives and hedging activities on the GAAP financial statements.
(3)
Includes reconciling adjustments for the reclassification of yield maintenance income and expenses related to interest rate swaps not designated as hedges and fair value adjustments on financial derivatives and trading assets. Also includes a reconciling adjustment related to the recognition of deferred gains over the estimated lives of certain Farmer Mac II Guaranteed Securities and USDA Guaranteed Securities.
(4)
Includes directly attributable costs and an allocation of indirectly attributable costs based on headcount.
(5)
Net  adjustments to reconcile core earnings before income taxes; core earnings before preferred stock dividends and attribution of income to non-controlling interest - preferred stock dividends; and segment core earnings to corresponding GAAP measures: income before income taxes, net income, and net income attributable to common stockholders, respectively.



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Core Earnings by Business Segment
For the Nine Months Ended September 30, 2011
 
Farmer Mac I
 
Farmer Mac II
 
Rural Utilities
 
Corporate
 
Reconciling
Adjustments
 
GAAP
Amounts
 
(in thousands)
Interest income (1)
$
105,583

 
$
42,080

 
$
39,928

 
$
21,100

 
$
(6,646
)
 
$
202,045

Interest income related to consolidated trusts owned by third parties reclassified to guarantee fee income
(2,495
)
 
—

 
—

 
—

 
2,495

 
—

Interest expense (2)
(67,301
)
 
(33,984
)
 
(30,793
)
 
(10,722
)
 
28,695

 
(114,105
)
Net effective spread
35,787

 
8,096

 
9,135

 
10,378

 
24,544

 
87,940

Guarantee and commitment fees
17,151

 
154

 
4,045

 
—

 
(2,495
)
 
18,855

Other income/(expense) (3)
2,459

 
131

 
—

 
(1,686
)
 
(68,002
)
 
(67,098
)
Non-interest income/(loss)
19,610

 
285

 
4,045

 
(1,686
)
 
(70,497
)
 
(48,243
)
 
 
 
 
 
 
 
 
 
 
 
 
Provision for loan losses
(1,092
)
 
—

 
—

 
—

 
—

 
(1,092
)
 
 
 
 
 
 
 
 
 
 
 
 
Release of losses
3,321

 
—

 
—

 
—

 
—

 
3,321

Other non-interest expense
(12,651
)
 
(2,085
)
 
(3,698
)
 
(6,306
)
 
—

 
(24,740
)
Non-interest expense (4)
(9,330
)
 
(2,085
)
 
(3,698
)
 
(6,306
)
 
—

 
(21,419
)
Core earnings before income taxes
44,975

 
6,296

 
9,482

 
2,386

 
(45,953
)
(5)
17,186

Income tax (expense)/benefit
(15,741
)
 
(2,203
)
 
(3,319
)
 
7,255

 
16,083

 
2,075

Core earnings before preferred stock dividends and attribution of income to non-controlling interest - preferred stock dividends
29,234

 
4,093

 
6,163

 
9,641

 
(29,870
)
(5)
19,261

Preferred stock dividends
—

 
—

 
—

 
(2,159
)
 
—

 
(2,159
)
Non-controlling interest - preferred stock dividends
—

 
—

 
—

 
(16,641
)
 
—

 
(16,641
)
Segment core earnings
$
29,234

 
$
4,093

 
$
6,163

 
$
(9,159
)
 
$
(29,870
)
(5)
$
461

 
 
 
 
 
 
 
 
 
 
 
 
Total assets at carrying value
$
4,790,409

 
$
1,483,750

 
$
2,356,590

 
$
2,799,758

 
$
—

 
$
11,430,507

Total on- and off-balance sheet program assets at principal balance
8,088,365

 
1,463,129

 
2,289,899

 
—

 
—

 
11,841,393


(1)
Includes reconciling adjustments for yield maintenance income and amortization of premiums on assets consolidated at fair value to reflect core earnings amounts.
(2)
Based on effective funding cost determined for each operating segment, including expenses related to interest rate swaps, which are included in Gains/(losses) on financial derivatives and hedging activities on the GAAP financial statements.
(3)
Includes reconciling adjustments for the reclassification of yield maintenance income, expenses related to interest rate swaps and fair value adjustments on loans held for sale, financial derivatives and trading assets. Also includes a reconciling adjustment related to the recognition of deferred gains over the estimated lives of certain Farmer Mac II Guaranteed Securities and USDA Guaranteed Securities.
(4)
Includes directly attributable costs and an allocation of indirectly attributable costs based on headcount.
(5)
Net  adjustments to reconcile core earnings before income taxes; core earnings before preferred stock dividends and attribution of income to non-controlling interest - preferred stock dividends; and segment core earnings to corresponding GAAP measures: income before income taxes, net income, and net income attributable to common stockholders, respectively.



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Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
 
Financial information included in this report is consolidated to include the accounts of Farmer Mac and its subsidiaries, Farmer Mac Mortgage Securities Corporation and Farmer Mac II LLC. Farmer Mac II LLC was formed as a Delaware limited liability company in December 2009 to operate substantially all of the business related to the Farmer Mac II program - primarily the acquisition of USDA-guaranteed portions. The business operations of Farmer Mac II LLC began in January 2010. Since then, Farmer Mac has operated only that part of the Farmer Mac II program that involves the issuance of Farmer Mac II Guaranteed Securities to investors other than Farmer Mac or Farmer Mac II LLC.

This discussion and analysis of financial condition and results of operations should be read together with: (1) the interim unaudited consolidated financial statements and the related notes that appear elsewhere in this report; and (2) Farmer Mac's Annual Report on Form 10‑K for the fiscal year ended December 31, 2011 filed with the SEC on March 15, 2012.

The discussion below is not necessarily indicative of future results.


Forward-Looking Statements

Some statements made in this report are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 pertaining to management's current expectations as to Farmer Mac's future financial results, business prospects and business developments.  Forward-looking statements include, without limitation, any statement that may predict, forecast, indicate or imply future results, performance or achievements, and typically are accompanied by, and identified with, such terms as "anticipates," "believes," "expects," "intends," "should" and similar phrases.  The following management's discussion and analysis includes forward-looking statements addressing Farmer Mac's:
 
•
prospects for earnings;
•
prospects for growth in loan purchase, guarantee, securitization, and LTSPC volume;
•
trends in net interest income and net effective spread;
•
trends in portfolio credit quality, delinquencies, and provisions for losses;
•
trends in expenses;
•
trends in investment securities;
•
prospects for asset impairments and allowance for losses;
•
changes in capital position; and
•
other business and financial matters.


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Table of Contents

Management's expectations for Farmer Mac's future necessarily involve a number of assumptions and estimates and the evaluation of risks and uncertainties.  Various factors or events could cause Farmer Mac's actual results to differ materially from the expectations as expressed or implied by the forward-looking statements, including the factors discussed under "Risk Factors" in Part I, Item 1A of Farmer Mac's Annual Report on Form 10-K for the year ended December 31, 2011 filed with the SEC on March 15, 2012, as well as uncertainties regarding:
 
•
the availability to Farmer Mac and Farmer Mac II LLC of debt financing and, if available, the reasonableness of rates and terms;
•
legislative or regulatory developments that could affect Farmer Mac, including but not limited to developments in relation to agricultural policies and programs contained in the 2008 Farm Bill, many of which expired this year;
•
fluctuations in the fair value of assets held by Farmer Mac and Farmer Mac II LLC;
•
the rate and direction of development of the secondary market for agricultural mortgage and rural utilities loans, including lender interest in Farmer Mac credit products and the Farmer Mac secondary market;
•
the general rate of growth in agricultural mortgage and rural utilities indebtedness;
•
the impact of economic conditions, including the effects of drought and other weather-related conditions and fluctuations in agricultural real estate values, on agricultural mortgage lending and borrower repayment capacity;
•
developments in the financial markets, including possible investor, analyst and rating agency reactions to events involving GSEs, including Farmer Mac;
•
financial market volatility, including the future level and direction of interest rates; and
•
volatility in commodity prices and/or export demand for U.S. agricultural products.

In light of these potential risks and uncertainties, no undue reliance should be placed on any forward-looking statements expressed in this report.  Furthermore, Farmer Mac undertakes no obligation to release publicly the results of revisions to any forward-looking statements that may be made to reflect new information or any future events or circumstances, except as otherwise mandated by the SEC.



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Overview

Farmer Mac added $841.5 million of new program volume during third quarter 2012, which raised the aggregate outstanding amount of program volume to a record level $12.5 billion as of September 30, 2012. Farmer Mac's GAAP net income attributable to common stockholders for third quarter 2012 was $16.4 million, compared to net losses of $4.3 million and $23.0 million for second quarter 2012 and third quarter 2011, respectively.  The increase in Farmer Mac's GAAP net income compared to the previous quarter and prior year quarter was almost entirely attributable to the effects of fair value changes of its financial derivatives. Because Farmer Mac's financial derivatives were not designated in hedge relationships for accounting purposes prior to third quarter 2012, changes in the fair values of these instruments were recorded in earnings, without offsetting fair value adjustments on the corresponding hedged items. As a result, movements in long-term interest rates have historically created significant volatility in Farmer Mac's periodic GAAP earnings due to changes in the fair values of financial derivatives.

Beginning in third quarter 2012, Farmer Mac designated $950.0 million notional amount of interest rate swaps in fair value hedge relationships. Accordingly, Farmer Mac recorded in earnings offsetting fair value adjustments on the hedged items attributable to the risk being hedged. For third quarter 2012, Farmer Mac recorded unrealized fair value gains of $5.3 million on its financial derivatives and hedging activities. This compares to unrealized fair value losses of $21.6 million for second quarter 2012 and $55.2 million for third quarter 2011. Because Farmer Mac expects its fair value hedge relationships to remain highly effective through maturity, a substantial portion of the volatility caused from changes in the fair values of financial derivatives is expected to be eliminated in future periods.
  
Farmer Mac's non-GAAP core earnings for third quarter 2012 were $13.4 million, up from $12.9 million in second quarter 2012 and $11.2 million in third quarter 2011. Core earnings for third quarter 2012 benefited from higher net effective spread of $27.3 million (95 basis points), compared to $27.2 million (99 basis points) in second quarter 2012 and $22.8 million (93 basis points) in third quarter 2011. This higher net effective spread was partially offset by net provisions to the allowance for losses of $0.1 million and $0.2 million in third quarter 2012 and second quarter 2012, respectively, compared to net releases of $0.8 million for third quarter 2011.

Farmer Mac uses core earnings to measure corporate economic performance and develop financial plans because, in management's view, core earnings is a useful alternative measure in understanding Farmer Mac's economic performance, transaction economics and business trends.  Core earnings differs from GAAP net income by excluding the effects of fair value accounting guidance, which are not expected to have a permanent effect on capital. Core earnings also differs from GAAP net income by excluding specified infrequent or unusual transactions that Farmer Mac believes are not indicative of future operating results and that may not reflect the trends and economic financial performance of the Corporation's core business. This non-GAAP financial measure may not be comparable to similarly labeled non-GAAP financial measures disclosed by other companies. Farmer Mac's disclosure of this non-GAAP measure is not intended to replace GAAP information but, rather, to supplement it. Further discussion of Farmer Mac's financial results and a reconciliation of Farmer Mac's GAAP net income/(loss) attributable to common stockholders to core earnings is presented in "—Results of Operations."

Farmer Mac's agricultural and rural utilities portfolios continued to perform well during third quarter 2012. Historically, from quarter to quarter, Farmer Mac's 90‑day delinquencies have fluctuated, both in dollars and as a percentage of the outstanding portfolio, with higher levels likely at the end of the first and

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third quarters of each year corresponding to the annual (January 1st) and semi-annual (January 1st and July 1st) payment characteristics of most Farmer Mac I loans. As of September 30, 2012, Farmer Mac's 90-day delinquencies were $40.8 million (0.93 percent of the non-AgVantage Farmer Mac I portfolio), uncharacteristically lower than $47.0 million (1.07 percent) as of June 30, 2012, and down from $44.8 million (1.02 percent) as of September 30, 2011.  

This year's drought conditions in the Midwest and Great Plains have caused significant deterioration in the yields of feed grains and the quality and availability of adequate grazing land. The reduced size of the crop has resulted in prices well beyond what was forecast early in the year and at levels that in many cases compensate for the yield shortfall in terms of overall farm receipts. However, higher feed grain prices are expected to affect the profitability of agricultural industries that rely on these commodities as an input to production, including ethanol, dairy, and livestock producers. Although the drought has had no measurable impact on the credit quality of Farmer Mac's portfolio as of September 30, 2012, Farmer Mac will continue to monitor closely the effects of the drought. Farmer Mac believes that it generally remains well collateralized on its exposures in drought areas and that there are no additional probable losses inherent in the portfolio as of September 30, 2012 due to the drought conditions. See "—Outlook" for further discussion about the expected effects of the drought on Farmer Mac's portfolio.

When analyzing the overall risk profile of its program business, Farmer Mac takes into account more than the Farmer Mac I agricultural loan delinquency percentages. The total program business includes AgVantage securities and rural utilities loans, neither of which had any delinquencies as of September 30, 2012, and the USDA Guaranteed Securities and USDA-guaranteed portions underlying Farmer Mac II Guaranteed Securities, which are backed by the full faith and credit of the United States. Across Farmer Mac's entire program business, 90-day delinquencies represented 0.33 percent of the total program business as of September 30, 2012, compared to 0.38 percent as of June 30, 2012 and September 30, 2011.

Farmer Mac remains well-positioned to meet the needs of future business opportunities. As of September 30, 2012, Farmer Mac's core capital of $508.5 million exceeded its minimum capital requirement of $368.4 million by $140.1 million. See "—Outlook" for further discussion about the opportunities that Farmer Mac foresees for future business growth.

Critical Accounting Policies and Estimates

The preparation of Farmer Mac's consolidated financial statements in conformity with GAAP requires the use of estimates and assumptions that affect the amounts reported in the consolidated financial statements and related notes for the periods presented. Actual results could differ from those estimates. The critical accounting policies that are both important to the portrayal of Farmer Mac's financial condition and results of operations and require complex, subjective judgments are the accounting policies for: (1) the allowance for losses, (2) fair value measurement, and (3) other-than-temporary impairment.

For a discussion of these critical accounting policies and the related use of estimates and assumptions, see “Management's Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies and Estimates” in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2011 filed with the SEC on March 15, 2012.


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Results of Operations

Farmer Mac's GAAP net income attributable to common stockholders for third quarter 2012 was $16.4 million or $1.49 per diluted common share, compared to a net loss of $23.0 million or $2.22 per diluted common share for third quarter 2011. For the nine months ended September 30, 2012, Farmer Mac's GAAP net income attributable to common stockholders was $34.3 million or $3.12 per diluted common share, compared to $0.5 million or $0.04 per diluted common share for the nine months ended September 30, 2011. Farmer Mac's non-GAAP core earnings were $13.4 million or $1.22 per diluted common share in third quarter 2012, compared to $11.2 million or $1.04 per diluted common share in third quarter 2011.  For the nine months ended September 30, 2012 and 2011, Farmer Mac's non-GAAP core earnings were $38.0 million or $3.47 per diluted share and $30.3 million or $2.83 per diluted share, respectively.

The adjustments required to reconcile from GAAP net income/(loss) attributable to common stockholders to Farmer Mac's core earnings are related principally to the effects of fair value accounting guidance that cause volatility in periodic GAAP earnings but are not expected to have a cumulative net impact on GAAP earnings if the financial instruments are held to maturity, as is generally expected. Adjustments are also made to exclude specified infrequent or unusual transactions that Farmer Mac believes are not indicative of future operating results and that may not reflect the trends and economic financial performance of the Corporation's core business.


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A reconciliation of Farmer Mac's GAAP net income/(loss) attributable to common stockholders to core earnings is presented in the following table, and the adjustments are described in more detail below the table:

Reconciliation of GAAP Net Income/(Loss) Attributable to Common Stockholders to Core Earnings
 
For the Three Months Ended
 
September 30, 2012
 
September 30, 2011
 
(in thousands, except per share amounts)
GAAP net income/(loss) attributable to common stockholders
$
16,381

 
$
(23,032
)
Less the after-tax effects of:
 

 
 

Unrealized gains/(losses) on financial derivatives and hedging activities
3,456

 
(35,857
)
Unrealized losses on trading assets
(286
)
 
(2,361
)
Amortization of premiums and deferred gains on assets consolidated at fair value
(873
)
 
(1,154
)
Net effects of settlements on agency forward contracts
699

 
(1,291
)
Lower of cost or fair value adjustment on loans held for sale
—

 
6,403

      Sub-total
2,996

 
(34,260
)
Core earnings
$
13,385

 
$
11,228

 
 
 
 
Core earnings per share:
 
 
 
  Basic
$
1.28

 
$
1.08

  Diluted
1.22

 
1.04

Weighted-average shares:
 
 
 
  Basic
10,492

 
10,354

  Diluted
10,996

 
10,760

 
 
 
 
 
For the Nine Months Ended
 
September 30, 2012
 
September 30, 2011
 
(in thousands, except per share amounts)
GAAP net income attributable to common stockholders
$
34,293

 
$
461

Less the after-tax effects of:
 

 
 

Unrealized losses on financial derivatives and hedging activities
(394
)
 
(31,316
)
Unrealized losses on trading assets
(1,578
)
 
(230
)
Amortization of premiums and deferred gains on assets consolidated at fair value
(2,732
)
 
(1,817
)
Net effects of settlements on agency forward contracts
958

 
(2,283
)
Lower of cost or fair value adjustment on loans held for sale
—

 
5,776

      Sub-total
(3,746
)
 
(29,870
)
Core earnings
$
38,039

 
$
30,331

 
 
 
 
Core earnings per share:
 
 
 
  Basic
$
3.64

 
$
2.94

  Diluted
3.47

 
2.83

Weighted-average shares:
 
 
 
  Basic
10,442

 
10,328

  Diluted
10,974

 
10,715


Fair value accounting guidance for financial derivatives requires all derivatives to be recognized as either assets or liabilities on the consolidated balance sheet and measured at fair value. Because Farmer Mac's financial derivatives were not designated in hedge relationships for accounting purposes prior to third quarter 2012, changes in the fair value of these instruments were recorded in earnings as they occurred,

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with no fair value adjustments on the corresponding hedged items. In an effort to mitigate volatility in GAAP earnings caused from these fair value changes, Farmer Mac previously elected the fair value option for certain investment securities and Farmer Mac Guaranteed Securities that were funded or hedged principally with financial derivatives. Farmer Mac classifies these assets as trading and measures them at fair value, with changes in fair value recorded in earnings as they occur.
  
Effective July 1, 2012, Farmer Mac designated $950.0 million notional amount of interest rate swaps in fair value hedge relationships. Beginning in third quarter 2012, Farmer Mac recorded in earnings offsetting fair value adjustments on the hedged items attributable to the risk being hedged. Any differences arising from fair value changes that are not offset result in hedge ineffectiveness and affect GAAP earnings. Farmer Mac excludes the after-tax effect of unrealized gains and losses resulting from changes in the fair values of financial derivatives and hedging activities from core earnings.

Farmer Mac recorded unrealized gains of $5.3 million ($3.5 million after-tax) and unrealized losses of $0.6 million ($0.4 million after-tax), respectively, for fair value changes on its financial derivatives and hedging activities for the three and nine months ended September 30, 2012, compared to unrealized losses of $55.2 million ($35.9 million after-tax) and $48.2 million ($31.3 million after-tax), respectively, for the same periods in 2011. Fair value losses on trading assets totaled $0.4 million ($0.3 million after-tax) and $2.4 million ($1.6 million after-tax), respectively, for the three and nine months ended September 30, 2012, compared to fair value losses of $3.6 million ($2.4 million after-tax) and $0.4 million ($0.2 million after-tax), respectively, for the same periods in 2011.  Changes in the fair values of financial derivatives and trading assets have historically contributed significant volatility to Farmer Mac's periodic GAAP earnings. Because Farmer Mac expects its fair value hedge relationships to remain highly effective through maturity, a substantial portion of the volatility caused from changes in the fair values of financial derivatives is expected to be eliminated in future periods. As of September 30, 2012, the cumulative fair value of after-tax losses recorded on financial derivatives was $83.7 million.  Over time, Farmer Mac will realize in earnings the net effect of the cash settlements on its interest rate swap contracts, which will on its own produce either income or expense, but is expected to generate positive net effective spread when combined with the interest received and paid on the assets and liabilities Farmer Mac holds on its balance sheet.  Any positive net effective spread would continue to build retained earnings and capital over time.  

In 2010, Farmer Mac consolidated certain variable interest entities ("VIEs") where Farmer Mac held beneficial interests in trusts used as vehicles for securitization. Prior to consolidation, Farmer Mac classified these assets as trading Farmer Mac Guaranteed Securities because of a fair value option election made previously. As such, these assets were measured at fair value and the unrealized gains and losses resulting from changes in fair value were excluded from Farmer Mac's core earnings.  Upon consolidation, these assets were transferred to loans held for investment in consolidated trusts at their fair value, which resulted in an unamortized premium of $42.7 million.  This premium is being amortized into interest income over the contractual lives of the underlying assets.

Also in 2010, Farmer Mac contributed substantially all of the assets, in excess of $1.1 billion, comprising the Farmer Mac II program to a subsidiary, Farmer Mac II LLC.  The contributed assets included Farmer Mac II Guaranteed Securities and USDA Guaranteed Securities that were designated as either available-for-sale or trading, depending on whether a fair value option election had been made previously. Farmer Mac transferred these assets at their fair value, which resulted in an unamortized premium of $39.1 million being recorded by Farmer Mac II LLC. This premium is being amortized into interest income over the estimated remaining lives of the USDA-guaranteed portions that were transferred.


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At the time of transfer, Farmer Mac had after-tax unrealized gains of $7.0 million recorded in accumulated other comprehensive income related to changes in the fair value of the contributed securities designated as available-for-sale. These gains are being amortized into other income based on the estimated remaining lives of the related USDA-guaranteed portions. On a consolidated basis, the amortization of these gains will offset the premium amortization on the contributed securities designated as available-for-sale.

The after-tax net effect of the amortization of the premiums and deferred gains described above are shown as amortization of premiums and deferred gains on assets consolidated at fair value in the table above. Farmer Mac excludes these items from core earnings because they are not expected to have an economic effect on Farmer Mac's financial performance if the assets are held to maturity, as is generally expected. As of September 30, 2012, $53.9 million of these premiums were still outstanding and $2.9 million of after-tax gains remained deferred in accumulated other comprehensive income.

Farmer Mac routinely enters into forward sales contracts on the debt of other GSEs to reduce its interest rate exposure on forecasted future debt issuances. In its calculation of core earnings, Farmer Mac reverses the gains or losses resulting from the net settlement of these contracts in the period of settlement and amortizes them over the estimated lives of the associated debt issuances.  The after-tax net effect of these items is shown as net effect of settlements on agency forward contracts in the table above. Changes in the fair values of these contracts prior to net settlement are excluded from Farmer Mac's core earnings and are captured in unrealized gains/(losses) on financial derivatives and hedging activities in the table above.

Farmer Mac's portfolio of loans held for sale is reported at the lower of cost or fair value and is subject to fair value adjustments in certain periods. These periodic unrealized gains and losses recorded to adjust the carrying value of loans held for sale to the lower of cost or fair value are excluded from Farmer Mac's core earnings.  

The following sections provide more detail regarding specific components of Farmer Mac's results of operations.


Net Interest Income.  Net interest income for the three and nine months ended September 30, 2012 was $30.4 million and $99.2 million, respectively, compared to $31.7 million and $87.9 million, respectively, for the same periods during 2011. The increase in net interest income in the first nine months of 2012 was primarily attributable to purchases of AgVantage securities throughout 2011 and 2012 that Farmer Mac held on balance sheet. The overall net interest yield was 114 basis points for the nine months ended September 30, 2012, compared to 120 basis points for the nine months ended September 30, 2011.


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The following table provides information regarding interest-earning assets and funding for the nine months ended September 30, 2012 and 2011.  The balance of non-accruing loans is included in the average balance of loans, Farmer Mac Guaranteed Securities and USDA Guaranteed Securities presented, though the related income is accounted for on a cash basis.  Therefore, as the balance of non-accruing loans and the income received increases or decreases, the net interest yield will fluctuate accordingly.  The balance of consolidated loans with beneficial interests owned by third parties is disclosed in the net effect of consolidated trusts and is not included in the average balances of interest-earning assets and interest-bearing liabilities.  The interest income and expense associated with these trusts are shown in the net effect of consolidated trusts.  The average rate earned on cash and investments reflects lower short-term market rates during the first nine months of 2012 compared to the first nine months of 2011.  The lower average rate on loans, Farmer Mac Guaranteed Securities and USDA Guaranteed Securities during the first nine months of 2012 reflects the decline in market rates reflected in the rates on loans acquired or reset during the past year.  The lower average rate on Farmer Mac's notes payable due within one year is consistent with general trends in average short-term rates during the periods presented.  The downward trend in the average rate on notes payable due after one year reflects the retirement of older debt and the issuance of new debt at lower market rates.

  
For the Nine Months Ended
 
September 30, 2012
 
September 30, 2011
 
Average
Balance
 
Income/
Expense
 
Average
Rate
 
Average
Balance
 
Income/
Expense
 
Average
Rate
 
(dollars in thousands)
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
Cash and investments
$
2,997,130

 
$
18,693

 
0.83
%
 
$
2,447,032

 
$
21,100

 
1.15
%
Loans, Farmer Mac Guaranteed Securities and USDA Guaranteed Securities (1)
8,099,888

 
173,900

 
2.86
%
 
6,569,953

 
152,599

 
3.10
%
Total interest-earning assets
11,097,018

 
192,593

 
2.31
%
 
9,016,985

 
173,699

 
2.57
%
Funding:
 

 
 

 
 

 
 

 
 

 
 

Notes payable due within one year
5,220,955

 
7,068

 
0.18
%
 
4,019,952

 
6,962

 
0.23
%
Notes payable due after one year (2)
5,403,647

 
87,801

 
2.17
%
 
4,529,535

 
81,292

 
2.39
%
Total interest-bearing liabilities (3)
10,624,602

 
94,869

 
1.19
%
 
8,549,487

 
88,254

 
1.38
%
Net non-interest-bearing funding
472,416

 
—

 
 

 
467,498

 
—

 
 

Total funding
11,097,018

 
94,869

 
1.14
%
 
9,016,985

 
88,254

 
1.31
%
Net interest income/yield prior to consolidation of certain trusts
11,097,018

 
97,724

 
1.17
%
 
9,016,985

 
85,445

 
1.26
%
Net effect of consolidated trusts (4)
468,825

 
1,463

 
0.42
%
 
760,581

 
2,495

 
0.44
%
Adjusted net interest income/yield
$
11,565,843

 
$
99,187

 
1.14
%
 
$
9,777,566

 
$
87,940

 
1.20
%

(1)
Excludes interest income of $15.9 million and $28.3 million in 2012 and 2011, respectively, related to consolidated trusts with beneficial interests owned by third parties.
(2)
Includes current portion of long-term notes.
(3)
Excludes interest expense of $14.4 million and $25.8 million in 2012 and 2011, respectively, related to consolidated trusts with beneficial interests owned by third parties.
(4)
Includes the effect of consolidated trusts with beneficial interests owned by third party investors.


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The following table sets forth information regarding the changes in the components of Farmer Mac's net interest income for the periods indicated.  For each category, information is provided on changes attributable to changes in volume (change in volume multiplied by old rate) and changes in rate (change in rate multiplied by old volume).  Combined rate/volume variances, the third element of the calculation, are allocated based on their relative size.  The decreases in income due to changes in rate reflect the reset of variable rate investments and adjustable rate mortgages to lower rates and the acquisition of new lower-yielding investments, loans, Farmer Mac Guaranteed Securities and USDA Guaranteed Securities, as described above.  The decreases in expense reflect the decreased cost of funding due to lower interest rates in the debt markets. The increases due to changes in volume reflect the increase in on-balance sheet assets during the first nine months of 2012 compared to the first nine months of 2011.

  
For the Nine Months Ended September 30, 2012
Compared to Same Period 2011
 
Increase/(Decrease) Due to
 
Rate
 
Volume
 
Total
 
(in thousands)
Income from interest-earning assets:
 
 
 
 
 
Cash and investments
$
(6,561
)
 
$
4,154

 
$
(2,407
)
Loans, Farmer Mac Guaranteed Securities and USDA Guaranteed Securities
(12,205
)
 
33,506

 
21,301

Total
(18,766
)
 
37,660

 
18,894

Expense from interest-bearing liabilities
(12,947
)
 
19,562

 
6,615

Change in net interest income prior to consolidation of certain trusts (1)
$
(5,819
)
 
$
18,098

 
$
12,279


(1)
Excludes the effect of consolidated trusts with beneficial interests owned by third parties.

The net interest yield includes yield maintenance payments received upon the early payoff of certain borrowers' loans and the amortization of premiums on assets consolidated at fair value and excludes the accrual of income and expense related to the contractual amounts due on financial derivatives that are not designated in hedging relationships.  The following paragraphs describe the effects of these items on the net interest yield and the table below presents them as adjustments to reconcile to the net effective spread Farmer Mac earns on the difference between its interest-earning assets and its net funding costs, including payments for income and expense related to financial derivatives.

Farmer Mac uses interest rate swap contracts to manage its interest rate risk exposure by modifying the interest rate reset or maturity characteristics of certain assets and liabilities.  Farmer Mac historically accounted for its financial derivatives as undesignated financial derivatives, however, beginning in third quarter 2012, Farmer Mac designated $950.0 million notional amount of financial derivatives in fair value hedge relationships.  The Corporation presents the income or expense related to the contractual amounts due on undesignated financial derivatives in "Gains/(losses) on financial derivatives and hedging activities" on the consolidated statements of operations. For derivatives designated in fair value hedge relationships, the income or expense related to the contractual amounts due on the financial derivatives is included as an adjustment to the yield of the hedged item and is included in interest income. Farmer Mac includes the accrual of the contractual amounts due for undesignated financial derivatives in its calculation of net effective spread.  For the three months ended September 30, 2012, expenses related to undesignated financial derivatives were $4.1 million (14 basis points), compared to $10.4 million (42 basis points) for the three months ended September 30, 2011. For the nine months ended September 30, 2012, expenses related to undesignated financial derivatives were $22.2 million (27 basis points), compared to $28.7 million (42 basis points) for the nine months ended September 30, 2011.


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Net interest income and net interest yields for the three months ended September 30, 2012 and 2011 include the benefits of yield maintenance payments of $0.5 million (2 basis points) and $0.1 million (less than one basis point), respectively. Net interest income and net interest yields for the nine months ended September 30, 2012 and 2011 include the benefits of yield maintenance payments of $0.8 million (1 basis point) and $0.7 million (1 basis point), respectively. Yield maintenance payments represent the present value of expected future interest income streams and accelerate the recognition of interest income from the related loans.  Because the timing and size of these payments vary greatly, variations do not necessarily indicate positive or negative trends to gauge future financial results.

Farmer Mac's net interest income and net interest yield for the three months ended September 30, 2012 and 2011 also include expenses of $1.7 million (6 basis points) and $2.3 million (9 basis points), respectively, related to the amortization of premiums on assets consolidated at fair value. Farmer Mac's net interest income and net interest yield for the nine months ended September 30, 2012 and 2011 also include expenses of $5.3 million (6 basis points) and $7.3 million (11 basis points), respectively, related to the amortization of premiums on assets consolidated at fair value. These premiums are being amortized into interest income over the contractual or estimated remaining lives of the underlying assets.

The following table presents the net effective spread between Farmer Mac's interest-earning assets and its net funding costs.  This spread is measured by including income or expense related to undesignated financial derivatives and excluding yield maintenance payments and the amortization of premiums on assets consolidated at fair value. New on-balance sheet program volume added during the first nine months of 2012 and throughout 2011 increased Farmer Mac's net effective spread for the three and nine months ended September 30, 2012 to $27.3 million and $80.1 million, respectively, up from $22.8 million and $63.4 million, respectively, for the same periods in 2011. The net effective spreads have remained relatively stable at 0.95 percent and 0.96 percent for the three and nine months ended September 30, 2012, respectively, compared to 0.93 percent and 0.94 percent, respectively, for the same periods in 2011. See Note 9 to the consolidated financial statements for more information regarding net effective spread for Farmer Mac's individual business segments.

  
For the Three Months Ended
 
For the Nine Months Ended
 
September 30, 2012
 
September 30, 2011
 
September 30, 2012
 
September 30, 2011
 
Dollars
 
Yield
 
Dollars
 
Yield
 
Dollars
 
Yield
 
Dollars
 
Yield
 
(dollars in thousands)
Net interest income/yield prior to consolidation of certain trusts
$
30,172

 
1.05
 %
 
$
30,927

 
1.26
 %
 
$
97,724

 
1.18
 %
 
$
85,445

 
1.26
 %
Expense related to undesignated financial derivatives
(4,130
)
 
(0.14
)%
 
(10,375
)
 
(0.42
)%
 
(22,163
)
 
(0.27
)%
 
(28,695
)
 
(0.42
)%
Yield maintenance payments
(473
)
 
(0.02
)%
 
(77
)
 
—
 %
 
(784
)
 
(0.01
)%
 
(699
)
 
(0.01
)%
Amortization of premiums on assets consolidated at fair value
1,687

 
0.06
 %
 
2,290

 
0.09
 %
 
5,320

 
0.06
 %
 
7,346

 
0.11
 %
Net effective spread
$
27,256

 
0.95
 %
 
$
22,765

 
0.93
 %
 
$
80,097

 
0.96
 %
 
$
63,397

 
0.94
 %


Provision for and Release of Loan Losses.  During the three months ended ended September 30, 2012, Farmer Mac recorded provisions to its allowance for loan losses of $0.1 million and charge-offs of $0.4 million, respectively, compared to releases of $0.3 million and charge-offs of $5,000, respectively, for the same periods in 2011. During the nine months ended September 30, 2012, Farmer Mac recorded releases of $0.7 million and charge-offs of $0.4 million, respectively, compared to provisions of $1.1 million and charge-offs of $0.2 million, respectively, for the same periods in 2011. The releases

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Table of Contents

recorded during the first nine months of 2012 were driven primarily by reductions in specific allowances for certain loans due to principal payments received and updated appraisal information and the reclassification of approximately $0.3 million from the allowance for loan losses to the reserve for losses due to the deconsolidation of certain VIEs resulting from a change in related party status.

In the first nine months of 2011, Farmer Mac purchased two defaulted loans pursuant to the terms of an LTSPC agreement. This resulted in a reclassification of $1.8 million of specific allowance, which had been recorded in 2010, from the reserve for losses to the allowance for loan losses. This reclassification was partially offset by a decline in Farmer Mac's general loan loss allowance related to its exposure to the ethanol industry. As of September 30, 2012, Farmer Mac's total allowance for loan losses was $9.1 million, compared to $10.2 million as of December 31, 2011.  See "—Risk Management—Credit Risk – Loans."

Release of and Provision for Losses.  During the three and nine months ended September 30, 2012, Farmer Mac recorded releases of losses of $43,000 and provisions for losses of $1.4 million, respectively, compared to releases of $0.5 million and $3.3 million, respectively, for the same periods in 2011. The provision for losses recorded during the first nine months of 2012 resulted primarily from an increase in a specific allowance on an ethanol loan and the reclassification of approximately $0.3 million described above. The release of losses recorded in the first nine months of 2011 primarily resulted from the reclassification of the $1.8 million specific allowance described above.  As of September 30, 2012, Farmer Mac's reserve for losses was $8.7 million, compared to $7.4 million as of December 31, 2011.  See "—Risk Management—Credit Risk – Loans."

Guarantee and Commitment Fees.  Guarantee and commitment fees, which compensate Farmer Mac for assuming the credit risk on loans underlying Farmer Mac Guaranteed Securities and LTSPCs, were $6.4 million and $18.4 million, respectively, for the three and nine months ended September 30, 2012, compared to $6.1 million and $18.9 million, respectively, for the same periods in 2011. The decrease in guarantee and commitment fees in 2012 was primarily attributable to the maturity of a $475.0 million AgVantage security during 2011.

Gains and Losses on Financial Derivatives and Hedging Activities.  Effective July 1, 2012, Farmer Mac designated $950.0 million notional amount of interest rate swaps in fair value hedge relationships. Prior to third quarter 2012, Farmer Mac did not designate its financial derivatives in hedging relationships for accounting purposes. The net effect of unrealized and realized gains and losses on Farmer Mac's financial derivatives and hedging activities for the three and nine months ended September 30, 2012 was a net gain of $1.6 million and a net loss of $23.3 million, respectively, compared to a net loss of $68.6 million and $82.4 million, respectively, for the three and nine months ended September 30, 2011.


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The components of gains and losses on financial derivatives and hedging activities for the three and nine months ended September 30, 2012 and 2011 are summarized in the following table:

 
For the Three Months Ended
 
For the Nine Months Ended
 
September 30,
2012
 
September 30,
2011
 
September 30,
2012
 
September 30,
2011
 
(in thousands)
Fair value hedges:
 
 
 
 
 
 
 
Unrealized (losses)/gains due to fair value changes:
 
 
 
 
 
 
 
Financial derivatives
$
(5,142
)
 
$
—

 
$
(5,142
)
 
$
—

Hedged items
8,378

 
—

 
8,378

 
—

Gains on hedging activities
3,236

 
—

 
3,236

 
—

No hedge designation:
 
 
 
 
 
 
 
Unrealized gains/(losses) due to fair value changes
2,081

 
(55,204
)
 
(3,842
)
 
(48,184
)
Realized:
 
 
 
 
 
 
 
Expense related to financial derivatives
(4,130
)
 
(10,375
)
 
(22,164
)
 
(28,695
)
Gains/(losses) due to terminations or net settlements
371

 
(2,988
)
 
(564
)
 
(5,489
)
Losses on financial derivatives not designated in hedging relationships
(1,678
)
 
(68,567
)
 
(26,570
)
 
(82,368
)
Gains/(losses) on financial derivatives and hedging activities
$
1,558

 
$
(68,567
)
 
$
(23,334
)
 
$
(82,368
)

Changes in the fair values of Farmer Mac's open derivative positions for both designated and undesignated hedges are captured in unrealized (losses)/gains due to fair value changes in the table above and are primarily the result of fluctuations in long-term interest rates. For financial derivatives designated as fair value hedges, changes in the fair values of the hedged items attributable to the hedged risk are also included in unrealized (losses)/gains due to fair value changes above. The accrual of periodic cash settlements for interest paid or received from Farmer Mac's interest rate swap contracts that are not designated in hedging relationships is shown as expense related to financial derivatives.  Payments or receipts to terminate derivative positions or net cash settle forward sales contracts on the debt of other GSEs and U.S. Treasury futures that are not designated in hedging relationships are included in losses due to terminations or net settlements.    

For the three and nine months ended September 30, 2012 and 2011, Farmer Mac was a party to interest rate swap contracts with one related party, Zions First National Bank.  Farmer Mac realized expenses of $0.2 million and $0.8 million for the three and nine months ended September 30, 2012, respectively, related to these interest rate swap contracts, compared to realized expenses of $0.5 million and $1.4 million, respectively, for the same periods in 2011.

Losses on Trading Assets.  During the three and nine months ended September 30, 2012, Farmer Mac recorded unrealized losses on trading assets of $0.4 million and $2.4 million, respectively, compared to unrealized losses of $3.6 million and $0.4 million, respectively, for the same periods in 2011. Of the total unrealized losses recognized on trading assets during the three and nine months ended September 30, 2012, $0.5 million and $2.6 million, respectively, related to assets selected for the fair value option, compared to $3.3 million and $1.4 million for the same periods in 2011. Farmer Mac made no fair value option elections during the three and nine months ended September 30, 2012 and 2011.


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Table of Contents

The unrealized trading losses recorded in the first nine months of 2012 resulted primarily from the reversal of previously recorded unrealized fair value gains upon payoff or refinancing of certain fixed rate USDA Guaranteed Securities given the low interest rate environment and decreases in the fair values of USDA Guaranteed Securities due to wider spreads on mortgage securities.

Gains on Sale of Available-for-Sale Investment Securities.  During the three months ended September 30, 2012, Farmer Mac did not sell any securities from its available-for-sale investment portfolio. During the nine months ended September 30, 2012, Farmer Mac realized net gains of $28,000 from the sale of securities from its available-for-sale investment portfolio, compared to net gains of $0.1 million and $0.3 million, for the three and nine months ended September 30, 2011, respectively.   

Losses and Gains on Sale of Real Estate Owned ("REO"). During the three and nine months ended September 30, 2012, Farmer Mac realized losses of $13,000 and gains of $0.2 million upon the sale of REO properties. This compares to losses of $4,000 and gains of $0.7 million, respectively, for the same periods in 2011.

Lower of Cost or Fair Value Adjustment on Loans Held for Sale.  During the three and nine months ended September 30, 2012, Farmer Mac did not record any fair value adjustments on loans held for sale, compared to unrealized gains of $9.9 million and $8.9 million, for the three and nine months ended September 30, 2011, respectively. The unrealized gains recorded during 2011 resulted from the reversal of previously recognized unrealized losses as the fair value of these loans increased above their cost amounts.

Other Income. Other income totaled $1.0 million and $2.5 million for the three and nine months ended September 30, 2012, respectively, compared to $0.7 million and $5.7 million, respectively, for the same periods in 2011. Other income for the first nine months of 2012 and 2011 included the recognition of $1.1 million and $4.6 million, respectively, of gains previously deferred in accumulated other comprehensive income related to fair value changes of certain Farmer Mac II Guaranteed Securities and USDA Guaranteed Securities contributed to Farmer Mac II LLC in 2010.

Compensation and Employee Benefits.  Compensation and employee benefits were $4.4 million and $13.4 million, respectively, for the three and nine months ended September 30, 2012, compared to $4.8 million and $14.0 million, respectively, for the same periods in 2011. The decreased level of expenses in 2012 was primarily attributable to lower employee health insurance costs resulting from a change in the type of health insurance plan offered to employees in 2012. Farmer Mac expects employee heath insurance costs to increase in 2013.

General and Administrative Expenses.  General and administrative expenses, including legal, audit and consulting fees, were $2.8 million and $8.2 million for the three and nine months ended September 30, 2012, compared to $2.5 million and $7.4 million for the same periods in 2011. The increased level of expenses during the first nine months of 2012 was primarily related to higher costs for consulting and information technology services associated with general corporate activities.


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Table of Contents

Regulatory Fees.  Regulatory fees for the three and nine months ended September 30, 2012 and 2011 were $0.6 million and $1.7 million, respectively. FCA has advised Farmer Mac that its estimated fees for the federal fiscal year ending September 30, 2013 will be $2.4 million, compared to $2.3 million for the federal fiscal year ended September 30, 2012.  After the end of a federal government fiscal year, FCA may revise its prior year estimated assessments to reflect actual costs incurred, and has issued both additional assessments and refunds in the past.

REO Operating Costs. Farmer Mac recorded $0.1 million of REO operating costs for both the three and nine months ended September 30, 2012. During the three and nine months ended September 30, 2011, Farmer Mac recorded REO operating costs of $0.1 million and $0.7 million, respectively, primarily to adjust the carrying value of REO properties to net realizable value (fair value less estimated costs to sell).

Other Expense. During first quarter 2011, Farmer Mac recorded $0.9 million of expense related to the termination of an agreement with a third party that previously provided services related to loan and security administration for certain Farmer Mac I assets. Farmer Mac is currently performing those services internally and expects to continue to do so in the future. Since then, Farmer Mac incurred no comparable termination charges.

Income Tax Benefit/Expense.  For the three and nine months ended September 30, 2012, Farmer Mac recorded an income tax expense of $8.3 million and $17.3 million, respectively, compared to income tax benefit of $14.1 million and $2.1 million, respectively, for the same periods in 2011.  The income tax benefits recorded in 2011 were primarily due to a pre-tax book loss for third quarter 2011 resulting from fair value adjustments on the Corporation's financial derivatives combined with the consolidated tax benefit of the dividends declared on the Farmer Mac II LLC Preferred Stock, which is presented as "Net income attributable to non-controlling interest - preferred stock dividends" on the consolidated statements of operations on a pre-tax basis. Because of this non-controlling interest, Farmer Mac's effective tax rate varies from the statutory federal rate of 35 percent.



69
Table of Contents

Business Volume.  During third quarter 2012, Farmer Mac added $841.5 million of new program volume. Specifically, Farmer Mac:
 
•
purchased $132.9 million of newly originated Farmer Mac I eligible loans;
•
added $115.8 million of Farmer Mac I eligible loans under LTSPCs;
•
purchased $201.0 million of Farmer Mac I AgVantage securities;
•
purchased $26.8 million of loans under the Rural Utilities program;
•
purchased $250.0 million of Rural Utilities AgVantage securities; and
•
purchased $115.0 million of Farmer Mac II USDA-guaranteed portions.

Farmer Mac's outstanding program volume was $12.5 billion as of September 30, 2012, an increase of $554.8 million from December 31, 2011, as new volume exceeded maturities and principal paydowns on existing program assets. The new program volume in the first nine months of 2012 included $600.0 million of AgVantage securities with maturities between two and five years purchased from Rabo Agrifinance Inc., and $250.0 million of Rural Utilities AgVantage securities with an original term-to-maturity of 13 months purchased from CFC. Principal paydowns and maturities in the first nine months of 2012 included $495.7 million related to Rural Utilities AgVantage securities.

The following table sets forth Farmer Mac I, Farmer Mac II and Rural Utilities loan purchase, LTSPC and guarantee activities for newly originated and current seasoned loans during the periods indicated:

Farmer Mac Loan Purchases, Guarantees and LTSPCs
 
For the Three Months Ended
 
For the Nine Months Ended
 
September 30,
2012
 
September 30,
2011
 
September 30,
2012
 
September 30,
2011
 
(in thousands)
Farmer Mac I:
 
 
 
 
 
 
 
Loans
$
132,882

 
$
68,201

 
$
388,791

 
$
397,030

LTSPCs
115,757

 
266,906

 
365,852

 
374,306

Farmer Mac Guaranteed Securities - AgVantage
201,000

 
1,001,500

 
601,000

 
1,801,500

Farmer Mac II:
 
 
 
 
 
 
 
USDA Guaranteed Securities
114,974

 
85,787

 
376,985

 
300,311

Farmer Mac Guaranteed Securities
—

 
1,264

 
5,327

 
3,268

Rural Utilities:
 
 
 
 
 
 
 
Loans
26,843

 
32,387

 
109,479

 
148,782

Farmer Mac Guaranteed Securities - AgVantage
250,000

 
—

 
250,000

 
2,796

Total purchases, guarantees and commitments
$
841,456

 
$
1,456,045

 
$
2,097,434

 
$
3,027,993

 

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Table of Contents

The following table presents the outstanding principal balance of loans held, loans underlying LTSPCs and on- and off-balance sheet Farmer Mac Guaranteed Securities and USDA Guaranteed Securities as of September 30, 2012 and December 31, 2011:

Outstanding Balance of Loans, Loans Underlying Farmer Mac
Guaranteed Securities and LTSPCs, and USDA Guaranteed Securities
 
September 30,
2012
 
December 31,
2011
 
(in thousands)
On-balance sheet:
 
 
 
Farmer Mac I:
 
 
 
Loans
$
1,382,273

 
$
1,251,370

Loans held in trusts:


 


Beneficial interests owned by Farmer Mac
40

 
181

Beneficial interests owned by third party investors
163,088

 
696,554

Farmer Mac Guaranteed Securities - AgVantage
3,339,200

 
2,741,000

Farmer Mac II:


 


USDA Guaranteed Securities
1,536,974

 
1,435,679

Farmer Mac Guaranteed Securities
28,957

 
35,410

Rural Utilities:


 


Loans
606,459

 
529,227

Loans held in trusts:


 


Beneficial interests owned by Farmer Mac
368,848

 
386,800

Farmer Mac Guaranteed Securities - AgVantage
1,165,100

 
1,410,800

Total on-balance sheet
$
8,590,939

 
$
8,487,021

Off-balance sheet:
 

 
 

Farmer Mac I:
 

 
 

Farmer Mac Guaranteed Securities - AgVantage
$
970,000

 
$
970,000

LTSPCs
1,881,836

 
1,776,051

Farmer Mac Guaranteed Securities
975,720

 
621,871

Farmer Mac II:


 


Farmer Mac Guaranteed Securities
33,295

 
42,088

Rural Utilities:


 


Farmer Mac Guaranteed Securities - AgVantage
16,269

 
16,271

Total off-balance sheet
$
3,877,120

 
$
3,426,281

Total
$
12,468,059

 
$
11,913,302


Of the $12.5 billion outstanding principal balance of volume included in Farmer Mac's three programs as of September 30, 2012, $5.5 billion were Farmer Mac Guaranteed Securities structured as AgVantage securities.  Each AgVantage security is a general obligation of an issuing institution approved by Farmer Mac and is secured by eligible loans in an amount at least equal to the outstanding principal amount of the security.  Unlike business volume in the form of purchased loans, USDA Guaranteed Securities, and loans underlying LTSPCs and non-AgVantage Farmer Mac Guaranteed Securities, the Farmer Mac Guaranteed Securities structured as AgVantage securities do not pay down principal based on amortization schedules and instead have fixed maturity dates when the secured general obligation is due.


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Table of Contents

The following table summarizes by maturity date the outstanding principal amount of both on- and off-balance sheet AgVantage securities as of September 30, 2012:

AgVantage Balances by Year of Maturity
 
As of
 
September 30, 2012
 
(in thousands)
2013
658,250

2014
1,060,900

2015
650,250

2016
1,252,000

2017
1,250,500

Thereafter (1)
618,669

Total
$
5,490,569


(1) Includes various maturities ranging from 2018 to 2024.

The weighted-average remaining maturity of the outstanding $5.5 billion of AgVantage securities shown in the table above was 3.5 years as of September 30, 2012.  As a general matter, if the issuer of a maturing AgVantage security does not issue new AgVantage securities to replace the maturing securities, and Farmer Mac does not find alternate sources of business volume, the Corporation's income could be adversely affected. However, the income effect of future maturing AgVantage securities, particularly off-balance sheet transactions, may not be material and will likely not be proportional to the amount of any resulting decrease in business volume. The Corporation's income could also be adversely affected if the net interest margin earned by Farmer Mac on new AgVantage securities that replace maturing AgVantage securities is lower than the margin earned on the maturing securities, as was the case in the CFC transaction completed in third quarter 2012.

The weighted-average age of the Farmer Mac I newly originated and current seasoned loans purchased during third quarter 2012 and 2011 was two months and four months, respectively. The third quarter 2012 and 2011 purchases had a weighted-average remaining term to maturity of 16.7 years and 15.7 years, respectively. Of the Farmer Mac I newly originated and current seasoned loans purchased during third quarter 2012 and 2011, 65 percent and 79 percent, respectively, had principal amortization periods longer than the maturity date, resulting in balloon payments at maturity.

As part of fulfilling its guarantee obligations for Farmer Mac I Guaranteed Securities and commitments to purchase eligible loans underlying LTSPCs, Farmer Mac purchases defaulted loans, all of which are at least 90 days delinquent or in material non-monetary default at the time of purchase, out of the loan pools underlying those securities and LTSPCs, and records the purchased loans as such on its balance sheet.  The purchase price for defaulted loans purchased out of Farmer Mac I Guaranteed Securities is the current outstanding principal balance of the loan plus accrued and unpaid interest.  The purchase price for defaulted loans purchased under an LTSPC is the then-current outstanding principal balance of the loan, with accrued and unpaid interest on the defaulted loans payable out of any future loan payments or liquidation proceeds as received.  The purchase price of a defaulted loan is not an indicator of the expected loss on that loan; many other factors affect expected loss, if any, on loans so purchased. The weighted-average age of delinquent loans purchased out of securitized pools and LTSPCs during third quarter 2012 and 2011 was 4.7 years and 9.9 years, respectively. See "Management's Discussion and Analysis of Financial Condition and Results of Operations—Risk Management—Credit Risk - Loans" in the

72
Table of Contents

Corporation's Annual Report on Form 10‑K for the year ended December 31, 2011 filed with the SEC on March 15, 2012.

The following table presents Farmer Mac's purchases of newly originated and current seasoned loans under the Farmer Mac I program and purchases of defaulted loans underlying Farmer Mac I Guaranteed Securities and LTSPCs for the periods indicated:

 
For the Three Months Ended
 
For the Nine Months Ended
 
September 30,
2012
 
September 30,
2011
 
September 30,
2012
 
September 30,
2011
 
(in thousands)
Farmer Mac I newly originated and current seasoned loan purchases
$
132,882

 
$
68,201

 
$
388,791

 
$
397,030

Defaulted loans purchased underlying Farmer Mac I Guaranteed Securities owned by third party investors
6,742

 
2,921

 
8,069

 
7,292

Defaulted loans purchased underlying LTSPCs
432

 
—

 
2,962

 
13,974

Total loan purchases
$
140,056

 
$
71,122

 
$
399,822

 
$
418,296



Farmer Mac II LLC.  In January 2010, Farmer Mac contributed substantially all of the assets comprising the Farmer Mac II program (in excess of $1.1 billion) to Farmer Mac's subsidiary, Farmer Mac II LLC.  The assets that Farmer Mac contributed to Farmer Mac II LLC consisted primarily of USDA-guaranteed portions that had not been securitized by Farmer Mac but also included $35.0 million of Farmer Mac II Guaranteed Securities.  Farmer Mac did not and will not guarantee the timely payment of principal and interest on the $1.1 billion of contributed USDA-guaranteed portions.  The financial information presented in this report reflects the accounts of Farmer Mac and its subsidiaries on a consolidated basis.  Accordingly, Farmer Mac's reportable operating segments presented in this report will differ from the stand-alone financial statements of Farmer Mac II LLC.  Those separate financial statements are available on the website of Farmer Mac II LLC and are not incorporated in this report by reference.

The assets of Farmer Mac II LLC will only be available to creditors of Farmer Mac after all obligations owed to creditors of and equity holders in Farmer Mac II LLC have been satisfied.  As of September 30, 2012, Farmer Mac II LLC held assets with a fair value of $1.6 billion, had debt outstanding of $293.0 million, had preferred stock outstanding with a liquidation preference of $250.0 million, and had $1.0 billion of common stock outstanding held by Farmer Mac. For more information about the formation and operations of Farmer Mac II LLC and the features of the preferred stock issued by Farmer Mac II LLC in January 2010, see Notes 7 and 9 to the consolidated financial statements.


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Outlook  

Farmer Mac continues to provide a source of liquidity, capital, and risk management tools to help lenders meet the borrowing needs of their customers, and continues to be well-positioned for future business opportunities. While the pace of Farmer Mac's growth will be dictated by the capital and liquidity demands of lenders and their commodity concentrations, Farmer Mac foresees opportunities for continued growth in both the agricultural and rural utilities segments of its business.

Agricultural Sector: The agricultural sector includes many diverse industries that respond in different ways to changes in economic conditions. Those individual industries often are affected differently, sometimes positively and sometimes negatively, by prevailing economic and weather conditions. This results in cycles where one or more industries may be under stress at the same time that others are not. In addition, producers that rely on non-farm sources of income as a significant percentage of overall income may experience stress associated with weakness in the general economy.

These industries are also affected by commodity inventories and their associated market prices, which can vary largely as a result of weather patterns and harvest conditions. The agricultural sector has remained profitable across a variety of industries through the first nine months of 2012, but the extremely high temperatures and drought that areas of the Midwest and Great Plains experienced this past summer generated concerns of substantial yield reductions in the grain crop. Although the drought has been widespread, factors such as a producer's specific location, soil makeup, and irrigation and cultural practices, including seed genetics used, have resulted in great variability in crop yields.

The drought has had no measurable impact on the credit quality of Farmer Mac's portfolio as of the end of third quarter 2012. In general, Farmer Mac does not expect the drought to have a significant negative effect on grain producers because the majority use risk management strategies such as crop insurance to reduce the impact of these situations. Many grain producers also entered this period of drought in a position of financial strength after a period of high profitability and, to the extent that they have a harvestable crop, they may also benefit from the increased grain prices attributable to the reduced grain supply resulting from the drought. However, these increased grain prices may adversely affect the profitability of producers in many industries, including livestock, dairy, and ethanol producers that have already experienced stress over the past few years and face yet another period of high production costs and reduced incomes. Farmer Mac believes that it generally remains well collateralized on its exposures in drought areas, due in part to the appreciation in land values in those areas over the last several years, and will continue to monitor closely the effects of drought on its portfolio.

Agricultural land values that have increased over the past several years have remained elevated. Concern over the sustainability of current land values is mitigated somewhat by the amount of cash used to make purchases and the consideration that a majority of agricultural land purchases have been made by producers rather than investors. Farmer Mac continues to closely monitor sector profitability and agricultural land value trends to tailor underwriting practices to changing conditions. For example, in response to the recent increases in land values, during third quarter 2012 Farmer Mac adopted more conservative underwriting standards for loans in designated states in the upper Midwest by decreasing the maximum loan-to-value ratio ("LTV") from 70 percent to 60 percent for those loans. Furthermore, although Farmer Mac underwrites loans with an emphasis on the borrower's repayment capacity, it is noteworthy that the weighted average original LTV (based on original appraised value that has not been indexed to provide a current market value) for non-AgVantage Farmer Mac I loans was approximately 53 percent and 52 percent as of September 30, 2012 and December 31, 2011, respectively.


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Farmer Mac also continues to monitor the establishment and evolution of legislation and regulations that affect farmers, ranchers, and rural lenders. Many existing federal agricultural policies contained in the 2008 Farm Bill, including policies affecting crop subsidies, availability of crop insurance, and other aspects of agricultural production, expired in September of this year. These policies and others have been the subject of recent political debate within the context of proposals to replace the 2008 Farm Bill.  Although various legislative initiatives have been introduced in Congress to modify or extend the policies contained in the 2008 Farm Bill, Congress has not yet passed any such legislation. Farmer Mac will continue to closely monitor these developments.

Farmer Mac has recently observed increased demand for its longer-term, fixed-rate loan products in the agricultural segment of its portfolio. Farmer Mac believes that the trend toward longer-term mortgage financing by farmland owners will continue and that demand for Farmer Mac's secondary market tools will also increase as rural lenders make more loans and adapt to the changing regulatory environment, which could require more liquidity and capital.

Renewable Energy Sector: Farmer Mac's support of the renewable energy sector is centered in ethanol production, an industry that continues to experience narrow or uneven profit margins in many cases due to a variety of factors. Government support for this industry in the form of an excise tax credit and an import tariff expired in 2011. In anticipation of this expiration, many ethanol blenders established large inventories of ethanol in late 2011, creating downward pressure on ethanol prices. Oversupply, combined with reduced demand for gasoline, has resulted in narrow margins for the ethanol industry this year. As a result, many ethanol plants have curtailed production or shut down to minimize operating losses. The escalation in corn prices from the drought has placed additional pressure on profit margins as operators have experienced increased input costs, and has also increased political pressure on legislators to reduce or eliminate the Renewable Fuel Standard, which currently mandates targeted use of fuel from renewable sources. While a reduction or elimination of the Renewable Fuel Standard is not expected, any such change would have an adverse effect on demand for ethanol. Variability in consumer demand for gasoline has also had periodic negative effects on the demand for ethanol as a blending agent. On the other hand, many producers have begun installing and utilizing corn oil extraction technologies in their plants in an effort to increase profitability. Nonetheless, profit margins at the ethanol production level will likely remain narrow for the foreseeable future, and it is likely that the trend of ethanol plants operating at less than full capacity will continue. Although the ethanol loans in Farmer Mac's portfolio has decreased in recent years both in dollar amount ($153.5 million as of September 30, 2012) and as a percentage of its overall portfolio volume (3.5 percent of the non-AgVantage Farmer Mac I portfolio as of September 30, 2012), Farmer Mac continues to monitor developments in the ethanol industry and evaluate their potential impact on the overall performance of Farmer Mac's portfolio. Other than $14.8 million of undisbursed commitments on existing ethanol loans, Farmer Mac does not expect to add additional ethanol loans to its portfolio.

Rural Utilities Industry: The demand of the rural utilities industry for capital and financing tends to follow the state of the general economy. Continued weakness in the general economy has reduced the demand for rural electric power and, consequently, the need for rural utilities cooperatives to expand. This lower demand within the industry is the primary reason for the lack of growth in Farmer Mac's rural utilities portfolio over the past few years. However, many domestic economic indicators have improved recently, and Farmer Mac and industry sources expect that demand for rural utilities loans will increase as the economy strengthens.

Farmer Mac believes that the rural utilities industry will have significant needs for financing over the course of the next decade, as capital will be needed for growth and modernization such as transmission

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and distribution system improvements and demand-side management. In addition, the industry will also require capital to comply with any future public policy initiatives such as environmental regulations and clean energy initiatives. For example, in response to low natural gas fuel costs, many power generators are building environmentally cleaner natural gas-fired generating projects to replace their aging coal-fired plants.

Any increase in rural utilities cooperatives' demand for loans could result in increased business volume for Farmer Mac in that segment of its portfolio.

Balance Sheet Review

Assets.  Total assets as of September 30, 2012 were $12.5 billion, compared to $11.9 billion as of December 31, 2011.  The increase in total assets was driven by higher levels of non-program assets held for liquidity purposes and purchases of AgVantage securities during 2012 that were retained on balance sheet, offset partially by the deconsolidation of $460.3 million unpaid principal balance of Farmer Mac Guaranteed Securities held by a third party, previously reported as loans held for investment in consolidated trusts, that was no longer a related party during second quarter 2012.

As of September 30, 2012, Farmer Mac had $870.0 million of cash and cash equivalents and $2.6 billion of investment securities, compared to $817.0 million of cash and cash equivalents and $2.2 billion of investment securities as of December 31, 2011.  As of September 30, 2012, Farmer Mac had, $4.6 billion of Farmer Mac Guaranteed Securities, $1.6 billion of USDA Guaranteed Securities and $2.5 billion of loans, net of allowance. This compares to, $4.3 billion of Farmer Mac Guaranteed Securities, $1.5 billion of USDA Guaranteed Securities and $2.9 billion of loans, net of allowance, as of December 31, 2011.

Liabilities.  Total liabilities increased to $11.9 billion as of September 30, 2012 from $11.3 billion as of December 31, 2011.  The increase in liabilities was due to an increase in notes payable used to purchase program and non-program assets, offset partially by a decrease in debt securities of consolidated trusts held by a third party of $460.3 million that were deconsolidated in second quarter 2012 because the third party was no longer a related party.  

Equity.  As of September 30, 2012, Farmer Mac had total equity of $600.3 million comprised of stockholders' equity of $358.4 million and non-controlling interest – preferred stock of $241.9 million.  As of December 31, 2011 Farmer Mac had total equity of $554.5 million comprised of stockholders' equity of $312.6 million and non-controlling interest – preferred stock of $241.9 million.  The increase in total equity during the first nine months of 2012 was the result of increased retained earnings and accumulated other comprehensive income driven by increases in the fair values of securities designated as available-for-sale.

Regulatory Capital Compliance.  Farmer Mac was in compliance with its statutory minimum capital requirement and its risk-based capital standard as of September 30, 2012.  Farmer Mac is required to hold capital at the higher of its statutory minimum capital requirement and the amount required by its risk-based capital stress test.  As of September 30, 2012, Farmer Mac's core capital totaled $508.5 million and exceeded its statutory minimum capital requirement of $368.4 million by $140.1 million.  As of December 31, 2011, Farmer Mac's core capital totaled $475.2 million and exceeded its statutory minimum capital requirement of $348.7 million by $126.5 million.  As of September 30, 2012, Farmer Mac's risk-based capital stress test generated a risk-based capital requirement of $42.0 million.  Farmer Mac's regulatory capital of $526.3 million exceeded that amount by approximately $484.3 million.  Accumulated other comprehensive income is not a component of Farmer Mac's core capital or regulatory capital.

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Off-Balance Sheet Arrangements 

Farmer Mac offers approved lenders two credit enhancement alternatives to increase their liquidity or lending capacity while retaining the cash flow benefits of their loans:  (1) LTSPCs, which are available only through the Farmer Mac I and Rural Utilities programs; and (2) Farmer Mac Guaranteed Securities, which are available through each of the Farmer Mac I, Farmer Mac II and Rural Utilities programs. For securitization trusts where Farmer Mac is the primary beneficiary, the trust assets and liabilities are included on Farmer Mac's consolidated balance sheet. For the remainder of these transactions, and in the event of deconsolidation, both of these alternatives result in the creation of off-balance sheet obligations
for Farmer Mac. See Notes 1(f) and 6 to the consolidated financial statements for further information regarding consolidation and Farmer Mac's off-balance sheet program activities.

Risk Management

Credit Risk – Loans.  Farmer Mac is exposed to credit risk resulting from the inability of borrowers to repay their loans in conjunction with a deficiency in the value of the collateral relative to the outstanding balance of the loan and the costs of liquidation.  Farmer Mac is exposed to credit risk on:
 
•
loans held;
•
loans underlying Farmer Mac Guaranteed Securities; and
•
loans underlying LTSPCs.

Farmer Mac generally assumes 100 percent of the credit risk on loans held and loans underlying Farmer Mac I Guaranteed Securities, LTSPCs and Farmer Mac Guaranteed Securities – Rural Utilities. Farmer Mac has direct credit exposure to loans in non-AgVantage transactions and indirect credit exposure to loans that secure AgVantage transactions, which involve a general obligation of a lender secured by qualified loans.  The credit exposure of Farmer Mac and Farmer Mac II LLC on USDA-guaranteed portions is covered by the full faith and credit of the United States.  Farmer Mac believes that the Corporation and Farmer Mac II LLC have little or no credit risk exposure to USDA-guaranteed portions because of the USDA guarantee.  As of September 30, 2012, neither Farmer Mac nor Farmer Mac II LLC had experienced any credit losses on any business under the Farmer Mac II program and does not expect that the Corporation or Farmer Mac II LLC will incur any such losses in the future.


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Farmer Mac has established underwriting, collateral valuation and documentation standards (including interest rate shock tests for adjustable rate mortgages with initial reset periods of less than five years) for agricultural real estate mortgage loans and rural utilities loans. Farmer Mac believes that these standards mitigate the risk of loss from borrower defaults and provide guidance about the management, administration, and conduct of underwriting and appraisals to all participating sellers and potential sellers in its programs.  These standards were developed on the basis of industry norms for agricultural real estate mortgage loans and rural utilities loans and are designed to assess the creditworthiness of the borrower, as well as the value of the collateral securing the loan.  Farmer Mac evaluates and adjusts these standards on an ongoing basis based on current and anticipated market conditions.  For example, in mid-August 2012 Farmer Mac refined its non-AgVantage Farmer Mac I loan underwriting standards to:

•
increase the minimum ratio of current assets to current liabilities (current ratio) from 1.0 to 1.25;
•
decrease the maximum LTV from 70 percent to 60 percent for loans secured by agricultural real estate located in designated states in the upper Midwest; and
•
focus on a borrower's total debt coverage ratio for purposes of analyzing loan repayment capacity (rather than considering total debt coverage ratio in conjunction with property debt coverage ratio).

These changes were in response to economic conditions affecting agricultural producers, including volatility in revenues and concern over the sustainability of current land values in certain areas, that Farmer Mac believes may have an effect on overall borrower repayment capability. Farmer Mac believes that these refinements to its underwriting standards are consistent with practices undertaken within the agricultural credit industry in general, and does not expect these changes to have a significant impact on Farmer Mac's business volume.

Farmer Mac requires sellers to make representations and warranties regarding the conformity of eligible mortgage and rural utilities loans to these standards, the accuracy of loan data provided to Farmer Mac and other requirements related to the loans.  Sellers are responsible to Farmer Mac for breaches of those representations and warranties, and Farmer Mac has the ability to require a seller to cure, replace or repurchase a loan sold or transferred to Farmer Mac if any breach of a representation or warranty is discovered that was material to Farmer Mac's decision to purchase the loan or that directly or indirectly causes a default or potential loss on a loan sold or transferred by the seller to Farmer Mac.  Pursuant to contracts with Farmer Mac and in consideration for servicing fees, Farmer Mac-approved central servicers service mortgage loans in accordance with Farmer Mac requirements.  Central servicers are responsible to Farmer Mac for serious errors in the servicing of those mortgage loans.  Detailed information regarding Farmer Mac's underwriting and collateral valuation standards and seller eligibility requirements are presented in "Business—Farmer Mac Programs—Farmer Mac I—Underwriting and Collateral Valuation (Appraisal) Standards," "Business—Farmer Mac Programs—Farmer Mac I—Sellers" and "Business—Farmer Mac Programs—Rural Utilities" in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2011 filed with the SEC on March 15, 2012.

Farmer Mac AgVantage securities are general obligations of institutions approved by Farmer Mac and are secured by eligible loans in an amount at least equal to the outstanding principal amount of the security.  Farmer Mac excludes the loans that secure AgVantage securities from the credit risk metrics it discloses because of the credit quality of the issuing institutions, the collateralization level for the securities, and because delinquent loans are required to be removed from the pool of pledged loans and replaced with current eligible loans.  As such, all AgVantage securities are secured by current loans representing at least 100 percent of the outstanding amount of the security.  As of September 30, 2012, Farmer Mac had not experienced any credit losses on any AgVantage securities and does not expect to

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incur any such losses in the future. See "—Credit Risk—Institutional" for more information about Farmer Mac's credit risk on AgVantage securities.

Farmer Mac has developed different underwriting standards for rural utilities loans that depend on whether direct or indirect credit exposure is assumed on a loan and whether the borrower is an electric distribution cooperative or a generation and transmission ("G&T") cooperative. As of September 30, 2012, there were no delinquencies in Farmer Mac's portfolio of rural utilities loans, which includes rural utilities loans held and rural utilities loans underlying or securing Farmer Mac Guaranteed Securities - Rural Utilities. Farmer Mac's direct credit exposure to rural utilities loans as of September 30, 2012 was $975.3 million, of which $950.4 million were loans to electric distribution cooperatives and $24.9 million were loans to G&T cooperatives. Farmer Mac also had indirect credit exposure to the rural utilities loans securing Farmer Mac Guaranteed Securities - Rural Utilities structured as AgVantage securities, some of which were secured by loans to G&T cooperatives. For more information, see "—Credit Risk—Institutional."

Farmer Mac maintains an allowance for losses to cover estimated probable losses on loans held and loans underlying LTSPCs and Farmer Mac Guaranteed Securities.  The methodology that Farmer Mac uses to determine the level of its allowance for losses is described in "Management's Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies and Estimates—Allowance for Losses" in Farmer Mac's Annual Report on Form 10-K for the year ended December 31, 2011 filed with the SEC on March 15, 2012.  Management believes that this methodology produces a reasonable estimate of probable losses, as of the balance sheet date, for all loans held and loans underlying Farmer Mac Guaranteed Securities and LTSPCs, in accordance with accounting guidance related to contingencies and measuring impairment of individual loans.

The following table summarizes the components of Farmer Mac's allowance for losses as of September 30, 2012 and December 31, 2011:

 
September 30, 2012
 
December 31, 2011
 
(in thousands)
Allowance for loan losses
$
9,050

 
$
10,161

Reserve for losses:
 

 
 

Off-balance sheet Farmer Mac I Guaranteed Securities
570

 
364

LTSPCs
8,166

 
6,991

Total allowance for losses
$
17,786

 
$
17,516



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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, 2012 and 2011:

 
September 30, 2012
 
September 30, 2011
 
Allowance
for Loan
Losses
 
Reserve
for Losses
 
Total
Allowance
for Losses
 
Allowance
for Loan
Losses
 
Reserve
for Losses
 
Total
Allowance
for Losses
  
(in thousands)
For the Three Months Ended:
 
 
 
 
 
 
 
 
 
 
 
Beginning Balance
$
9,361

 
$
8,779

 
$
18,140

 
$
11,053

 
$
7,443

 
$
18,496

Provision for/(release of) losses
137

 
(43
)
 
94

 
(349
)
 
(452
)
 
(801
)
Charge-offs
(448
)
 
—

 
(448
)
 
(5
)
 
—

 
(5
)
Ending Balance
$
9,050

 
$
8,736

 
$
17,786

 
$
10,699

 
$
6,991

 
$
17,690

 
 
 
 
 
 
 
 
 
 
 
 
For the Nine Months Ended:
 
 
 
 
 
 
 
 
 
 
 
Beginning Balance
$
10,161

 
$
7,355

 
$
17,516

 
$
9,803

 
$
10,312

 
$
20,115

Provision for/(release of) losses
(663
)
 
1,381

 
718

 
1,092

 
(3,321
)
 
(2,229
)
Charge-offs
(448
)
 
—

 
(448
)
 
(196
)
 
—

 
(196
)
Ending Balance
$
9,050

 
$
8,736

 
$
17,786

 
$
10,699

 
$
6,991

 
$
17,690


Farmer Mac recorded net provisions of $0.1 million and $0.7 million to the allowance for losses during the three and nine months ended September 30, 2012, respectively, compared to net releases of $0.8 million and $2.2 million for the same periods 2011, respectively. Farmer Mac recorded charge-offs of $0.4 million during the three and nine months ended September 30, 2012. During the three and nine months ended September 30, 2011, Farmer Mac recorded charge-offs of $5,000 and $0.2 million, respectively. As of September 30, 2012, Farmer Mac's allowance for losses totaled $17.8 million, or 40 basis points of the outstanding principal balance of loans held and loans underlying LTSPCs and Farmer Mac I Guaranteed Securities (excluding AgVantage securities), compared to $17.5 million, or 40 basis points as of December 31, 2011.

As of September 30, 2012, Farmer Mac's 90-day delinquencies were $40.8 million (0.93 percent of the non-AgVantage Farmer Mac I portfolio), compared to $44.8 million (1.02 percent of the non-AgVantage Farmer Mac I portfolio) as of September 30, 2011.  Some participants within the ethanol industry continue to experience stress, which has been exacerbated by rising corn prices due to the drought, as well as the elimination of tax and tariff support earlier this year. As of September 30, 2012, Farmer Mac had in its portfolio one ethanol facility loan that was more than 90 days delinquent and for which Farmer Mac has recorded a specific allowance.

Loans that have been restructured were insignificant and are included within the reported 90-day delinquency disclosure.  From quarter to quarter, Farmer Mac anticipates that 90-day delinquencies will fluctuate, both in dollars and as a percentage of the outstanding portfolio, with typically higher levels likely at the end of the first and third quarters of each year corresponding to the semi-annual (January 1 and July 1) payment characteristics of most Farmer Mac I loans.

When analyzing the overall risk profile of its program business, Farmer Mac takes into account more than the Farmer Mac I agricultural loan delinquency percentages provided above. The total program business includes AgVantage securities and rural utilities loans, neither of which have any delinquencies, and the USDA Guaranteed Securities and USDA-guaranteed portions underlying Farmer Mac II Guaranteed Securities, which are backed by the full faith and credit of the United States. Across Farmer Mac's entire

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program business, 90-day delinquencies represented 0.33 percent of total program business as of September 30, 2012, compared to 0.38 percent as of June 30, 2012 and 0.38 percent as of September 30, 2011.

As of September 30, 2012, Farmer Mac's ethanol exposure, which includes loans held and loans subject to LTSPCs, was $153.5 million (3.5 percent of the non-AgVantage Farmer Mac I portfolio) on 27 different plants, with an additional $14.8 million of undisbursed commitments.  Other than the undisbursed commitments, Farmer Mac does not expect to add additional ethanol loans to its portfolio.

The following table presents historical information regarding Farmer Mac's 90-day delinquencies in the Farmer Mac I program compared to the principal balance of all Farmer Mac I loans held and loans underlying Farmer Mac I Guaranteed Securities (excluding AgVantage securities) and LTSPCs:
 
 
Outstanding Loans, Guarantees, and LTSPCs (1)
 
90-day
Delinquencies
 
Percentage
 
(dollars in thousands)
As of:
 
 
 
 
 
September 30, 2012
$
4,402,957

 
$
40,797

 
0.93
%
June 30, 2012
4,403,212

 
47,026

 
1.07
%
March 31, 2012
4,372,483

 
53,119

 
1.21
%
December 31, 2011
4,349,163

 
40,622

 
0.93
%
September 30, 2011
4,381,264

 
44,848

 
1.02
%
June 30, 2011
4,315,987

 
54,633

 
1.27
%
March 31, 2011
4,314,328

 
57,324

 
1.33
%
December 31, 2010
4,304,120

 
70,248

 
1.63
%
September 30, 2010
4,225,346

 
64,800

 
1.53
%

(1)
Excludes loans pledged to secure AgVantage securities.

As of September 30, 2012, Farmer Mac individually analyzed $44.6 million of the $110.7 million of recorded investment in impaired loans for collateral shortfalls against updated appraised values, other updated collateral valuations or discounted values. For the remaining $66.1 million of impaired assets for which updated valuations were not available, Farmer Mac evaluated them in the aggregate in consideration of their similar risk characteristics and historical statistics. Farmer Mac recorded specific allowances of $8.0 million for undercollateralized assets as of September 30, 2012. Farmer Mac's non-specific or general allowances were $9.8 million as of September 30, 2012.
As of September 30, 2012, the weighted-average original LTV for Farmer Mac I loans held and loans underlying LTSPCs and Farmer Mac I Guaranteed Securities (excluding AgVantage securities) was
53 percent, and the weighted-average original LTV for all 90-day delinquencies was 57 percent.


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The following table presents outstanding Farmer Mac I loans held and loans underlying LTSPCs and Farmer Mac I Guaranteed Securities (excluding AgVantage securities) and 90-day delinquencies as of September 30, 2012 by year of origination, geographic region, commodity/collateral type, and original LTV:
Farmer Mac I 90-Day Delinquencies as of September 30, 2012
 
Distribution of Outstanding Loans, Guarantees, and LTSPCs
 
Outstanding Loans, Guarantees, and LTSPCs (1)
 
90-Day Delinquencies (2)
 
Percentage
 
(dollars in thousands)
By year of origination:
 
 
 
 
 
 
 
  Before 2000
9
%
 
$
411,912

 
$
1,803

 
0.44
%
2000
2
%
 
83,726

 
—

 
—
%
2001
3
%
 
149,818

 
1,628

 
1.09
%
2002
5
%
 
199,076

 
2,744

 
1.38
%
2003
5
%
 
226,667

 
2,497

 
1.10
%
2004
6
%
 
253,912

 
904

 
0.36
%
2005
7
%
 
326,120

 
561

 
0.17
%
2006
8
%
 
361,824

 
11,558

 
3.19
%
2007
7
%
 
315,303

 
16,375

 
5.19
%
2008
8
%
 
364,621

 
1,029

 
0.28
%
2009
6
%
 
267,403

 
145

 
0.05
%
2010
10
%
 
420,498

 
701

 
0.17
%
2011
12
%
 
516,435

 
852

 
0.16
%
2012
12
%
 
505,642

 
—

 
—
%
Total
100
%
 
$
4,402,957

 
$
40,797

 
0.93
%
By geographic region (3):
 

 
 

 
 

 
 

Northwest
18
%
 
$
785,454

 
$
6,849

 
0.87
%
Southwest
35
%
 
1,555,368

 
10,669

 
0.69
%
Mid-North
20
%
 
897,453

 
5,847

 
0.65
%
Mid-South
12
%
 
512,628

 
2,797

 
0.55
%
Northeast
6
%
 
273,420

 
1,897

 
0.69
%
Southeast
9
%
 
378,634

 
12,738

 
3.36
%
Total
100
%
 
$
4,402,957

 
$
40,797

 
0.93
%
By commodity/collateral type:
 
 
 

 
 

 
 

Crops
45
%
 
$
1,957,295

 
$
13,414

 
0.69
%
Permanent plantings
19
%
 
833,455

 
11,861

 
1.42
%
Livestock
27
%
 
1,186,477

 
4,899

 
0.41
%
Part-time farm
5
%
 
214,566

 
6,125

 
2.85
%
Ag. Storage and processing (including ethanol facilities)
4
%
 
198,106

 
4,498

 
2.27
%
Other
—

 
13,058

 
—

 
—
%
Total
100
%
 
$
4,402,957

 
$
40,797

 
0.93
%
By original loan-to-value ratio:
 
 
 
 
 
 
 
0.00% to 40.00%
25
%
 
$
1,119,814

 
$
12,308

 
1.10
%
40.01% to 50.00%
18
%
 
802,204

 
17,112

 
2.13
%
50.01% to 60.00%
28
%
 
1,216,706

 
1,861

 
0.15
%
60.01% to 70.00%
25
%
 
1,097,884

 
4,989

 
0.45
%
70.01% to 80.00%
3
%
 
126,297

 
4,216

 
3.34
%
80.01% to 90.00%
1
%
 
40,052

 
311

 
0.78
%
Total
100
%
 
$
4,402,957

 
$
40,797

 
0.93
%

(1)
Excludes loans pledged to secure AgVantage securities.
(2)
Includes loans and loans underlying Farmer Mac I Guaranteed Securities and LTSPCs that are 90 days or more past due, in foreclosure, restructured after delinquency, and in bankruptcy, excluding loans performing under either their original loan terms or a court-approved bankruptcy plan.
(3)
Geographic regions - Northwest (AK, ID, MT, ND, NE, OR, SD, WA, WY); Southwest (AZ, CA, CO, HI, NM, NV, UT); Mid-North (IA, IL, IN, MI, MN, MO, WI); Mid-South (KS, OK, TX); Northeast (CT, DE, KY, MA, MD, ME, NC, NH, NJ, NY, OH, PA, RI, TN, VA, VT, WV); and Southeast (AL, AR, FL, GA, LA, MS, SC).

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The following table presents Farmer Mac's cumulative net credit losses relative to the cumulative original balance for all Farmer Mac I loans purchased and loans underlying LTSPCs and Farmer Mac I Guaranteed Securities (excluding AgVantage securities) as of September 30, 2012 by year of origination, geographic region and commodity/collateral type.  The purpose of this information is to present information regarding losses relative to original Farmer Mac I purchases, guarantees, and commitments.

Farmer Mac I Credit Losses Relative to all Cumulative
Original Loans, Guarantees and LTSPCs as of September 30, 2012
 
Cumulative Original Loans, Guarantees and LTSPCs (1)
 
Cumulative Net Credit Losses
 
Cumulative Loss Rate
 
(dollars in thousands)
By year of origination:
 
 
 
 
 
Before 2000
$
6,564,771

 
$
8,803

 
0.13
 %
2000
780,325

 
2,924

 
0.37
 %
2001
1,147,379

 
177

 
0.02
 %
2002
1,177,522

 
73

 
0.01
 %
2003
990,532

 
58

 
0.01
 %
2004
726,802

 
167

 
0.02
 %
2005
878,717

 
(188
)
 
(0.02
)%
2006
900,667

 
7,722

 
0.86
 %
2007
683,002

 
1,643

 
0.24
 %
2008
733,669

 
3,236

 
0.44
 %
2009
462,127

 
1,517

 
0.33
 %
2010
584,521

 
—

 
—
 %
2011
618,737

 
—

 
—
 %
2012
533,092

 
—

 
—
 %
Total
$
16,781,863

 
$
26,132

 
0.16
 %
By geographic region (2):
 

 
 

 
 

Northwest
$
3,173,932

 
$
11,060

 
0.35
 %
Southwest
6,122,632

 
7,302

 
0.12
 %
Mid-North
2,912,657

 
7,051

 
0.24
 %
Mid-South
1,579,043

 
(358
)
 
(0.02
)%
Northeast
1,462,331

 
83

 
0.01
 %
Southeast
1,531,268

 
994

 
0.06
 %
Total
$
16,781,863

 
$
26,132

 
0.16
 %
By commodity/collateral type:
 

 
 

 
 

Crops
$
6,984,342

 
$
2,940

 
0.04
 %
Permanent plantings
3,627,758

 
9,383

 
0.26
 %
Livestock
4,378,988

 
3,731

 
0.09
 %
Part-time farm
1,043,616

 
576

 
0.06
 %
Ag. Storage and processing (including ethanol facilities) (3)
600,877

 
9,502

 
1.58
 %
Other
146,282

 
—

 
—
 %
Total
$
16,781,863

 
$
26,132

 
0.16
 %

(1)
Excludes loans pledged to secure AgVantage securities.
(2)
Geographic regions - Northwest (AK, ID, MT, ND, NE, OR, SD, WA, WY); Southwest (AZ, CA, CO, HI, NM, NV, UT); Mid-North (IA, IL, IN, MI, MN, MO, WI); Mid-South (KS, OK, TX); Northeast (CT, DE, KY, MA, MD, ME, NC, NH, NJ, NY, OH, PA, RI, TN, VA, VT, WV); and Southeast (AL, AR, FL, GA, LA, MS, SC).
(3)
Several of the loans underlying agricultural storage and processing LTSPCs are for facilities under construction and, as of September 30, 2012, approximately $14.8 million of the loans were not yet disbursed by the lender.

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In Farmer Mac's experience, the degree to which the collateral is specialized or highly improved, such as permanent plantings and facilities, is a more significant determinant of ultimate losses on a given loan than the geographic location of a particular borrower or in many cases the particular commodity type. In Farmer Mac's experience, the versatility of a borrower's operation (and in the case of persisting adverse economic conditions, the borrower's ability to switch commodity groups) will more likely result in profitability for the borrower and, consequently, a lower risk of decreased value for the underlying collateral. However, producers of agricultural commodities that require specialized or highly improved property are less able to adapt their operations when faced with adverse economic conditions. If such adverse economic conditions persist for these commodities, not only might the borrower face a higher risk of default, but also the prospective sale value of the collateral is more likely to decrease and the related loan may become undercollateralized.  This analysis is consistent with corresponding commodity analyses, which indicate that Farmer Mac has experienced higher loss and collateral deficiency rates in its loans classified as permanent plantings as well as storage and processing loans, including Farmer Mac's exposure to loans on ethanol plants, for which the collateral is typically highly improved and specialized.  

Farmer Mac anticipates that one or more particular commodity groups will be under economic pressure at any one time and actively manages its portfolio to mitigate concentration risks while preserving Farmer Mac's ability to meet the financing needs of all commodity groups. For additional information, see "Management's Discussion and Analysis of Financial Condition and Results of Operations—Outlook," in this report and "Management's Discussion and Analysis of Financial Condition and Results of Operations—Credit Risk—Loans" in Farmer Mac's Annual Report on Form 10-K for the year ended December 31, 2011 filed with the SEC on March 15, 2012.

Credit Risk – Institutional.  Farmer Mac is exposed to credit risk arising from its business relationships with other institutions including:
 
•
issuers of AgVantage securities and other investments held or guaranteed by Farmer Mac;
•
sellers and servicers; and
•
interest rate swap counterparties.

Each AgVantage security is a general obligation of an issuing institution approved by Farmer Mac and is secured by eligible loans in an amount at least equal to the outstanding principal amount of the security, with some level of overcollateralization also required for Farmer Mac I AgVantage securities.  The required collateralization level is established at the time of issuance and does not change during the life of the security.  In AgVantage transactions, the corporate obligor is required to remove from the pool of pledged collateral any loan that becomes more than 30 days delinquent in the payment of principal or interest and to substitute an eligible loan that is current in payment to maintain the minimum required collateralization level.  In the event of a default on the general obligation, Farmer Mac would have recourse to the pledged collateral and have rights to the ongoing borrower payments of principal and interest. For a more detailed description of AgVantage securities, see "Business—Farmer Mac Programs—Farmer Mac I—AgVantage Securities" in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2011 filed with the SEC on March 15, 2012.

Outstanding AgVantage on-balance sheet Farmer Mac I Guaranteed Securities totaled $3.3 billion and $2.7 billion as of September 30, 2012 and December 31, 2011, respectively. Farmer Mac Guaranteed Securities— Rural Utilities structured as AgVantage transactions issued by CFC and held by Farmer Mac totaled $1.2 billion and $1.4 billion as of September 30, 2012 and December 31, 2011, respectively. In addition, outstanding off-balance sheet AgVantage transactions totaled $1.0 billion as of both September 30, 2012 and December 31, 2011.

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The following table provides information about the issuers of AgVantage securities, as well as the required collateralization levels for those transactions as of September 30, 2012 and December 31, 2011:

 
 
September 30, 2012
 
December 31, 2011
Counterparty
 
Balance
 
Credit Rating
 
Required Collateralization
 
Balance
 
Credit Rating
 
Required Collateralization
 
 
(dollars in thousands)
MetLife (1)
 
$
2,750,000

 
AA-
 
103%
 
$
2,750,000

 
AA-
 
103%
CFC
 
1,181,369

 
A
 
100%
 
1,427,071

 
A
 
100%
Rabo Agrifinance, Inc.
 
1,500,000

 
N/A
 
106%
 
900,000

 
N/A
 
106%
Rabobank N.A.
 
50,000

 
N/A
 
106%
 
50,000

 
N/A
 
106%
Other (2)
 
9,200

 
N/A
 
111% to 120%
 
11,000

 
N/A
 
111% to 120%
Total outstanding
 
$
5,490,569

 
 
 
 
 
$
5,138,071

 
 
 
 

(1)
Includes securities issued by Metropolitan Life Insurance Company and MetLife Insurance Company of Connecticut.
(2)
Consists of AgVantage securities issued by 4 different issuers as of both September 30, 2012 and December 31, 2011.

Farmer Mac manages institutional credit risk related to sellers and servicers by requiring those institutions to meet Farmer Mac's standards for creditworthiness.  Farmer Mac monitors the financial condition of those institutions by evaluating financial statements and bank credit rating agency reports.  For more information on Farmer Mac's approval of sellers, see "Business—Farmer Mac Programs—Farmer Mac I—Sellers" in the Corporation's Annual Report on From 10-K for the year ended December 31, 2011 filed with the SEC on March 15, 2012.

Farmer Mac manages institutional credit risk related to its interest rate swap counterparties through collateralization provisions contained in each of its swap agreements that varies based on the market value of its swaps portfolio with each counterparty. In addition, Farmer Mac transacts interest rate swaps with multiple counterparties to ensure a more even distribution of institutional credit risk related to its swap transactions.

Credit Risk – Other Investments. As of September 30, 2012, Farmer Mac had $870.0 million of cash and cash equivalents and $2.6 billion of investment securities. The management of the credit risk inherent in these investments is governed by Farmer Mac's own policies and regulations promulgated by FCA, including dollar amount, issuer concentration, and credit quality limitations. Those regulations can be found at 12 C.F.R. §§ 652.1-652.45 (the "Liquidity and Investment Regulations"). In addition to assuring that Farmer Mac maintains a portfolio of highly liquid investments as an available source of cash, the goals of Farmer Mac's investment policies are designed to minimize the Corporation's exposure to financial market volatility, preserve capital, and support the Corporation's access to the debt markets.

FCA's current Liquidity and Investment Regulations and Farmer Mac's policies generally require each investment or issuer of an investment to be highly rated by a nationally-recognized statistical rating organization ("NRSRO").  Investments in mortgage securities and asset-backed securities are required to have a rating in the highest NRSRO category. Corporate debt securities with maturities of no more than five years but more than three years are required to be rated in one of the two highest categories; corporate debt securities with maturities of three years or less are required to be rated in one of the three highest categories.  Some investments do not require a rating, such as Treasury Securities and other obligations fully insured by the United States Government or a Government Agency or diversified investment funds regulated under the Investment Company Act of 1940.  Investments in diversified investment funds are further limited to those funds that are holding only instruments approved for direct investment by

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Farmer Mac. FCA has recently sought public comment regarding its use of credit ratings in its Liquidity and Investment Regulations for purposes of a final rule to be published at a later date.

FCA's Liquidity and Investment Regulations and Farmer Mac's policies also establish concentration limits, which are intended to limit exposure to any one counterparty. FCA's Liquidity and Investment Regulations limit Farmer Mac's total credit exposure to any single issuer of securities and uncollateralized financial derivatives to 25 percent of the Corporation's regulatory capital (as of September 30, 2012,
25 percent of Farmer Mac's regulatory capital was $131.6 million). This limitation is not applied to the obligations of the United States or to qualified investment funds. The limitation applied to the obligations of any GSE is 100 percent of Farmer Mac's regulatory capital. Since June 2010, Farmer Mac's policy applicable to new investments limits the Corporation's total exposure to any single issuer of securities (other than GSEs and Government Agencies) and uncollateralized financial derivatives to 5 percent of the Corporation's regulatory capital. For more information on recent and proposed changes to the Liquidity and Investment Regulations, see "—Regulatory Matters."

Interest Rate Risk.  Farmer Mac is subject to interest rate risk on all assets held for investment because of possible timing differences in the cash flows of the assets and related liabilities.  This risk is primarily related to loans held and on-balance sheet Farmer Mac Guaranteed Securities and USDA Guaranteed Securities due to the ability of borrowers to prepay their mortgages before the scheduled maturities, thereby increasing the risk of asset and liability cash flow mismatches.  Cash flow mismatches in a changing interest rate environment can reduce the earnings of the Corporation if assets repay sooner than expected and the resulting cash flows must be reinvested in lower-yielding investments when Farmer Mac's funding costs cannot be correspondingly reduced, or if assets repay more slowly than expected and the associated debt must be replaced by higher-cost debt.

Yield maintenance provisions and other prepayment penalties contained in many agricultural mortgage and rural utilities loans reduce, but do not eliminate, prepayment risk, particularly in the case of a defaulted loan where yield maintenance may not be collected.  Those provisions require borrowers to make an additional payment when they prepay their loans so that, when reinvested with the prepaid principal, yield maintenance payments generate substantially the same cash flows that would have been generated had the loan not prepaid.  Those provisions create a disincentive to prepayment and compensate the Corporation for some of its interest rate risks.  As of September 30, 2012, 6 percent of the total outstanding balance of loans in the Farmer Mac I program where Farmer Mac either owned the loan or the beneficial interest in the underlying loan had yield maintenance provisions and 4 percent had other forms of prepayment protection (together covering 14 percent of all loans with fixed interest rates).  Of the Farmer Mac I new and current loans purchased in third quarter 2012, none had yield maintenance or another form of prepayment protection.  As of September 30, 2012, none of the USDA Guaranteed Securities or USDA-guaranteed portions underlying Farmer Mac II Guaranteed Securities had yield maintenance provisions; however, 9 percent contained prepayment penalties.  Of the USDA-guaranteed portions purchased in third quarter 2012, 6 percent contained various forms of prepayment penalties.  As of September 30, 2012, 65 percent of the rural utilities loans owned by Farmer Mac had yield maintenance provisions.  Of the rural utilities loans purchased in the third quarter 2012, 35 percent had yield maintenance provisions.  As of September 30, 2012, substantially all of the rural utilities loans held in trusts where Farmer Mac owned the beneficial interest in the underlying loan had yield maintenance provisions.

Taking into consideration the prepayment provisions and the default probabilities associated with its mortgage assets, Farmer Mac uses prepayment models to project and value cash flows associated with these assets.  Because borrowers' behaviors in various interest rate environments may change over time,

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Farmer Mac periodically evaluates the effectiveness of these models compared to actual prepayment experience and adjusts and refines the models as necessary to improve the precision of subsequent prepayment forecasts.

The goal of interest rate risk management at Farmer Mac is to create and maintain a portfolio that generates stable earnings and value across a variety of interest rate environments. Farmer Mac's primary strategy for managing interest rate risk is to fund asset purchases with liabilities that have similar duration and cash flow characteristics so that they will perform similarly as interest rates change. To achieve this match, Farmer Mac issues discount notes and both callable and non-callable medium-term notes across a spectrum of maturities. Farmer Mac issues callable debt to offset the prepayment risk associated with some loans. By using a blend of liabilities that includes callable debt, the interest rate sensitivities of the liabilities tend to increase or decrease as interest rates change in a manner similar to changes in the interest rate sensitivities of the assets. Farmer Mac also uses financial derivatives to better match the durations of the Corporation's assets and liabilities, thereby reducing overall interest rate sensitivity.

Farmer Mac's $870.0 million of cash and cash equivalents mature within three months and are funded with discount notes having similar maturities. As of September 30, 2012, $2.3 billion of the $2.6 billion of investment securities (86 percent) were floating rate securities with rates that adjust within one year or fixed rate securities with original maturities between three months and one year.  Those securities are funded with effectively floating rate medium-term notes or discount notes that closely match the rate adjustment dates of the associated investments. As of September 30, 2012, Farmer Mac had outstanding discount notes of $5.7 billion, medium-term notes that mature within one year of $1.1 billion and medium-term notes that mature after one year of $4.7 billion.

An important "stress test" of Farmer Mac's exposure to long-term interest rate risk is the measurement of the sensitivity of its market value of equity ("MVE") to yield curve shocks.  MVE represents management's estimate of the present value of all future cash flows from on- and off-balance sheet assets, liabilities and financial derivatives, discounted at current interest rates and appropriate spreads.  Longer-term interest rates decreased significantly during the second and third quarters of 2012. This rate movement, coupled with increased mortgage prepayments, shortened the duration of Farmer Mac's assets relative to its liabilities resulting in a wider duration gap and increased MVE sensitivity. The early retirement of callable debt, however, has offset much of this impact. Overall interest rate sensitivity remains relatively low and at manageable levels. The following schedule summarizes the results of Farmer Mac's MVE sensitivity analysis as of September 30, 2012 and December 31, 2011 to an immediate and instantaneous uniform or "parallel" shift in the yield curve:

 
 
Percentage Change in MVE from Base Case
Interest Rate Scenario
 
September 30, 2012
 
December 31, 2011
+300 basis points
 
5.8
%
 
(1.3
)%
+200 basis points
 
7.1
%
 
2.3
 %
+100 basis points
 
5.4
%
 
2.9
 %
-100 basis points
 
*

 
*

-200 basis points
 
*

 
*

-300 basis points
 
*

 
*


* As of the date indicated, a parallel shift of the U.S. Treasury yield curve by the number of basis points indicated produced negative interest rates for all or portions of this curve.



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As of September 30, 2012, Farmer Mac's effective duration gap, another standard measure of interest rate risk that measures the difference between the sensitivities of assets compared to that of liabilities, was minus 2.0 months, compared to minus 1.5 months as of December 31, 2011.  Duration matching of assets and the corresponding liabilities helps maintain the correlation of cash flows and stabilizes portfolio earnings even when interest rates are not stable.

Farmer Mac also calculates sensitivity of net interest income ("NII") to changes in interest rates which represents a shorter-term measure of interest rate risk.  As of September 30, 2012, a parallel increase of 100 basis points would have decreased Farmer Mac's NII by 4.7 percent, while a parallel decrease of 25 basis points would have decreased NII by 7.4 percent.  Farmer Mac also measures the sensitivity of both MVE and NII to a variety of non-parallel interest rate shocks, including flattening and steepening yield curve scenarios.  As of September 30, 2012, both MVE and NII showed similar or lesser sensitivity to non-parallel shocks than to the parallel shocks.

The economic effects of financial derivatives are included in the Corporation's MVE, NII and duration gap analyses.  Farmer Mac enters into the following financial derivative transactions principally to protect against risk from the effects of market price or interest rate movements on the value of assets, future cash flows, credit exposure and debt issuance, not for trading or speculative purposes:
 
•
"pay-fixed" interest rate swaps, in which Farmer Mac pays fixed rates of interest to, and receives floating rates of interest from, counterparties;
•
"receive-fixed" interest rate swaps, in which Farmer Mac receives fixed rates of interest from, and pays floating rates of interest to, counterparties;
•
"basis swaps," in which Farmer Mac pays variable rates of interest based on one index to, and receives variable rates of interest based on another index from, counterparties; and
•
"credit default swaps," in which Farmer Mac pays a periodic fee to a counterparty in exchange for the counterparty's agreement to make payments in the event of an instrument's default or other credit event.

As of September 30, 2012, Farmer Mac had $6.1 billion combined notional amount of interest rate swaps, with terms ranging from less than one to twenty five years, of which $1.7 billion were pay-fixed interest rate swaps, $3.8 billion were receive-fixed interest rate swaps, $0.6 billion were basis swaps.

Liquidity and Capital Resources

Farmer Mac regularly accesses the capital markets for liquidity, and Farmer Mac maintained access to the capital markets at favorable rates throughout 2012. Assuming continued access to the capital markets, Farmer Mac believes it has sufficient liquidity and capital resources to support its operations for the next 12 months and for the foreseeable future. Farmer Mac also has a liquidity contingency plan to manage unanticipated disruptions in its access to the capital markets. That plan involves borrowing through repurchase agreement arrangements and the sale of liquid assets. In accordance with the calculation prescribed by FCA regulations, Farmer Mac is required to maintain a minimum of 60 days of liquidity and targets 90 days of liquidity. In accordance with the methodology prescribed by those regulations, Farmer Mac maintained an average of 142 days of liquidity during third quarter 2012 and had 128 days of liquidity as of September 30, 2012.


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Debt Issuance.  Farmer Mac funds its purchases of program and non-program assets primarily by issuing debt obligations of various maturities in the public capital markets.  Debt obligations issued by Farmer Mac include discount notes and fixed and floating rate medium-term notes, including callable notes. Farmer Mac also issues discount notes and medium-term notes to obtain funds to finance investment activities, transaction costs, guarantee payments and LTSPC purchase obligations.  

Farmer Mac's board of directors has authorized the issuance of up to $12.0 billion of discount notes and medium-term notes (of which $11.5 billion was outstanding as of September 30, 2012), subject to periodic review of the adequacy of that level relative to Farmer Mac's borrowing requirements. Farmer Mac invests the proceeds of such issuances in loans, Farmer Mac Guaranteed Securities, and liquidity investment assets in accordance with policies established by its board of directors and subject to regulations established by FCA.

Liquidity.  The funding and liquidity needs of Farmer Mac's business programs are driven by the purchase and retention of eligible loans, USDA-guaranteed portions, and Farmer Mac Guaranteed Securities; the maturities of Farmer Mac's discount notes and medium-term notes; and payment of principal and interest on Farmer Mac Guaranteed Securities.  Farmer Mac's primary sources of funds to meet these needs are the fees for its guarantees and commitments, net effective spread, proceeds of debt issuances, loan repayments and maturities of AgVantage securities.
 
Farmer Mac's borrowing costs have remained at favorable levels throughout 2012. Farmer Mac may use a combination of pay-fixed interest rate swaps and receive-fixed interest rate swaps to mitigate its exposure to interest rate risk and monitors the effects of actual and potential fair value changes on its regulatory capital surplus. From time to time, Farmer Mac uses pay-fixed interest rate swaps, combined with a planned series of discount note issuances, as an alternative source of effectively fixed rate funding. While the swap market may provide favorable effectively fixed rates, interest rate swap transactions expose Farmer Mac to the risk of future variability of its own issuance spreads versus corresponding LIBOR rates. If the spreads on the Farmer Mac discount notes were to deteriorate relative to LIBOR, Farmer Mac would be exposed to a commensurate reduction on its net interest yield on the notional amount of its pay-fixed interest rate swaps and its LIBOR-based floating rate assets. Conversely, if the rates on the Farmer Mac discount notes were to improve relative to LIBOR, Farmer Mac would benefit from a commensurate increase on its net interest yield on the notional amount of its pay-fixed interest rate swaps and its LIBOR-based floating rate assets. Further, the use of pay-fixed interest rate swaps that are not designated in hedge relationships for accounting purposes subject the Corporation's regulatory capital surplus to the potential adverse effects of a reduction in the fair values of those interest rate swaps. Farmer Mac routinely enters into receive-fixed interest rate swaps that may provide some offset to the fair value movements of the pay-fixed interest rate swaps. These transactions reduce the susceptibility of Farmer Mac's regulatory capital surplus to changes in the fair values of its financial derivatives.


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Farmer Mac maintains cash, cash equivalents (including U.S. Treasury bills and other short-term money market instruments) and other investment securities that can be drawn upon for liquidity needs.  The following table presents these assets as of September 30, 2012 and December 31, 2011:

 
September 30,
2012
 
December 31,
2011
 
(in thousands)
Cash and cash equivalents
$
870,040

 
$
817,046

Investment securities:
 

 
 

Guaranteed by U.S. Government and its agencies
1,476,844

 
1,125,823

Guaranteed by GSEs
761,009

 
700,442

Preferred stock issued by GSEs
85,859

 
84,878

Corporate debt securities
151,497

 
122,532

Asset-backed securities principally backed by Government-guaranteed student loans
161,119

 
150,815

Total
$
3,506,368

 
$
3,001,536


Farmer Mac's asset-backed investment securities include callable, highly rated auction-rate certificates ("ARCs"), the interest rates on which are reset through an auction process, most commonly at intervals of 28 days, or at formula-based floating rates as set forth in the related transaction documents in the event of a failed auction.  These formula-based floating rates, which may at times reset to zero, are intended to preserve the underlying principal balance of the securities and avoid overall cash shortfalls.  Accordingly, payments of accrued interest may also be delayed and are ultimately subject to cash availability. Beginning in mid-February 2008, there were widespread failures of the auction mechanism designed to provide regular liquidity to these types of securities.  Consequently, Farmer Mac has not sold any of its ARCs into the auctions since that time.  All ARCs held by Farmer Mac are collateralized entirely by pools of Federal Family Education Loan Program ("FFELP") guaranteed student loans that are backed by the full faith and credit of the United States.  Farmer Mac continues to believe that the credit quality of these securities is high, based on the underlying collateralization and the securities' ratings.  To date, Farmer Mac has received all interest due on ARCs it holds and expects to continue to do so. Farmer Mac does not believe that the auction failures will affect the Corporation's liquidity or its ability to fund its operations or make dividend payments.  All ARCs held by Farmer Mac are callable by the issuers at par at any time.

Farmer Mac held $60.0 million of ARCs as of September 30, 2012, compared to $60.2 million as of December 31, 2011.  As of September 30, 2012, Farmer Mac's carrying value of its ARCs was 81.0 percent of par.  The discounted carrying value reflects uncertainty regarding the ability to obtain par in the absence of any active market trading. See Note 8 for more information on the carrying value of ARCs.

Capital.  See "—Balance Sheet Review—Regulatory Capital Compliance" for more information about Farmer Mac's capital position.



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Other Matters

Common Stock. For each of the first three quarters of 2012, Farmer Mac paid a quarterly dividend of $0.10 per share on all classes of its common stock. For each quarter in 2011, Farmer Mac paid a quarterly dividend of $0.05 per share on all classes of its common stock.  Farmer Mac's ability to declare and pay a dividend could be restricted if it failed to comply with regulatory capital requirements. See "Business—Government Regulation of Farmer Mac—Regulation—Capital Standards—Enforcement Levels" in Farmer Mac's Annual Report on Form 10-K for the fiscal year ended December 31, 2011 filed with the SEC on March 15, 2012.

Preferred Stock Dividends. For each of the first three quarters of 2012 and for each quarter during 2011, Farmer Mac paid a quarterly dividend of $12.50 per share on its Series C Preferred Stock.

Non-controlling Interest. For each of the first three quarters of 2012 and for each quarter during 2011, Farmer Mac II LLC paid a quarterly dividend of $22.1875 per share on the company's preferred stock. Farmer Mac's net income attributable to non-controlling interest totaled $5.5 million and $16.6 million for the three and nine months ended September 30, 2012 and 2011. These amounts represent the dividends paid on the Farmer Mac II LLC preferred stock held by third parties. Farmer Mac's income tax expense is determined based on income before income taxes less the amount of these dividends.

Change in Management. On October 3, 2012, Farmer Mac's Board of Directors appointed Timothy L. Buzby as President and Chief Executive Officer of Farmer Mac. Mr. Buzby had been Farmer Mac's Chief Financial Officer and Treasurer since 2009 and prior to that served as Farmer Mac's Controller beginning in 2000. This change in Farmer Mac's President and Chief Executive Officer is reported in Item 5.02 of the Current Reports on Form 8-K filed with the SEC on October 10, 2012 and October 30, 2012. Those sections of the referenced reports are hereby incorporated by reference in this report.  As previously reported, Farmer Mac will make a severance payment to its former President and Chief Executive Officer during fourth quarter 2012 pursuant to the terms of his employment agreement. The effect of this severance payment on Farmer Mac's fourth quarter results is expected to be a net after-tax expense of approximately $968,000. Farmer Mac's Board of Directors and Mr. Buzby will work together to identify and select a new Chief Financial Officer to succeed Mr. Buzby. In the interim, Mr. Buzby will continue to serve as the Chief Financial Officer and Treasurer of Farmer Mac.


Regulatory Matters

The Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") contains a variety of provisions designed to regulate financial markets. Certain provisions of the Dodd-Frank Act, including those regarding derivatives reporting and clearing, corporate governance and executive compensation, apply to Farmer Mac. Farmer Mac does not expect that any of the final rules that have been passed or that are anticipated to be passed under the Dodd-Frank Act, including those mandating clearing of interest rate derivatives transactions, will have a material impact on the Corporation's business activities and operations or financial condition. Farmer Mac will continue to monitor all applicable developments in the implementation of the Dodd-Frank Act and expects to be able to adapt successfully to any new applicable legislative and regulatory requirements.

On November 18, 2011, the FCA published in the Federal Register a proposed rule to revise the Liquidity and Investment Regulations. On November 5, 2012, the FCA published in the Federal Register a final rule addressing some of the investment management changes to the Liquidity and Investment Regulations

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that had been included in the proposed rule, including requirements for due diligence and stress testing of non-program assets and interest rate risk management. The final rule also streamlines the process for handling investments that fail to meet eligibility criteria after purchase and modifies the permissible purposes of Farmer Mac’s non-program investments to include FCA-approved investments that would complement Farmer Mac’s program activities. The final rule will be effective 30 days after publication in the Federal Register during which either or both Houses of Congress are in session.

The FCA has indicated that it intends to issue additional final rules addressing changes to the Liquidity and Investment Regulations relating to liquidity management and investment eligibility that had also been included in the proposed rule. The proposed rule also included suggested approaches for substituting the use of credit ratings in the Liquidity and Investment Regulations, as mandated by the Dodd-Frank Act, although FCA has not indicated when further action regarding these changes (including any final rule) would be forthcoming. Farmer Mac does not expect its compliance with the final rule published on November 5 or any of the other proposed changes to the Liquidity and Investment Regulations (if enacted) to have a significant impact on its liquidity or operations.



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Supplemental Information

The following tables present quarterly and annual information regarding loan purchases, guarantees and LTSPCs and outstanding loans, guarantees and LTSPCs.

Farmer Mac Purchases, Guarantees and LTSPCs
 
Farmer Mac I
 
Farmer Mac II
 
Rural Utilities
 
 
 
Loans and
 
 
 
and USDA
 
Loans and
 
 
 
Guaranteed
 
 
 
Guaranteed
 
Guaranteed
 
 
 
Securities
 
LTSPCs (1)
 
Securities
 
Securities
 
Total
 
(in thousands)
For the quarter ended:
 
 
 
 
 
 
 
 
 
September 30, 2012
$
333,882

 
$
115,757

 
$
114,974

 
$
276,843

 
$
841,456

June 30, 2012
345,423

 
70,458

 
165,613

 
58,286

 
639,780

March 31, 2012
310,486

 
179,637

 
101,725

 
24,350

 
616,198

December 31, 2011
98,425

 
97,688

 
104,134

 
55,007

 
355,254

September 30, 2011
1,069,701

 
266,906

 
87,051

 
32,387

 
1,456,045

June 30, 2011
416,930

 
53,248

 
99,275

 
38,674

 
608,127

March 31, 2011
711,899

 
54,152

 
117,253

 
80,517

 
963,821

December 31, 2010
474,216

 
128,752

 
102,858

 
543,966

 
1,249,792

September 30, 2010
632,270

 
25,416

 
139,667

 
285,242

 
1,082,595

 
 
 
 
 
 
 
 
 
 
For the year ended:
 
 
 
 
 
 
 
 
 
December 31, 2011
2,296,955

 
471,994

 
407,713

 
206,585

 
3,383,247

December 31, 2010
1,282,669

 
263,741

 
457,875

 
965,952

 
2,970,237


(1) Several of the loans underlying agricultural storage and processing LTSPCs are for facilities under construction and, as of September 30, 2012, approximately $14.8 million of the loans were not yet disbursed by the lender.

Outstanding Balance of Farmer Mac Loans, Guarantees and LTSPCs and USDA Guarantees
 
Farmer Mac I
 
Farmer Mac II
 
Rural Utilities
 
 
 
Loans and
 
 
 
and USDA
 
Loans and
 
 
 
Guaranteed
 
 
 
Guaranteed
 
Guaranteed
 
 
 
Securities
 
LTSPCs
 
Securities
 
Securities
 
Total
 
(in thousands)
As of:
 
 
 
 
 
 
 
 
 
September 30, 2012
$
6,830,321

 
$
1,881,836

 
$
1,599,226

 
$
2,156,676

 
$
12,468,059

June 30, 2012
6,655,132

 
1,858,080

 
1,579,187

 
2,158,021

 
12,250,420

March 31, 2012
6,433,121

 
1,850,362

 
1,529,642

 
2,253,300

 
12,066,425

December 31, 2011
6,280,976

 
1,776,051

 
1,513,177

 
2,343,098

 
11,913,302

September 30, 2011
6,277,085

 
1,811,280

 
1,463,129

 
2,289,899

 
11,841,393

June 30, 2011
6,803,951

 
1,694,470

 
1,425,883

 
2,274,193

 
12,198,497

March 31, 2011
6,485,156

 
1,712,791

 
1,402,831

 
2,235,522

 
11,836,300

December 31, 2010
6,434,031

 
1,754,597

 
1,385,398

 
2,642,683

 
12,216,709

September 30, 2010
6,059,184

 
1,697,578

 
1,365,993

 
2,353,453

 
11,476,208






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Table of Contents

Outstanding Balance of Loans Held and Loans Underlying
On-Balance Sheet Farmer Mac Guaranteed Securities and USDA Guaranteed Securities
 
Fixed Rate
 
5- to 10-Year ARMs & Resets
 
1-Month to 3-Year ARMs
 
Total Held in Portfolio
 
(in thousands)
As of:
 
 
 
 
 
 
 
September 30, 2012
$
4,904,265

 
$
1,213,588

 
$
2,473,086

 
$
8,590,939

June 30, 2012
5,035,743

 
1,259,568

 
2,063,490

 
8,358,801

March 31, 2012
4,993,233

 
1,210,405

 
2,410,310

 
8,613,948

December 31, 2011
5,288,687

 
1,230,374

 
1,967,960

 
8,487,021

September 30, 2011
5,233,417

 
1,192,497

 
1,909,470

 
8,335,384

June 30, 2011
4,193,132

 
1,198,740

 
1,907,698

 
7,299,570

March 31, 2011
3,835,010

 
1,164,567

 
1,893,487

 
6,893,064

December 31, 2010
3,662,363

 
1,133,871

 
1,907,266

 
6,703,500

September 30, 2010
3,006,105

 
1,087,714

 
1,883,049

 
5,976,868



Item 3.   Quantitative and Qualitative Disclosures About Market Risk

Farmer Mac is exposed to market risk from changes in interest rates.  Farmer Mac manages this market risk through its funding strategies, by entering into various financial transactions, including financial derivatives, and by monitoring and measuring its exposure to changes in interest rates.  See "Management's Discussion and Analysis of Financial Condition and Results of Operations—Risk Management—Interest Rate Risk" for more information about Farmer Mac's exposure to interest rate risk and its strategies to manage such risk.  For information regarding Farmer Mac's use of financial derivatives and related accounting policies, see Note 1(c) and Note 4 to the consolidated financial statements.



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Table of Contents

Item 4.   Controls and Procedures

(a) Management's Evaluation of Disclosure Controls and Procedures. Farmer Mac maintains disclosure controls and procedures designed to ensure that information required to be disclosed in the Corporation's periodic filings under the Securities Exchange Act of 1934 (the “Exchange Act”), including this report, is recorded, processed, summarized and reported on a timely basis. These disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed under the Exchange Act is accumulated and communicated to the Corporation's management on a timely basis to allow decisions regarding required disclosure. Management, including Farmer Mac's Chief Executive Officer who is also currently serving as Chief Financial Officer (principal executive and principal financial officer), has evaluated the effectiveness of the design and operation of the Corporation's disclosure controls and procedures (as defined under Rules 13a‑15(e) and 15d‑15(e) of the Exchange Act) as of September 30, 2012.

The Corporation carried out the evaluation of the effectiveness of Farmer Mac's disclosure controls and procedures, required by paragraph (b) of Exchange Act Rules 13a-15 and 15d-15, under the supervision and with the participation of management, including the Chief Executive Officer/Chief Financial Officer. Based upon this evaluation, the Chief Executive Officer/Chief Financial Officer concluded that the Corporation's disclosure controls and procedures were effective as of September 30, 2012.

(b) Changes in Internal Control Over Financial Reporting. There were no changes in Farmer Mac's internal control over financial reporting during the three months ended September 30, 2012 that have materially affected, or are reasonably likely to materially affect, Farmer Mac's internal control over financial reporting.



95
Table of Contents

PART II - OTHER INFORMATION


Item 1.
Legal Proceedings

None.


Item 1A.
Risk Factors

There were no material changes from the risk factors previously disclosed in Farmer Mac's Annual Report on Form 10-K for the year ended December 31, 2011 filed with the SEC on March 15, 2012.


Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds

(a)    Farmer Mac is a federally chartered instrumentality of the United States and its debt and equity securities are exempt from registration pursuant to Section 3(a)(2) of the Securities Act of 1933.
During third quarter 2012, one type of transaction occurred related to Farmer Mac common stock that was not registered under the Securities Act of 1933 and not otherwise reported on a Current Report on Form 8-K. On July 6, 2012, pursuant to Farmer Mac's policy that permits directors of Farmer Mac to elect to receive shares of Class C non-voting common stock in lieu of their cash retainers, Farmer Mac issued an aggregate of 133 shares of its Class C common stock to the four directors who elected to receive such stock in lieu of their cash retainers. The number of shares issued to the directors was calculated based on a price of $26.23 per share, which was the closing price of the Class C common stock on June 30, 2012 as reported by the New York Stock Exchange.

(b)    Not applicable.

(c)    None.


Item 3.
Defaults Upon Senior Securities

(a)
None.

(b)
None.


Item 4.
Mine Safety Disclosures

Not applicable.



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Table of Contents

Item 5.
Other Information

(a)
None.

(b)
None.

Item 6.
Exhibits

*
 
3.1
 
—
 
Title VIII of the Farm Credit Act of 1971, as most recently amended by the Food, Conservation and Energy Act of 2008 (Form 10-Q filed August 12, 2008).
*
 
3.2
 
—
 
Amended and Restated By-Laws of the Registrant (previously filed as Exhibit 3.1 to Form 8-K filed August 9, 2012).
*
 
4.1
 
—
 
Specimen Certificate for Farmer Mac Class A Voting Common Stock (Form 10-Q filed
May 15, 2003).
*
 
4.2
 
—
 
Specimen Certificate for Farmer Mac Class B Voting Common Stock (Form 10-Q filed
May 15, 2003).
*
 
4.3
 
—
 
Specimen Certificate for Farmer Mac Class C Non-Voting Common Stock (Form 10-Q filed May 15, 2003).
*
 
4.4
 
—
 
Amended and Restated Certificate of Designation of Terms and Conditions of Non-Voting Cumulative Preferred Stock, Series C (Previously filed as Exhibit 4.7 to Form 10-Q filed November 9, 2009).
†*
 
10.1
 
—
 
Amended and Restated 1997 Incentive Plan (Form 10-Q filed November 14, 2003).
†*
 
10.1.1
 
—
 
Form of stock option award agreement under 1997 Incentive Plan (Form 10-K filed
March 16, 2005).
†*
 
10.1.2
 
—
 
2008 Omnibus Incentive Plan (Form 10-Q filed August 12, 2008).
†*
 
10.1.3
 
—
 
Form of SAR Agreement under the 2008 Omnibus Incentive Plan for grants made prior to
April 1, 2012 (Previously filed as Exhibit 10 to Form 8-K filed June 11, 2008).
†*
 
10.1.4
 
—
 
Form of SAR Agreement under the 2008 Omnibus Incentive Plan for grants made on and after April 1, 2012 (Previously filed as Exhibit 10.1 to Form 8-K filed April 6, 2012).
†*
 
10.1.5
 
—
 
Form of Restricted Stock Agreement (Officers) under the 2008 Omnibus Incentive Plan for grants made prior to April 1, 2012 (Previously filed as Exhibit 10.1 to Form 8-K filed June 10, 2009).
†*
 
10.1.6
 
—
 
Form of Restricted Stock Agreement (Officers) under the 2008 Omnibus Incentive Plan for grants made on and after April 1, 2012 (Previously filed as Exhibit 10.2 to Form 8-K filed
April 6, 2012).
†*
 
10.1.7
 
—
 
Form of Restricted Stock Agreement (Directors) under the 2008 Omnibus Incentive Plan (Previously filed as Exhibit 10.3 to Form 8-K filed April 6, 2012).
†*
 
10.1.8
 
—
 
Federal Agricultural Mortgage Corporation Executive Officer Severance Plan (Previously filed as Exhibit 10.1 to Form 8-K filed June 13, 2012).
†*
 
10.1.9
 
—
 
Form of Participation Agreement to the Federal Agricultural Mortgage Corporation Executive Officer Severance Plan (Previously filed as Exhibit 10.2 to Form 8-K filed June 13, 2012).
†*
 
10.2
 
—
 
Amended and Restated Employment Agreement dated as of April 1, 2011 between Michael A. Gerber and the Registrant (Form 10-Q filed May 10, 2011).
†*
 
10.2.1
 
—
 
Separation Agreement, Waiver and Release effective October 18, 2012 between the Registrant and Michael A. Gerber (Previously filed as Exhibit 10.1 to Form 8-K filed October 30, 2012).
†*
 
10.3
 
—
 
Compiled Amended and Restated Employment Contract dated as of June 5, 2008 between Tom D. Stenson and the Registrant (Previously filed as Exhibit 10.4 to Form 10-Q filed
August 12, 2008).

*
Incorporated by reference to the indicated prior filing.
**
Filed with this report.
†
Management contract or compensatory plan.
#
Portions of this exhibit have been omitted pursuant to a request for confidential treatment.

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Table of Contents

†*
 
10.4
 
—
 
Compiled Amended and Restated Employment Contract dated June 5, 2008 between Timothy L. Buzby and the Registrant (Previously filed as Exhibit 10.5 to Form 10-Q filed August 12, 2008).
†*
 
10.4.1
 
—
 
Amendment No. 6 to Employment Contract between Timothy L. Buzby and the Registrant, dated as of April 2, 2009 (Form 10-Q filed August 10, 2009).
†*
 
10.5
 
—
 
Form of Indemnification Agreement for Directors (Previously filed as Exhibit 10.1 to Form 8-K filed April 9, 2008).
†*
 
10.6
 
 
 
Description of compensation agreement between the Registrant and its directors (Form 10-K filed March 16, 2011).
*
 
10.7
 
—
 
Farmer Mac I Seller/Servicer Agreement dated as of August 7, 1996 between Zions First National Bank and the Registrant (Form 10-Q filed November 14, 2002).
*
 
10.8
 
—
 
Medium-Term Notes U.S. Selling Agency Agreement dated as of October 1, 1998 between Zions First National Bank and the Registrant (Form 10-Q filed November 14, 2002).
*
 
10.9
 
—
 
Discount Note Dealer Agreement dated as of September 18, 1996 between Zions First National Bank and the Registrant (Form 10-Q filed November 14, 2002).
*#
 
10.10
 
—
 
ISDA Master Agreement and Credit Support Annex dated as of June 26, 1997 between Zions First National Bank and the Registrant (Form 10-Q filed November 14, 2002).
*#
 
10.11
 
—
 
Amended and Restated Master Central Servicing Agreement dated as of May 1, 2004 between Zions First National Bank and the Registrant (Previously filed as Exhibit 10.11.2 to Form 10-Q filed August 9, 2004).
*#
 
10.11.1
 
—
 
Amendment No. 1 to Amended and Restated Master Central Servicing Agreement between Zions First National Bank and the Registrant, dated as of June 1, 2009 (Form 10-Q filed August 10, 2009).
*#
 
10.11.2
 
—
 
Amendment No. 2 to Amended and Restated Master Central Servicing Agreement between Zions First National Bank and the Registrant, dated as of August 25, 2010 (Form 10-Q filed November 9, 2010).
*#
 
10.12
 
—
 
Loan Closing File Review Agreement dated as of August 2, 2005 between Zions First National Bank and the Registrant (Form 10-Q filed November 9, 2005).
*#
 
10.13
 
—
 
Long Term Standby Commitment to Purchase dated as of August 1, 1998 between AgFirst Farm Credit Bank and the Registrant (Form 10-Q filed November 14, 2002).
*#
 
10.13.1
 
—
 
Amendment No. 1 dated as of January 1, 2000 to Long Term Standby Commitment to Purchase dated as of August 1, 1998 between AgFirst Farm Credit Bank and the Registrant (Form 10-Q filed November 14, 2002).
*
 
10.13.2
 
—
 
Amendment No. 2 dated as of September 1, 2002 to Long Term Standby Commitment to Purchase dated as of August 1, 1998, as amended by Amendment No. 1 dated as of
January 1, 2000, between AgFirst Farm Credit Bank and the Registrant (Form 10-Q filed November 14, 2002).
*
 
10.14
 
—
 
Sublease Agreement dated as of December 6, 2010 between Mayer Brown LLP and the Registrant (Previously filed as Exhibit 10.43 to Form 10-K/A filed June 1, 2011).
*#
 
10.15
 
—
 
Long Term Standby Commitment to Purchase dated as of August 1, 2007 between Farm Credit Bank of Texas and the Registrant (Previously filed as Exhibit 10.20 to Form 10-Q filed November 8, 2007).
*#
 
10.16
 
—
 
Long Term Standby Commitment to Purchase dated as of June 1, 2003 between Farm Credit Bank of Texas and the Registrant (Form 10-Q filed November 9, 2004).
*#
 
10.16.1
 
—
 
Amendment No. 1 dated as of December 8, 2006 to Long Term Standby Commitment to Purchase dated as of June 1, 2003 between Farm Credit Bank of Texas and the Registrant (Form 10-K filed March 15, 2007).
 
*
Incorporated by reference to the indicated prior filing.
**
Filed with this report.
†
Management contract or compensatory plan.
#
Portions of this exhibit have been omitted pursuant to a request for confidential treatment.



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Table of Contents

*#
 
10.17
 
—
 
Central Servicer Delinquent Loan Servicing Transfer Agreement dated as of July 1, 2004 between AgFirst Farm Credit Bank and the Registrant (Form 10-Q filed November 9, 2004).
 
 
10.18
 
—
 
Exhibit number reserved for future use.
*
 
10.19
 
—
 
Master Trust, Sale and Servicing Agreement dated as of October 20, 2006 between CFC Advantage, LLC, National Rural Utilities Cooperative Finance Corporation, U.S. Bank National Association, and the Registrant (Previously filed as Exhibit 10.22 to Form 10-Q filed
August 9, 2010).
*
 
10.20
 
—
 
Registration Rights Agreement Series 2007-1 dated as of February 15, 2007 between CFC Advantage, LLC, National Rural Utilities Cooperative Finance Corporation, and the Registrant (Previously filed as Exhibit 10.23 to Form 10-Q filed August 9, 2010).
*
 
10.21
 
—
 
Registration Rights Agreement Series 2007-2 dated as of August 10, 2007 between CFC Advantage, LLC, National Rural Utilities Cooperative Finance Corporation and the Registrant (Previously filed as Exhibit 10.24 to Form 10-Q filed August 9, 2010).
*
 
10.22
 
—
 
Amended and Restated Note Purchase Agreement dated as of March 24, 2011 between Farmer Mac Mortgage Securities Corporation, National Rural Utilities Cooperative Finance Corporation, and the Registrant (Form 10-Q filed May 10, 2011).
*
 
10.22.1
 
 
 
First Supplemental Note Purchase Agreement dated as of March 24, 2011 between Farmer Mac Mortgage Securities Corporation, National Rural Utilities Cooperative Finance Corporation, and the Registrant (Previously filed as Exhibit 10.25 to Form 10-Q filed May 10, 2011).
*
 
10.23
 
—
 
Amended, Restated and Consolidated Pledge Agreement dated as of March 24, 2011 between Farmer Mac Mortgage Securities Corporation, National Rural Utilities Cooperative Finance Corporation, U.S. Bank National Association, and the Registrant (Form 10-Q filed
May 10, 2011).
*
 
10.24
 
—
 
Setoff Rights Letter Agreement dated as of March 24, 2011 between National Rural Utilities Cooperative Finance Corporation, Farmer Mac Mortgage Securities Corporation, and the Registrant (Form 10-Q filed May 10, 2011).
 
 
10.25
 
—
 
Exhibit number reserved for future use.
*
 
10.26
 
—
 
Amended and Restated Master Sale and Servicing Agreement dated as of August 12, 2011 between National Rural Utilities Cooperative Finance Corporation and the Registrant (Form 10-Q filed November 9, 2011).
*#
 
10.27
 
—
 
Credit Support Agreement dated as of September 1, 2009 between National Rural Utilities Cooperative Finance Corporation and the Registrant (Previously filed as Exhibit 10.38 to Form 10-Q filed August 9, 2010).
*
 
10.28
 
—
 
Indenture dated as of September 1, 2009 between National Rural Utilities Cooperative Finance Corporation, U.S. Bank National Association and the Registrant (Previously filed as Exhibit 10.39 to Form 10-Q filed August 9, 2010).
*#
 
10.29
 
—
 
Long Term Standby Commitment to Purchase dated as of February 1, 2012 between AgGeorgia Farm Credit, ACA and the Registrant (Form 10-Q filed May 10, 2012).
*#
 
10.30
 
—
 
Master Central Servicing Agreement dated as of February 1, 2012 between AgGeorgia Farm Credit, ACA and the Registrant (Form 10-Q filed May 10, 2012).
*
 
21
 
—
 
List of the Registrant's subsidiaries (Form 10-K filed March 16, 2010).
**
 
31.1
 
—
 
Certification of Registrant's principal executive officer relating to the Registrant's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2012, pursuant to Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
**
 
31.2
 
—
 
Certification of Registrant's principal financial officer relating to the Registrant's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2012, pursuant to Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
**
 
32
 
—
 
Certification of Registrant's principal executive and principal financial officer relating to the Registrant's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2012, pursuant to 18 U.S.C. § 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
*
Incorporated by reference to the indicated prior filing.
**
Filed with this report.
†
Management contract or compensatory plan.
#
Portions of this exhibit have been omitted pursuant to a request for confidential treatment.

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SIGNATURES
 
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

FEDERAL AGRICULTURAL MORTGAGE CORPORATION


November 8, 2012

 
By:
     /s/ Timothy L. Buzby
 
 
Timothy L. Buzby
President and Chief Executive Officer and Chief Financial Officer
(principal executive and principal financial officer)







100