-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, P62dXLRomM2DqnAX7povdbwwR22akCg5AnUjN0LAZpMlVXgXeeBJRAexOLM3AUL3 KFZ7SS1LZHTLIg2DYDz+Nw== 0000845877-05-000047.txt : 20050316 0000845877-05-000047.hdr.sgml : 20050316 20050316165115 ACCESSION NUMBER: 0000845877-05-000047 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20041231 FILED AS OF DATE: 20050316 DATE AS OF CHANGE: 20050316 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FEDERAL AGRICULTURAL MORTGAGE CORP CENTRAL INDEX KEY: 0000845877 STANDARD INDUSTRIAL CLASSIFICATION: FEDERAL & FEDERALLY-SPONSORED CREDIT AGENCIES [6111] IRS NUMBER: 521578738 FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-14951 FILM NUMBER: 05686111 BUSINESS ADDRESS: STREET 1: 1133 21ST STREET, N.W. STREET 2: STE 600 CITY: WASHINGTON STATE: DC ZIP: 20036 BUSINESS PHONE: 2028727700 MAIL ADDRESS: STREET 1: 1133 21ST STREET, N.W. STREET 2: SUITE 600 CITY: WASHINGTON STATE: DC ZIP: 20036 10-K 1 f10k_031605.txt As filed with the Securities and Exchange Commission on March 16, 2005 - -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 - -------------------------------------------------------------------------------- FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2004. OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____ to _____. Commission File Number 0-17440 ----------------------------------------------------------------------- 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 (I.R.S. employer identification number) incorporation or organization) 1133 21st Street, N.W., Suite 600, Washington, D.C. 20036 ---------------------------------------- --------------------------------- (Address of principal executive offices) (Zip code) (202) 872-7700 --------------------------------------------------- (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: Title of Each Class Exchange on Which Registered ------------------- ---------------------------- Class A voting common stock New York Stock Exchange Class C non-voting common stock New York Stock Exchange Securities registered pursuant to Section 12(g) of the Act: Class B voting common stock 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 twelve months (or 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 [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (17 C.F.R. section 229.405) is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes [X] No [ ] The aggregate market values of the Class A voting common stock and Class C non-voting common stock held by non-affiliates of the registrant were $19,584,820 and $251,453,353, respectively, as of the last business day of the registrant's most recently completed second fiscal quarter, based upon the closing prices for the respective classes on June 30, 2004 reported by the New York Stock Exchange. For purposes of this information, the outstanding shares of Class C non-voting common stock owned by directors and executive officers of the registrant were deemed to be held by affiliates. The aggregate market value of the Class B voting common stock is not ascertainable due to the absence of publicly available quotations or prices for the Class B voting common stock as a result of the limited market for, and infrequency of trades in, Class B voting common stock and the fact that any such trades are privately negotiated transactions. As of March 1, 2005, the registrant had outstanding 1,030,780 shares of Class A voting common stock, 500,301 shares of Class B voting common stock and 10,119,731 shares of Class C non-voting common stock. DOCUMENTS INCORPORATED BY REFERENCE Proxy Statement to be filed on or about April 28, 2005 in connection with the Annual Meeting of Stockholders to be held on June 16, 2005 (portions of which are incorporated by reference into Part II and Part III of this Annual Report on Form 10-K). ____________________________ Table of Contents PART I.........................................................................5 Item 1. Business...........................................................5 General............................................................5 FARMER MAC PROGRAMS................................................7 Farmer Mac I.......................................................7 Loan Eligibility................................................7 Purchases.......................................................8 Off-Balance Sheet Guarantees and Commitments....................9 Underwriting and Appraisal Standards...........................10 Sellers........................................................13 Servicing......................................................13 Farmer Mac I Guaranteed Securities.............................14 Farmer Mac I Transactions......................................15 Funding of Guarantee and Purchase Commitment Obligations.......16 Portfolio Diversification......................................16 Farmer Mac II.....................................................17 General........................................................17 United States Department of Agriculture Guaranteed Loan Programs.....................................................17 Farmer Mac II Guaranteed Securities............................18 Farmer Mac II Transactions.....................................19 Financing.........................................................19 Debt Issuance..................................................19 Equity Issuance................................................20 FARMER MAC'S AUTHORITY TO BORROW FROM THE U.S. TREASURY...........22 GOVERNMENT REGULATION OF FARMER MAC...............................22 Item 2. Properties........................................................25 Item 3. Legal Proceedings.................................................25 Item 4. Submission of Matters to a Vote of Security Holders...............26 PART II.......................................................................27 Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.........................27 Item 6. Selected Financial Data...........................................29 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.............................................30 Forward-Looking Statements........................................30 Critical Accounting Policy and Estimates..........................31 Results of Operations.............................................33 Balance Sheet Review..............................................48 Risk Management...................................................50 Liquidity and Capital Resources...................................65 Other Matters.....................................................72 Item 7A. Quantitative and Qualitative Disclosures About Market Risk........74 Item 8. Financial Statements..............................................75 Management's Report on Internal Control Over Financial Reporting..75 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM REGARDING INTERNAL CONTROL OVER FINANCIAL REPORTING........... .............76 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM...........78 CONSOLIDATED BALANCE SHEETS.......................................79 CONSOLIDATED STATEMENTS OF OPERATIONS.............................80 CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY........81 CONSOLIDATED STATEMENTS OF CASH FLOWS.............................82 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS........................83 Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.............................................124 Item 9A. Controls and Procedures..........................................124 Item 9B. Other Information................................................125 PART III.....................................................................126 Item 10. Directors and Executive Officers of the Registrant...............126 Item 11. Executive Compensation...........................................126 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters......................................126 Item 13. Certain Relationships and Related Transactions...................126 Item 14. Principal Accountant Fees and Services...........................126 PART IV......................................................................127 Item 15. Exhibits and Financial Statement Schedules.......................127 PART I Item 1. Business General The Federal Agricultural Mortgage Corporation ("Farmer Mac" or the "Corporation") was chartered by the U.S. Congress in the Agricultural Credit Act of 1987 (12 U.S.C. sections 2279aa et seq.), which amended the Farm Credit Act of 1971 (collectively, as amended, the "Act"). Farmer Mac is a stockholder-owned instrumentality of the United States that was created to establish a secondary market for agricultural real estate and rural housing mortgage loans and to increase the availability of long-term credit at stable interest rates to American farmers, ranchers and rural homeowners. The Farmer Mac secondary market for agricultural mortgage loans accomplishes that mission by providing liquidity and lending capacity to agricultural mortgage lenders by: o purchasing newly originated and pre-existing ("seasoned") eligible mortgage loans directly from lenders; o exchanging newly issued agricultural mortgage-backed securities guaranteed by Farmer Mac ("Farmer Mac Guaranteed Securities") for newly originated and seasoned eligible mortgage loans that back those securities in "swap" transactions; o issuing long-term standby purchase commitments ("LTSPCs") for newly originated and seasoned eligible mortgage loans; and o purchasing and guaranteeing mortgage-backed bonds secured by eligible mortgage loans, which are referred to as AgVantage bonds. Farmer Mac conducts these activities through two programs--Farmer Mac I and Farmer Mac II. Under the Farmer Mac I program, Farmer Mac: o purchases eligible mortgage loans; o securitizes eligible mortgage loans purchased and guarantees the timely payment of principal and interest on the agricultural mortgage-backed securities backed by such loans; and o commits to purchase eligible mortgage loans under LTSPCs for such loans. To be eligible for the Farmer Mac I program, loans must meet Farmer Mac's underwriting, appraisal, documentation and other specified standards that are discussed in "Business--Farmer Mac Programs--Farmer Mac I." Under the Farmer Mac II program, Farmer Mac purchases the guaranteed portions of loans guaranteed by the United States Department of Agriculture (the "USDA-guaranteed portions") pursuant to the Consolidated Farm and Rural Development Act (7 U.S.C. sections 1921 et seq.) and guarantees securities backed by those USDA-guaranteed portions purchased by Farmer Mac. Farmer Mac may retain Farmer Mac Guaranteed Securities in its portfolio or sell them to third parties. As of December 31, 2004, outstanding loans held by Farmer Mac and loans that either back Farmer Mac Guaranteed Securities or are subject to LTSPCs totaled $5.5 billion. For more information about Farmer Mac's securities and its financial performance, see "Management's Discussion and Analysis of Financial Condition and Results of Operations." Farmer Mac's two principal sources of revenue are: o fees received in connection with outstanding Farmer Mac Guaranteed Securities and LTSPCs; and o net interest income earned on its portfolio of Farmer Mac Guaranteed Securities, mortgage loans, AgVantage bonds and investments. Farmer Mac funds its program purchases primarily by issuing debt obligations of various maturities. As of December 31, 2004, Farmer Mac had outstanding $1.8 billion of discount notes and $1.7 billion of medium-term notes. During 2004, the Corporation continued its strategy of regularly issuing debt to increase its presence in the capital markets in order to reduce the rates it pays on its debt, which allows Farmer Mac to accept lower rates on mortgages to farmers, ranchers and rural homeowners that it purchases from lenders. To the extent the proceeds of the debt issuances exceed Farmer Mac's need to fund program assets, those proceeds are invested in high quality non-program liquid assets. Farmer Mac is an institution of the Farm Credit System (the "FCS"), but is not liable for any debt or obligation of any other institution of the FCS. Likewise, neither the FCS nor any other individual institution of the FCS is liable for any debt or obligation of Farmer Mac. The Farm Credit Administration ("FCA"), acting through its Office of Secondary Market Oversight, has general regulatory and enforcement authority over Farmer Mac, including the authority to promulgate rules and regulations governing the activities of Farmer Mac and to apply FCA's general enforcement powers to Farmer Mac and its activities. For a discussion of Farmer Mac's statutory capital requirements and its capital levels, see "Business--Government Regulation of Farmer Mac--Regulation--Capital Standards" and "Management's Discussion and Analysis of Financial Condition and Results of Operations--Balance Sheet Review--Capital" and "--Liquidity and Capital Resources--Capital Requirements." For a discussion of two pending proposed regulations that would affect Farmer Mac if promulgated in their current form, see "Management's Discussion and Analysis of Financial Condition and Results of Operations--Regulatory Matters." Farmer Mac has three classes of common stock outstanding--Class A voting, Class B voting and Class C non-voting. See "Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities" for information regarding Farmer Mac's common stock. Farmer Mac has one class of preferred stock outstanding. See "--Farmer Mac Programs--Financing--Equity Issuance" for information regarding Farmer Mac's preferred stock. As of December 31, 2004, Farmer Mac employed 38 persons, located primarily at its principal executive offices at 1133 Twenty-First Street, N.W., Suite 600, Washington, D.C. 20036. Farmer Mac's main telephone number is (202) 872-7700. Farmer Mac makes available free of charge on its Internet website at www.farmermac.com (in the "Investors" section) copies of materials it files with, or furnishes to, the U.S. Securities and Exchange Commission ("SEC"), including Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports, as soon as reasonably practicable after electronically filing such materials with, or furnishing such materials to, the SEC. Please note that all references to www.farmermac.com in this report are inactive textual references only and that the information contained on Farmer Mac's website is not incorporated by reference into this Form 10-K. FARMER MAC PROGRAMS Farmer Mac I Loan Eligibility Under the Farmer Mac I program, Farmer Mac purchases, or commits to purchase, eligible mortgage loans and guarantees the timely payment of principal and interest on securities backed by, or representing interests in, eligible mortgage loans. A loan is eligible for the Farmer Mac I program if it is: o secured by a fee simple mortgage or a long-term leasehold mortgage, with status as a first lien on agricultural real estate or rural housing (as defined below) located within the United States; o an obligation of a citizen or national of the United States, an alien lawfully admitted for permanent residence in the United States or a private corporation or partnership that is majority-owned by U.S. citizens, nationals or legal resident aliens; o an obligation of a person, corporation or partnership having training or farming experience that is sufficient to ensure a reasonable likelihood that the loan will be repaid according to its terms; and o in conformance with Farmer Mac's underwriting, appraisal, documentation and other specified standards to be eligible for participation in the Farmer Mac I program. See "--Underwriting and Appraisal Standards" and "--Sellers" for a description of these standards. For purposes of the Farmer Mac I program, agricultural real estate is one or more parcels of land, which may be improved by permanently affixed buildings or other structures, that: o is used for the production of one or more agricultural commodities or products; and o consists of a minimum of five acres or generates minimum annual receipts of $5,000. For an eligible agricultural mortgage loan secured by 1,000 acres or less of agricultural real estate, the current maximum Farmer Mac I loan size set by Farmer Mac is $23.8 million. For an eligible agricultural mortgage loan secured by more than 1,000 acres of agricultural real estate, the Act currently limits the maximum Farmer Mac I loan size to $5.0 million (adjusted annually for inflation). For purposes of the Farmer Mac I program, rural housing is a one- to four-family, owner-occupied, moderately priced principal residence located in a community with a population of 2,500 or less. Since November 2004, the maximum purchase price or current appraised value for a dwelling, excluding the land to which the dwelling is affixed, that secures a rural housing loan has been $213,189, as adjusted for inflation. In addition to the dwelling itself, an eligible rural housing loan can be secured by land associated with the dwelling having an appraised value of no more than 50 percent of the total appraised value of the combined property. As of December 31, 2004, loans meeting the eligibility criteria under the rural housing segment of Farmer Mac's requirements had not represented a significant part of Farmer Mac's business. Purchases Loan Purchases. Farmer Mac offers credit products designed to increase the secondary market liquidity of agricultural mortgage loans and the lending capacity of financial institutions that originate agricultural mortgage loans, while permitting Farmer Mac to efficiently securitize eligible mortgage loans acquired through its secondary market activities. Farmer Mac enters into mandatory and optional delivery commitments to purchase loans and offers rates to price such commitments daily. Because the securitization process requires the grouping of loans into uniform pools, Farmer Mac emphasizes the importance of conformity to its program requirements, including the interest rate, amortization, maturity and payment frequency specifications. Farmer Mac also purchases portfolios of newly originated and seasoned loans on a negotiated basis. Farmer Mac purchases fixed- and adjustable-rate loans primarily, but also may purchase other types of loans, including convertible mortgage loans. Loans purchased by Farmer Mac have a variety of maturities and often include balloon payments. Loans purchased or subject to purchase commitments also may include provisions that require a yield maintenance payment or some other form of prepayment penalty in the event a borrower prepays a loan (depending upon the level of interest rates at the time of prepayment). During 2004, Farmer Mac purchased $104.4 million of loans in the Farmer Mac I program. Of the loans purchased during 2004, 64.0 percent included balloon payments and 8.0 percent included yield maintenance prepayment protection. By comparison, during 2003, Farmer Mac purchased $192.6 million of loans under the Farmer Mac I program. Of the loans purchased during 2003, 74.0 percent included balloon payments and 11.0 percent included yield maintenance prepayment protection. During 2004, Farmer Mac's top ten sellers generated 82.5 percent of the total Farmer Mac I loan purchase volume, of which Zions First National Bank, Farmer Mac's largest combined Class A and Class C stockholder, accounted for 33.0 percent. The top ten sellers in 2003 generated 80.8 percent of the total Farmer Mac I loan purchase volume, of which Zions First National Bank accounted for 38.7 percent. For more information regarding loan volume, see "Management's Discussion and Analysis of Financial Condition and Results of Operations--Results of Operations--Business Volume." Mortgage-Backed Bond Purchases. Farmer Mac purchases and guarantees timely payment of principal and interest on AgVantage bonds issued by institutions approved by Farmer Mac. In approving such institutions, Farmer Mac assesses an institution's agricultural loan underwriting and servicing capabilities as well as their creditworthiness for issuing AgVantage bonds to Farmer Mac. Each AgVantage bond is a general obligation of the issuing institution and is secured by eligible collateral in an amount ranging from 120 percent to 150 percent of the bond's outstanding principal amount. Eligible collateral consists of loans that meet the same loan eligibility criteria applied by Farmer Mac in its loan purchases and commitments and have an outstanding aggregate principal balance equal to at least 100 percent of the bond's outstanding principal amount plus cash or securities issued by the U.S. Treasury or guaranteed by an agency or instrumentality of the United States that make up any remaining required collateral. During 2004, Farmer Mac purchased fourteen AgVantage bonds for $32.5 million with maturities ranging from one month to ten years from four institutions. During 2003, Farmer Mac purchased nine AgVantage bonds for $13.5 million with maturities ranging from one month to three years from five institutions. As of December 31, 2004 and 2003, the outstanding principal amount of AgVantage bonds was $24.3 million and $25.2 million, respectively. As of December 31, 2004, Farmer Mac had experienced no losses, nor had it been called upon to make a guarantee payment, on any of its AgVantage bonds. Off-Balance Sheet Guarantees and Commitments Farmer Mac offers two Farmer Mac I credit enhancement alternatives that allow approved agricultural and rural residential mortgage lenders both to retain the cash flow benefits of their loans and increase their liquidity and lending capacity. Both of these alternatives result in off-balance sheet transactions for Farmer Mac: o a swap transaction, in which Farmer Mac acquires eligible loans from sellers in exchange for Farmer Mac Guaranteed Securities backed by those loans. As consideration for its assumption of the credit risk on loans underlying the Farmer Mac Guaranteed Securities, Farmer Mac receives guarantee fees payable in arrears out of periodic loan interest payments and based on the outstanding balance of the Farmer Mac Guaranteed Securities; and o an LTSPC, which is not a guarantee of loans or securities, but a Farmer Mac commitment to purchase loans from a segregated pool of loans on one or more undetermined future dates. As consideration for its assumption of the credit risk on loans underlying an LTSPC, Farmer Mac receives commitment fees payable monthly in arrears, in an amount approximating what would have been the guarantee fees if the transaction were structured as a swap transaction. A swap transaction or an LTSPC may involve loans with payment, maturity and interest rate characteristics that differ from Farmer Mac's standard product offerings. Both types of transactions permit a seller to nominate from its portfolio a segregated pool of loans, subject to review by Farmer Mac for conformance with its underwriting, appraisal and documentation standards. Upon Farmer Mac's acceptance of the eligible loans, whether under a swap transaction or an LTSPC, the seller effectively transfers the credit risk on those loans to Farmer Mac, thereby reducing the seller's credit and concentration risk exposures and, consequently, its regulatory capital and its loss reserve requirements. Only the LTSPC structure permits the seller to retain the segregated loan pool in its portfolio until such time, if ever, as the seller delivers some or all of the segregated loans to Farmer Mac for purchase under the LTSPC. An LTSPC commits Farmer Mac to a future purchase of loans that met Farmer Mac's underwriting standards at the time the loans first became subject to the LTSPC and Farmer Mac assumed the credit risk on loans. Farmer Mac generally purchases loans subject to an LTSPC at: o par plus accrued interest (if the loans become four months delinquent); o a mark-to-market price or in exchange for Farmer Mac I Guaranteed Securities (if the loans are not delinquent and are standard Farmer Mac loan products); or o either a mark-to-market negotiated price for all (but not some) loans in the pool, based on the sale of Farmer Mac I Guaranteed Securities in the capital markets or the funding obtained by Farmer Mac through the issuance of matching debt in the capital markets, or in exchange for Farmer Mac I Guaranteed Securities (if the loans are not four months delinquent). In 2004, Farmer Mac entered into $392.6 million of LTSPCs, compared to $763.3 million in 2003. Notwithstanding the significant decline in business volume during 2004 (described further at "Management's Discussion and Analysis of Financial Condition and Results of Operations--Results of Operations--Business Volume"), LTSPCs remained the preferred credit enhancement alternative for new non-cash transactions and were a significant portion of the Farmer Mac I program. As of December 31, 2004, Farmer Mac's outstanding LTSPCs covered 11,909 mortgage loans with an aggregate principal balance of $2.3 billion. As of December 31, 2004, outstanding off-balance sheet Farmer Mac I Guaranteed Securities were backed by 1,680 mortgage loans having an aggregate principal balance of $882.3 million. For more information regarding guarantee and LTSPC volume, see "Management's Discussion and Analysis of Financial Condition and Results of Operations--Results of Operations--Business Volume." Underwriting and Appraisal Standards Farmer Mac has established underwriting and appraisal standards for agricultural mortgage loans to manage its credit risk, to mitigate the risk of loss from borrower defaults and to provide guidance concerning 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 mortgage loans and are designed to assess the creditworthiness of the borrower, as well as the value of the mortgaged property relative to the amount of the mortgage loan. Farmer Mac requires sellers of agricultural mortgage loans to make representations and warranties regarding the conformity of eligible mortgage loans to these standards and any other requirements it may impose from time to time. Farmer Mac I credit underwriting standards require that the loan-to-value ratio ("LTV") of any loan not exceed 70 percent, except that a loan secured by a livestock facility and supported by a contract with an integrator may have an LTV of up to 75 percent, a part-time farm loan supported by private mortgage insurance may have an LTV of up to 85 percent and a rural housing loan supported by private mortgage insurance may have an LTV of up to 97 percent. Farmer Mac also has a loan product for borrowers with high credit scores whose loans are secured by collateral with low LTVs. For those borrowers, loan processing has been simplified and documentation of the credit ratios described below is not necessary. Farmer Mac may require that a loan have a lower LTV when the Corporation determines that such lower LTV is appropriate. In the case of newly originated loans that are not part-time farm, facility, low-documentation or rural housing loans, borrowers on the loans must, among other criteria set forth in Farmer Mac's underwriting standards, meet the following standard underwriting ratios on a pro forma basis (i.e., giving effect to the new loan): o debt-to-asset ratio of 50 percent or less; o cash flow debt service coverage ratio on the mortgaged property of not less than 1:1; o total debt service coverage ratio, including farm and non-farm income, of not less than 1.25:1; and o ratio of current assets to current liabilities of not less than 1:1. Farmer Mac's underwriting standards provide for acceptance of loans that do not conform to one or more of the standard underwriting ratios, other than LTV, when those loans: o exceed minimum requirements for one or more of the underwriting standards to a degree that compensates for noncompliance with one or more other standards, referred to as compensating strengths; and o are made to producers of particular agricultural commodities or products in a segment of agriculture in which such compensating strengths are typical of the financial condition of sound borrowers in that segment. Farmer Mac's use of compensating strengths is not intended to provide a basis for waiving or lessening the requirement that eligible mortgage loans under the Farmer Mac I program be of consistently high quality. In fact, loans approved on the basis of compensating strengths have not demonstrated a significantly different rate of default than that of loans that were approved on the basis of conformance with all of the standard underwriting ratios. As of December 31, 2004, a total of $1.4 billion (30.2 percent) of the outstanding balance of loans held and loans underlying LTSPCs and Farmer Mac I Guaranteed Securities issued after the enactment of the Farm Credit System Reform Act of 1996 (the "1996 Act") were approved based upon compensating strengths ($8.6 million of which had original LTVs of greater than 70 percent). The original LTV of a loan is calculated by dividing the loan's principal balance at the time of guarantee, purchase or commitment by the appraised value at the date of loan origination or, when available, updated appraised value at the time of guarantee, purchase or commitment. During 2004, $169.3 million (34 percent) of the loans purchased or added under LTSPCs were approved based upon compensating strengths ($1.5 million of which had original LTVs of greater than 70 percent). In the case of a seasoned loan, Farmer Mac considers sustained performance to be a reliable alternative indicator of a borrower's ability to pay the loan according to its terms. A seasoned loan generally will be deemed an eligible loan if: o it has been outstanding for at least five years and has an LTV of 60 percent or less; o there have been no payments more than 30 days past due during the previous three years; and o there have been no material restructurings or modifications for credit reasons during the previous five years. A seasoned loan that has been outstanding for more than one year but less than five years must substantially comply with the underwriting standards for newly originated loans as of the date the loan was originated by the lender. The loan must also have a payment history that shows no payment more than 30 days past due during the three-year period immediately prior to the date the loan is either purchased by Farmer Mac or made subject to an LTSPC. As with the secondary market for residential mortgages, there is no requirement that each loan's compliance with the underwriting standards be re-evaluated after Farmer Mac accepts the loan into its program. In the case of rural housing and part-time farm loans, the borrower may finance up to 97 percent and 85 percent, respectively, of the appraised value of the property if the amount above 80 percent is covered by private mortgage insurance. For newly originated part-time farm loans, the borrower must generate sufficient income from all sources to repay all creditors. A borrower's capacity to repay debt obligations is determined by two tests: o the borrower's monthly mortgage payment-to-income ratio should be 28 percent or less; and o the borrower's monthly debt payment-to-income ratio should be 36 percent or less. As Farmer Mac develops new loan products, it establishes underwriting guidelines for them. Those guidelines result in industry-specific measures equivalent to the basic underwriting standards and provide Farmer Mac the flexibility to deliver the benefits of a secondary market to farmers, ranchers and rural homeowners in diverse sectors of the agricultural economy. The due diligence Farmer Mac performs before purchasing, guaranteeing securities backed by, or committing to purchase seasoned loans includes: o evaluation of loan database information to determine conformity to the criteria set forth in the preceding paragraphs; o confirmation that loan file data conform to database information; o validation of supporting credit information in the loan files; and o review of loan documentation and collateral appraisals. All of the foregoing are performed through methods that give due regard to the size, age, leverage and nature of the collateral for the loans. Farmer Mac's appraisal standards for newly originated loans require, among other things, that the appraisal function be performed independently of the credit decision-making process and conform to the Uniform Standards of Professional Appraisal Practice promulgated by the Appraisal Standards Board. Farmer Mac's appraisal standards require the appraisal function to be conducted or administered by an individual meeting specific qualification and competence criteria and who: o is not associated, except by the engagement for the appraisal, with the credit underwriters making the loan decision, though both the appraiser and the credit underwriter may be directly or indirectly employed by a common employer; o receives no financial or professional benefit of any kind by virtue of the report content, valuation or credit decision made or based on the appraisal product; and o has no present or contemplated future direct or indirect interest in the appraised property. The appraisal standards also require uniform reporting of reliable and credible opinions of the market value, market rent and property net income characteristics of the mortgaged property and the relative market forces. Farmer Mac requires current appraisals in conformance with the Uniform Standards of Professional Appraisal Practice for newly originated loans purchased or placed under a Farmer Mac I Guaranteed Security or LTSPC. For seasoned loans, Farmer Mac obtains appraisal updates as considered necessary by its assessment of collateral risk determined in the due diligence process. Farmer Mac personnel include experienced agricultural credit underwriters, appraisers and servicers who perform those functions with respect to many loans that come into the Farmer Mac I program. In addition, those personnel oversee the activities of several servicing centers to which Farmer Mac outsources the remainder of its underwriting function in order to access the expertise and specialized knowledge of several industry-recognized third-party service providers throughout the country. The outsourcing agreements afford Farmer Mac the benefits of those servicing centers at fees based upon marginal costs, which allows Farmer Mac to avoid the fixed costs associated with such operations. Farmer Mac supervises and monitors the performance of the outsourced functions. Farmer Mac believes that the combined expertise of those third-party service providers and its own internal staff provides the Corporation with access to adequate resources for performing the necessary underwriting, appraisal and servicing functions. Sellers As of December 31, 2004, there were 157 approved loan sellers in the Farmer Mac I program, of which 59 were active participants in the program. The approved sellers range from single-office to multi-branch institutions, spanning community banks, FCS associations, mortgage companies, large multi-state FCS banks, commercial banks and insurance companies. As of December 31, 2003, there were 142 approved sellers in the Farmer Mac I program, of which 81 were active participants in the program. In addition to participating directly in the Farmer Mac I program, some of the approved loan sellers enable other lenders to participate indirectly in the Farmer Mac I program by managing correspondent networks of lenders from which they purchase loans to sell to Farmer Mac. As of December 31, 2004, more than 75 lenders were participating in those networks, bringing the total Farmer Mac I program participants to more than 230 as of that date. To be considered for approval as a Farmer Mac I seller, a financial institution must meet the criteria that Farmer Mac establishes, including: o owning a requisite amount of Farmer Mac Class A or Class B voting common stock according to a schedule prescribed for the size and type of institution; o having, in the judgment of Farmer Mac, the ability and experience to make or purchase and sell agricultural mortgage loans of the type that will qualify for purchase by Farmer Mac and service such mortgage loans in accordance with the Farmer Mac requirements either through its own staff or through contractors and originators; o maintaining a minimum adjusted net worth of $1.0 million; o maintaining a fidelity bond and errors and omissions insurance coverage (or acceptable substitute insurance coverage) in a prescribed amount according to the size of the institution; and o entering into a Seller/Servicer agreement to comply with the terms of the Farmer Mac Seller/Servicer Guide, including representations and warranties regarding the eligibility of the loans and accuracy of loan data provided to Farmer Mac. Servicing Farmer Mac generally does not directly service loans held in its portfolio, although it does act as "master servicer" for pools of loans and loans underlying Farmer Mac Guaranteed Securities and may assume direct servicing for impaired loans. Farmer Mac's loans and the loans underlying its Farmer Mac Guaranteed Securities are serviced only by Farmer Mac-approved entities designated as "central servicers" that have entered into central servicing contracts with Farmer Mac. Sellers of eligible mortgage loans sold into the Farmer Mac I program have a right to retain certain "field servicing" functions (typically direct borrower contacts) and may enter into contracts with Farmer Mac's central servicers that specify such servicing functions. Loans underlying LTSPCs are serviced by the holders of those loans in accordance with those lenders' servicing procedures, which are reviewed and approved by Farmer Mac before entering into the LTSPC. Farmer Mac I Guaranteed Securities Farmer Mac guarantees the timely payment of principal and interest on Farmer Mac Guaranteed Securities. Farmer Mac Guaranteed Securities backed by mortgage loans eligible for the Farmer Mac I program are referred to as "Farmer Mac I Guaranteed Securities." By statute, public offerings of Farmer Mac Guaranteed Securities are required to be registered with the SEC under the federal securities laws. Accordingly, Farmer Mac, through its subsidiary Farmer Mac Mortgage Securities Corporation, maintains a shelf registration statement with the SEC through which Farmer Mac Guaranteed Securities may be publicly offered from time to time. Farmer Mac also may offer Farmer Mac Guaranteed Securities in private, unregistered offerings. U.S. Bank National Association, a national banking association based in Minneapolis, Minnesota, or Farmer Mac serves as trustee for the trusts that acquire eligible loans and issue Farmer Mac Guaranteed Securities. Farmer Mac I Guaranteed Securities are agricultural mortgage pass-through certificates guaranteed by Farmer Mac that represent beneficial interests in pools of agricultural mortgage loans or in obligations backed by pools of agricultural mortgage loans. All Farmer Mac I Guaranteed Securities issued during and since 1996 have been single class or multiclass "grantor trust" pass-through certificates. These securities entitle each investor in a class of securities to receive a portion of the payments of principal and interest on the related underlying pool of loans equal to the investor's proportionate interest in the pool. These securities also may support other Farmer Mac I Guaranteed Securities, including real estate mortgage investment conduit securities, commonly referred to as REMICs, and other agricultural mortgage-backed securities. Farmer Mac I Guaranteed Securities issued prior to the enactment of changes to Farmer Mac's statutory charter in 1996 are supported by unguaranteed first-loss subordinated interests that represented ten percent of the balance of the loans underlying the securities at issuance. Farmer Mac I Guaranteed Securities are not assets of Farmer Mac, except when acquired for investment purposes, and are not recorded as liabilities on Farmer Mac's consolidated financial statements. Farmer Mac, however, is liable under its guarantee on the securities to make timely payments to investors of principal (including balloon payments) and interest based on the scheduled payments on the underlying loans, regardless of whether the grantor trust has actually received such scheduled payments. Because it guarantees timely payments on Farmer Mac I Guaranteed Securities, Farmer Mac assumes the ultimate credit risk of borrower defaults on the underlying loans, which are subject to Farmer Mac's underwriting standards described above in "--Underwriting and Appraisal Standards." See also "Management's Discussion and Analysis of Financial Condition and Results of Operations--Risk Management--Credit Risk - Loans." Farmer Mac receives guarantee fees in return for its guarantee obligations on Farmer Mac I Guaranteed Securities. These fees are collected out of installment payments made on the underlying loans until those loans have been repaid or otherwise liquidated (generally as a result of default). The aggregate amount of guarantee fees received on Farmer Mac I Guaranteed Securities depends upon the amount of such securities outstanding and on the guarantee fee rate, which is capped by statute at 50 basis points (0.50 percent) per annum. The Farmer Mac I guarantee fee rate typically ranges from 40 to 50 basis points (0.40 to 0.50 percent) per annum, depending on the credit quality of and other criteria regarding the loans. The amount of Farmer Mac I Guaranteed Securities outstanding is influenced by the repayment rates on the underlying loans and by the rate at which Farmer Mac issues new Farmer Mac I Guaranteed Securities. In general, when the level of interest rates declines significantly below the interest rates on loans underlying Farmer Mac I Guaranteed Securities, the rate of prepayments is likely to increase; conversely, when interest rates rise above the interest rates on the loans underlying Farmer Mac I Guaranteed Securities, the rate of prepayments is likely to decrease. In addition to changes in interest rates, the rate of principal payments on Farmer Mac I Guaranteed Securities is also influenced by a variety of economic, demographic and other considerations, including yield maintenance provisions that are associated with many of the loans underlying Farmer Mac I Guaranteed Securities. For more information regarding yield maintenance provisions, see "Management's Discussion and Analysis of Financial Condition and Results of Operations--Risk Management--Interest Rate Risk." For each of the years ended December 31, 2004 and 2003, Farmer Mac sold Farmer Mac I Guaranteed Securities in the amounts of $91.4 million and $78.3 million, respectively, principally to a related party. In 2004, Farmer Mac recognized a $0.4 million gain on the sale of $26.9 million of Farmer Mac Guaranteed Securities. In 2003 and 2002, Farmer Mac recognized no gain or loss on any such sale. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Results of Operations--Business Volume." Farmer Mac I Transactions During the year ended December 31, 2004, Farmer Mac purchased or placed under guarantee or LTSPC $0.5 billion of loans under the Farmer Mac I program. As of December 31, 2004, loans held and loans underlying Farmer Mac I Guaranteed Securities and LTSPCs totaled $4.7 billion. The 1996 Act revised Farmer Mac's statutory charter to eliminate the requirement of a first-loss subordinated interest in Farmer Mac I Guaranteed Securities. As of December 31, 2004, $18.6 million of Farmer Mac I Guaranteed Securities issued prior to the 1996 Act remained outstanding. The following table summarizes loans purchased or newly placed under guarantees or LTSPCs under the Farmer Mac I program for each of the years ended December 31, 2004, 2003 and 2002.
For the Year Ended December 31, ---------------------------------------------- 2004 2003 2002 --------------- -------------- --------------- (in thousands) Loans and Guaranteed Securities $ 104,404 $ 192,577 $ 747,881 LTSPCs 392,559 763,342 1,155,479 --------------- -------------- --------------- Total $ 496,963 $ 955,919 $1,903,360 --------------- -------------- ---------------
The following table presents the outstanding balances of Farmer Mac I loans and loans underlying Farmer Mac I Guaranteed Securities and LTSPCs as of the dates indicated:
Outstanding Balances as of December 31, --------------------------------------- 2004 2003 ------------------- ------------------ (in thousands) Post-1996 Act: Loans and Guaranteed Securities $ 2,371,405 $ 2,696,530 LTSPCs 2,295,103 2,348,702 Pre-1996 Act 18,640 24,734 ------------------- ------------------ Total Farmer Mac I program $ 4,685,148 $ 5,069,966 ------------------- ------------------
Funding of Guarantee and Purchase Commitment Obligations The principal sources of funding for the payment of Farmer Mac's obligations under its guarantees and LTSPCs are the fees for its guarantees and commitments, net interest income and the proceeds of debt issuance. Farmer Mac satisfies its guarantee and purchase commitment obligations by purchasing defaulted loans out of LTSPCs and from the related trusts for Farmer Mac Guaranteed Securities. Farmer Mac typically recovers a significant portion of the value of defaulted loans purchased either through borrower payments, loan payoffs, payments by third parties or foreclosure and sale of the property securing the loans. Ultimate losses arising from Farmer Mac's guarantees and commitments are reflected in the Corporation's charge-offs against its allowance for losses and gains and losses on the sale of real estate owned. During 2004, Farmer Mac's net charge-offs were $4.5 million, compared to $5.2 million in net charge-offs during 2003. Net gains on the sale of real estate owned were $0.5 million and $0.2 million for each of the years ended December 31, 2004 and 2003, respectively. The Act requires Farmer Mac to set aside, as an allowance for losses in a reserve account, a portion of the guarantee fees it receives from its guarantee activities. Among other things, that reserve account must be exhausted before Farmer Mac may issue obligations to the U.S. Treasury against the $1.5 billion Farmer Mac is statutorily authorized to borrow from the U.S. Treasury to fulfill its guarantee obligations. That borrowing authority is not intended to be a routine funding source and has never been used. Although total outstanding guarantees and LTSPCs exceed the amount held as an allowance for losses and the amount it may borrow from the U.S. Treasury, Farmer Mac does not expect its obligations under the guarantees and LTSPCs to exceed amounts available to satisfy those obligations. For information regarding the allowance for losses, see "Management's Discussion and Analysis of Financial Condition and Results of Operations--Risk Management--Credit Risk - Loans," Note 2(j) and Note 8 to the consolidated financial statements. For a more detailed discussion of Farmer Mac's borrowing authority from the U.S. Treasury, see "Farmer Mac's Authority to Borrow from the U.S. Treasury." Portfolio Diversification It is Farmer Mac's policy to diversify its portfolio of loans held and loans underlying Farmer Mac Guaranteed Securities and LTSPCs, both geographically and by agricultural commodity/product. Farmer Mac directs its marketing efforts toward agricultural lenders throughout the nation to achieve commodity/product and geographic diversification in its exposure to credit risk. Farmer Mac measures its credit exposure in particular geographic regions and commodities/products as a percentage of the total principal amount of all loans outstanding, adjusted for the credit quality of the loans in that particular geographic region or commodity/product group based on its criteria for underwriting discussed above. Farmer Mac is not obligated to buy every loan submitted to it by an eligible seller that meets its underwriting and appraisal standards. Farmer Mac considers other factors such as its overall portfolio diversification, commodity and farming forecasts and risk management objectives in deciding whether to accept the loans into the Farmer Mac I program. For example, if industry forecasts indicate possible weakness in a geographic area or agricultural commodity or product, Farmer Mac may decide not to purchase or commit to purchase an affected loan as part of managing its overall portfolio exposure to areas of possible heightened risk exposure. Because Farmer Mac effectively assumes the credit risk on all loans under an LTSPC, Farmer Mac's commodity/product and geographic diversification disclosures reflect all loans under LTSPCs and any loans that have been purchased out of LTSPC pools. For information regarding the diversification of Farmer Mac's existing portfolio, see "Management's Discussion and Analysis of Financial Condition and Results of Operations--Risk Management--Credit Risk - Loans" and Note 8 to the consolidated financial statements. Farmer Mac II General The Farmer Mac II program was initiated in 1992 and is authorized under sections 8.0(3) and 8.0(9)(B) of Farmer Mac's statutory charter (12 U.S.C. sections 2279aa(3) and 2279aa(9)(B)), which provide that: o USDA-guaranteed portions are statutorily included in the definition of loans eligible for Farmer Mac's secondary market programs; o USDA-guaranteed portions are exempted from the underwriting, appraisal and repayment standards that all other loans must meet to be eligible for Farmer Mac programs, and are exempted from any diversification and internal credit enhancement that may be required of pools of other loans eligible for Farmer Mac programs; and o Farmer Mac is authorized to pool and issue Farmer Mac Guaranteed Securities backed by USDA-guaranteed portions. United States Department of Agriculture Guaranteed Loan Programs The United States Department of Agriculture ("USDA"), acting through its various agencies, currently administers the federal rural credit programs first developed in the mid-1930s. The USDA makes direct loans and guarantees portions of loans made and serviced by USDA-qualified lenders for various purposes. The USDA's guarantee is supported by the full faith and credit of the United States. USDA-guaranteed portions represent up to 95 percent of the principal amount of guaranteed loans. Through its Farmer Mac II program, Farmer Mac is one of several competing purchasers of USDA-guaranteed portions of farm ownership loans, farm operating loans, business and industry loans and other loans that are fully guaranteed as to principal and interest by the USDA (collectively, the "guaranteed loans"). USDA Guarantees. Each USDA guarantee is a full faith and credit obligation of the United States and becomes enforceable if a lender fails to repurchase the USDA-guaranteed portion from its owner within 30 days after written demand from the owner when: o the borrower under the guaranteed loan is in default not less than 60 days in the payment of any principal or interest due on the USDA-guaranteed portion; or o the lender has failed to remit to the owner the payment made by the borrower on the USDA-guaranteed portion or any related loan subsidy within 30 days after the lender's receipt of the payment. If the lender does not repurchase the USDA-guaranteed portion as provided above, the USDA is required to purchase the unpaid principal balance of the USDA-guaranteed portion together with accrued interest (including any loan subsidy) to the date of purchase, less the servicing fee, within 30 days after written demand upon the USDA by the owner. While the USDA guarantee will not cover the note interest to the owner on USDA-guaranteed portions accruing after 90 days from the date of the original demand letter of the owner to the lender requesting repurchase, Farmer Mac has established procedures to require prompt tendering of USDA-guaranteed portions. If, in the opinion of the lender (with the concurrence of the USDA) or in the opinion of the USDA, repurchase of the USDA-guaranteed portion is necessary to service the related guaranteed loan adequately, the owner will sell the USDA-guaranteed portion to the lender or USDA for an amount equal to the unpaid principal balance and accrued interest (including any loan subsidy) on such USDA-guaranteed portion less the lender's servicing fee. Federal regulations prohibit the lender from repurchasing USDA-guaranteed portions for arbitrage purposes. Lenders. Any lender authorized by the USDA to obtain a USDA guarantee on a loan may be a seller in the Farmer Mac II program. As of December 31, 2004, there were 133 active sellers in the Farmer Mac II program, consisting mostly of community and regional banks, compared to 150 sellers as of December 31, 2003, for a decrease of 17 active lenders. In the aggregate, more than 360 sellers were actively participating either directly or indirectly in one or both of the Farmer Mac I or Farmer Mac II programs during 2004. Loan Servicing. The lender on each guaranteed loan is required by regulation to retain the unguaranteed portion of the guaranteed loan, to service the entire underlying guaranteed loan, including the USDA-guaranteed portion, and to remain mortgagee and/or secured party of record. The USDA-guaranteed portion and the unguaranteed portion of the underlying guaranteed loan are to be secured by the same security with equal lien priority. The USDA-guaranteed portion cannot be paid later than, or in any way be subordinated to, the related unguaranteed portion. Farmer Mac II Guaranteed Securities Farmer Mac guarantees the timely payment of principal and interest on Farmer Mac II Guaranteed Securities backed by USDA-guaranteed portions. Farmer Mac does not guarantee the repayment of the USDA-guaranteed portions, only the Farmer Mac II Guaranteed Securities that are backed by USDA-guaranteed portions. In addition to purchasing USDA-guaranteed portions for retention in its portfolio, Farmer Mac offers Farmer Mac II Guaranteed Securities to lenders in swap transactions or to other investors for cash. Farmer Mac II Transactions During the years ended December 31, 2004 and 2003, Farmer Mac issued $174.1 million and $271.2 million of Farmer Mac II Guaranteed Securities, respectively. As of December 31, 2004, $768.5 million of Farmer Mac II Guaranteed Securities were outstanding. See Note 5 and Note 12 to the consolidated financial statements. The following table presents Farmer Mac II Guaranteed Securities issued for each of the years indicated:
For the Year Ended December 31, ---------------------------------------------- 2004 2003 2002 --------------- -------------- -------------- (in thousands) Purchased and retained $ 162,286 $ 270,727 $ 173,011 Swaps (issued to third parties) 11,788 502 - --------------- -------------- -------------- Total $ 174,074 $ 271,229 $ 173,011 --------------- -------------- --------------
The following table presents the outstanding balance of Farmer Mac II Guaranteed Securities as of the dates indicated:
Outstanding Balance of Farmer Mac II Guaranteed Securites as of December 31, ----------------------------------------- 2004 2003 ------------------ ------------------- (in thousands) On-balance sheet $ 712,653 $ 678,229 Off-balance sheet 55,889 51,241 ------------------ ------------------- Total $ 768,542 $ 729,470 ------------------ -------------------
As of December 31, 2004, Farmer Mac had experienced no credit losses on any of its Farmer Mac II transactions. As of December 31, 2004, Farmer Mac had outstanding $0.5 million of principal and interest advances on Farmer Mac II Guaranteed Securities, compared to $1.2 million as of December 31, 2003. Financing Debt Issuance Section 8.6(e) of Farmer Mac's statutory charter (12 U.S.C. sections 2279aa-6(e)) authorizes Farmer Mac to issue debt obligations to purchase eligible mortgage loans and Farmer Mac Guaranteed Securities and to maintain reasonable amounts for business operations, including adequate liquidity. Farmer Mac funds its program purchases primarily by issuing debt obligations, consisting of discount notes and medium-term notes of various maturities, in the public capital markets. Farmer Mac also issues discount notes and medium-term notes to obtain funds to finance its investments, transaction costs and guarantee and LTSPC payments. The Corporation's discount notes and medium-term notes are obligations of Farmer Mac only, are not rated by a nationally recognized statistical rating organization ("NRSRO"). The interest and principal thereon are not guaranteed by, and do not constitute debts or obligations of, FCA or the United States or any agency or instrumentality of the United States other than Farmer Mac. Farmer Mac is an institution of the FCS, but is not liable for any debt or obligation of any other institution of the FCS. Likewise, neither the FCS nor any other individual institution of the FCS is liable for any debt or obligation of Farmer Mac. Income to the purchaser of a Farmer Mac discount note or medium-term note is not exempt under federal law from federal, state or local taxation. Farmer Mac's board of directors has authorized the issuance of up to $5.0 billion outstanding of discount notes and medium-term notes, 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 non-program investment assets in accordance with policies established by its board of directors. The current policies authorize non-program investments in: o U.S. Treasury obligations; o agency and instrumentality obligations; o repurchase agreements; o commercial paper; o guaranteed investment contracts; o certificates of deposit; o federal funds and bankers acceptances; o securities and debt obligations of corporate and municipal issuers; o auction rate securities; o mortgage-backed securities; o asset-backed securities; o corporate money market funds; and o preferred stock of government-sponsored enterprises ("GSEs"). For more information about Farmer Mac's outstanding investments and indebtedness, see Note 4 and Note 7 to the consolidated financial statements. Equity Issuance The Act authorizes Farmer Mac to issue voting common stock, non-voting common stock and non-voting preferred stock. Only banks, other financial entities, insurance companies and institutions of the FCS eligible to participate in one or more of the Farmer Mac programs may hold voting common stock. 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. There are no ownership restrictions applicable to Class C non-voting common stock or preferred stock. The Class C non-voting common stock and the preferred stock are freely transferable. Upon liquidation, dissolution or winding up of the business of Farmer Mac, after payment and provision for payment of outstanding debt of the Corporation, the holders of shares of preferred stock would be paid in full at par value, plus all accrued dividends, before the holders of shares of common stock received any payment. The dividend rights of all three classes of the Corporation's common stock are the same, and dividends may be paid on common stock only when, as, and if declared by Farmer Mac's board of directors in its sole discretion, subject to the payment of dividends on outstanding preferred stock. As of December 31, 2004, 1,030,780 shares of Class A voting common stock, 500,301 shares of Class B voting common stock, 10,291,041 shares of Class C non-voting common stock and 700,000 shares of 6.40 percent non-voting cumulative preferred stock, Series A were outstanding. Farmer Mac may obtain additional capital from future issuances of voting and non-voting common stock and non-voting preferred stock. Farmer Mac has no present intention to issue any additional shares of common stock, except pursuant to programs in which employees, members of management or the board of directors may be granted or may purchase Class C non-voting common stock, or exercise options to purchase Class C non-voting common stock granted as part of their compensation arrangements. The following table presents the dividends declared on the common stock during and subsequent to 2004:
Date Per For For Dividend Share Period Period Date Declared Amount Beginning Ending Paid - ------------------------ ------------ ---------------------- ----------------------- ---------------------- October 7, 2004 $ 0.10 October 1, 2004 December 31, 2004 December 31, 2004 February 10, 2005 0.10 January 1, 2005 March 31, 2005 * * The dividend declared on February 10, 2005 is scheduled to be paid on March 31, 2005.
Farmer Mac's ability to declare and pay common stock dividends could be restricted if it were to fail to comply with its regulatory capital requirements. See Note 9 to the consolidated financial statements and "--Government Regulation of Farmer Mac--Regulation--Capital Standards--Enforcement levels." The cumulative preferred stock, Series A has a redemption price and liquidation preference of $50.00 per share, plus accrued and unpaid dividends. The preferred stock does not have a maturity date. Beginning on June 30, 2012, Farmer Mac has the option to redeem the preferred stock at any time, in whole or in part, at the redemption price of $50.00 per share, plus accrued and unpaid dividends through and including the redemption date. The costs of issuing the preferred stock were charged to additional paid-in capital. Farmer Mac pays cumulative dividends on the preferred stock quarterly in arrears, when and if declared by the board of directors. Farmer Mac's ability to declare and pay a dividend could be restricted if it failed to comply with regulatory capital requirements. The following table presents the dividends declared on the preferred stock during and subsequent to 2004:
Date Per For For Dividend Share Period Period Date Declared Amount Beginning Ending Paid - ---------------------- ---------- ---------------------- ----------------------- ---------------------- February 5, 2004 $ 0.80 January 1,02004 March 31, 2004 March 31, 2004 April 1, 2004 0.80 April 1, 2004 June 30, 2004 June 30, 2004 August 3, 2004 0.80 July 1, 2004 September 30, 2004 September 30, 2004 October 7, 2004 0.80 October 1, 2004 December 31, 2004 December 31, 2004 February 10, 2005 0.80 January 1, 2005 March 31, 2005 * * The dividend declared on February 10, 2005 is scheduled to be paid on March 31, 2005.
On August 4, 2004, Farmer Mac established a program to repurchase up to 10 percent of the Corporation's outstanding Class C non-voting common stock. The authority for this stock repurchase program expires in August 2006. During 2004, Farmer Mac repurchased 299,248 shares of its Class C non-voting common stock at an average price of $20.82 per share. All of the repurchased shares were purchased in open market transactions and were retired to become authorized but unissued shares available for future issuance. FARMER MAC'S AUTHORITY TO BORROW FROM THE U.S. TREASURY Farmer Mac may, in extreme circumstances, issue obligations to the U.S. Treasury in a cumulative amount not to exceed $1.5 billion. The proceeds of such obligations may be used solely for the purpose of fulfilling Farmer Mac's guarantee commitments under the Farmer Mac I and Farmer Mac II programs. The Act provides that the U.S. Treasury is required to purchase such obligations of Farmer Mac if Farmer Mac certifies that: o a portion of the guarantee fees assessed by Farmer Mac has been set aside as a reserve against losses arising out of Farmer Mac's guarantee activities in an amount determined by Farmer Mac's board of directors to be necessary and such reserve has been exhausted; and o the proceeds of such obligations are needed to fulfill Farmer Mac's guarantee obligations. Such obligations would bear interest at a rate determined by the U.S. Treasury, taking into consideration the average rate on outstanding marketable obligations of the United States as of the last day of the last calendar month ending before the date of the purchase of the obligations from Farmer Mac, and would be required to be repurchased from the U.S. Treasury by Farmer Mac within a "reasonable time." The United States government does not guarantee payments due on Farmer Mac Guaranteed Securities, funds invested in the equity or debt securities of Farmer Mac, any dividend payments on shares of Farmer Mac stock or the profitability of Farmer Mac. GOVERNMENT REGULATION OF FARMER MAC General Public offerings of Farmer Mac Guaranteed Securities must be registered with the SEC under the federal securities laws. Farmer Mac also is required to file reports with the SEC pursuant to the SEC's periodic reporting requirements. Regulation Office of Secondary Market Oversight As an institution of the FCS, Farmer Mac is subject to the regulatory authority of FCA. FCA, acting through its Office of Secondary Market Oversight, has general regulatory and enforcement authority over Farmer Mac, including the authority to promulgate rules and regulations governing the activities of Farmer Mac and to apply its general enforcement powers to Farmer Mac and its activities. The Director of the Office of Secondary Market Oversight, who is selected by and reports to the FCA board, is responsible for the examination of Farmer Mac and the general supervision of the safe and sound performance by Farmer Mac of the powers and duties vested in it by the Act. The Act requires an annual examination of the financial transactions of Farmer Mac and authorizes FCA to assess Farmer Mac for the cost of its regulatory activities, including the cost of any examination. Farmer Mac is required to file quarterly reports of condition with FCA. Department of the Treasury In connection with the passage of the 1996 Act, the Chairmen of the House and Senate Agriculture Committees requested FCA, in a cooperative effort with the Department of the Treasury, to "monitor and review the operations and financial condition of Farmer Mac and to report in writing to the appropriate subcommittees of the House Agriculture Committee, the House Financial Services Committee and the Senate Agriculture, Nutrition and Forestry Committee at six-month intervals during the capital deferral period and beyond, if necessary." The "capital deferral period" expired on January 1, 1999, the risk-based capital rule went into effect on May 23, 2002 and the FCA reports and monitoring continue. Capital Standards General. The Act, as amended by the 1996 Act, establishes three capital standards for Farmer Mac: o Minimum capital - Farmer Mac's minimum capital level is an amount of core capital 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 Farmer Mac's aggregate off-balance sheet obligations, specifically including: o the unpaid principal balance of outstanding Farmer Mac Guaranteed Securities; o instruments issued or guaranteed by Farmer Mac that are substantially equivalent to Farmer Mac Guaranteed Securities, including LTSPCs; and o other off-balance sheet obligations of Farmer Mac. o Critical capital - 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. o Risk-based capital - The Act directs FCA to establish a risk-based capital stress test for Farmer Mac, using specified stress-test parameters. While the Act does not specify the required level of risk-based capital, that level is permitted to exceed the statutory minimum capital requirement applicable to Farmer Mac, if so indicated by the risk-based capital stress test. Farmer Mac is required to comply with the higher of the minimum capital requirement or the risk-based capital requirement. FCA issued its final risk-based capital regulation for Farmer Mac on April 12, 2001 and the Corporation was required to meet the risk-based capital standards beginning on May 23, 2002. The risk-based capital stress test promulgated by FCA is intended to determine the amount of regulatory capital (core capital plus the allowance for losses, but excluding the valuation allowance for real estate owned) that Farmer Mac would need to maintain positive capital during a ten-year period in which: o annual losses occur at a rate of default and severity "reasonably related" to the rates of the highest sequential two-years in a limited U.S. geographic area; and o interest rates increase to a level equal to the lesser of 600 basis points or 50 percent of the ten-year U.S. Treasury rate, and interest rates remain at such level for the remainder of the period. The risk-based capital stress test then adds an additional 30 percent to the resulting capital requirement for management and operational risk. FCA has published its intent to review the risk-based capital regulation. Farmer Mac does not know what action, if any, the Agency will take as a result of its review of the risk-based capital requirement, although any action taken would likely increase the requirement, nor when any changes to the requirement would become effective. As of December 31, 2004, Farmer Mac's minimum and critical capital requirements were $128.9 million and $64.5 million, respectively, and its actual core capital level was $237.7 million, $108.8 million above the minimum capital requirement and $173.2 million above the critical capital requirement. Based on the risk-based capital stress test, Farmer Mac's risk-based capital requirement as of December 31, 2004 was $37.1 million and Farmer Mac's regulatory capital of $254.8 million exceeded that amount by approximately $217.7 million. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources--Capital Requirements" for a presentation of Farmer Mac's current regulatory capital position. Enforcement levels. The Act directs FCA to classify Farmer Mac within one of four enforcement levels for purposes of determining compliance with capital standards. As of December 31, 2004, Farmer Mac was classified as within level I--the highest compliance level. Failure to comply with the applicable required capital level in the Act would result in Farmer Mac being classified as within level II (below the applicable risk-based capital level, but above the minimum capital level), level III (below the minimum capital level, but above the critical capital level) or level IV (below the critical capital level). In the event that Farmer Mac were classified as within level II, III or IV, the Act requires the Director of the Office of Secondary Market Oversight to take a number of mandatory supervisory measures and provides the Director with discretionary authority to take various optional supervisory measures depending on the level in which Farmer Mac is classified. The mandatory measures applicable to level II include: o requiring Farmer Mac to submit and comply with a capital restoration plan; o prohibiting the payment of dividends if such payment would result in Farmer Mac being reclassified as within level III or IV, and requiring the pre-approval of any dividend payment even if such payment would not result in reclassification as within level IV; and o reclassifying Farmer Mac as within level III if it does not submit a capital restoration plan that is approved by the Director, or the Director determines that Farmer Mac has failed to make, in good faith, reasonable efforts to comply with such a plan and fulfill the schedule for the plan approved by the Director. The mandatory measures applicable to level III include: o requiring Farmer Mac to submit (and comply with) a capital restoration plan; o prohibiting the payment of dividends if such payment would result in Farmer Mac being reclassified as within level IV and requiring the pre-approval of any dividend payment even if such payment would not result in reclassification as within level IV; and o reclassifying Farmer Mac as within a lower level if it does not submit a capital restoration plan that is approved by the Director or the Director determines that Farmer Mac has failed to make, in good faith, reasonable efforts to comply with such a plan and fulfill the schedule for the plan approved by the Director. If Farmer Mac were classified as within level III, then, in addition to the foregoing mandatory supervisory measures, the Director of the Office of Secondary Market Oversight could take any of the following discretionary supervisory measures: o imposing limits on any increase in, or ordering the reduction of, any obligations of Farmer Mac, including off-balance sheet obligations; o limiting or prohibiting asset growth or requiring the reduction of assets; o requiring the acquisition of new capital in an amount sufficient to provide for reclassification as within a higher level; o terminating, reducing or modifying any activity the Director determines creates excessive risk to Farmer Mac; or o appointing a conservator or a receiver for Farmer Mac. The Act does not specify any supervisory measures, either mandatory or discretionary, to be taken by the Director in the event Farmer Mac were classified as within level IV. The Director of the Office of Secondary Market Oversight has the discretionary authority to reclassify Farmer Mac to a level that is one level below its then current level (for example, from level I to level II) if the Director determines that Farmer Mac is engaging in any action not approved by the Director that could result in a rapid depletion of core capital or if the value of property subject to mortgages backing Farmer Mac Guaranteed Securities has decreased significantly. Item 2. Properties Farmer Mac currently occupies its principal offices, which are located at 1133 Twenty-First Street, N.W., Suite 600, Washington, D.C. 20036, under the terms of a lease that expires on November 30, 2011 and covers approximately 13,500 square feet of office space. Farmer Mac's offices are suitable and adequate for its needs. Item 3. Legal Proceedings Farmer Mac is not a party to any material pending legal proceedings. Item 4. Submission of Matters to a Vote of Security Holders Not applicable. PART II Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities (a) Farmer Mac has three classes of common stock outstanding. Ownership of Class A voting common stock is restricted to banks, insurance companies and other financial institutions or similar entities that are not institutions of the FCS. Ownership of Class B voting common stock is restricted to institutions of the FCS. There are no ownership restrictions on the Class C non-voting common stock. Under the terms of the original public offering of the Class A and Class B voting common stock, the Corporation reserved the right to redeem at book value any shares of either class held by an ineligible holder. The Class A and Class C common stocks trade on the New York Stock Exchange under the symbols AGMA and AGM, respectively. The Class B voting common stock, which has a limited market and trades infrequently, is not listed or quoted on any exchange or other medium, and Farmer Mac is unaware of any publicly available quotations or prices for that class. The information below represents the high and low closing sales prices for the Class A and Class C common stocks for the periods indicated as reported by the New York Stock Exchange.
Sales Prices --------------------------------------------------- Class A Stock Class C Stock ------------------------- ------------------------- High Low High Low ------------ ------------ ------------ ------------ (per share) 2005 First quarter (through March 1, 2005) $ 17.20 $ 15.40 $ 23.36 $ 19.28 2004 Fourth quarter 17.80 15.60 24.03 19.60 Third quarter 19.05 16.80 23.85 17.13 Second quarter 20.30 19.00 27.00 21.78 First quarter 22.85 19.45 31.19 25.00 2003 Fourth quarter 22.90 20.01 32.00 26.68 Third quarter 22.00 16.75 30.49 23.11 Second quarter 17.92 16.70 25.14 21.86 First quarter 22.65 15.50 34.50 20.25
As of March 1, 2005, it was estimated that there were 1,381 registered owners of the Class A voting common stock, 100 registered owners of the Class B voting common stock and 1,305 registered owners of the Class C non-voting common stock. The dividend rights of all three classes of the Corporation's common stock are the same, and dividends may be paid on common stock only when, as and if declared by Farmer Mac's board of directors in its sole discretion. In August 2004, Farmer Mac's board of directors adopted a policy to pay a quarterly dividend of $0.10 per share on all classes of the Corporation's common stock beginning in fourth quarter 2004. On October 7, 2004, for the first time Farmer Mac's board of directors declared a quarterly dividend of $0.10 per share on the Corporation's three classes of common stock, which was paid on December 31, 2004. Prior to that dividend payment, Farmer Mac had not paid any dividends on its common stock. On February 10, 2005, the Farmer Mac board of directors declared a quarterly dividend of $0.10 per share on the Corporation's common stock payable on March 31, 2005. Farmer Mac expects to continue to pay comparable quarterly cash dividends for the foreseeable future, subject to the outlook and indicated capital needs of the Corporation and the determination of the board of directors. Farmer Mac's ability to declare and pay dividends could be restricted if it were to fail to comply with regulatory capital requirements. See "Business--Government Regulation of Farmer Mac--Regulation--Capital Standards--Enforcement levels." Farmer Mac's ability to pay dividends on its common stock is also subject to the payment of dividends on its outstanding preferred stock. Information about securities authorized for issuance under Farmer Mac's equity compensation plans appears under "Equity Compensation Plans" in Farmer Mac's Proxy Statement to be filed on or about April 28, 2005. That portion of the Proxy Statement is incorporated by reference into this report. Farmer Mac is a federally chartered instrumentality of the United States and its common stock is exempt from registration pursuant to Section 3(a)(2) of the Securities Act of 1933. On October 4, 2004, 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 annual cash retainers, Farmer Mac issued an aggregate of 670 shares of its Class C non-voting common stock, at an issue price of $22.19 per share, to the eight directors who elected to receive such stock in lieu of their cash retainers. (b) Not applicable. (c) As shown in the table below, Farmer Mac repurchased 228,297 shares of its Class C non-voting common stock during fourth quarter 2004 at an average price of $21.10 per share. All of the repurchased shares were purchased in open market transactions and were retired to become authorized but unissued shares available for future issuance.
Issuer Purchases of Equity Securities - -------------------------------------------------------------------------------------------------------------------- Total Number of Class C Shares Maximum Number Total Number Average Purchased as Part of Class C Shares of Class C Price Paid of Publicly that May Yet be Shares per Class Announced Purchased Under Period Purchased C Share Program* the Program October 1, 2004 - October 31, 2004 113,902 $ 20.95 113,902 870,647 November 1, 2004 - November 30, 2004 114,395 21.26 114,395 756,252 December 1, 2004 - December 31, 2004 - - - 756,252 --------------- ------------- ------------------- ---------------------- Total 228,297 $ 21.10 228,297 756,252 --------------- ------------- ------------------- ---------------------- * On August 9, 2004, Farmer Mac publicly announced that its board of directors had authorized a program to repurchase up to 10 percent of the Corporation's outstanding Class C non-voting common stock. The authority for this stock repurchase program expires in August 2006.
Item 6. Selected Financial Data
As of December 31, ----------------------------------------------------------------------- Summary of Financial Condition: 2004 2003 2002 2001 2000 -------------- -------------- ------------ ------------- ------------ (dollars in thousands) Cash and cash equivalents $ 430,504 $ 623,674 $723,800 $437,831 $537,871 Investment securities 1,056,143 1,064,782 830,409 1,007,954 836,757 Farmer Mac Guaranteed Securities 1,376,847 1,508,134 1,608,507 1,690,376 1,679,993 Loans, net 882,874 983,624 963,461 198,003 30,279 Total assets 3,846,817 4,299,650 4,222,915 3,415,856 3,160,899 Notes payable: Due within one year 2,620,172 2,799,384 2,895,746 2,233,267 2,141,548 Due after one year 862,201 1,136,110 985,318 968,463 827,635 Total liabilities 3,609,965 4,086,396 4,039,344 3,281,419 3,028,238 Stockholders' equity 236,852 213,254 183,571 134,437 132,661 Selected Financial Ratios: Return on average assets 0.69% 0.59% 0.56% 0.50% 0.36% Return on average common equity 14.85% 15.32% 15.00% 12.19% 9.50% Average equity to assets 5.53% 4.66% 4.16% 4.06% 3.82% For the Year Ended December 31, ----------------------------------------------------------------------- Summary of Operations: 2004 2003 2002 2001 2000 -------------- -------------- ------------ ------------- ------------ (in thousands, except per share amounts) Net interest income after provision for loan losses $ 31,658 $ 30,728 $ 37,759 $ 28,666 $ 17,398 Guarantee and commitment fees 20,977 20,685 19,277 15,807 11,677 Gains/(losses) on financial derivatives and trading assets 2,846 2,357 (8,433) (3,053) - Gains on the repurchase of debt - - 1,368 - - Gain on sale of Farmer Mac Guaranteed Securities 367 - - - - Gains on the sale of real estate owned 523 178 24 61 - Representation and warranty claims income 2,816 - - - - Other income 1,495 812 1,332 560 399 -------------- -------------- ------------ ------------- ------------ Total revenues 60,682 54,760 51,327 42,041 29,474 Total operating expenses 16,263 15,182 18,767 16,616 13,288 -------------- -------------- ------------ ------------- ------------ Income before income taxes and cumulative effect of change in accounting principles 44,419 39,578 32,560 25,425 16,186 Income tax expense 13,951 12,308 9,809 8,419 5,749 Cumulative effect of change in accounting principles, net of taxes - - - (726) - -------------- -------------- ------------ ------------- ------------ Net income 30,468 27,270 22,751 16,280 10,437 Preferred stock dividends (2,240) (2,240) (1,456) - - -------------- -------------- ------------ ------------- ------------ Net income available to common stockholders $ 28,228 $ 25,030 $ 21,295 $ 16,280 $ 10,437 -------------- -------------- ------------ ------------- ------------ Allowance for Losses Activity: Provision for Losses $ (412) $ 7,285 $ 8,247 $ 6,786 $ 4,739 Net charge-offs 4,540 5,243 4,120 2,225 - Ending Balance 17,101 22,053 20,011 15,884 11,323 Earnings Per Common Share: Basic earnings per common share $ 2.35 $ 2.13 $ 1.83 $ 1.44 $ 0.94 Diluted earnings per common share $ 2.32 $ 2.08 $ 1.77 $ 1.38 $ 0.92 Common stock dividends $ 0.10 $ - $ - $ - $ -
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Financial information as of and for each of the years ended December 31, 2004, 2003 and 2002 is consolidated to include the accounts of Farmer Mac and its wholly-owned subsidiary, Farmer Mac Mortgage Securities Corporation. The following discussion should be read together with Farmer Mac's consolidated financial statements and is not necessarily indicative of future results. Forward-Looking Statements There are statements made in this Form 10-K that 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 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 discussion and analysis includes forward-looking statements addressing Farmer Mac's: o prospects for earnings; o prospects for growth in loan purchase, guarantee, securitization and LTSPC volume; o trends in net interest income; o trends in provisions for losses; o trends in expenses; o changes in capital position; and o other business and financial matters. 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 could cause Farmer Mac's actual results or events to differ materially from the expectations as expressed or implied by the forward-looking statements, including uncertainties regarding: o the rate and direction of development of the secondary market for agricultural mortgage loans; o the possible establishment of additional statutory or regulatory restrictions or constraints on Farmer Mac that could hamper its growth or diminish its profitability; o increases in general and administrative expenses attributable to growth of the business and the regulatory environment, including the hiring of additional personnel with expertise in key functional areas; o legislative or regulatory developments or interpretations of Farmer Mac's statutory charter that could adversely affect Farmer Mac, the ability of Farmer Mac to offer new products or the ability or motivation of certain lenders to participate in its programs or the terms of any such participation, or increase the cost of regulation and related corporate activities; o possible reaction in the financial markets to events involving GSEs other than Farmer Mac; o Farmer Mac's access to the debt markets at favorable rates and terms; o the possible effect of the risk-based capital requirement, which could, under certain circumstances, be in excess of the statutory minimum capital requirement; o the rate of growth in agricultural mortgage indebtedness; o lender interest in Farmer Mac credit products and the Farmer Mac secondary market; o borrower preferences for fixed-rate agricultural mortgage indebtedness; o competitive pressures in the purchase of agricultural mortgage loans and the sale of agricultural mortgage-backed securities and debt securities; o substantial changes in interest rates, agricultural land values, commodity prices, export demand for U.S. agricultural products, the general economy and other factors that may affect delinquency levels and credit losses; o protracted adverse weather, market or other conditions affecting particular geographic regions or particular agricultural commodities or products related to agricultural mortgage loans backing Farmer Mac I Guaranteed Securities or under LTSPCs; o the willingness of investors to invest in agricultural mortgage-backed securities; or o the effects on the agricultural economy or the value of agricultural real estate of any changes in federal assistance for agriculture. The foregoing factors are not exhaustive. Other sections of this report may include additional factors that could adversely affect Farmer Mac's business and its financial performance. Furthermore, new risk factors emerge from time to time and it is not possible for management to predict all such risk factors, nor assess the effects of such factors on Farmer Mac's business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from the expectations expressed or implied by the forward-looking statements. 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 any future events or circumstances, except as otherwise mandated by the SEC. Critical Accounting Policy and Estimates The preparation of the consolidated financial statements in conformity with accounting principals generally accepted in the United States 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 policy that is both important to the portrayal of Farmer Mac's financial condition and results of operations and requires complex, subjective judgments is the accounting policy for the allowance for losses. Farmer Mac's allowance for losses is presented in four components on its consolidated balance sheet: o an "Allowance for loan losses" on loans held for investment; o a valuation allowance on real estate owned, which is included in the balance sheet under "Real estate owned, net of valuation allowance"; o a "Contingent obligation for probable losses" on loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs entered into or modified after January 1, 2003, for which inherent losses existed at the time of the guarantee or commitment and could be reasonably estimated, is included in the balance sheet as a portion of the amount reported as "Guarantee and commitment obligation"; and o an allowance for losses on loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs, which is included in the balance sheet under "Reserve for losses." The provision for losses is presented in two components on the consolidated statement of operations: o a "Provision for loan losses," which represents losses on Farmer Mac's loans held for investment; and o a "Provision for losses," which represents losses on loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs and real estate owned. The purpose of the allowance for losses is to provide for estimated losses that are probable to have occurred as of the balance sheet date, and not to predict or account for future potential losses. The determination of the allowance for losses requires management to make significant estimates based on information available as of the balance sheet date, including the amounts and timing of losses and current market and economic conditions. These estimates are subject to change in future reporting periods if such conditions and information change. For example, a decline in the national or agricultural economy could result in an increase in delinquencies or foreclosures, which may require additional allowances for losses in future periods. Farmer Mac maintains an allowance for losses to cover estimated probable losses on loans held for investment, real estate owned and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs. Farmer Mac estimates probable losses using a systematic process that begins with management's evaluation of the results of its proprietary loan pool simulation and guarantee fee model (the "Model"). The Model draws upon historical information from a data set of agricultural mortgage loans recorded over a longer period of time than Farmer Mac's own experience to date, screened to include only those loans with credit characteristics similar to those on which Farmer Mac has assumed credit risk. The results generated by the Model are modified by the application of management's judgment as required to take key factors into account, including: o economic conditions; o geographic and agricultural commodity/product concentrations in Farmer Mac's portfolio; o the credit profile of Farmer Mac's portfolio; o delinquency trends of Farmer Mac's portfolio; o Farmer Mac's experience in the management and sale of real estate owned; and o historical charge-off and recovery activities of Farmer Mac's portfolio. The allowance for losses is increased through periodic provisions for loan losses that are charged against net interest income and provisions for losses charged to operating expenses and reduced by charge-offs for actual losses, net of recoveries. Negative provisions for loan losses or provisions for losses are recorded in the event that the estimate of probable losses as of the end of a period is lower than the estimate at the beginning of the period. Charge-offs represent losses on the outstanding principal balance, any interest payments previously accrued or advanced and expected costs of liquidation. The establishment of and periodic adjustments to the valuation allowance for real estate owned are charged against income as a portion of the provision for losses charged to operating expense. Gains and losses on the sale of real estate owned are recorded in income based on the difference between the recorded investment at the time of sale and liquidation proceeds. No allowance for losses has been made for loans underlying Farmer Mac I Guaranteed Securities issued prior to the 1996 Act or Farmer Mac II Guaranteed Securities. Farmer Mac I Guaranteed Securities issued prior to the 1996 Act are supported by unguaranteed first loss subordinated interests, which are expected to exceed the estimated credit losses on those loans. USDA-guaranteed portions collateralizing Farmer Mac II Guaranteed Securities are obligations backed by the full faith and credit of the United States. As of December 31, 2004, Farmer Mac had experienced no credit losses on any pre-1996 Act Farmer Mac I Guaranteed Securities or on any Farmer Mac II Guaranteed Securities and does not expect to incur any such losses in the future. Further information regarding the allowance for losses is included in "--Risk Management--Credit Risk - Loans." Results of Operations Overview. Net income available to common stockholders for 2004 rose to $28.2 million or $2.32 per diluted common share, compared to $25.0 million or $2.08 per diluted common share in 2003 and $21.3 million or $1.77 per diluted common share in 2002. Farmer Mac's business volume declined in 2004, with outstanding guarantee and LTSPC volume as of December 31, 2004 that was $345.7 million lower than as of December 31, 2003. During 2004, Farmer Mac: o added $392.6 million of Farmer Mac I eligible loans under LTSPCs; o purchased $104.4 million of newly originated Farmer Mac I eligible loans; and o purchased $174.1 million of Farmer Mac II USDA-guaranteed portions of loans. As of December 31, 2004, the percentage of 90-day delinquencies (Farmer Mac I loans purchased or placed under Farmer Mac I Guaranteed Securities or LTSPCs after changes to Farmer Mac's statutory charter in 1996 that were 90 days or more past due, in foreclosure, restructured after delinquency, or in bankruptcy, excluding loans performing under either their original loan terms or a court-approved bankruptcy plan) decreased to 0.55 percent of the principal balance of all loans held and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs, compared to 0.60 percent at the end of 2003 and 1.21 percent at the end of 2002. After careful evaluation of the overall improved credit quality of Farmer Mac's portfolio, the strong U.S. agricultural economy, the recent upward trend in agricultural land values and the $345.7 million year-over-year reduction in Farmer Mac's outstanding guarantees and commitments, Farmer Mac determined that the appropriate level of allowance for losses as of December 31, 2004 was $17.1 million, compared to $22.1 million as of December 31, 2003 and $20.0 million as of December 31, 2002. As a result of this determination, Farmer Mac released a net $0.4 million from its allowance for losses in 2004, compared to total provisions for losses of $7.3 million in 2003 and $8.2 million in 2002. For further discussion of the change in the allowance for losses and provision for losses, see "--Risk Management--Credit Risk - Loans." As of December 31, 2004, Farmer Mac had $3.8 million of real estate owned, compared to $15.5 million as of December 31, 2003 and $5.0 million as of December 31, 2002. Prior to acquisition of property securing a loan, Farmer Mac develops a liquidation strategy that results in either an immediate sale or retention pending later sale. Farmer Mac evaluates these and other alternatives based upon the economics of the transactions and the requirements of local law. The decrease in real estate owned in 2004 was the result of the lower default rate in Farmer Mac's portfolio and the completion of the liquidation process of previously held real estate owned. Farmer Mac's portfolio also has developed a core of loans that, though the borrowers on those loans have filed for bankruptcy protection, are current under the original terms of the loans or as modified under a court-approved bankruptcy plan. The following table presents Farmer Mac's non-performing assets, which aggregates 90-day delinquencies, loans performing in bankruptcy and real estate owned.
As of December 31, --------------------------- 2004 2003 ------------- ------------ (in thousands) 90-day delinquencies (including loans in $25,283 $ 30,056 foreclosure and loans restructured after delinquency) Loans performing in bankruptcy 21,508 24,192 Real estate owned 3,845 15,716 ------------- ------------ Non-performing assets $50,636 $ 69,964 ------------- ------------
The following table presents historical information regarding Farmer Mac's non-performing assets and 90-day delinquencies:
Outstanding Post-1996 Act Less: Loans, Non- REO and Guarantees and performing Performing 90-day LTSPCs Assets Percentage Bankruptcies Delinquencies Percentage ------------------ ----------------- ------------- ---------------- ----------------- ---------------- (dollars in thousands) As of: December 31, 2004 $ 4,642,208 $ 50,636 1.09% $ 25,353 $ 25,283 0.55% September 30, 2004 4,756,839 75,022 1.58% 27,438 47,584 1.01% June 30, 2004 4,882,505 69,751 1.43% 36,978 32,773 0.68% March 31, 2004 4,922,759 91,326 1.86% 33,951 57,375 1.17% December 31, 2003 5,020,032 69,964 1.39% 39,908 30,056 0.60% September 30, 2003 4,871,756 84,583 1.74% 37,442 47,141 0.98% June 30, 2003 4,875,059 80,169 1.64% 28,883 51,286 1.06% March 31, 2003 4,820,887 94,822 1.97% 18,662 76,160 1.58% December 31, 2002 4,821,634 75,308 1.56% 17,094 58,214 1.21% September 30, 2002 4,506,330 91,286 2.03% 11,460 79,826 1.77% June 30, 2002 4,489,735 65,196 1.45% 14,931 50,265 1.12% March 31, 2002 3,754,171 87,097 2.32% 7,903 79,194 2.11%
Farmer Mac experienced $4.5 million in net losses charged against the allowance for losses in 2004, compared with $5.2 million in net losses for 2003 and $4.1 million in 2002. Farmer Mac recorded gains on the sale of real estate owned of $0.5 million, $0.2 million and $0.1 million in 2004, 2003 and 2002, respectively. During 2004, Farmer Mac recovered approximately $2.8 million from three sellers (one of which was a related party) for breaches of representations and warranties associated with prior sales of agricultural mortgage loans to Farmer Mac, which amount Farmer Mac had previously charged off as losses on the associated loans, consistent with its policy on accounting for claims for breaches of representations and warranties. As these payments are received from sellers rather than borrowers, these recoveries are reported as other income and are not reflected as recoveries in the net losses charged against the allowance for losses discussed above. As of December 31, 2004, approximately $1.4 billion (31 percent) of Farmer Mac's portfolio of post-1996 Act Farmer Mac I loans and loans underlying LTSPCs and Farmer Mac Guaranteed Securities were in their peak default years (approximately years three through five after origination), compared to $1.7 billion (34 percent) as of December 31, 2003 and $1.8 billion (38 percent) as of December 31, 2002. Notwithstanding the recent positive trends in delinquency rates and the overall agricultural economy, during 2005, the level of 90-day delinquencies could increase and higher charge-offs could follow. Outlook for 2005. USDA's most recent publications (as available on USDA's website as of March 15, 2005) forecast: o 2005 net cash farm income to be 78.1 billion, exceeding the two successive record years of $77.8 billion in 2004 and $68.6 billion in 2003; o 2005 net farm income to be $64.4 billion, which is a decrease of $9.2 billion from the record $73.6 billion estimated for 2004 but still $13.3 million higher than the 10-year average net farm income; o Total direct government payments to be $24.1 billion in 2005, an increase from the 2004 estimate of $14.5 billion. Market prices for crops affect direct government payment rates for government programs; USDA anticipates program crop prices to be lower in 2005, due to large inventories from 2003 and 2004 bumper crops; o The value of U.S. farm real estate to increase 4.5 percent in 2005 to $1.232 trillion, a smaller increase as compared to the 2004 increase of 5.4 percent. USDA is anticipating improvement in the general economy to support further growth in farmland values, though at a rate slower than the average annual gain of 5.85 percent since 1999; and o The amount of farm real estate debt to increase by 5.2 percent in 2005 to $119.5 billion, up from $113.6 billion in 2004. The USDA forecast components referenced above relate to U.S. agriculture generally, but should be favorable for Farmer Mac's financial condition relative to its exposure to outstanding guarantees and commitments, as they indicate strong borrower cash flows, and generally increased values in U.S. farm real estate. Factors that significantly lowered Farmer Mac's 2004 new business volume compared to previous years included: o reduced growth rates in the agricultural mortgage market, due largely to the increased liquidity of agricultural borrowers; o increased available capital and liquidity of agricultural lenders; o new alternative sources of funding and credit enhancement for agricultural lenders; o increased competition in the secondary market for purchases of quality agricultural mortgage loans; o adverse publicity about and increased regulatory pressure on GSEs; and o uncertainty created by the proposed FCA regulation concerning risk-weighting of assets held by FCS institutions which, if adopted in its current form, could decrease the value of LTSPCs and Farmer Mac swaps to those institutions (See "- Regulatory Matters"). These factors are likely to continue to constrain Farmer Mac's business opportunities and growth through at least 2005. As a matter of historical practice, many financial institutions have preferred to retain agricultural mortgage loans in their portfolios rather than sell the loans into the secondary market. That preference persists notwithstanding the corporate finance and capital planning benefits these institutions might otherwise realize through participation in Farmer Mac's programs, such as greater liquidity, greater lending capacity, increased return on equity, and decreased capital requirements. In recent years, the preference to retain loans has been reinforced by the stronger capital and liquidity positions of agricultural lenders, combined with their willingness to accept greater asset and liability mismatch in light of the significant differential between lower, short-term interest rates and higher, long-term rates. Those stronger capital and liquidity positions, in turn, have increased competition in the origination, funding and acquisition (for investment) of the limited supply of new agricultural real estate mortgage lending opportunities. Limited supply and increased demand by FCS institutions, insurance companies, commercial banks and other financial institutions for agricultural mortgage loans have narrowed the investment returns on those loans, as has the ability of some lending institutions to subsidize, in effect, their agricultural mortgage loan rates through low-return use of equity. These conditions have limited the need for many agricultural lenders to obtain the benefits of Farmer Mac's programs. Farmer Mac expects these conditions to continue through at least 2005. See "--Business Volume." Farmer Mac faces significant challenges in its efforts to regain its past business volume levels. Unless the Corporation is successful in its current efforts to expand beyond its current business with the FCS and with the commercial banks, its business prospects will continue to be constrained. To succeed in realizing its business development and profitability goals over the longer term, Farmer Mac must successfully market existing and new programs and products to agricultural mortgage lenders. Farmer Mac's outstanding program volume as of December 31, 2004 was $5.5 billion, which represented 12 percent of management's estimate of a $45.4 billion market of eligible agricultural mortgage loans. As part of its efforts to capture a greater share of the market, Farmer Mac is proceeding with a new strategic alliance with a related party FCS institution and sees additional longer-term opportunities that could lead to renewed growth in business volume as a result of the Corporation's marketing efforts. Further, Farmer Mac believes that prospects for larger portfolio transactions similar to those that have accounted for a significant portion of growth in prior years continue to exist, but, in light of market conditions, no assurance can be given at this time as to the certainty or timing of such transactions. While Farmer Mac will continue to market actively its existing secondary market products, it also must address the constraints of the existing business environment, consistent with its charter and purposes. Therefore, Farmer Mac is actively evaluating new loan programs intended to provide for new, diversified business opportunities. In that regard, the Board and management are carrying out initiatives that include agribusiness; federal and state agricultural finance programs; new arrangements to encourage agricultural mortgage sales by banks; and rural development associated with agriculture. Some of the agribusiness and rural development initiatives will require Farmer Mac to consider credit risks that expand upon or differ from those the Corporation has accepted previously. Farmer Mac will use underwriting standards appropriate to those credit risks, and likely will draw upon outside expertise to analyze and evaluate the credit and funding aspects of loans submitted pursuant to those initiatives. While Farmer Mac is seeking actively to expand its mix of loan types within the scope of its Congressional charter, investors are cautioned that it is too early to assess the probability of success of these efforts. During 2004 and 2005 to date, Farmer Mac has continued to validate and enhance its risk management practices, internal controls, accounting and financial reporting, as a result of ongoing corporate diligence and a number of regulatory considerations, including the Sarbanes-Oxley Act of 2002 and FCA requirements, as well as the general regulatory environment for GSEs. A detailed presentation of Farmer Mac's financial results for the years ended December 31, 2004, 2003 and 2002 follows. Net Interest Income. Net interest income, which does not include guarantee fees for loans purchased prior to April 1, 2001 (the effective date of Statement of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities ("SFAS 140")), was $33.2 million for 2004, $37.3 million for 2003 and $39.1 million for 2002. The net interest yield was 86 basis points for the year ended December 31, 2004, compared to 93 basis points for the year ended December 31, 2003 and 104 basis points for the year ended December 31, 2002. The effect of the adoption of SFAS 140 was a reclassification of approximately $4.1 million (10 basis points) of guarantee fee income as interest income for the year ended December 31, 2004, compared to $4.4 million (11 basis points) for the year ended December 31, 2003 and $2.7 million (7 basis points) for the year ended December 31, 2002. In 2003, the Chief Accountant at the U.S. Securities and Exchange Commission provided additional guidance to all registrants regarding the classification on the statement of operations of realized gains and losses resulting from financial derivatives that are not in fair value or cash flow hedge relationships. All registrants were requested to comply with this guidance in future filings and to reclassify this activity for all prior periods presented. As a result of the application of this additional guidance, the net interest income and expense realized on financial derivatives that are not in fair value or cash flow hedge relationships have been reclassified from net interest income into gains and losses on financial derivatives and trading assets. For the years ended December 31, 2004, 2003 and 2002, this reclassification resulted in a decrease of the net interest yield of 5 basis points, one basis point, and 11 basis points, respectively. The net interest yields for the years ended December 31, 2004, 2003 and 2002 included the benefits of yield maintenance payments received of 13 basis points, 12 basis points and 8 basis points, 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 should not be considered indicative of positive or negative trends to gauge future financial results. For the years ended December 31, 2004, 2003 and 2002, the after-tax effects of yield maintenance payments on net income and diluted earnings per share were $3.4 million or $0.28 per diluted share, $3.0 million or $0.25 per diluted share and $2.1 million or $0.17 per diluted share, respectively. In light of current expectations that interest rates will rise during 2005, it should be expected that prepayments will be down in the year, which would result in lower levels of yield maintenance payments received by Farmer Mac. The following table provides information regarding interest-earning assets and funding for the years ended December 31, 2004, 2003 and 2002. The balance of non-accruing loans is included in the average balance of interest-earning loans presented, though no related income is included in the income figures presented. Therefore, as the balance of non-accruing loans increases or decreases, the net interest yield will increase or decrease accordingly. Net interest income and the yield will also fluctuate due to the uncertainty of the timing and size of yield maintenance payments. The low average rate earned on cash and cash equivalents reflects the relatively low level of short-term interest rates in 2004 and 2003, compared to 2002, and an increase in short-term market rates in 2004 compared to 2003. The decrease in the average rate for investments reflects the narrower spreads between U.S. Treasury securities and corresponding floating rate investments acquired and outstanding during 2004, compared to wider spreads on investments acquired and outstanding during the prior periods. The lower average rate on loans and Farmer Mac Guaranteed Securities reflects the normal amortization and prepayment of principal balances of older, higher-yielding fixed rate loans. The fluctuations in the average rate on Farmer Mac's notes payable due within one year are 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, higher rate debt, as well as the issuance of new debt at lower rates and the relative stability of long-term interest rates during 2004.
2004 2003 2002 ------------------------------------ ----------------------------------- --------------------------------- Average Income/ Average Average Income/ Average Average Income/ Average Balance Expense Rate Balance Expense Rate Balance Expense Rate ------------ ---------- ----------- ------------- ----------- ---------- ------------ ----------- ------- (dollars in thousands) Interest-earning assets: Cash and cash equivalents $ 600,964 $ 8,496 1.41% $ 677,075 $ 8,171 1.21% $ 564,614 $10,237 1.81% Investments 973,230 27,890 2.87% 932,738 27,115 2.91% 902,740 32,392 3.59% Loans and Farmer Mac Guaranteed Securities 2,274,046 117,608 5.17% 2,415,466 126,273 5.24% 2,291,887 129,241 5.64% ------------ ---------- ----------- ------------- ----------- ---------- ------------ ----------- ------ Total interest-earning assets $ 3,848,240 153,994 4.00% $ 4,025,279 161,559 4.02% $ 3,759,241 171,870 4.57% ------------ ------------- ------------- Funding: Notes payable due within one year $ 2,050,934 52,788 2.57% $ 2,702,188 60,756 2.26% $ 2,533,762 67,896 2.68% Notes payable due after one year 1,609,236 67,959 4.22% 1,200,219 63,551 5.29% 1,102,485 64,875 5.88% ------------- ---------- ----------- ------------- ----------- --------- ------------ ----------- ------ Total interest-bearing liabilities 3,660,170 120,747 3.30% 3,902,407 124,307 3.19% 3,636,247 132,771 3.65% Net non-interest-bearing funding 188,070 - 0.00% 122,872 - 0.00% 122,994 - 0.00% ------------ ---------- ----------- ------------- ----------- --------- ------------ ----------- ------ Total funding $ 3,848,240 120,747 3.14% $ 4,025,279 124,307 3.10% $ 3,759,241 132,771 3.53% ------------ ---------- ----------- ------------- ----------- --------- ------------ ----------- ------ Net interest income/ yield $ 33,247 0.86% $ 37,252 0.93% $39,099 1.04% ---------- ----------- ------------ -------- ------------ ------
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 increases due to rate reflect the short-term or adjustable-rate nature of the assets or liabilities and the general increases in short term market rates, while the decrease due to rate for loans and Farmer Mac Guaranteed Securities reflects the normal amortization and prepayment of principal balances of older higher-yielding fixed rate loans, as described above.
2004 vs. 2003 2003 vs. 2002 ----------------------------------- ------------------------------------ Increase (Decrease) Due to Increase (Decrease) Due to ----------------------------------- ------------------------------------ Rate Volume Total Rate Volume Total ----------- ----------- ----------- ------------ ----------- ----------- (in thousands) Income from interest-earning assets: Cash and cash equivalents $ 1,305 $ (981) $ 324 $(2,572) $ 506 $(2,066) Investments (390) 1,165 775 (6,323) 1,046 (5,277) Loans and Farmer Mac Guaranteed Securities (1,338) (7,326) (8,664) (9,719) 6,751 (2,968) ----------- ----------- ----------- ------------ ----------- ----------- Total (423) (7,142) (7,565) (18,614) 8,303 (10,311) Expense from interest-bearing liabilities 2,646 (6,206) (3,560) (17,593) 9,129 (8,464) ----------- ----------- ----------- ------------ ----------- ----------- Change in net interest income $(3,069) $ (936) $ (4,005) $(1,021) $ (826) $(1,847) ----------- ----------- ----------- ------------ ----------- -----------
Guarantee and Commitment Fees. Guarantee and commitment fee income, which compensate Farmer Mac for assuming the credit risk on loans underlying Farmer Mac Guaranteed Securities and LTSPCs, was $21.0 million for 2004, compared to $20.7 million for 2003 and $19.3 million for 2002. The increase in guarantee and commitment fee income reflects an increase in the average balance of outstanding guarantees and LTSPCs. For 2004, the effect of SFAS 140 classified $4.1 million of guarantee fees received as interest income, although management considers that amount to have been earned in consideration for the assumption of credit risk. That portion of the difference or "spread" between the cost of Farmer Mac's debt funding for loans and the yield on post-1996 Act Farmer Mac I Guaranteed Securities held on its books compensates for credit and interest rate risk. When a post-1996 Act Farmer Mac I Guaranteed Security is sold to a third party, Farmer Mac continues to receive the guarantee fee component of that spread, which continues to compensate Farmer Mac for its assumption of credit risk. The portion of the spread that compensates for interest rate risk would not typically continue to be received by Farmer Mac if the asset were sold, except to the extent attributable to any retained interest-only strip. Gains and Losses on Financial Derivatives and Trading Assets. Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS 133") requires the change in the fair values of financial derivatives to be reflected in a company's net income or accumulated other comprehensive income. The net effect of financial derivatives that do not qualify for hedge accounting under SFAS 133 and trading assets recorded in Farmer Mac's consolidated statements of operations was a net gain of $2.8 million for 2004, a net gain of $2.4 million for 2003 and a net loss of $8.4 million for 2002. On a net after-tax basis, those gains and losses, combined with the cumulative effect of the change in accounting principles and benefits received from the elimination of the amortization of certain premium payments that resulted from SFAS 133, increased net income available to common stockholders by $0.8 million in 2004, increased net income available to common stockholders by $2.0 million for 2003 and reduced net income available to common stockholders by $1.6 million for 2002. Gains on the Sale of Real Estate Owned. Gains on the sale of real estate owned were $0.5 million, $0.2 million and $0.1 million for each of the years ended December 31, 2004, 2003 and 2002, respectively. Representation and Warranty Claims Income. During 2004, Farmer Mac recovered approximately $2.8 million from three sellers (one of which was a related party) for breaches of representations and warranties associated with prior sales of agricultural mortgage loans to Farmer Mac. During 2003 and 2002, Farmer Mac had no representation and warranty claims income. Other Income. Other income was $1.5 million for 2004, compared to $0.8 million for 2003 and $1.3 million for 2002. Expenses. During 2003 and 2004, and into 2005, Farmer Mac undertook (and expects to continue) several initiatives to validate and enhance its risk management practices, internal controls, and accounting and financial reporting. These initiatives are the result of ongoing corporate diligence and a number of regulatory considerations, including compliance with the Sarbanes-Oxley Act of 2002 and FCA requirements, as well as the heightened focus on the regulatory environment for GSEs generally. The general increases in both compensation and employee benefits and general and administrative expenses from 2002 to 2004 reflect the costs of those initiatives, particularly staffing increases relative to the internal controls function. Compensation and employee benefits were $7.0 million, $6.1 million and $5.1 million for 2004, 2003 and 2002, respectively. General and administrative expenses, including consultants' fees, were $8.8 million, $6.0 million and $5.5 million for 2004, 2003 and 2002, respectively. Farmer Mac expects all of the above-mentioned expenses to continue at or above current levels through 2005. Regulatory fees were $2.1 million, $2.0 million and $1.2 million for 2004, 2003 and 2002, respectively. FCA has advised Farmer Mac that its estimated assessment for 2005 is $2.3 million. The regulatory assessments from FCA for each of the examination periods corresponding approximately with each of the years ended December 31, 2004, 2003 and 2002 include both their originally estimated assessments and revisions to those estimates that reflect actual costs incurred. These revisions have resulted in both additional assessments and refunds in the past. Real estate owned net operating expenses were $0.3 million for each of the years ended December 31, 2004 and 2003. These net costs were negligible for the year ended December 31, 2002. After careful evaluation of the overall improved credit quality of Farmer Mac's portfolio, the strong U.S. agricultural economy, the recent upward trend in agricultural land values and the $345.7 million year-over-year reduction in Farmer Mac's outstanding guarantees and commitments, Farmer Mac determined that the appropriate level of allowance for losses as of December 31, 2004 was $17.1 million, compared to $22.1 million as of December 31, 2003 and $20.0 million as of December 31, 2002. As a result of this determination, Farmer Mac released a net $0.4 million from its allowance for losses in 2004, compared to total provisions for the allowance for losses in 2003 and 2002 of $7.3 million and $8.2 million, respectively. For 2004, the release of the allowance for losses of $0.4 million was the net effect of a release of $2.0 million from the provision for losses, which is a component of operating expenses, and a partially offsetting provision for loan losses of $1.6 million, which was charged against net interest income. The $2.0 million release from the provision for losses in 2004 compares to provisions for losses of $0.8 million and $6.9 million for 2003 and 2002, respectively. For additional information regarding Farmer Mac's provisions for losses and allowances for losses in the aggregate, see "--Risk Management--Credit Risk - Loans." Income Tax Expense. Income tax expense totaled $14.0 million in 2004, compared to $12.3 million in 2003 and $9.8 million in 2002. Farmer Mac's effective tax rates for 2004, 2003 and 2002 were approximately 31.4 percent, 31.1 percent and 30.1 percent, respectively. For more information about income taxes, see Note 10 to the consolidated financial statements. Gains and Losses on the Repurchase of Debt. During 2004 and 2003, Farmer Mac did not repurchase any of its outstanding debt. During 2002, Farmer Mac recognized $1.4 million of net gains on the repurchase of $103.7 million of its outstanding debt. All of the repurchases were from outstanding Farmer Mac debt that had a maturity date of October 14, 2011 and an interest rate of 5.4 percent. Those debt securities were replaced with new fixed-rate funding to the same maturity dates at more attractive interest rates, which preserved Farmer Mac's asset-liability match and reduced future interest expense. Non-GAAP Performance Measures. Farmer Mac reports its financial results in accordance with accounting principles generally accepted in the United States of America ("GAAP"). In addition to GAAP measures, Farmer Mac presents certain non-GAAP performance measures. Farmer Mac uses the latter measures to develop financial plans, to gauge corporate performance and to set incentive compensation because, in management's view, the non-GAAP measures more accurately represent Farmer Mac's economic performance, transaction economics and business trends. Investors and the investment analyst community have previously relied upon similar measures to evaluate Farmer Mac's historical and future performance. Farmer Mac's disclosure of non-GAAP measures is not intended to replace GAAP information but, rather, to supplement it. Farmer Mac developed non-GAAP core earnings to present net income less the after-tax effects of SFAS 133 and less the after-tax net gains and losses on the repurchase of debt that, prior to January 1, 2003, were reported as extraordinary items. Core earnings for the years ended December 31, 2004, 2003 and 2002 were $27.4 million, $23.0 million and $22.9 million, respectively. The reconciliation of GAAP net income available to common stockholders to core earnings is presented in the following table:
Reconciliation of GAAP Net Income Available to Common Stockholders to Core Earnings - ------------------------------------------------------------------------------------------ For the Year Ended December 31, ------------------------------------------------------ 2004 2003 2002 ----------------- ------------------ ----------------- (in thousands) GAAP net income available to common stockholders $ 28,228 $ 25,030 $ 21,295 Less the effects of SFAS 133: Unrealized gains/(losses) on financial derivatives and trading assets, net of tax 588 1,720 (2,834) Benefit from non-amortization of premium payments on financial derivatives, net of tax 228 317 382 Less gains on the repurchase of debt previously reported as extraordinary items - - 889 ----------------- ------------------ ----------------- Core earnings $ 27,412 $ 22,993 $ 22,858 ----------------- ------------------ -----------------
Effects of SFAS 133 on Accounting for Callable Interest Rate Swaps. Farmer Mac enters into financial derivative transactions to protect against risk from the effects of market price or interest rate movements on the value of assets, future cash flows and 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 mortgage and other assets, and also to adjust the characteristics of its long-term debt to match more closely the cash flow and duration characteristics of its short-term assets, thereby reducing interest rate risk and also to derive an overall lower effective fixed-rate cost of borrowing than would otherwise be available to Farmer Mac in the conventional debt market. Specifically, interest rate swaps convert economically the variable cash flows related to the forecasted issuance of short-term debt to effectively fixed-rate medium-term and long-term notes that match the anticipated duration, repricing and interest rate characteristics of the corresponding assets. Since this strategy provides Farmer Mac with the same cash flows as those that are inherent in the issuance of medium-term notes, Farmer Mac uses either the bond market or the swap market based upon their relative pricing efficiencies. Farmer Mac uses callable interest rate swaps (in conjunction with the issuance of short-term debt) as an alternative to callable medium-term notes with equivalently structured maturities and call options. The call options on the swaps are designed to match the implicit prepayment options on those mortgage assets without prepayment protection. The blended durations of the swaps are also designed to match the duration of the mortgages over their estimated lives. If the mortgages prepay, the swaps can be called and the short-term debt repaid; if the mortgages do not prepay, the swaps remain outstanding and the short-term debt is rolled over, effectively providing fixed-rate callable funding over the lives of the mortgages. Thus, the economics of the assets are closely matched to the economics of the interest rate swap and funding combination. The callable interest rate swaps are recorded at fair value on Farmer Mac's balance sheet with the related changes in fair value recognized in the consolidated statement of operations. Although Farmer Mac believes that this strategy achieves its economic and risk management objectives, the Financial Accounting Standards Board has adopted a mixed attribute accounting model for callable swaps that does not reflect the economics of the transactions. Pursuant to that model, while the issuance of a callable medium-term note is recorded at historical cost, the economic equivalent (the issuance of short term-debt with the forecasted rollover of that debt and the simultaneous issuance of a callable interest rate swap) is recorded differently (the discount notes are recorded at historical cost and the interest rate swap is recorded at fair value). Despite the closely matched economics and optionality of the assets and the associated interest rate swap and funding combination, the callable swaps do not qualify for hedge accounting under SFAS 133 because the test for hedge effectiveness under SFAS 133 is based on the linkage between the forecasted short-term funding and the callable interest rate swap and ignores the prepayable characteristics of the associated assets being funded. Business Volume. Loans are brought into the Farmer Mac I and Farmer Mac II programs as follows: o Farmer Mac purchases eligible loans and guarantees timely payments of principal and interest of securities backed by those loans as part of the Farmer Mac I program. Farmer Mac may retain some or all of those securities in its portfolio or sell them to third parties in capital markets transactions. o Farmer Mac purchases USDA-guaranteed portions of loans and guarantees timely payments of principal and interest of securities backed by those guaranteed portions as part of the Farmer Mac II program. Farmer Mac may retain some or all of those securities in its portfolio or sell them to third parties in capital markets transactions. o Farmer Mac enters into LTSPCs for eligible loans. Farmer Mac's commitments through LTSPCs include either newly originated or seasoned eligible loans, and are part of the Farmer Mac I program. o Farmer Mac exchanges Farmer Mac Guaranteed Securities for eligible loans or USDA-guaranteed portions of loans. Farmer Mac Guaranteed Securities exchanged for USDA-guaranteed portions of loans are part of the Farmer Mac II program; Farmer Mac Guaranteed Securities exchanged for any other eligible loans are part of the Farmer Mac I program. During 2004, the volume of loans purchased or placed under Farmer Mac Guaranteed Securities and LTSPCs totaled $0.7 billion, a decrease from 2003 volume of $1.2 billion. That decrease was attributable to a decrease of $88.2 million in Farmer Mac I Loans and Farmer Mac Guaranteed Securities volume, a decrease of $370.8 million in LTSPC volume, and a decrease of $97.2 million in Farmer Mac II volume in 2004. See "Business--Farmer Mac Programs--Farmer Mac I--Off-Balance Sheet Guarantees and Commitments" and Note 12 to the consolidated financial statements for a description of LTSPCs. The following table sets forth information regarding the volume of loans purchased or placed under Farmer Mac Guaranteed Securities or LTSPCs for the periods indicated:
Farmer Mac Loan Purchases, Guarantees and LTSPCs - -------------------------------------------------------------------------------- For the Year Ended December 31, --------------------------------------------- 2004 2003 2002 --------------- -------------- ------------- (in thousands) Farmer Mac I: Loans and Guaranteed Securities $ 104,404 $ 192,577 $ 747,881 LTSPCs 392,559 763,342 1,155,479 Farmer Mac II 174,074 271,229 173,011 --------------- -------------- ------------- Total $ 671,037 $ 1,227,148 $ 2,076,371 --------------- -------------- -------------
The purchase price of newly originated and seasoned eligible loans and portfolios, none of which are delinquent at the time of purchase, is the fair value based on current market interest rates and Farmer Mac's target net yield, which includes an amount to compensate Farmer Mac for credit risk that is similar to the guarantee or commitment fee it receives for accepting credit risk on loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs. The purchase price for loans purchased from all related parties is determined in the same manner as for loans acquired from any other third party. See Note 3 to the consolidated financial statements for a description of related party transactions. 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 at the time of purchase, out of those securities and pools. 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. See "--Risk Management--Credit Risk - Loans." The following table presents Farmer Mac's purchases of newly originated and current seasoned loans and purchases of defaulted loans underlying Farmer Mac I Guaranteed Securities and LTSPCs.
For the Year Ended December 31, ------------------------------ 2004 2003 -------------- -------------- (in thousands) Farmer Mac I newly originated and current seasoned loan purchases $ 104,404 $ 192,577 Defaulted loans purchased underlying off-balance sheet Farmer Mac I Guaranteed Securities 2,186 16,276 Defaulted loans purchased underlying LTSPCs 2,292 4,266 Defaulted loans underlying on-balance sheet Farmer Mac I Guaranteed Securities transferred to loans 8,305 35,100
The decrease in newly originated and current seasoned loan purchases was attributable to a decrease in program volume. The purchases of defaulted loans from Farmer Mac I Guaranteed Securities and LTSPCs are pursuant to Farmer Mac's obligations as guarantor and under its contractual commitments, respectively. Farmer Mac may, in its sole discretion, repurchase the defaulted loans underlying Farmer Mac Guaranteed Securities and is obligated to purchase those underlying an LTSPC. With respect to the transfer of loans from on-balance sheet Farmer Mac I Guaranteed Securities to loans, when particular criteria are met, such as the default of the borrower, Farmer Mac becomes entitled to purchase the defaulted loans underlying Farmer Mac I Guaranteed Securities (commonly referred to as "removal-of-account" provisions). Farmer Mac records all such defaulted loans at their value during the period in which Farmer Mac becomes entitled to repurchase the loans and therefore regains effective control over the transferred loans. Fair value is determined by appraisal or management's estimate of discounted collateral value. Farmer Mac records, at acquisition, the difference between each loan's acquisition cost and its fair value, if any, as a charge to the reserve for losses. The weighted-average age of the Farmer Mac I newly originated and current seasoned loans purchased during both 2004 and 2003 was less than one year. Of the combined total of Farmer Mac I newly originated and seasoned loans that were purchased (excluding purchases of defaulted loans) during 2004 and 2003, 64 percent and 74 percent, respectively, had principal amortization periods longer than the maturity date, resulting in balloon payments at maturity, with a weighted-average remaining term to maturity of 17.5 and 15.2 years, respectively. The weighted-average age of delinquent loans purchased out of securitized pools and LTSPCs during 2004 and 2003 was 6.1 years and 4.7 years, respectively. The outstanding principal balance of loans held and loans underlying LTSPCs and on- and off-balance sheet Farmer Mac Guaranteed Securities decreased six percent to $5.5 billion as of December 31, 2004 from $5.8 billion as of December 31, 2003. The following table sets forth information regarding those outstanding balances as of the dates indicated:
Outstanding Balance of Farmer Mac Loans and Loans Underlying Farmer Mac Guaranteed Securities and LTSPCs - ------------------------------------------------------------------------------------------- As of December 31, -------------------------------------------------- 2004 2003 2002 --------------- --------------- --------------- (in thousands) Farmer Mac I: Post-1996 Act: Loans and Guaranteed Securities $ 2,371,405 $ 2,696,530 $ 2,168,994 LTSPCs 2,295,103 2,348,702 2,681,240 Pre-1996 Act 18,640 24,734 31,960 Farmer Mac II 768,542 729,470 645,790 --------------- --------------- --------------- Total $ 5,453,690 $ 5,799,436 $ 5,527,984 --------------- --------------- ---------------
The following table sets forth information regarding the Farmer Mac I Guaranteed Securities issued during the periods indicated:
Farmer Mac I Guaranteed Securities Issuances - ----------------------------------------------------------------------------------------------------- For the Year Ended December 31, ---------------------------------------------- 2004 2003 2002 --------------- -------------- -------------- (in thousands) Retained $ - $ - $ - Sold 91,362 78,254 47,682 Swap transactions - 722,315 - --------------- -------------- -------------- Total Farmer Mac Guaranteed Securities Issuances $ 91,362 $ 800,569 $ 47,682 --------------- -------------- --------------
Based on market conditions, Farmer Mac either retains the loans it purchases or securitizes them and issues Farmer Mac I Guaranteed Securities backed by those loans. During 2004 and 2003, Farmer Mac securitized and sold $91.4 million and $78.3 million, respectively ($64.5 million and $75.8 million, respectively, of such securities were sold to a related party, Zions First National Bank), of the loans purchased, and during 2003 issued $722.3 million in the form of a swap transaction with a related party participant, Farm Credit West, ACA. This transaction resulted from the participant's exercise of a conversion feature incorporated in all existing LTSPCs. Farmer Mac's decision to retain the remainder of the loans it purchased was based on favorable underlying funding costs that resulted in attractive net interest income over the lives of the loans and Farmer Mac Guaranteed Securities it holds. LTSPCs typically involve seasoned loans, while cash purchase transactions usually represent acquisitions of newly originated loans. The decreased LTSPC activity in 2004 was a result of reduced growth rates in the agricultural mortgage market, which have tended to be a function of the interest rate environment and other factors described two paragraphs below. With particular regard to FCS institutions, some business prospects have been constrained by increased FCSIC insurance premiums assessed on loans held by those institutions, including loans under LTSPCs. In addition, FCSIC has recently indicated to those institutions that they should be cautious about the risk of doing business with GSEs, including Farmer Mac, as counterparties. Moreover, FCSIC has raised objections to FCS institutions' use of Farmer Mac swaps, which generate Farmer Mac I Guaranteed Securities that are not subject to the previously mentioned insurance premiums. Notwithstanding this, management expects that LTSPCs will continue to constitute a significant portion of new Farmer Mac I program activity during 2005. Indicators of future loan purchase and guarantee volume (excluding LTSPC, swap or portfolio purchase volume) in the immediately succeeding reporting period include outstanding commitments to purchase loans (other than under LTSPCs) and the total balance of loans submitted for approval or approved but not yet purchased. Many purchase commitments entered into by Farmer Mac are mandatory delivery commitments. If a seller obtains a mandatory commitment and is unable to deliver the loans required, Farmer Mac requires the seller to pay a fee to modify, extend or cancel the commitment. As of December 31, 2004, outstanding commitments to purchase Farmer Mac I loans and Farmer Mac II guaranteed portions totaled $13.0 million, compared to $11.2 million as of December 31, 2003. All of those commitments were mandatory commitments. Loans submitted for approval or approved but not yet committed to purchase totaled $19.2 million as of December 31, 2004, compared to $26.6 million as of December 31, 2003. Not all of such loans are purchased, as some are denied for credit reasons or withdrawn by the seller. New business volume decreased during 2004 compared to 2003. Factors that significantly lowered Farmer Mac's 2004 new business volume compared to previous years included: o reduced growth rates in the agricultural mortgage market, due largely to the increased liquidity of agricultural borrowers; o increased available capital and liquidity of agricultural lenders; o new alternative sources of funding and credit enhancement for agricultural lenders; o increased competition in the secondary market for purchases of quality agricultural mortgage loans; o adverse publicity about and increased regulatory pressure on GSEs; and o uncertainty created by the proposed FCA regulation concerning risk-weighting of assets held by FCS institutions which, if adopted in its current form, could decrease the value of LTSPCs and Farmer Mac swaps to those institutions (See "- Regulatory Matters"). During 2004, Farmer Mac was not able to replicate recent prior years' volume growth in Farmer Mac I and II individual loan purchases, nor in additions to existing LTSPC arrangements. However, Farmer Mac believes its marketing initiatives are generating business opportunities for 2005 and beyond. Initiatives currently underway include: o new and expanded business relationships, including a strategic alliance with a related party Farm Credit System institution that will serve a cross-section of agricultural lenders in many areas of the nation; o product enhancements, such as new open prepayment loan structures; o agribusiness and rural development loans associated with agriculture, in fulfillment of its Congressional mission; o federal and state agricultural finance programs; and o new loan securitization structures. Some of the agribusiness and rural development initiatives will require Farmer Mac to consider credit risks that expand upon or differ from those the Corporation has accepted previously. Farmer Mac will use underwriting standards appropriate to those credit risks, and likely will draw upon outside expertise to analyze and evaluate the credit and funding aspects of loans submitted pursuant to those initiatives. While Farmer Mac is seeking actively to expand its mix of loan types within the scope of its Congressional charter, investors are cautioned that it is too early to assess the probability of success of these efforts. Farmer Mac believes that prospects for larger portfolio transactions similar to those that have accounted for a significant portion of growth in prior years continue to exist, but, in light of market conditions, no assurance can be given at this time as to the certainty or timing of such transactions. For information regarding sellers in the Farmer Mac I and Farmer Mac II programs, see "Business--Farmer Mac Programs--Farmer Mac I--Sellers" and "--Farmer Mac II--United States Department of Agriculture Guaranteed Loan Programs." Related Party Transactions. In 2004 and 2003, Farmer Mac conducted business with entities that are related parties as a result of either a member of Farmer Mac's board of directors being affiliated with the entity in some capacity or the entity being the holder of at least 10 percent of a class of voting common stock. These transactions were conducted in the ordinary course of business, with terms and conditions comparable to those available to any other third party. For more information about related party transactions, see Note 3 to the consolidated financial statements. Balance Sheet Review Assets. As of December 31, 2004, total assets were $3.8 billion compared to $4.3 billion as of December 31, 2003. On-balance sheet program assets (Farmer Mac Guaranteed Securities and loans), decreased $232.0 million during 2004 to a total of $2.2 billion, while non-program assets decreased $220.8 million to $1.6 billion as of December 31, 2004. The following table presents Farmer Mac's on-balance sheet program assets based on their repricing frequency.
Outstanding Balance of Loans Held and Loans Underlying On-Balance Sheet Farmer Mac Guaranteed Securities - --------------------------------------------------------------------------- As of December 31, ------------------------------------ 2004 2003 ----------------- ---------------- (in thousands) Fixed rate (10-yr. wtd. avg. term) $ 763,210 $ 860,874 5-to-10 year ARMs and resets 923,520 1,045,217 1-Month-to-3-Year ARMs 533,686 542,024 ----------------- ---------------- Total held in portfolio $ 2,220,416 $ 2,448,115 ----------------- ----------------
Liabilities. Total liabilities decreased to $3.6 billion as of December 31, 2004 from $4.1 billion as of December 31, 2003. The decrease in liabilities was due primarily to a reduction in notes payable, which corresponded to the reduction of on-balance sheet assets. For more information about Farmer Mac's funding and interest rate risk practices and how financial derivatives are used, see "--Risk Management--Interest Rate Risk." For more information about Farmer Mac's reserve for losses, see "--Risk Management--Credit Risk - Loans." Capital. As of December 31, 2004, stockholders' equity totaled $236.9 million, compared to $213.3 million as of December 31, 2003. The increase was primarily due to net income available to common stockholders of $28.2 million earned during 2004. Additionally, there was a $1.4 million net increase in accumulated other comprehensive income/(loss) resulting from a net increase of $11.1 million in the market values of financial derivatives classified as cash flow hedges and a decrease of $9.7 million in net unrealized gains on investment securities and Farmer Mac Guaranteed Securities classified as available for sale. Farmer Mac's return on average common equity was 14.9 percent for 2004, compared to 15.3 percent for 2003 and 15.0 percent for 2002. Accumulated other comprehensive income is not a component of Farmer Mac's core capital or regulatory capital. Farmer Mac is required to hold capital at the higher of its statutory minimum capital requirement or the amount required by its risk-based capital stress test. As of December 31, 2004, Farmer Mac's core capital totaled $237.7 million and exceeded its statutory minimum capital requirement of $128.9 million by $108.8 million. As of December 31, 2004 Farmer Mac's risk-based capital stress test generated a regulatory capital requirement of $37.1 million. Farmer Mac's regulatory capital of $254.8 million exceeded that amount by approximately $217.7 million. For further information, see "--Liquidity and Capital Resources--Capital Requirements." Off-Balance Sheet Farmer Mac Guaranteed Securities and LTSPCs. Farmer Mac offers approved agricultural and rural residential mortgage lenders two 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 either the Farmer Mac I program or the Farmer Mac II program, and (2) LTSPCs, which are available only through the Farmer Mac I program. Both of these alternatives result in off-balance sheet transactions for Farmer Mac. To be eligible for the Farmer Mac I program, a loan must meet Farmer Mac's credit underwriting, appraisal and documentation standards. Accordingly, Farmer Mac believes the credit risk it assumes for Farmer Mac Guaranteed Securities backed by loans that are eligible for the Farmer Mac I program and for LTSPCs is the same and considers the effects of all on- and off-balance sheet activities on its overall portfolio diversification and credit risk. See Note 12 to Farmer Mac's consolidated financial statements for more detail on the Corporation's off-balance sheet program activities. As of December 31, 2004, outstanding off-balance sheet Farmer Mac Guaranteed Securities and LTSPCs totaled $3.2 billion, compared to $3.4 billion as of December 31, 2003. The following table presents the balance of outstanding LTSPCs and off-balance sheet Farmer Mac Guaranteed Securities as of December 31, 2004 and 2003:
Outstanding Balance of LTSPCs and Off-Balance Sheet Farmer Mac Guaranteed Securities - ------------------------------------------------------------------------------ As of December 31, ---------------------------------- 2004 2003 ----------------- --------------- (in thousands) Farmer Mac I: Post-1996 Act obligations: Farmer Mac I Guaranteed Securities $ 882,282 $ 952,134 LTSPCs 2,295,103 2,348,702 ----------------- --------------- Total Farmer Mac I 3,177,385 3,300,836 Farmer Mac II Guaranteed Securities 55,889 51,241 ----------------- --------------- Total Farmer Mac I and II $ 3,233,274 $ 3,352,077 ----------------- ---------------
For more information about off-balance sheet Farmer Mac Guaranteed Securities, see "--Risk Management--Credit Risk - Loans" and Note 12 to the consolidated financial statements. Risk Management 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 because of 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 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 its interest rate risks to a large degree. As of December 31, 2004, 58 percent of the outstanding balance of all loans held and loans underlying on-balance sheet Farmer Mac I Guaranteed Securities (including 94 percent of all loans with fixed interest rates) were covered by yield maintenance provisions and other prepayment penalties. As of December 31, 2004, 52 percent of the total outstanding balance of retained Farmer Mac I loans and Guaranteed Securities had yield maintenance provisions and 6 percent had other forms of prepayment protection. Of the Farmer Mac I new and current loans purchased in 2004, 8 percent had yield maintenance or another form of prepayment protection (including 25 percent of all loans with fixed interest rates). As of December 31, 2004, none of the USDA-guaranteed portions underlying Farmer Mac II Guaranteed Securities had yield maintenance provisions; however, 13 percent contained prepayment penalties. Of the USDA-guaranteed portions purchased in 2004, 25 percent contained prepayment penalties. 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' behavior in various interest rate environments may change over time, 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. In addition, Farmer Mac consults with independent prepayment experts as part of the model evaluation process. 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 durations 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 mortgage assets. 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 alter the duration of its assets and liabilities to better match their durations, thereby reducing overall interest rate sensitivity. Farmer Mac's $430.5 million of cash and cash equivalents as of December 31, 2004 matures within three months and is match-funded with discount notes having similar maturities. As of December 31, 2004, $823.4 million of the $1.1 billion of investment securities (78.0 percent) were floating rate securities with rates that adjust within one year. See Note 4 to the consolidated financial statements for more information on investment securities. These floating rate investments are funded using: o a series of discount note issuances in which each successive discount note is issued and matures on or about the corresponding repricing date of the related investment; o floating-rate notes having similar rate reset provisions as the related investment; or o fixed-rate notes swapped to floating rates having similar reset provisions as the related investment. Farmer Mac is also subject to interest rate risk on loans, including loans that Farmer Mac has committed to acquire (other than through LTSPCs) but has not yet purchased. When Farmer Mac commits to purchase such loans, it is exposed to interest rate risk between the time it commits to purchase the loans and the time it either: o sells Farmer Mac Guaranteed Securities backed by the loans; or o issues debt to retain the loans in its portfolio (although issuing debt to fund the loans as investments does not fully eliminate interest rate risk due to the possible timing differences in the cash flows of the assets and related liabilities, as discussed above). Farmer Mac manages the interest rate risk related to such loans, and any related Farmer Mac Guaranteed Securities or debt issuance, through the use of forward sale contracts on the debt and mortgage-backed securities of other GSEs and futures contracts involving U.S. Treasury securities. Farmer Mac uses forward sale contracts on GSE securities to reduce its interest rate exposure to changes in both Treasury rates and spreads on Farmer Mac debt and Farmer Mac I Guaranteed Securities. Recognizing that interest rate sensitivity may change with the passage of time and as interest rates change, Farmer Mac assesses this exposure on a regular basis and, if necessary, readjusts its portfolio of assets and liabilities by: o purchasing mortgage assets in the ordinary course of business; o refunding existing liabilities; or o using derivatives to alter the characteristics of existing assets or liabilities. The most comprehensive 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 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 spreads. The following schedule summarizes the results of Farmer Mac's MVE sensitivity analysis as of December 31, 2004 and December 31, 2003 to an immediate and instantaneous parallel shift in the yield curve.
Percentage Change in MVE from Base Case ---------------------------------- As of December 31, Interest Rate ---------------------------------- Scenario 2004 2003 --------------- ---------------- ---------------- + 300 bp -5.8% -0.4% + 200 bp -3.3% 0.2% + 100 bp -1.2% 0.4% - 100 bp 0.0% 0.0% - 200 bp -1.3% N/A* - 300 bp N/A* N/A* * As of the dates indicated, a parallel shift of the U. S. Treasury yield curve by the number of basis points indicated produced negative interest rates for maturities of 2 years and shorter.
As measured by this MVE analysis, Farmer Mac's long-term interest rate sensitivity increased somewhat during 2004, but remained at relatively low levels despite the significant change in the slope of the yield curve that occurred during the year. Farmer Mac's effective duration gap was plus 0.4 months as of December 31, 2004, compared to minus 0.1 months as of December 31, 2003. As of December 31, 2004, a uniform or "parallel" increase of 100 basis points would have increased net interest income ("NII") by 9.2 percent, while a parallel decrease of 100 basis points would have decreased NII by 7.7 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 December 31, 2004, both MVE and NII showed similar sensitivity to non-parallel shocks as to the parallel shocks. The sensitivity of Farmer Mac's MVE and NII to both parallel and non-parallel interest rate shocks, and its duration gap, indicate the effectiveness of Farmer Mac's approach to managing its interest rate risk exposures. The economic effects of financial derivatives, including interest rate swaps, are included in the MVE, NII and duration gap analyses. Farmer Mac generally enters into various interest rate swaps to reduce interest rate risk as follows: o "floating-to-fixed interest rate swaps" in which it pays fixed rates of interest to, and receives floating rates of interest from, counterparties; these swaps adjust the characteristics of short-term debt to match more closely the cash flow and duration characteristics of longer-term reset and fixed-rate mortgages and other assets and may provide an overall lower effective cost of borrowing than would otherwise be available in the conventional debt market; o "fixed-to-floating interest rate swaps" in which it receives fixed rates of interest from, and pays floating rates of interest to, counterparties; these transactions adjust the characteristics of long-term debt to match more closely the cash flow and duration characteristics of short-term or floating-rate assets; and o "basis swaps" in which it pays variable rates of interest based on one index to, and receives variable rates of interest based on another index from, counterparties; these swaps alter interest rate indices of liabilities to match those of assets, and vice versa. As of December 31, 2004, Farmer Mac had $1.5 billion combined notional amount of interest rate swaps, with terms ranging from one to fifteen years, of which $639.5 million were floating-to-fixed interest rate swaps, $651.7 million were basis swaps and $205.0 million were fixed-to-floating interest rate swaps. Farmer Mac uses financial derivatives as an end-user for hedging purposes, not for trading or speculative purposes. When financial derivatives meet the specific hedge criteria under SFAS 133, they are accounted for as either fair value hedges or cash flow hedges. Financial derivatives that do not satisfy those hedge criteria are not accounted for as hedges and changes in the fair value of those financial derivatives are reported as a gain or loss on financial derivatives and trading assets in the consolidated statement of operations. All of Farmer Mac's financial derivative transactions are conducted under standard collateralized agreements that limit Farmer Mac's potential credit exposure to any counterparty. As of December 31, 2004, Farmer Mac had no uncollateralized net exposure to any counterparty. Credit Risk - Loans. Farmer Mac's primary exposure to credit risk is the risk of loss resulting from the inability of borrowers to repay their mortgages in conjunction with a deficiency in the value of the collateral relative to the amount outstanding on the mortgage and the cost of liquidation. Farmer Mac is exposed to credit risk on: o loans it holds; o loans underlying Farmer Mac Guaranteed Securities; and o loans underlying LTSPCs. Loans held or loans underlying Farmer Mac Guaranteed Securities or LTSPCs can be divided into four groups: o loans held for investment; o loans underlying pre-1996 Act Farmer Mac I Guaranteed Securities; o loans underlying post-1996 Act Farmer Mac I Guaranteed Securities or LTSPCs; and o USDA-guaranteed portions underlying Farmer Mac II Guaranteed Securities. For loans underlying pre-1996 Act Farmer Mac I Guaranteed Securities, ten percent first-loss subordinated interests mitigate Farmer Mac's credit risk exposure. Before Farmer Mac incurs a credit loss, full recourse must first be taken against the subordinated interest. The 1996 Act eliminated the subordinated interest requirement. As a result, Farmer Mac generally assumes 100 percent of the credit risk on loans held for investment and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs. Farmer Mac's credit exposure on USDA-guaranteed portions is covered by the full faith and credit of the United States. Farmer Mac believes it has little or no credit risk exposure to loans underlying pre-1996 Act Farmer Mac I Guaranteed Securities because of the subordinated interests, or to USDA-guaranteed portions because of the USDA guarantee. The outstanding principal balance of loans held, real estate owned and loans underlying Farmer Mac Guaranteed Securities (including AgVantage bonds) or LTSPCs is summarized in the following table.
As of December 31, ---------------------------------- 2004 2003 ---------------------------------- (in thousands) Farmer Mac I: Post-1996 Act $ 4,666,508 $ 5,045,232 Pre-1996 Act 18,640 24,734 Farmer Mac II: USDA-guaranteed portions 768,542 729,470 ---------------- --------------- $ 5,453,690 $ 5,799,436 ---------------- ---------------
Farmer Mac conducts guarantee fee adequacy analyses, using stress-test models developed internally and with the assistance of outside experts. These analyses have taken into account the diverse and dissimilar characteristics of the various asset categories for which Farmer Mac manages its risk exposures, and have evolved as the mix and character of assets under management has shifted with growth in the business and the addition of new asset categories. Based on current information, Farmer Mac believes that its guarantee fee is adequate compensation for the credit risk that it assumes. Farmer Mac has established underwriting, appraisal and documentation standards for agricultural mortgage loans to mitigate the risk of loss from borrower defaults and to provide guidance concerning 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 mortgage loans and are designed to assess the creditworthiness of the borrower, as well as the value of the collateral securing the loan. Farmer Mac requires sellers to make representations and warranties regarding the conformity of eligible mortgage 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 that result in economic losses to the Corporation. Pursuant to contracts with Farmer Mac and in consideration for underwriting and servicing fees, Farmer Mac-approved central servicers underwrite mortgage loans for Farmer Mac in accordance with those standards and other requirements, and service those loans in accordance with Farmer Mac requirements. Central servicers are responsible to Farmer Mac for serious errors in the underwriting and servicing of those mortgage loans. Detailed information regarding Farmer Mac's underwriting and appraisal standards and seller eligibility requirements are presented in "Business--Farmer Mac Programs--Farmer Mac I--Underwriting and Appraisal Standards" and "Business--Farmer Mac Programs--Farmer Mac I--Sellers." Farmer Mac maintains an allowance for losses to cover estimated probable losses on loans held for investment, real estate owned and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs in accordance with Statement of Financial Accounting Standard No. 5, Accounting for Contingencies ("SFAS 5") and Statement of Financial Accounting Standard No. 114, Accounting by Creditors for Impairment of a Loan, as amended ("SFAS 114"). The methodology for determining the allowance for losses is the same for loans held for investment and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs because Farmer Mac believes the ultimate credit risk is substantially the same, i.e., the underlying agricultural mortgage loans all meet the same credit underwriting and appraisal standards. For accepting the credit risk on loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs, Farmer Mac receives guarantee fees and commitment fees, respectively. For loans held, Farmer Mac receives interest income that includes a component that correlates to its guarantee fee, which Farmer Mac views as compensation for accepting credit risk. No allowance for losses has been made for loans underlying Farmer Mac I Guaranteed Securities issued prior to the 1996 Act or Farmer Mac II Guaranteed Securities. Farmer Mac I Guaranteed Securities issued prior to the 1996 Act are supported by unguaranteed first-loss subordinated interests, which are expected to exceed the estimated credit losses on those loans. USDA-guaranteed portions collateralizing Farmer Mac II Guaranteed Securities are obligations backed by the full faith and credit of the United States. As of December 31, 2004, Farmer Mac had experienced no credit losses on any pre-1996 Act Farmer Mac I Guaranteed Securities or on any Farmer Mac II Guaranteed Securities and does not expect to incur any such losses in the future. Farmer Mac's allowance for losses is presented in four components on its consolidated balance sheet: o an "Allowance for loan losses" on loans held for investment; o a valuation allowance on real estate owned, which is included in the balance sheet under "Real estate owned, net of valuation allowance"; o a "Contingent obligation for probable losses" on loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs entered into or modified after January 1, 2003, for which inherent losses existed at the time of the guarantee or commitment and could be reasonably estimated, is included in the balance sheet as a portion of the amount reported as "Guarantee and commitment obligation"; and o an allowance for losses on loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs, which is included in the balance sheet under "Reserve for losses." Farmer Mac's provision for losses is presented in two components on its consolidated statement of operations: o a "Provision for loan losses," which represents losses on Farmer Mac's loans held for investment; and o a "Provision for losses," which represents losses on loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs and real estate owned. Farmer Mac estimates probable losses using a systematic process that begins with management's evaluation of the results of its proprietary loan pool simulation and guarantee fee model (the "Model"). The Model draws upon historical information from a data set of agricultural mortgage loans recorded over a longer period of time than Farmer Mac's own experience to date, screened to include only those loans with credit characteristics similar to those on which Farmer Mac has assumed credit risk. The results generated by the Model are modified by the application of management's judgment, as required to take key factors into account, including: o economic conditions; o geographic and agricultural commodity/product concentrations in Farmer Mac's portfolio; o the credit profile of Farmer Mac's portfolio; o delinquency trends of Farmer Mac's portfolio; o Farmer Mac's experience in the management and sale of real estate owned; and o historical charge-off and recovery activities of Farmer Mac's portfolio. Management believes that its use of this methodology produces a reliable estimate of total probable losses, as of the balance sheet date, for all loans included in Farmer Mac's portfolio, including loans held, real estate owned and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs. Farmer Mac's methodology for determining its allowance for losses will migrate over time away from the Model, to become based on Farmer Mac's own historical portfolio loss experience. Until that time, Farmer Mac will continue to use the results from the Model, augmented by the application of management's judgment, to determine its allowance for losses. In addition, Farmer Mac specifically analyzes its portfolio of non-performing assets (loans 90 days or more past due, in foreclosure, restructured, in bankruptcy, including loans performing under either their original loan terms or a court-approved bankruptcy plan, and real estate owned) on a loan-by-loan basis. This analysis measures impairment based on the fair value of the underlying collateral for each individual loan relative to the total recorded investment, including principal, interest and advances under SFAS 114. In the event that the updated appraisal or management's estimate of discounted collateral value does not support the total investment, Farmer Mac specifically allocates an allowance for the loan for the difference between the recorded investment and its fair value, less estimated costs to liquidate the collateral. For this analysis and the allocation of specific allowances, Farmer Mac reviews: o non-performing assets (loans 90 days or more past due, in foreclosure, restructured, in bankruptcy - including loans performing under either their original loan terms or a court-approved bankruptcy plan - and real estate owned); o loans for which Farmer Mac had adjusted the timing of borrowers' payment schedules, but still expects to collect all amounts due and has not made economic concessions; and o additional performing loans that have previously been delinquent or are secured by real estate that produces agricultural commodities or products currently under stress. Management believes that the general allowance, which is the difference between the total allowance for losses (generated through use of the Model) and the specific allowances, adequately covers any probable losses inherent in the portfolio of performing loans under SFAS 5. Farmer Mac believes that the methodology described above produces a reliable estimate of the total probable losses inherent in Farmer Mac's portfolio. The Model: o uses historical agricultural real estate loan origination and servicing data that reflect varied economic conditions and stress levels in the agricultural sector; o contains features that allow variations for changes in loan portfolio characteristics to make the data set more representative of Farmer Mac's portfolio and credit underwriting standards; and o considers the effects of the ageing of the loan portfolio along the expected loss curves associated with individual origination years, including the segments that are entering into or coming out of their peak default years. Farmer Mac analyzes various iterations of the Model data and considers various configurations of loan types, terms, economic conditions and borrower eligibility criteria to generate a distribution of loss exposures over time for all loans in the portfolio, all to evaluate its overall allowance for losses, and back tests the results to validate the Model. Such tests use prior period data to project losses expected in a current period and compare those projections to actual losses incurred during the current period. The allowance for losses is increased through periodic provisions for loan losses that are charged against net interest income and provisions for losses charged to operating expense and reduced by charge-offs for actual losses, net of recoveries. Negative provisions for loan losses or provisions for losses are recorded in the event that the estimate of probable losses as of the end of a period is lower than the estimate at the beginning of the period. Charge-offs represent losses on the outstanding principal balance, any interest payments previously accrued or advanced and expected costs of liquidation. The establishment of and periodic adjustments to the valuation allowance for real estate owned are charged against income as a portion of the provision for losses charged to operating expense. Gains and losses on the sale of real estate owned are recorded in income based on the difference between the recorded investment at the time of sale and liquidation proceeds. The following table summarizes the changes in the components of Farmer Mac's allowance for losses for each year in the three-year period ended December 31, 2004:
------------------------------------------------------------------------- Contingent Allowance REO Obligation Total for Loan Valuation Reserve for Probable Allowance Losses Allowance for Losses Losses for Losses -------------- -------------- ------------- -------------- ------------- (in thousands) Balances as of January 1, 2002 $ 1,352 $ - $ 14,532 $ - $ 15,884 -------------- -------------- ------------- -------------- ------------- Provision for losses 1,340 - 6,907 - 8,247 Net allocation of allowance 3,221 1,308 (4,529) - - Net charge-offs (3,251) (716) (153) - (4,120) -------------- -------------- ------------- -------------- ------------- Balances as of December 31, 2002 $ 2,662 $ 592 $ 16,757 $ - $ 20,011 -------------- -------------- ------------- -------------- ------------- Provision for losses 6,524 1,230 (3,145) 2,676 7,285 Net charge-offs (3,219) (1,584) (440) - (5,243) -------------- -------------- ------------- -------------- ------------- Balances as of December 31, 2003 $ 5,967 $ 238 $ 13,172 $ 2,676 $ 22,053 -------------- -------------- ------------- -------------- ------------- Provision for losses 1,589 1,137 (2,439) (699) (412) Net charge-offs (3,161) (1,375) (4) - (4,540) -------------- -------------- ------------- -------------- ------------- Balances as of December 31, 2004 $ 4,395 $ - $ 10,729 $ 1,977 $ 17,101 -------------- -------------- ------------- -------------- -------------
Farmer Mac released $0.4 million from the allowance for losses during 2004, compared to provisions for losses of $7.3 million in 2003. During 2004, Farmer Mac recorded net charge-offs of $4.5 million in losses against the allowance for losses, compared to net charge-offs of $5.2 million in 2003. The net charge-offs for 2004 did not include any amounts related to previously accrued or advanced interest on loans or Farmer Mac I Guaranteed Securities, compared to $0.1 million for 2003. Additionally, Farmer Mac recorded gains on the sale of real estate owned in 2004 and 2003 of $0.5 million and $0.2 million, respectively. As of December 31, 2004, Farmer Mac's allowance for losses totaled $17.1 million, or 37 basis points of the outstanding principal balance of loans held and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs, compared to $22.1 million (44 basis points) as of December 31, 2003. The year-to-year decrease in this ratio is a result of the overall improved credit quality of the Farmer Mac portfolio, the strong U.S. agricultural economy, the recent upward trend in agricultural land values and the $345.7 million year-over-year reduction in Farmer Mac's outstanding guarantees and commitments. As of December 31, 2004, Farmer Mac's 90-day delinquencies totaled $25.3 million and represented 0.55 percent of the principal balance of all loans held and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs, compared to $30.1 million (0.60 percent) as of December 31, 2003. From quarter to quarter, Farmer Mac anticipates the 90-day delinquencies will fluctuate, both in dollars and as a percentage of the outstanding portfolio, with higher levels likely at the end of the first and third quarters of each year corresponding to the semi-annual (January 1st and July 1st) payment characteristics of most Farmer Mac I loans. As of December 31, 2004, loans held and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs that were 90 days or more past due, in foreclosure, restructured after delinquency, in bankruptcy (including loans performing under either their original loan terms or a court-approved bankruptcy plan) and real estate owned ("post-1996 Act non-performing assets") totaled $50.6 million and represented 1.09 percent of the principal balance of all loans held and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs, compared to $70.0 million (1.39 percent) as of December 31, 2003. Loans that have been restructured after delinquency were insignificant and are included within the reported 90-day delinquency and non-performing asset disclosures. The following table presents historical information regarding Farmer Mac's non-performing assets and 90-day delinquencies:
Outstanding Post-1996 Act Less: Loans, Non- REO and Guarantees and performing Performing 90-day LTSPCs Assets Percentage Bankruptcies Delinquencies Percentage ------------------ ------------- -------------- ---------------- ----------------- ---------------- (dollars in thousands) As of: December 31, 2004 $ 4,642,208 $ 50,636 1.09% $ 25,353 $ 25,283 0.55% September 30, 2004 4,756,839 75,022 1.58% 27,438 47,584 1.01% June 30, 2004 4,882,505 69,751 1.43% 36,978 32,773 0.68% March 31, 2004 4,922,759 91,326 1.86% 33,951 57,375 1.17% December 31, 2003 5,020,032 69,964 1.39% 39,908 30,056 0.60% September 30, 2003 4,871,756 84,583 1.74% 37,442 47,141 0.98% June 30, 2003 4,875,059 80,169 1.64% 28,883 51,286 1.06% March 31, 2003 4,820,887 94,822 1.97% 18,662 76,160 1.58% December 31, 2002 4,821,634 75,308 1.56% 17,094 58,214 1.21% September 30, 2002 4,506,330 91,286 2.03% 11,460 79,826 1.77% June 30, 2002 4,489,735 65,196 1.45% 14,931 50,265 1.12% March 31, 2002 3,754,171 87,097 2.32% 7,903 79,194 2.11%
The dollar level of 90-day delinquencies and period-over-period charge-offs correlates to the proportion of Farmer Mac's portfolio of loans, guarantees and commitments entering their peak delinquency and default years (approximately years three through five after origination). As of December 31, 2004, approximately $1.4 billion (31 percent) of Farmer Mac's outstanding loans held and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs were in their peak delinquency and default years, compared to $1.7 billion (34 percent) of such loans as of December 31, 2003. The Model takes the portfolio age distribution and maturation into consideration. Accordingly, those trends did not cause management to alter the Model's projection for the provisions for losses. As of December 31, 2004, Farmer Mac analyzed the following three categories of assets for impairment, based on the fair value of the underlying collateral: o $50.6 million of non-performing assets; o $32.3 million of loans for which Farmer Mac has adjusted the timing of borrowers' payment schedules within the past three years, but still expects to collect all amounts due and has not made economic concessions; and o $56.6 million of performing loans that have been previously delinquent or are secured by real estate that produces agricultural commodities or products currently under stress. Those individual assessments covered a total of $139.5 million of assets measured for impairment against updated appraised values, other updated collateral valuations or discounted values. Of the $139.5 million of assets analyzed, $126.7 million were adequately collateralized. For assets that were not adequately collateralized, individual collateral shortfalls totaled $1.4 million. Accordingly, Farmer Mac allocated specific allowances of $1.4 million to those under-collateralized assets as of December 31, 2004. As of December 31, 2004, after the allocation of specific allowances to under-collateralized loans, Farmer Mac had additional non-specific or general allowances of $15.7 million, bringing the total allowance for losses to $17.1 million. The following table summarizes Farmer Mac's assets specifically reviewed for impairment and its specific allowance for losses:
Farmer Mac I Post-1996 Act Assets Specifically Reviewed for Impairment and the Allowance for Losses - ------------------------------------------------------------------------------------------------------------- As of December 31, -------------------------------------------------------------------------- 2004 2003 ----------------------------------- ------------------------------------ (in thousands) Assets Specific Assets Specific Specifically Allowance Specifically Allowance Reviewed for Losses Reviewed for Losses ------------------ ------------- ------------------- -------------- 90-day delinquencies $ 25,283 $ 34 $ 30,056 $ 1,852 Performing bankruptcies 21,508 119 24,192 1,136 Other loans specifically reviewed 88,895 1,280 102,736 536 Real estate owned 3,845 - 15,716 238 ------------------- -------------- -------------------- --------------- Total $ 139,531 $ 1,433 $ 172,700 $ 3,762 ------------------- -------------- -------------------- --------------- Allowance Allowance for Losses for Losses -------------- --------------- Specific allowance for losses $ 1,433 $ 3,762 General allowance for losses 15,668 18,291 -------------- --------------- Total allowance for losses $ 17,101 $ 22,053 -------------- ---------------
Based on Farmer Mac's loan-by-loan analyses, loan collection experience and continuing provisions for the allowance for losses, Farmer Mac believes that ongoing losses will be covered adequately by the allowance for losses. Original loan-to-value ratios (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, updated appraised value at the time of guarantee, purchase or commitment) are one of many factors Farmer Mac considers in evaluating loss severity. Other factors include, but are not limited to, other underwriting standards, commodity and farming forecasts and regional economic and agricultural conditions. Loans in the Farmer Mac I program are all first mortgage agricultural real estate loans. Accordingly, Farmer Mac's exposure on a loan is limited to the difference between the total of the accrued interest, advances and the principal balance of a loan and the value of the property. Measurement of that excess or shortfall is the best predictor and determinant of loss compared to other measures that evaluate the efficiency of a particular farm operator. Loan-to-value ratios depend upon the market value of a property with due regard for its income-producing potential in the hands of a competent operator. As required by Farmer Mac's collateral valuation standards, an appraisal of agricultural real estate must include analysis of the income producing capability of the property and address the income estimate in the market analysis. Debt service ratios depend upon farm operator efficiency and leverage, which can vary widely within a geographic region, commodity type, or an operator's business and farming skills. As of December 31, 2004, the weighted-average original loan-to-value ratio for all post-1996 Act loans and loans underlying Farmer Mac Guaranteed Securities and LTSPCs was 50 percent, and the weighted-average original loan-to-value ratio for all post-1996 Act non-performing assets was 55 percent. The following table summarizes the post-1996 Act non-performing assets by original loan-to-value ratio:
Distribution of Post-1996 Act Non-performing Assets by Original LTV Ratio as of December 31, 2004 - ---------------------------------------------------------- (dollars in thousands) Post-1996 Act Non-performing Original LTV Ratio Assets Percentage - -------------------- ---------------- ------------------- 0.00% to 40.00% $ 3,752 8% 40.01% to 50.00% 7,132 14% 50.01% to 60.00% 26,494 52% 60.01% to 70.00% 12,128 24% 70.01% to 80.00% 1,059 2% 80.01% + 71 0% -------------- ----------- Total $ 50,636 100% -------------- -----------
The following table presents outstanding loans held and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs, post-1996 Act non-performing assets and specific allowances for losses as of December 31, 2004 by year of origination, geographic region and commodity.
Farmer Mac I Post-1996 Act Non-performing Assets and Specific Allowance for Losses - --------------------------------------------------------------------------------------------------------------------- Distribution of Outstanding Outstanding Post-1996 Act Loans, Loans, Non- Non- Specific Guarantees and Guarantees and performing performing Allowance LTSPCs LTSPCs Assets (1) Asset Rate for Losses ------------------- ------------------- ---------------- ------------- --------------- (dollars in thousands) By year of origination: Before 1994 12% $ 541,561 $ 1,755 0.32% $ - 1994 3% 130,935 507 0.39% - 1995 3% 127,128 2,869 2.26% 100 1996 6% 292,258 8,108 2.77% 395 1997 8% 353,594 8,127 2.30% 91 1998 12% 565,536 7,328 1.30% 501 1999 12% 567,633 9,071 1.60% 346 2000 7% 341,760 5,280 1.54% - 2001 11% 519,914 6,069 1.17% - 2002 12% 575,000 937 0.16% - 2003 10% 449,799 585 0.13% - 2004 4% 177,090 - 0.00% - ------------------- ------------------- ---------------- ------------- --------------- Total 100% $ 4,642,208 $ 50,636 1.09% $ 1,433 ------------------- ------------------- ---------------- ------------- --------------- By geographic region (2): Northwest 21% $ 951,859 $ 31,568 3.32% $ 1,041 Southwest 46% 2,147,272 9,758 0.45% 152 Mid-North 13% 597,130 2,575 0.43% 158 Mid-South 6% 290,046 4,982 1.72% 82 Northeast 8% 379,502 1,333 0.35% - Southeast 6% 276,399 420 0.15% - ------------------- ------------------- ---------------- ------------- --------------- Total 100% $ 4,642,208 $ 50,636 1.09% $ 1,433 ------------------- ------------------- ---------------- ------------- --------------- By commodity: Crops 44% $ 2,033,146 $ 19,604 0.96% $ 82 Permanent plantings 27% 1,234,311 20,783 1.68% 1,351 Livestock 21% 1,052,585 6,763 0.64% - Part-time farm 7% 295,470 3,486 1.18% - Other 1% 26,696 - 0.00% - ------------------- ------------------- ---------------- ------------- --------------- Total 100% $ 4,642,208 $ 50,636 1.09% $ 1,433 ------------------- ------------------- ---------------- ------------- --------------- (1) Includes loans 90 days or more past due, in foreclosure, restructured after delinquency, in bankruptcy (including loans performing under either their original loan terms or a court-approved bankruptcy plan), and real estate owned. (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).
The following table presents Farmer Mac's cumulative charge-offs and current specific allowances relative to the cumulative original purchased, guaranteed or LTSPC principal balances for all loans purchased and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs. This information is presented by year of origination, geographic region and commodity. The purpose of this information is to present information regarding losses and collateral deficiencies relative to original guarantees and commitments.
Farmer Mac I Post-1996 Act Credit Losses and Specific Allowance for Losses Relative to all Cumulative Original Loans, Guarantees and LTSPCs - --------------------------------------------------------------------------------------------------------------------- Cumulative Combined Original Loans, Cumulative Cumulative Current Credit Loss Guarantees Net Loss Specific and Specific and LTSPCs Credit Losses Rate Allowance Allowance Rate ---------------- ---------------- ------------- ----------------- ----------------- (dollars in thousands) By year of origination: Before 1994 $ 2,012,611 $ - 0.00% $ - 0.00% 1994 370,687 - 0.00% - 0.00% 1995 325,896 968 0.30% 100 0.33% 1996 633,560 1,390 0.22% 395 0.28% 1997 725,190 2,779 0.38% 91 0.40% 1998 1,078,625 4,206 0.39% 501 0.44% 1999 1,064,661 1,202 0.11% 346 0.15% 2000 666,022 2,318 0.35% - 0.35% 2001 892,744 695 0.08% - 0.08% 2002 841,865 - 0.00% - 0.00% 2003 570,637 - 0.00% - 0.00% 2004 195,630 - 0.00% - 0.00% ---------------- ---------------- ------------- ----------------- ----------------- Total $ 9,378,128 $ 13,558 0.14% $ 1,433 0.16% ---------------- ---------------- ----------------- By geographic region (1): Northwest $ 2,031,879 $ 6,621 0.33% $ 1,041 0.38% Southwest 4,106,732 4,691 0.11% 152 0.12% Mid-North 1,147,641 38 0.00% 158 0.02% Mid-South 501,526 1,845 0.37% 82 0.38% Northeast 798,084 38 0.00% - 0.00% Southeast 792,266 325 0.04% - 0.04% ---------------- ---------------- ------------- ----------------- ----------------- Total $ 9,378,128 $ 13,558 0.14% $ 1,433 0.16% ---------------- ---------------- ----------------- By commodity: Crops $ 4,024,455 $ 93 0.00% $ 82 0.00% Permanent plantings 2,414,354 8,868 0.37% 1,351 0.42% Livestock 2,182,914 4,034 0.18% - 0.18% Part-time farm 661,377 563 0.09% - 0.09% Other 95,028 - 0.00% - 0.00% ---------------- ---------------- ------------- ----------------- ----------------- Total $ 9,378,128 $ 13,558 0.14% $ 1,433 0.16% ---------------- ---------------- ----------------- (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); and Southeast (AL, AR, FL, GA, LA, MS, SC).
An analysis of Farmer Mac's historical losses and identified specific collateral deficiencies within the portfolio (by origination year) indicates that Farmer Mac has experienced peak loss years as loans have aged between approximately their third and fifth years subsequent to origination, regardless of the year the loans were added to Farmer Mac's portfolio. As a consequence of the combination of principal amortization and collateral value appreciation, there are few loans in the portfolio originated prior to 1996 with known collateral deficiencies. While Farmer Mac expects that there will be loans that have aged past their fifth year that will become delinquent and possibly default, Farmer Mac does not anticipate significant losses on such loans. Analysis of portfolio performance by commodity distribution indicates that losses and collateral deficiencies have been and are expected to remain less prevalent in the loans secured by real estate producing agricultural commodities that receive significant government support (such as cotton, soybeans, wheat and corn) and more prevalent in those that do not receive such support. This analysis is consistent with corresponding commodity analysis, which indicates that Farmer Mac has experienced higher loss and collateral deficiency rates in its loans classified as permanent plantings. Most of the loans classified as permanent plantings do not receive significant government support and are therefore more susceptible to adverse commodity-specific economic trends. Further, as adverse economic conditions persist for a particular commodity that requires a long-term improvement on the land, such as permanent plantings, the prospective sale value of the land is likely to decrease and the related loans may become under-collateralized. 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. Analysis of portfolio performance by geographic distribution indicates that, while commodities are the primary determinant of exposure to loss, within most commodity groups certain geographic areas allow greater economies of scale or proximity to markets than others and, consequently, result in more successful farms within the commodity group. Likewise, certain geographic areas offer better growing conditions than others and, consequently, result in more versatile and more successful farms within a given commodity group - and the ability to switch crops among commodity groups. Farmer Mac's methodologies for pricing its guarantee and commitment fees, managing credit risks and providing adequate allowances for losses consider all of the foregoing factors and information. Credit Risk - Institutional. Farmer Mac is also exposed to credit risk arising from its business relationships with other institutions including: o issuers of AgVantage bonds and other investments held by Farmer Mac; o sellers and servicers; and o interest rate contract counterparties. AgVantage bonds are general obligations of the AgVantage Issuers and are secured by collateral in an amount ranging from 120 percent to 150 percent of the bond amount. In addition to requiring collateral, Farmer Mac mitigates credit risk related to AgVantage bonds by evaluating and monitoring the financial condition of the issuers of the AgVantage bonds. Outstanding AgVantage bonds totaled $24.3 million as of December 31, 2004, and $25.2 million as of December 31, 2003. 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 and confirms that they maintain adequate fidelity bonds and errors and omissions insurance. For more information on Farmer Mac's approval of sellers, see "Business--Farmer Mac Programs--Farmer Mac I--Sellers." Credit risk related to interest rate contracts is discussed in "--Risk Management--Interest Rate Risk" and Note 6 to the consolidated financial statements. Credit Risk - Other Investments. The credit risk inherent in other investments held by Farmer Mac is mitigated by Farmer Mac's policies of investing in highly-rated instruments and establishing concentration limits, which reduce exposure to any one counterparty. Farmer Mac's policies limit the Corporation's total credit exposure, including uncollateralized credit exposure resulting from financial derivatives, to a single entity by limiting the dollar amount of investments with each individual entity to the greater of 25 percent of Farmer Mac's regulatory core capital or $25 million. That limitation excludes exposure to agencies of the U.S. government, GSEs and money market funds. Farmer Mac policy also requires each individual entity to be rated in one of the three highest rating categories of at least one NRSRO for investments with terms greater than 270 days and in one of the two highest rating categories for investments with terms of 270 days or less. As of December 31, 2004, Farmer Mac had investments in commercial paper, corporate debt securities, asset-backed securities, auction rate certificates, and preferred stock issued by thirty-six entities totaling $959.0 million. Farmer Mac's investments in eighteen of these entities each exceeded 10 percent of Farmer Mac's core capital (the cumulative balance of investments in such entities totaled $475.0 million), and investments in two of these entities each exceeded 15 percent of core capital. In addition, as of December 31, 2004, Farmer Mac held $237.0 million of securities issued by GSEs or agencies of the U.S. government and $290.4 million in three money market investment accounts. The maximum amount held in any one money market fund investment fund at any time during 2004 was approximately $609.5 million. As of December 31, 2004, 36.2 percent of Farmer Mac's investment portfolio, excluding GSE and agency investments, consisted of short-term highly liquid investments. Liquidity and Capital Resources Farmer Mac has sufficient liquidity and capital resources to support its operations for the next twelve months and has a contingency funding plan to handle unanticipated disruptions in its access to the capital markets. Debt Issuance. Section 8.6(e) of Farmer Mac's statutory charter (12 U.S.C. section 2279aa-6(e)) authorizes Farmer Mac to issue debt obligations to purchase eligible mortgage loans and Farmer Mac Guaranteed Securities and to maintain reasonable amounts for business operations, including adequate liquidity. Farmer Mac funds its program purchases primarily by issuing debt obligations, consisting of discount notes and medium-term notes of various maturities, in the public capital markets. Farmer Mac also issues discount notes and medium-term notes to obtain funds to finance its investments, transaction costs and guarantee and LTSPC payments. The Corporation's discount notes and medium-term notes are obligations of Farmer Mac only, are not rated by a nationally recognized statistical rating organization and the interest and principal thereon are not guaranteed by, and do not constitute debts or obligations of, FCA or the United States or any agency or instrumentality of the United States other than Farmer Mac. Farmer Mac is an institution of the FCS, but is not liable for any debt or obligation of any other institution of the FCS. Likewise, neither the FCS nor any other individual institution of the FCS is liable for any debt or obligation of Farmer Mac. Income to the purchaser of a Farmer Mac discount note or medium-term note is not exempt under federal law from federal, state or local taxation. Farmer Mac's board of directors has authorized the issuance of up to $5.0 billion of discount notes and medium-term notes (of which $3.5 billion was outstanding as of December 31, 2004), 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 non-program investment assets in accordance with policies established by its board of directors. Liquidity. The funding and liquidity needs of Farmer Mac's business programs are driven by the purchase and retention of loans 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: o principal and interest payments and ongoing guarantee and commitment fees received on loans, Farmer Mac Guaranteed Securities and LTSPCs; o principal and interest payments received from investment securities; and o the issuance of new discount notes and medium-term notes. Farmer Mac projects its expected cash flows from loans and securities, other earnings and the sale of assets and matches those with its obligations to retire debt and pay other liabilities as they come due. Farmer Mac issues discount notes and medium-term notes to meet the needs associated with its business operations, including liquidity, and also to increase its presence in the capital markets in order to enhance the liquidity and pricing efficiency of its discount notes and medium-term notes and Farmer Mac Guaranteed Securities transactions and so improve the mortgage rates available to farmers, ranchers and rural homeowners. Though Farmer Mac's mortgage purchases do not currently necessitate daily debt issuance, the Corporation continued its strategy of using its non-program investment portfolio (referred to as Farmer Mac's liquidity portfolio) to facilitate increasing its ongoing presence in the capital markets during 2004. To meet investor demand for daily presence in the capital markets, Farmer Mac issues discount notes in maturities principally ranging from one day to approximately ninety days and invests the proceeds not needed for program asset purchases in highly-rated securities. Investments are predominantly short-term money market securities with maturities closely matched to the discount note maturities and floating-rate securities with reset terms of less than one year and closely matched to the maturity of the discount notes. The positive spread earned from these investments enhances the net interest income Farmer Mac earns, thereby improving the net yields at which Farmer Mac can purchase mortgages from lenders who may pass that benefit to farmers, ranchers and rural homeowners through the Farmer Mac programs. Subject to dollar amount, issuer concentration and credit quality limitations, the Corporation's board of directors has authorized non-program investments in: o U.S. Treasury obligations; o agency and instrumentality obligations; o repurchase agreements; o commercial paper; o guaranteed investment contracts; o certificates of deposit; o federal funds and bankers acceptances; o securities and debt obligations of corporate and municipal issuers; o auction rate securities; o mortgage-backed securities; o asset-backed securities; o corporate money market funds; and o preferred stock of GSEs. As of December 31, 2004, Farmer Mac was in compliance with the investment authorizations set forth in its investment guidelines. The following table presents Farmer Mac's five largest investments as of December 31, 2004:
Security Credit Percent of Investment Issuer Rating Investment Core Capital ------------------------------- ----------------------------- --------------- --------------- --------------- (dollars in thousands) Nations Qualified Purchaser Banc of America Securities N/A * $ 179,624 75.6% Funds Preferred Stock CoBank, ACB not rated ** 88,500 *** 37.2% Preferred Stock AgFirst Farm Credit Bank not rated ** 88,035 *** 37.0% Merrill Lynch Premier Merrill Lynch & Co., Inc. N/A * 60,603 25.5% Institutional Fund Federated Prime Value Federated Group Inc. N/A * 50,136 21.1% Obligations Fund * These money market funds are not rated, but invest in short-term, high quality money market securities and conform to Rule 2a-7 of the Investment Company Act of 1940. ** CoBank, ACB and AgFirst Farm Credit Bank are institutions of the Farm Credit System, a government- sponsored enterprise. *** Investment balance does not include premiums paid or unrealized gains on the securities.
As a result of Farmer Mac's regular issuance of discount notes and medium-term notes and its status as a federally chartered instrumentality of the United States, Farmer Mac has been able to access the capital markets at favorable rates. Farmer Mac has also used floating-to-fixed interest rate swaps, combined with discount note issuances, as a source of fixed-rate funding. While the swap market may provide favorable fixed rates, swap transactions expose Farmer Mac to the risk of future widening of its own issuance spreads versus corresponding LIBOR rates. If the spreads on the Farmer Mac discount notes were to increase relative to LIBOR, Farmer Mac would be exposed to a commensurate reduction on its net interest yield on the notional amount of its floating-to-fixed interest rate swaps and other LIBOR-based floating rate assets. Farmer Mac compensates for this risk by pricing the required net yield on program asset purchases to reflect the cost of medium-term notes without regard to the savings that may be achievable in the interest rate swap market. Farmer Mac maintains a liquidity investment portfolio of cash and cash equivalents (including commercial paper and other short-term money market instruments) and investment securities consisting mostly of floating rate securities with rates that adjust within one year, which can be drawn upon for liquidity needs. As of December 31, 2004, Farmer Mac's cash and cash equivalents and investment securities totaled $430.5 million and $1.1 billion, respectively, a combined 38.7 percent of total assets and 42.7 percent of total notes payable. In addition, as of December 31, 2004, Farmer Mac held a $712.7 million portfolio of Farmer Mac II Guaranteed Securities backed by USDA-guaranteed portions that carry the full faith and credit of the U.S. Government. As of December 31, 2004, the aggregate of the Farmer Mac II Guaranteed Securities and the liquidity investment portfolio represented 29.7 percent of total assets and 32.8 percent of total notes payable. During 2004, exclusive of daily overnight discount note issuances the proceeds of which were invested overnight, the average discount note issuance term and re-funding frequency was approximately 58 days. The principal sources of funding for Farmer Mac's obligations under its guarantees and LTSPCs are: o the ongoing fees received on its guarantees and commitments: o net interest income received on loans and Guaranteed Securities; and o the proceeds of debt issuance. Farmer Mac satisfies its guarantee and purchase commitment obligations by purchasing defaulted loans out of LTSPCs and from the related trusts for Farmer Mac Guaranteed Securities. Farmer Mac typically recovers a significant portion of the value of defaulted loans purchased either through borrower payments, loan payoffs, payments by third parties or foreclosure and sale of the property securing the loans. Farmer Mac's liquidity position and ready access to the debt markets also provide additional flexibility to meet liquidity needs that result from the uncertainty regarding the timing and amount of required purchases of loans underlying either Farmer Mac Guaranteed Securities or LTSPCs, should significantly more loans be required to be purchased than in prior periods. Capital Requirements. The Act, as amended by the 1996 Act, establishes three capital standards for Farmer Mac--minimum, critical and risk-based. The minimum capital requirement is expressed as a percentage of on-balance sheet assets and off-balance sheet obligations, with the critical capital requirement equal to one-half of the minimum capital amount. Higher minimum and critical capital requirements were phased in over a transition period, which ended on January 1, 1999, when the highest level of minimum capital became applicable. The Act does not specify the required level of risk-based capital. It directs FCA to establish a risk-based capital test for Farmer Mac, using specified stress-test parameters. For a discussion of risk-based capital, see "Business--Government Regulation of Farmer Mac--Regulation--Capital Standards--General." Certain enforcement powers are given to FCA depending upon Farmer Mac's compliance with the capital standards. See "Business--Government Regulation of Farmer Mac--Regulation--Capital Standards--Enforcement levels." As of December 31, 2004 and 2003, Farmer Mac was classified as within "level I" (the highest compliance level). The following table sets forth Farmer Mac's minimum capital requirement as of December 31, 2004 and 2003 based on the fully phased-in requirements.
December 31, 2004 December 31, 2003 -------------------------------------- ----------------------------------- Capital Capital Amount Ratio Required Amount Ratio Required ---------- ------------ ------------ --------- -------- ------------ (dollars in thousands) On-balance sheet assets as defined for determining statutory minimum capital $3,793,547 2.75% $104,323 $4,231,931 2.75% $116,378 Outstanding balance of Farmer Mac Guaranteed Securities held by others and LTSPCs 3,233,274 0.75% 24,250 3,352,078 0.75% 25,141 Derivative and hedging obligations 47,793 0.75% 358 67,670 0.75% 508 ------------- ------------ Minimum capital level 128,931 142,026 Actual core capital 237,733 215,550 ------------- ------------ Capital surplus $108,802 $73,524 ------------- ------------
Based on the statutory minimum capital requirements, Farmer Mac's current capital surplus would support additional guarantee growth in amounts ranging from $3.9 billion of on-balance sheet guarantees to more than $14.5 billion of off-balance sheet guarantees and commitments. Furthermore, Farmer Mac could sell $1.5 billion of on-balance sheet non-program assets (cash and cash equivalents and investment securities) and $2.3 billion of on-balance sheet program assets in order to support further increases of on- and off-balance sheet program guarantees and commitments. Any transactions would be evaluated for compliance with risk-based capital requirements and to optimize Farmer Mac's return on equity and capital flexibility. Based on the risk-based capital stress test, Farmer Mac's risk-based capital requirement as of December 31, 2004 was $37.1 million and Farmer Mac's regulatory capital of $254.8 million exceeded that amount by approximately $217.7 million. Accordingly, in the opinion of management, Farmer Mac has sufficient capital and liquidity for the next twelve months. Contractual Obligations, Contingent Liabilities and Off-Balance Sheet Arrangements. The following table presents the amount and timing of Farmer Mac's known fixed and determinable contractual obligations by payment date as of December 31, 2004. The payment amounts represent those amounts contractually due to the recipient and do not include any unamortized premiums or discounts or other similar carrying value adjustments.
One Year One to Three to Over Five or Less Three Years Five Years Years Total --------------- ---------------- ------------ ------------ -------------- (in thousands) Discount notes* $1,796,502 $ - $ - $ - $1,796,502 Medium-term notes* 956,766 315,760 440,529 213,839 1,926,894 Interest payments on fixed-rate medium-term notes 22,697 27,210 15,697 13,823 79,427 Operating lease obligations** 569 1,176 1,225 1,227 4,197 Purchase obligations*** 497 347 65 - 909 * Future events, including additional issuance of discount notes and medium-term notes and refinancing of those notes, could cause actual payments to differ significantly from these amounts. For more information regarding discount notes and medium-term notes, see Note 7 to the consolidated financial statements. ** Includes amounts due under non-cancelable operating leases for office space and office equipment. See Note 12 to the consolidated financial statements for more information regarding Farmer Mac's minimum lease payments for office space. *** Includes minimum amounts due under non-cancelable agreements to purchase goods or services that are enforceable and legally binding and specify all significant terms. These agreements include agreements for the provision of internal audit services, consulting services, information technology support, equipment maintenance, and financial analysis software and services. The amounts actually paid under these agreements will likely be higher due to the variable components of some of these agreements under which the ultimate obligation owed is determined by reference to actual usage or hours worked. The table does not include amounts due under agreements that are cancelable without penalty or further payment as of December 31, 2004 and therefore do not represent enforceable and legally binding obligations. The table also does not include amounts due under the terms of employment agreements with members of senior management; nor does it include payments that are based on a varying outstanding loan volume (such as servicing fees), as those payments are not known fixed and determinable contractual obligations.
See the tables below in this section for information about Farmer Mac's commitments to purchase loans and Farmer Mac's contingent obligations under outstanding Farmer Mac I Guaranteed Securities and LTSPCs. Farmer Mac enters into financial derivative contracts under which it either receives cash from counterparties, or is required to pay cash to them, depending on changes in interest rates. Financial derivatives are carried on the consolidated balance sheet at fair value, representing the net present value of expected future cash payments or receipts based on market interest rates as of the balance sheet date. The fair values of the contracts change daily as market interest rates change. Because the financial derivative liabilities recorded on the consolidated balance sheet as of December 31, 2004 do not represent the amounts that may ultimately be paid under the financial derivative contracts, those liabilities are not included in the table of contractual obligations presented above. Further information regarding financial derivatives is included in Note 2(h) and Note 6 to the consolidated financial statements. In conducting its loan purchase activities, Farmer Mac enters into mandatory and optional delivery commitments to purchase agricultural mortgage loans and corresponding optional commitments to deliver Farmer Mac Guaranteed Securities. As of December 31, 2004 and 2003, Farmer Mac had no optional delivery commitments to purchase loans or deliver Farmer Mac Guaranteed Securities outstanding. In conducting its LTSPC activities, Farmer Mac enters into arrangements whereby it commits to buy agricultural mortgage loans at an undetermined future date. The following table presents these significant commitments.
As of December 31, ----------------------------------- 2004 2003 ---------------- --------------- (in thousands) LTSPCs $ 2,295,103 $ 2,348,702 Mandatory commitments to purchase loans and USDA-guaranteed portions 13,048 11,226
Further information regarding commitments to purchase and sell agricultural mortgage loans is included in Note 12 to the consolidated financial statements. Farmer Mac also may have liabilities that arise from its Farmer Mac Guaranteed Securities. Farmer Mac Guaranteed Securities are issued through trusts and, when sold to third-party investors, accordingly, are not included in the consolidated balance sheets. In performing its obligations related to LTSPCs and Farmer Mac Guaranteed Securities, Farmer Mac would have the right to enforce the underlying agricultural mortgage loans, and in the event of the default under the terms of those loans, would have access to the underlying collateral. The following table presents the balance of outstanding LTSPCs and off-balance sheet Farmer Mac Guaranteed Securities as of December 31, 2004 and 2003:
Outstanding Balance of LTSPCs and Off-Balance Sheet Farmer Mac Guaranteed Securities - ----------------------------------------------------------------------------------- As of December 31, ---------------------------------- 2004 2003 ----------------- --------------- (in thousands) Farmer Mac I Post-1996 Act obligations: Farmer Mac I Guaranteed Securities $ 882,282 $ 952,134 LTSPCs 2,295,103 2,348,702 ----------------- --------------- Total Farmer Mac I Post-1996 Act obligations 3,177,385 3,300,836 Farmer Mac II Guaranteed Securities 55,889 51,241 ----------------- --------------- Total Farmer Mac I and II $ 3,233,274 $ 3,352,077 ----------------- ---------------
See Note 2(c), Note 2(e) and Note 5 to the consolidated financial statements for more information on Farmer Mac Guaranteed Securities and Note 2(o) and Note 12 to the consolidated financial statements for more information on LTSPCs. Regulatory Matters Regulatory actions continue to affect Farmer Mac's business outlook. Both FCA and FCSIC have cautioned FCS institutions about doing business with GSEs, including Farmer Mac, and FCSIC has raised technical objections to FCS institutions' use of Farmer Mac Guaranteed Securities swaps. During second quarter 2004, FCA published a proposed regulation relating to Farmer Mac's investments and liquidity. Farmer Mac expects to be able to comply with the regulation if it is adopted in its current form, though analysis indicates it could limit future increases in Farmer Mac's non-program investment portfolio and the related net interest income. The Corporation disagrees with certain aspects of the proposed regulation and submitted comments on the proposal to FCA accordingly. On August 6, 2004, FCA published a proposed regulation that, if adopted as proposed, could adversely affect Farmer Mac's business by establishing a new risk-weight allocation of capital applicable to Farmer Mac transactions with FCS institutions, a major segment of Farmer Mac's customer base. The proposed regulation would require FCS institutions to risk-weight assets on their books that are guaranteed by a GSE based on the financial strength rating of the GSE, as determined by an NRSRO. Under the proposed regulation: (a) the 20 percent risk-weight would apply to such assets only if the GSE guarantor had a AAA or AA rating from an NRSRO; (b) an A rating would result in a 50 percent risk-weight; and (c) a lower rating (or no rating) would result in a 100 percent risk-weight. Farmer Mac is currently unrated. Currently, all banking regulators and FCA accord a 20 percent risk-weight to assets backed by guarantees of GSEs such as Fannie Mae, Freddie Mac or Farmer Mac. The proposed regulation is subject to a 90-day public comment period and, as drafted, would have an effective date eighteen months after the final regulation is published. If the proposed regulation is adopted as a final rule in its current form and Farmer Mac does not receive a rating of at least AA within the period provided for in the proposed regulation, the benefit to an FCS institution of doing business with Farmer Mac would be diminished after the adoption of the regulation, and a significant portion of the current $2.9 billion of outstanding Farmer Mac I guarantees and commitments currently in place with FCS institutions might be subject to early termination. There can be no assurance that the regulation will not be adopted as a final rule in its current form, or in a modified form with substantially the same effect. Likewise, Farmer Mac currently is not rated, and there can be no assurance that Farmer Mac would receive a AAA or AA rating from an NRSRO. As set forth in prior disclosures, Farmer Mac disagrees with the proposed regulation as it would affect the Corporation, and has submitted a comment letter to FCA setting forth its position. Other Matters New Accounting Standards. On January 1, 2003, Farmer Mac adopted the liability recognition provisions of the Financial Accounting Standards Board Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others ("FIN 45") which requires Farmer Mac to recognize, 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 agreement and an asset that is equal to the fair value of the fees that will be received over the life of each guarantee. Subsequently, both the asset and the liability are measured and recorded at their fair value. In December of 2003, the SEC provided additional guidance on the "day two" accounting for these financial instruments. In accordance with this guidance, Farmer Mac has adopted the amortized cost model for day two accounting. This guidance was applied prospectively for guarantees and commitments recorded at December 31, 2003 and all guarantees and commitments issued or modified on or after January 1, 2004. In December 2003, the American Institute of Certified Public Accountants issued Statement of Position 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer ("SOP 03-3"). SOP 03-3 addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor's initial investment in loans or debt securities acquired in a transfer if those differences are attributable, at least in part, to credit quality. Specifically, SOP 03-3 limits the yield that may be accreted and prohibits the "carry-over" of a valuation allowance for all impaired loans that are within the scope of SOP 03-3. SOP 03-3 is effective for loans acquired in fiscal years beginning after December 15, 2004. Farmer Mac is evaluating the impact of SOP 03-3, and will adopt it when effective. In March 2004, the Emerging Issues Task Force ("EITF") amended EITF 03-1, The Meaning of Other-Than-Temporary Impairment, to introduce a three-step model to: (1) determine whether an investment is impaired; (2) evaluate whether the impairment is other-than-temporary; and (3) account for other-than-temporary impairments. In part, this amendment requires companies to apply qualitative and quantitative measures to determine whether a decline in the fair value of a security is other-than-temporary. The guidance in EITF 03-1 is effective for reporting periods beginning after June 15, 2004, with the exception of certain sections, which have been deferred. Farmer Mac is evaluating the impact of the amendment and will adopt it when it is effective in full. In the interim, Farmer Mac continues to apply earlier authoritative accounting guidance, primarily Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities and EITF 99-20, Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets, for the measurement and recognition of other-than-temporary impairment of its debt and equity securities. In December 2004, the Financial Accounting Standards Board issued Statement No. 123 (revised 2004), Share-Based Payment ("SFAS 123(R)"). SFAS 123(R) is a revision of the Financial Accounting Standards Board Statement No. 123, Accounting for Stock-Based Compensation ("SFAS 123") and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees ("APB 25"), and its related implementation guidance. SFAS 123(R) requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost will be recognized over the period during which an employee is required to provide service in exchange for the award. The grant-date fair value of employee share options and similar instruments will be estimated using option-pricing models adjusted for the unique characteristics of those instruments. SFAS 123(R) eliminates the alternative to use APB 25's intrinsic value method of accounting that was provided in SFAS 123 as originally issued. Currently, as discussed in Note 2(m), Farmer Mac accounts for its stock-based employee compensation plans using the intrinsic value method of accounting for employee stock options pursuant to APB 25 and has adopted the disclosure-only provisions of SFAS 123. The guidance in SFAS 123(R) is effective for reporting periods beginning after June 15, 2005. Farmer Mac is evaluating the impact of SFAS 123(R), and will adopt it when effective. Item 7A. 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 by entering into various financial transactions, including financial derivatives, and by monitoring 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 strategies to manage such risk. For information regarding Farmer Mac's use of and accounting policies for financial derivatives, see Note 2(h) and Note 6 to the consolidated financial statements. Item 8. Financial Statements MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING The management of Farmer Mac is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed under the supervision of Farmer Mac's Chief Executive Officer and Chief Financial Officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Corporation's financial statements for external purposes in accordance with generally accepted accounting principles. Farmer Mac's internal control over financial reporting includes those policies and procedures that: (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Corporation; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Corporation are being made only in accordance with authorizations of management and directors of the Corporation; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Corporation's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. With the participation of the Corporation's Chief Executive Officer and Chief Financial Officer, Farmer Mac's management assessed the effectiveness of the Corporation's internal control over financial reporting as of December 31, 2004. In making this assessment, the Corporation's management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control--Integrated Framework. Based on its assessment, management has concluded that, as of December 31, 2004, the Corporation's internal control over financial reporting is effective based on those criteria. Farmer Mac's independent registered public accounting firm, Deloitte & Touche LLP, has audited management's assessment of the effectiveness of the Corporation's internal control over financial reporting as of December 31, 2004, as stated in their report, appearing below, which expresses unqualified opinions on management's assessment and on the effectiveness of the Corporation's internal control over financial reporting as of December 31, 2004. /s/ Henry D. Edelman /s/ Nancy E. Corsiglia Henry D. Edelman Nancy E. Corsiglia President and Chief Executive Vice President -Finance and Chief Officer Financial Officer REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM REGARDING INTERNAL CONTROL OVER FINANCIAL REPORTING To the Board of Directors and Stockholders of Federal Agricultural Mortgage Corporation Washington, DC We have audited management's assessment, included in the accompanying Management's Report on Internal Control Over Financial Reporting, that the Federal Agricultural Mortgage Corporation and subsidiary ("Farmer Mac") maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Farmer Mac's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of Farmer Mac's internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions. A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, management's assessment that Farmer Mac maintained effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Also in our opinion, Farmer Mac maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on the criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year ended December 31, 2004 of Farmer Mac and our report dated March 14, 2005 expressed an unqualified opinion on those financial statements. /s/ Deloitte & Touche, LLP McLean, VA March 14, 2005 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of Federal Agricultural Mortgage Corporation Washington, DC We have audited the accompanying consolidated balance sheets of the Federal Agricultural Mortgage Corporation and subsidiary ("Farmer Mac") as of December 31, 2004 and 2003, and the related consolidated statements of operations, changes in stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2004. These financial statements are the responsibility of Farmer Mac's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Federal Agricultural Mortgage Corporation and subsidiary at December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004, in conformity with accounting principles generally accepted in the United States of America. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company's internal control over financial reporting as of December 31, 2004, based on the criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 14, 2005 expressed an unqualified opinion on management's assessment of the effectiveness of Farmer Mac's internal control over financial reporting and an unqualified opinion on the effectiveness of Farmer Mac's internal control over financial reporting. /s/ Delotte & Touche, LLP McLean, Virginia March 14, 2005 FEDERAL AGRICULTURAL MORTGAGE CORPORATION AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS
December 31, ------------------------------------ 2004 2003 ----------------- ----------------- (in thousands) Assets: Cash and cash equivalents $ 430,504 $ 623,674 Investment securities 1,056,143 1,064,782 Farmer Mac Guaranteed Securities 1,376,847 1,508,134 Loans held for sale 15,281 46,662 Loans held for investment 871,988 942,929 Allowance for loan losses (4,395) (5,967) ----------------- ----------------- Loans, net 882,874 983,624 Real estate owned, net of valuation allowance 3,845 15,478 of zero and $0.2 million Financial derivatives 1,499 961 Interest receivable 58,131 58,423 Guarantee and commitment fees receivable 19,871 16,885 Deferred tax asset, net 6,518 10,891 Prepaid expenses and other assets 10,585 16,798 ----------------- ----------------- Total Assets $ 3,846,817 $ 4,299,650 ----------------- ----------------- Liabilities and Stockholders' Equity: Liabilities: Notes payable: Due within one year $ 2,620,172 $ 2,799,384 Due after one year 862,201 1,136,110 ----------------- ----------------- Total notes payable 3,482,373 3,935,494 Financial derivatives 47,793 67,670 Accrued interest payable 25,511 26,342 Guarantee and commitment obligation 16,869 14,144 Accounts payable and accrued expenses 26,690 29,574 Reserve for losses 10,729 13,172 ----------------- ----------------- Total Liabilities 3,609,965 4,086,396 ----------------- ----------------- Commitments and Contingencies (Note 12) Stockholders' Equity: Preferred stock: Series A, stated at redemption/liquidation value, $50 per share, 700,000 shares authorized, issued and outstanding 35,000 35,000 Common stock: Class A Voting, $1 par value, no maximum authorization, 1,030,780 shares issued and outstanding 1,031 1,031 Class B Voting, $1 par value, no maximum authorization, 500,301 shares issued and outstanding 500 500 Class C Non-Voting, $1 par value, no maximum authorization, 10,291,041 and 10,522,513 shares issued and outstanding as of December 31, 2004 and 2003, respectively 10,291 10,523 Additional paid-in capital 87,777 88,652 Accumulated other comprehensive income/(loss) (882) (2,295) Retained earnings 103,135 79,843 ----------------- ----------------- Total Stockholders' Equity 236,852 213,254 ----------------- ----------------- Total Liabilities and Stockholders' Equity $ 3,846,817 $ 4,299,650 ----------------- ----------------- See accompanying notes to consolidated financial statements.
FEDERAL AGRICULTURAL MORTGAGE CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS
For Year Ended December 31, ------------------------------------------------ 2004 2003 2002 --------------- --------------- -------------- (in thousands, except per share amounts) Interest income: Investments and cash equivalents $ 36,386 $ 35,287 $ 42,629 Farmer Mac Guaranteed Securities 66,222 73,692 89,736 Loans 51,386 52,580 39,505 --------------- --------------- -------------- Total interest income 153,994 161,559 171,870 Interest expense 120,747 124,307 132,771 --------------- --------------- -------------- Net interest income 33,247 37,252 39,099 Provision for loan losses (1,589) (6,524) (1,340) --------------- --------------- -------------- Net interest income after provision for loan losses 31,658 30,728 37,759 Guarantee and commitment fees 20,977 20,685 19,277 Gains/(losses) on financial derivatives and trading assets 2,846 2,357 (8,433) Gain on sale of Farmer Mac Guaranteed Securities 367 - - Gains on the repurchase of debt - - 1,368 Gains on the sale of real estate owned 523 178 24 Representation and warranty claims income 2,816 - - Other income 1,495 812 1,332 --------------- --------------- -------------- Total revenues 60,682 54,760 51,327 --------------- --------------- -------------- Expenses: Compensation and employee benefits 7,036 6,121 5,142 General and administrative 8,800 6,031 5,521 Regulatory fees 2,141 2,005 1,172 Real estate owned operating costs, net 287 264 25 Provision for losses (2,001) 761 6,907 --------------- --------------- -------------- Total operating expenses 16,263 15,182 18,767 --------------- --------------- -------------- Income before income taxes 44,419 39,578 32,560 Income tax expense 13,951 12,308 9,809 ------------------------------------------------ Net income 30,468 27,270 22,751 Preferred stock dividends (2,240) (2,240) (1,456) --------------- --------------- -------------- Net income available to common stockholders $ 28,228 $ 25,030 $ 21,295 --------------- --------------- -------------- Earnings per common share: Basic earnings per common share $ 2.35 $ 2.13 $ 1.83 Diluted earnings per common share $ 2.32 $ 2.08 $ 1.77 Common stock dividends $ 0.10 $ - $ - See accompanying notes to consolidated financial statements.
FEDERAL AGRICULTURAL MORTGAGE CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (in thousands) Common Preferred Accumulated Stock Stock Additional Other --------------------- -------------------- Paid-in Comprehensive Retained Shares Amount Shares Amount Capital Income/(Loss) Earnings Total --------- --------- -------- ---------- ------------ --------------- ---------- --------- Balance, January 1, 2002 11,564 $11,564 - $ - $ 80,960 $ 8,395 $ 33,518 $ 134,437 --------- --------- -------- ---------- ------------ --------------- ---------- --------- Net Income 22,751 22,751 Change in unrealized gain/loss on securities available-for-sale, net of taxes of $20.7 million 38,423 38,423 Change in unrealized gain/loss on financial derivatives, net of taxes of $25.4 million (47,225) (47,225) ---------- Total comprehensive income 13,949 Exercise of stock options, including income tax benefit of $0.3 million 40 40 903 943 Issuance of class C common stock 34 34 997 1,031 Issuance of preferred stock 700 35,000 (333) 34,667 Preferred stock dividends (1,456) (1,456) --------- --------- -------- ---------- ------------ --------------- ---------- --------- Balance, December 31, 2002 11,638 $11,638 700 $35,000 $ 82,527 $ (407) $ 54,813 $ 183,571 --------- --------- -------- ---------- ------------ --------------- ---------- --------- Net Income 27,270 27,270 Change in unrealized gain/loss on securities available-for-sale, net of taxes of $10.3 million (19,063) (19,063) Change in unrealized gain/loss on financial derivatives, net of taxes of $9.2 million 17,175 17,175 ---------- Total comprehensive income 25,382 Exercise of stock options, including income tax benefit of $2.8 million 422 422 6,192 6,614 Issuance of class C common stock 39 39 947 986 Repurchase and retirement of class C common stock (45) (45) (1,014) (1,059) Preferred stock dividends (2,240) (2,240) --------- --------- -------- ---------- ------------ --------------- ---------- --------- Balance, December 31, 2003 12,054 $12,054 700 $35,000 $ 88,652 $ (2,295) $ 79,843 $ 213,254 --------- --------- -------- ---------- ------------ --------------- ---------- --------- Net Income 30,468 30,468 Change in unrealized gain/loss on securities available-for-sale, net of taxes of $5.2 million (9,714) (9,714) Change in unrealized gain/loss on financial derivatives, net of taxes of $6.0 million 11,127 11,127 ---------- Total comprehensive income 31,881 Exercise of stock options, including income tax benefit of $0.2 million 65 65 1,227 1,292 Issuance of class C common stock 2 2 88 90 Repurchase and retirement of class C common stock (299) (299) (2,190) (3,753) (6,242) Preferred stock dividends (2,240) (2,240) Common stock dividends (1,183) (1,183) --------- --------- -------- ---------- ------------ --------------- ---------- --------- Balance, December 31, 2004 11,822 $11,822 700 $35,000 $ 87,777 $ (882) $ 103,135 $ 236,852 --------- --------- -------- ---------- ------------ --------------- ---------- --------- See accompanying notes to consolidated financial statements.
FEDERAL AGRICULTURAL MORTGAGE CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS For Year Ended December 31, ------------------------------------------------------ 2004 2003 2002 ----------------- ---------------- ----------------- Cash flows from operating activities: (in thousands) Net income $ 30,468 $ 27,270 $ 22,751 Adjustments to reconcile net income to net cash provided by operating activities: Net amortization of investment premiums and discounts 2,564 (834) 743 Amortization of debt premiums, discounts and issuance costs 30,687 34,844 46,859 Proceeds from repayment of trading investment securities 4,617 7,184 34,029 Purchase of held for sale loans (70,524) (90,504) (39,268) Proceeds from repayment of held for sale loans 11,194 14,393 2,767 Proceeds from sale of held for sale loans 89,162 70,229 46,913 Net change in fair value of trading securities and derivatives (954) (2,479) 4,359 Amortization of settled financial derivatives contracts 1,206 1,596 1,111 Gain on the repurchase of debt - - (889) Gain on sale of Farmer Mac Guaranteed Securities (367) - - Gain on sale of real estate owned (523) (178) (24) Total provision for losses (412) 7,285 8,247 Deferred income taxes 2,371 (221) (2,959) Decrease/(increase) in interest receivable 292 6,853 (9,023) (Increase)/decrease in guarantee and commitment fees receivable (2,986) (10,947) 66 (Increase)/decrease in other assets 4,846 (31,897) (11,028) (Decrease)/increase in accrued interest payable (831) (3,414) 3,398 (Decrease)/increase in other liabilities (13,195) 23,436 6,756 ----------------- ---------------- ----------------- Net cash provided by operating activities 87,615 52,616 114,808 ----------------- ---------------- ----------------- Cash flows from investing activities: Purchases of available-for-sale investment securities (598,858) (959,081) (179,146) Purchases of Farmer Mac II Guaranteed Securities and AgVantage bonds (225,591) (299,079) (200,583) Purchases of loans (46,664) (157,715) (755,060) Proceeds from repayment of investment securities 615,555 719,262 331,880 Proceeds from repayment of Farmer Mac Guaranteed Securities 257,374 363,718 242,748 Proceeds from repayment of loans 145,536 137,431 64,401 Proceeds from sale of loans and Farmer Mac Guaranteed Securities 53,361 8,025 769 Proceeds from sale of real estate owned 12,482 9,984 4,802 ----------------- ---------------- ----------------- Net cash provided by/(used in) investing activities 213,195 (177,455) (490,189) ----------------- ---------------- ----------------- Cash flows from financing activities: Proceeds from issuance of discount notes 58,532,700 73,025,686 58,967,290 Proceeds from issuance of medium-term notes 675,782 354,027 303,017 Payments to redeem discount notes (59,414,100) (73,235,160) (58,433,613) Payments to redeem medium-term notes (278,760) (122,140) (205,476) Settlement of financial derivatives (1,319) (2,001) (5,053) Net proceeds from preferred stock issuance - - 34,667 Proceeds from common stock issuance 1,382 6,541 1,974 Purchases of common stock (6,242) - - Cash dividends paid (3,423) (2,240) (1,456) ----------------- ---------------- ----------------- Net cash provided by/(used in) financing activities (493,980) 24,713 661,350 ----------------- ---------------- ----------------- Net (decrease)/increase in cash and cash equivalents (193,170) (100,126) 285,969 Cash and cash equivalents at beginning of period 623,674 723,800 437,831 ----------------- ---------------- ----------------- Cash and cash equivalents at end of period $ 430,504 $ 623,674 $ 723,800 ----------------- ---------------- ----------------- See accompanying notes to consolidated financial statements.
FEDERAL AGRICULTURAL MORTGAGE CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2004, 2003 and 2002 1. ORGANIZATION The Federal Agricultural Mortgage Corporation ("Farmer Mac" or the "Corporation") was chartered by the U.S. Congress in the Agricultural Credit Act of 1987 (12 U.S.C. sections 2279aa et seq.), which amended the Farm Credit Act of 1971 (collectively, as amended, the "Act"). Farmer Mac is a stockholder-owned instrumentality of the United States that was created to establish a secondary market for agricultural real estate and rural housing mortgage loans and to increase the availability of long-term credit at stable interest rates to American farmers, ranchers and rural homeowners. The Farmer Mac secondary market for agricultural mortgage loans accomplishes that mission by providing liquidity and lending capacity to agricultural mortgage lenders by: o purchasing newly originated and pre-existing ("seasoned") eligible mortgage loans directly from lenders; o exchanging newly issued agricultural mortgage-backed securities guaranteed by Farmer Mac ("Farmer Mac Guaranteed Securities") for newly originated and seasoned eligible mortgage loans that back those securities in "swap" transactions; o issuing long-term standby purchase commitments ("LTSPCs") for newly originated and seasoned eligible mortgage loans; and o purchasing and guaranteeing mortgage-backed bonds secured by eligible mortgage loans, which are referred to as AgVantage bonds. Farmer Mac conducts these activities through two programs--Farmer Mac I and Farmer Mac II. Under the Farmer Mac I program, Farmer Mac: o purchases eligible mortgage loans; o securitizes eligible mortgage loans purchased and guarantees the timely payment of principal and interest on the agricultural mortgage-backed securities backed by such loans; and o commits to purchase eligible mortgage loans under LTSPCs for such loans. To be eligible for the Farmer Mac I program, loans must meet Farmer Mac's underwriting, appraisal, documentation and other specified standards. Under the Farmer Mac II program, Farmer Mac purchases the guaranteed portions of loans guaranteed by the United States Department of Agriculture (the "USDA-guaranteed portions") pursuant to the Consolidated Farm and Rural Development Act (7 U.S.C. sections 1921 et seq.) and guarantees securities backed by those USDA-guaranteed portions purchased by Farmer Mac. As of December 31, 2004, outstanding loans held by Farmer Mac and loans that either back Farmer Mac Guaranteed Securities or are subject to LTSPCs totaled $5.5 billion. Farmer Mac may retain Farmer Mac Guaranteed Securities in its portfolio or sell them to third parties. Farmer Mac's two principal sources of revenue are: o fees received in connection with outstanding Farmer Mac Guaranteed Securities and LTSPCs; and o net interest income earned on its portfolio of Farmer Mac Guaranteed Securities, mortgage loans and investments. Farmer Mac funds its program purchases primarily by issuing debt obligations of various maturities. As of December 31, 2004, Farmer Mac had outstanding $1.8 billion of discount notes and $1.7 billion of medium-term notes. During 2004, the Corporation continued its strategy of regularly issuing debt to increase its presence in the capital markets in order to reduce the rates it pays on its debt, which allows Farmer Mac to accept lower rates on mortgages to farmers, ranchers and rural homeowners that it purchases from lenders. To the extent the proceeds of the debt issuances exceed Farmer Mac's need to fund program assets, those proceeds are invested in high quality non-program liquid assets. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The accounting and reporting policies of Farmer Mac conform with accounting principles generally accepted in the United States of America ("generally accepted accounting principles"). The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities (including, but not limited to, the allowance for loan losses, reserve for losses, and valuation of Farmer Mac Guaranteed Securities) as of the date of the consolidated financial statements and the reported amounts of income and expenses during the reporting period. Actual results could differ from those estimates. The following are the significant accounting policies that Farmer Mac follows in preparing and presenting its consolidated financial statements: (a) Principles of Consolidation The consolidated financial statements include the accounts of Farmer Mac and its wholly-owned subsidiary, Farmer Mac Securities Corporation, whose principal activities are to facilitate the purchase and issuance of Farmer Mac Guaranteed Securities and to act as a registrant under registration statements filed with the Securities and Exchange Commission. All inter-company balances and transactions have been eliminated in consolidation. (b) Cash and Cash Equivalents Farmer Mac considers highly liquid investment securities with remaining maturities of three months or less at the time of purchase to be cash equivalents. Changes in the balance of cash and cash equivalents are reported in the consolidated statements of cash flows. The following table sets forth information regarding certain cash and non-cash transactions for the years ended December 31, 2004, 2003 and 2002.
2004 2003 2002 ------------ ------------- ------------- (in thousands) Cash paid during the year for: Interest $ 71,016 $ 60,745 $ 63,750 Income taxes 9,000 11,000 12,600 Non-cash activity: Real estate owned acquired through foreclosure 5,339 19,868 7,632 Loans acquired and securitized as Farmer Mac Guaranteed Securities 103,150 78,254 47,682 Loans previously under LTSPCs exchanged for Farmer Mac Guaranteed Securities - 722,315 -
(c) Investments and Farmer Mac Guaranteed Securities Farmer Mac classifies investments and Farmer Mac Guaranteed Securities that Farmer Mac has the positive intent and ability to hold to maturity as held-to-maturity. Such securities are carried at cost, adjusted for unamortized premiums and unearned discounts. Securities for which Farmer Mac does not have the positive intent to hold to maturity are classified as available-for-sale and are carried at estimated fair value. Unrealized gains and losses on available-for-sale securities are reported as accumulated other comprehensive income/(loss) in stockholders' equity. Securities classified as trading securities are reported at their fair value, with unrealized gains and losses included in earnings. Gains and losses on the sale of available-for-sale and trading securities are determined using the specific identification cost method. Farmer Mac determines the fair value of Farmer Mac Guaranteed Securities based on the present value of the associated expected future cash flows. In estimating the present value of the expected future cash flows, management is required to make estimates and assumptions. The key estimates and assumptions include future discount rates and collateral repayment rates. Premiums, discounts and other deferred costs are amortized to interest income over the estimated life of the security using the effective interest method. Interest income on investments and Farmer Mac Guaranteed Securities is recorded on an accrual basis unless the collection of interest is considered doubtful. Farmer Mac generally receives compensation (yield maintenance payments) when loans with yield maintenance provisions underlying Farmer Mac Guaranteed Securities prepay. These payments mitigate Farmer Mac's exposure to reinvestment risk and are calculated such that, when reinvested with the prepaid principal, they should generate substantially the same cash flows that would have been generated had the loans not prepaid. Yield maintenance payments are recognized as interest income in the consolidated statements of operations upon receipt. (d) Loans Loans for which Farmer Mac has the positive intent and ability to hold for the foreseeable future are classified as held for investment and reported at their unpaid principal balance net of unamortized purchase discounts or premiums. The net unamortized purchase premiums as of December 31, 2004 and 2003 were $9.4 million and $13.3 million, respectively. Loans that Farmer Mac does not intend to hold for the foreseeable future are classified as held for sale and reported at the lower of cost or market using the aggregate method. (e) Securitization of Loans Asset securitization involves the transfer of financial assets to another entity in exchange for cash and/or beneficial interests in the assets transferred. Farmer Mac transfers agricultural mortgage loans into trusts that are used as vehicles for the securitization of the transferred loans. The trusts issue Farmer Mac Guaranteed Securities that are beneficial interests in the assets of the trusts, to either Farmer Mac or third party investors. Farmer Mac may either retain the securities issued by the trusts or sell the securities issued by the trusts to third party investors. Farmer Mac guarantees the timely payment of principal and interest on the securities issued by the trusts and receives guarantee fees as compensation for its guarantee. Farmer Mac recognizes guarantee fees on an accrual basis over the terms of the Farmer Mac Guaranteed Securities, which coincide with the terms of the underlying loans. As such, no guarantee fees are unearned at the end of any reporting period. If Farmer Mac purchases a delinquent loan underlying a Farmer Mac Guaranteed Security, Farmer Mac stops accruing the guarantee fee upon the loan purchase. Statement of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities ("SFAS 140"), which became effective for transfers of financial assets after March 31, 2001, expanded the requirements for "qualifying special purposes entities." The trust vehicles used in loan securitization transactions after March 31, 2001, in which Farmer Mac retains all the Farmer Mac Guaranteed Securities issued by the trust, do not meet the "qualifying special purpose entity" requirements of SFAS 140. Accordingly, Farmer Mac accounts for the Farmer Mac Guaranteed Securities it retains in these transactions as loans in its consolidated balance sheets and the guarantee fees earned on those assets are recorded as interest income in the consolidated statements of operations. The Farmer Mac Guaranteed Securities securitized prior to April 1, 2001 that Farmer Mac retained, have been recorded in Farmer Mac's consolidated financial statements as Farmer Mac Guaranteed Securities and are classified and accounted for in accordance with Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities ("SFAS 115"). Transfers of agricultural mortgage loans into trusts in which Farmer Mac surrenders control over the financial assets and receives compensation other than beneficial interests in the underlying loans are recorded as sales under SFAS 140. The carrying amount of the assets that are transferred in these transactions is allocated between the assets sold and the interests retained, if any, based on the relative fair values of each at the date of the transfer. A gain or loss is included in income for the difference between the allocated carrying amount of the asset sold and the net cash proceeds received. In 2004 Farmer Mac realized $0.4 million gain on sale of loans accounted for as sales under SFAS 140. In 2003 and 2002, Farmer Mac did not realize any gains or losses upon the sale of loans accounted for as sales under SFAS 140. When particular criteria are met, such as the default of the borrower, Farmer Mac has the option to repurchase the defaulted loans underlying Farmer Mac Guaranteed Securities (these options are commonly referred to as "removal-of-account" provisions). Farmer Mac records these loans in the consolidated financial statements during the period in which Farmer Mac has the option to repurchase the loans and therefore regains effective control over the transferred loans. (f) Nonaccrual Loans Nonaccrual loans are loans for which it is probable that Farmer Mac will be unable to collect all amounts due according to the contractual terms of the loan agreement and include all loans 90 days or more past due. When a loan becomes 90 days past due, interest accrual on the loan is discontinued and interest previously accrued is reversed against interest income in the current period. The interest on such loans is accounted for on the cash basis until a loan qualifies for return to accrual status. Loans are returned to accrual status when all the principal and interest payments contractually due are collected and loans meet certain performance criteria. (g) Real Estate Owned Real estate owned consists of real estate acquired through foreclosure and is recorded at fair value less estimated selling costs at acquisition. Fair value is determined by appraisal or other appropriate valuation method. Losses estimated at the time of acquisition are charged to the allowance for loan losses. Subsequent to the acquisition, management continues to perform periodic valuations and establishes a valuation allowance for real estate owned through a charge to income in the provision for losses if the carrying value of a property exceeds its estimated fair value less estimated selling costs. Farmer Mac contracts with third parties to operate or preserve real estate owned and offered for sale when appropriate to maintain property value. Non-recoverable costs are expensed as incurred and those related to the production of saleable goods or crops are capitalized to the extent they are realizable. As revenues from the sale of goods or crops are received, they are applied first to any capitalized costs and any remaining revenues offset non-recoverable expenses incurred. (h) 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 and 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 mortgage and other assets, and also to adjust the characteristics of its long-term debt to match more closely the cash flow and duration characteristics of its short-term assets, thereby reducing interest rate risk. These transactions also may provide an overall lower effective cost of borrowing than would otherwise be available in the conventional debt market. Farmer Mac recognizes contracts and commitments as financial derivatives in accordance with Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended ("SFAS 133"). All financial derivatives are recorded on the balance sheet at fair value as a freestanding asset or liability. Financial derivatives in hedging relationships that mitigate exposure to changes in the fair value of assets are considered fair value hedges. Financial derivatives in hedging relationships that mitigate the exposure to the variability in expected future cash flows or other forecasted transactions are considered cash flow hedges. Financial derivatives that do not satisfy the hedging criteria of SFAS 133 are not accounted for as hedges and changes in the fair values of those financial derivatives are reported as gains or losses on financial derivatives and trading assets in the consolidated statements of operations. Fair value hedges are accounted for by recording the fair value of the financial derivative and the change in fair value of the asset attributable to the risk being hedged on the consolidated balance sheets with the net difference reported as ineffectiveness in the consolidated statements of operations as a gain or loss on financial derivatives. The adjustment to the hedged asset is included in the reported amount of the hedged item. Cash payments or receipts and related amounts accrued during the reporting period on financial derivatives in fair value hedging relationships are recorded as an adjustment to the interest income on the hedged asset. If a financial derivative in a fair value hedging relationship is no longer effective, is de-designated from its hedging relationship, or is terminated, Farmer Mac discontinues fair value hedge accounting for the financial derivative and the hedged item. Accordingly, the hedged item is no longer adjusted for changes in its fair value attributable to the risk being hedged. The accumulated adjustment of the carrying amount of the hedged asset is recognized in earnings as an adjustment to interest income over the expected remaining life of the asset using the effective interest rate method. 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/(loss) within stockholders' equity, net of tax. Amounts are reclassified from accumulated other comprehensive income/(loss) 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 a gain or loss on financial derivatives and trading assets 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/(loss) to the consolidated statements of operations and reported as gains or losses on financial derivatives and trading assets. Gains and losses on financial derivatives not considered highly effective in hedging the change in fair value or expected cash flows of the related hedged item are recognized in the consolidated statement of operations as a gain or loss on financial derivatives and trading assets, as these derivatives do not qualify for hedge accounting under SFAS 133. If a financial derivative has not been or will not continue to be highly effective as a hedge, hedge accounting is discontinued prospectively and the financial derivative continues to be recorded at fair value with changes in fair value reported as a gain or loss on financial derivatives and trading assets in the consolidated statement of operations. (i) Notes Payable Notes payable are classified as due within one year or due after one year based on their contractual maturities. Debt issuance costs are deferred and amortized to interest income or expense using the effective interest method over the estimated life of the related debt. (j) Allowance for Losses Farmer Mac maintains an allowance and contingent obligation for probable losses ("allowance for losses") to cover estimated probable losses on loans held for investment, real estate owned and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs in accordance with Statement of Financial Accounting Standard No. 5, Accounting for Contingencies ("SFAS 5"), and Statement of Financial Accounting Standard No. 114, Accounting by Creditors for Impairment of a Loan, as amended ("SFAS 114"). The methodology for determining the allowance for losses is the same for loans held for investment and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs because Farmer Mac believes the ultimate credit risk is substantially the same, i.e., the underlying agricultural mortgage loans all meet the same credit underwriting and appraisal standards. 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 operating expense and is reduced by charge-offs for actual losses, net of recoveries. Negative provisions for loan losses or provisions for losses are recorded in the event that the estimate of probable losses as of the end of a period is lower than the estimate at the beginning of the period. Charge-offs represent losses on the outstanding principal balance, any interest payments previously accrued or advanced and expected costs of liquidation. Farmer Mac estimates probable losses using a systematic process that begins with management's evaluation of the results of its proprietary loan pool simulation and guarantee fee model (the "Model"). The Model draws upon historical information from a data set of agricultural mortgage loans recorded over a longer period of time than Farmer Mac's own experience to date, screened to include only those loans with credit characteristics similar to those on which Farmer Mac has assumed credit risk. The results generated by the Model are modified by the application of management's judgment, as required to take key factors into account, including: o economic conditions; o geographic and agricultural commodity/product concentrations in Farmer Mac's portfolio; o the credit profile of Farmer Mac's portfolio; o delinquency trends of Farmer Mac's portfolio; o Farmer Mac's experience in the management and sale of real estate owned; and o historical charge-off and recovery activities of Farmer Mac's portfolio. Management believes that its use of this methodology produces a reliable estimate of total probable losses, as of the balance sheet date, for all loans included in Farmer Mac's portfolio, including loans held, real estate owned and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs. Farmer Mac also specifically analyzes certain assets in its portfolio for impairment. This analysis measures impairment based on the fair value of the underlying collateral for each individual loan relative to the total recorded investment, including principal, interest and advances under SFAS 114. In the event that the updated appraisal or management's estimate of discounted collateral value does not support the total recorded investment, Farmer Mac specifically allocates an allowance for the loan for the difference between the recorded investment and its fair value, less estimated costs to liquidate the collateral. For this analysis and the allocation of specific allowances, Farmer Mac reviews: o non-performing assets (loans 90 days or more past due, in foreclosure, restructured, in bankruptcy - including loans performing under either their original loan terms or a court-approved bankruptcy plan - and real estate owned); o loans for which Farmer Mac had adjusted the timing of borrowers' payment schedules, but still expects to collect all amounts due and has not made economic concessions; and o additional performing loans that have previously been delinquent or are secured by real estate that produces agricultural commodities or products currently under stress. Management believes that the general allowance, which is the difference between the total allowance for losses (generated through use of the Model) and the specific allowances, adequately covers any probable losses inherent in the portfolio of performing loans under SFAS 5. Farmer Mac believes that the methodology described above produces a reliable estimate of the total probable losses inherent in Farmer Mac's portfolio. The Model: o uses historical agricultural real estate loan origination and servicing data that reflect varied economic conditions and stress levels in the agricultural sector; o contains features that allow variations for changes in loan portfolio characteristics to make the data set more representative of Farmer Mac's portfolio and credit underwriting standards; and o considers the effects of the ageing of the loan portfolio along the expected loss curves associated with individual origination years, including the segments that are entering into or coming out of their peak default years. When certain criteria are met, such as the default of the borrower, Farmer Mac may, in its sole discretion, repurchase the defaulted loans underlying Farmer Mac Guaranteed Securities and is obligated to purchase those underlying an LTSPC. These purchases are recorded in the consolidated financial statements at their fair value. Fair value is determined by appraisal or management's estimate of discounted collateral value. No allowance for losses has been made for loans underlying Farmer Mac I Guaranteed Securities issued prior to the 1996 Act or Farmer Mac II Guaranteed Securities. Farmer Mac I Guaranteed Securities issued prior to the 1996 Act are supported by unguaranteed first loss subordinated interests, which are expected to exceed the estimated credit losses on those loans. USDA-guaranteed portions collateralizing Farmer Mac II Guaranteed Securities are obligations backed by the full faith and credit of the United States. As of December 31, 2004, Farmer Mac had experienced no credit losses on any pre-1996 Act Farmer Mac I Guaranteed Securities or on any Farmer Mac II Guaranteed Securities and does not expect to incur any such losses in the future. (k) Earnings Per Common Share Basic earnings per common share are based on the weighted-average number of common shares outstanding. Diluted earnings per common share is based on the weighted-average number of common shares outstanding adjusted to include all potentially dilutive common stock options. The following schedule reconciles basic and diluted earnings per common share ("EPS") for the years ended December 31, 2004, 2003 and 2002.
2004 2003 2002 --------------------------------- --------------------------------- --------------------------------- Dilutive Dilutive Dilutive stock Diluted stock Diluted stock Diluted Basic EPS options EPS Basic EPS options EPS Basic EPS options EPS --------------------------------- --------------------------------- --------------------------------- (in thousands, except per share amounts) Net income available to $ 28,228 $ 28,228 $ 25,030 $ 25,030 $ 21,295 $ 21,295 common stockholders Weighted-average 12,036 143 12,179 11,742 307 12,049 11,613 437 12,050 shares Earnings per common share $ 2.35 $ 2.32 $ 2.13 $ 2.08 $ 1.83 $ 1.77
(l) Income Taxes Deferred federal income tax assets and liabilities are established for temporary differences between financial and taxable income and are measured using the current enacted statutory tax rate. Income tax expense is equal to the income taxes payable in the current year plus the net change in the deferred tax asset or liability balance. (m) Stock-Based Compensation Farmer Mac accounts for its stock-based employee compensation plans, which are described more fully in Note 9, using the intrinsic value method of accounting for employee stock options pursuant to Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, as amended ("SFAS 123"). Accordingly, no compensation expense was recognized in 2004, 2003 and 2002 for employee stock option plans. Had Farmer Mac elected to use the fair value method of accounting for employee stock options, net income available to common stockholders and earnings per share for the years ended December 31, 2004, 2003 and 2002 would have been reduced to the pro forma amounts indicated in the following table:
For the Year Ended December 31, ---------------------------------------- 2004 2003 2002 ------------ ------------- ------------- (in thousands, except per share amounts) Net income available to common stockholders, as reported $ 28,228 $ 25,030 $ 21,295 Add back: Restricted stock compensation expense included in reported net income, net of taxes 15 304 617 Deduct: Total stock-based employee compensation expense determined under fair value-based method for all awards, net of tax (1,647) (2,833) (2,990) ------------ ------------- ------------- Pro forma net income available to common stockholders $ 26,596 $ 22,501 $ 18,922 ------------ ------------- ------------- Earnings per share: Basic - as reported $ 2.35 $ 2.13 $ 1.83 Basic - pro forma 2.21 1.92 1.63 Diluted - as reported $ 2.32 $ 2.08 $ 1.77 Diluted - pro forma 2.18 1.87 1.57
The underlying assumptions to these fair value calculations are presented in Note 9. (n) Comprehensive Income/(Loss) Comprehensive income/(loss) represents all changes in stockholders' equity except those resulting from investments by or distributions to stockholders, and is comprised of net income available to common stockholders, unrealized gains and losses on securities available-for-sale and the effective portion of the unrealized gains and losses on financial derivatives in cash flow hedge relationships, net of reclassification adjustments and related taxes. Comprehensive income is reported in the consolidated statements of changes in stockholders' equity. The following table presents Farmer Mac's accumulated other comprehensive income/(loss) as of December 31, 2004, 2003 and 2002.
As of December 31, --------------------------------------- 2004 2003 2002 ------------ ------------- ------------ (in thousands) Available-for-sale securities: Unrealized gains $ 51,759 $ 66,551 $ 95,897 Impact of realized gains and included in net income (153) - (19) Tax effect (18,062) (23,293) (33,557) ------------ ------------- ------------ Net change from available-for-sale securities 33,544 43,258 62,321 ------------ ------------- ------------ Cash flow hedging instruments: Unrealized losses (55,694) (71,747) (97,524) Amortization of losses on forward sale contracts into interest expense 1,563 1,665 1,019 Impact of realized losses related to de-designated cash flow hedges 1,168 - - Tax effect 18,537 24,529 33,777 ------------ ------------- ------------ Net change from cash flow hedging instruments (34,426) (45,553) (62,728) ------------ ------------- ------------ Accumulated other comprehensive income/(loss), net of tax $ (882) $ (2,295) $ (407) ------------ ------------- ------------
(o) Long-Term Standby Purchase Commitments ("LTSPCs") Farmer Mac accounts for its LTSPC commitment fees in accordance with provisions of FIN 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. In accordance with FIN 45, commitment fee income represents a reduction of the commitment obligation based on amortization using the actual prepayment experience on the underlying loans, which Farmer Mac refers to as the Declining Unpaid Principal Balance Method. See Note 2(j) for Farmer Mac's policy for estimating probable losses for LTSPCs. (p) New Accounting Standards On January 1, 2003, Farmer Mac adopted the liability recognition provisions of the Financial Accounting Standards Board Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others ("FIN 45"), which requires Farmer Mac to recognize, 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 agreement and an asset that is equal to the fair value of the fees that will be received over the life of each guarantee. In December 2003, the SEC provided additional guidance on the "day two" accounting for these financial instruments. In accordance with this guidance, Farmer Mac has adopted the amortized cost model for day two accounting effective January 1, 2004. In December 2003, the American Institute of Certified Public Accountants issued Statement of Position 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer ("SOP 03-3"). SOP 03-3 addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor's initial investment in loans or debt securities acquired in a transfer if those differences are attributable, at least in part, to credit quality. Specifically, SOP 03-3 limits the yield that may be accreted and prohibits the "carry-over" of a valuation allowance for all impaired loans that are within the scope of SOP 03-3. SOP 03-3 is effective for loans acquired in fiscal years beginning after December 15, 2004. Farmer Mac is evaluating the impact of SOP 03-3, and will adopt it when effective. In March 2004, the Emerging Issues Task Force ("EITF") amended EITF 03-1, The Meaning of Other-Than-Temporary Impairment, to introduce a three-step model to: (1) determine whether an investment is impaired; (2) evaluate whether the impairment is other-than-temporary; and (3) account for other-than-temporary impairments. In part, this amendment requires companies to apply qualitative and quantitative measures to determine whether a decline in the fair value of a security is other-than-temporary. The guidance in EITF 03-1 is effective for reporting periods beginning after June 15, 2004, with the exception of certain sections, which have been deferred. Farmer Mac is evaluating the impact of the amendment and will adopt it when it is effective in full. In the interim, Farmer Mac continues to apply earlier authoritative accounting guidance, primarily SFAS 115 and EITF 99-20, Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets, for the measurement and recognition of other-than-temporary impairment of its debt and equity securities. In December 2004, the Financial Accounting Standards Board issued Statement No. 123 (revised 2004), Share-Based Payment ("SFAS 123(R)"). SFAS 123(R) is a revision of the Financial Accounting Standards Board Statement No. 123, Accounting for Stock-Based Compensation ("SFAS 123") and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees ("APB 25"), and its related implementation guidance. SFAS 123(R) requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost will be recognized over the period during which an employee is required to provide service in exchange for the award. The grant-date fair value of employee share options and similar instruments will be estimated using option-pricing models adjusted for the unique characteristics of those instruments. SFAS 123(R) eliminates the alternative to use APB 25's intrinsic value method of accounting that was provided in SFAS 123 as originally issued. Currently, as discussed in Note 2(m), Farmer Mac accounts for its stock-based employee compensation plans using the intrinsic value method of accounting for employee stock options pursuant to APB 25 and has adopted the disclosure-only provisions of SFAS 123. The guidance in SFAS 123(R) is effective for reporting periods beginning after June 15, 2005. Farmer Mac is evaluating the impact of SFAS 123(R), and will adopt it when effective. (q) Reclassifications Certain reclassifications of prior year information were made to conform to the 2004 presentation. 3. RELATED PARTY TRANSACTIONS As provided by Farmer Mac's statutory charter, only banks, insurance companies and other financial institutions or similar entities may hold Farmer Mac's Class A voting common stock and only institutions of the Farm Credit System may hold Farmer Mac's Class B voting common stock. Farmer Mac's statutory charter also provides that Class A stockholders elect five members of Farmer Mac's 15-member board of directors and that Class B stockholders elect five members of the board of directors. Additionally, in order to participate in the Farmer Mac I program, a financial institution must own a requisite amount of Farmer Mac Class A or Class B voting common stock, based on the size and type of institution. As a result of these requirements, Farmer Mac conducts business with related parties in the normal course of Farmer Mac's business. During 2004, Farmer Mac purchased newly originated and current seasoned eligible loans from 37 entities (the top ten institutions generated 82.5 percent of the purchase volume), placed loans under LTSPCs with 18 entities and conducted Farmer Mac II transactions with 133 entities operating throughout the United States. During 2003, Farmer Mac purchased newly originated and current seasoned eligible loans from 48 entities (the top ten institutions generated 80.8 percent of the purchase volume), placed loans under LTSPCs with 11 entities and conducted Farmer Mac II transactions with 150 entities operating throughout the United States. All related party transactions were conducted in the ordinary course of business, with terms and conditions comparable to those available to any other third party. Long-Term Standby Purchase Commitments with Related Parties: For all of the LTSPC transactions discussed below, Farmer Mac has a related party relationship with each entity resulting from a member of Farmer Mac's board of directors being affiliated with the entity in some capacity. Farmer Mac 2004 and 2003 LTSPC activity with related parties is presented below:
For the Year Ended December 31, ------------------------------------------------- 2004 2003 ---------------------- -------------------------- Aggregate Aggregate Number of Principal Number of Principal Loans Balance Loans Balance ----------- ----------- ------------ ----------- (dollars in thousands) New extensions: AgFirst Farm Credit Bank 338 $ 95,528 1,016 $ 172,489 AgStar Financial Services, ACA 35 11,573 2,347 194,205 Farm Credit Bank of Texas 294 67,530 295 47,361 Farm Credit West, ACA or its affiliates 87 89,569 287 174,336 As of December 31, ------------------------------------------------ 2004 2003 ---------------------- -------------------------- Aggregate Aggregate Number of Principal Number of Principal Loans Balance Loans Balance ----------- ----------- ------------ ----------- (dollars in thousands) Aggregate LTSPCs outstanding: AgFirst Farm Credit Bank 3,548 $ 517,406 3,843 $ 545,895 AgStar Financial Services, ACA 3,214 237,155 3,570 265,560 Farm Credit Bank of Texas 532 96,995 275 40,768 Farm Credit West, ACA or its affiliate 215 172,230 157 106,234
For the Year Ended December 31, 2004 2003 2002 ------------ ------------- ------------ (in thousands) Commitment fees earned: AgFirst Farm Credit Bank $ 2,428 $ 2,077 $ 1,300 AgStar Financial Services, ACA 1,112 879 486 Farm Credit Bank of Texas 423 89 - Farm Credit West, ACA or its affiliates 1,046 1,947 2,800
As of December 31, 2004 and 2003, Farmer Mac had the following commitment fees receivable from related parties:
As of December 31, 2004 2003 ----------- ---------- (in thousands) AgFirst Farm Credit Bank $ 401 $ 380 AgStar Financial Services, ACA 88 100 Farm Credit Bank of Texas 44 18 Farm Credit West, ACA or its affiliates 71 41
Zions First National Bank or its affiliates: The following transactions occurred between Farmer Mac and Zions First National Bank or its affiliates ("Zions"), which is Farmer Mac's largest holder of Class A voting common stock and a major holder of Class C non-voting common stock, during 2004 and 2003:
For the Year Ended December 31, ------------------------------------------------- 2004 2003 ---------------------- -------------------------- Aggregate Aggregate Number of Principal Number of Principal Loans Balance Loans Balance ----------- ----------- ------------ ----------- (dollars in thousands) Purchases: Loans 75 $ 34,403 148 $ 74,496 USDA guaranteed portions 27 6,545 6 1,694 Sales of Farmer Mac Guaranteed Securities 64,458 75,834
The purchases of loans from Zions under the Farmer Mac I program represented approximately 33.0 percent and 38.7 percent of Farmer Mac I loan purchase volume for the years ended December 31, 2004 and 2003, respectively. The purchases of USDA-guaranteed portions under the Farmer Mac II program from Zions represented approximately 3.8 percent and 0.6 percent of that program's volume for the years ended December 31, 2004 and 2003, respectively. The following fees were paid or received by Farmer Mac with respect to transactions with Zions:
For the Year Ended December 31, 2004 2003 2002 ------------- ------------ ------------ (in thousands) Guarantee fees earned $ 2,996 $ 1,399 $ 1,000 Servicing expense paid 1,501 1,345 1,200 Debt issuance fees paid to agent - 226 43 Underwriting and loan file review fees paid 18 48 51 Commissions paid to dealer on debt issuance 31 18 89
Debt issuance fees were paid to Zions for acting as agent with respect to approximately $154.7 million and $28.3 million of Farmer Mac medium-term notes issued during 2003 and 2002, respectively. Zions did not act as agent for any Farmer Mac medium-term notes during 2004. Commissions were paid to Zions for acting as dealer with respect to approximately $512.0 million, $189.0 million and $738.7 million par value of Farmer Mac discount notes during 2004, 2003 and 2002, respectively. As of December 31, 2004 and 2003, Farmer Mac had net interest payable to Zions or its affiliates of approximately $4.2 million and $6.2 million, respectively. Farmer Mac and Zions were parties to interest rate swap contracts having an aggregate outstanding notional principal amount of approximately $262.0 million and $307.6 million as of December 31, 2004 and 2003, respectively. AgFirst Farm Credit Bank: Farmer Mac has a related party relationship with AgFirst Farm Credit Bank ("AgFirst"), resulting from a member of Farmer Mac's board of directors also being a member of AgFirst's board of directors and AgFirst being a major holder of Farmer Mac Class B voting common stock. Farmer Mac also owned $88.0 million of AgFirst preferred stock as of December 31, 2004 and 2003. Farmer Mac purchased 1 loan for $1.2 million from AgFirst in 2004, compared to the purchase of 4 loans for $0.9 million in 2003. For 2004, 2003 and 2002, Farmer Mac paid AgFirst fees for participating in Farmer Mac's programs as a central servicer in the amount of $0.4 million, $0.1 million and $0.1 million, respectively. As of December 31, 2004 and 2003, the outstanding balance of issued Farmer Mac Guaranteed Securities backed by rural housing loans for which Farmer Mac is second-loss guarantor for the last 10 percent of each security to AgFirst was $717.0 million and $741.5 million, respectively. During second quarter 2004, Farmer Mac sold Farmer Mac I Guaranteed Securities to AgFirst in the amount of $26.9 million at a gain of $0.4 million. Other Related Party Transactions: For all of the transactions discussed below, Farmer Mac has a related party relationship with each entity resulting from a member of Farmer Mac's board of directors being affiliated with the entity in some capacity. During 2003, Farm Credit West, ACA converted a $722.3 million LTSPC into a Farmer Mac I Guaranteed Security. As of December 31, 2004 and 2003, the outstanding balance of that Farmer Mac Guaranteed Security was $585.2 million and $680.2 million, respectively. The following is a summary of purchases of loans and USDA-guaranteed portions from other related parties during 2004 and 2003:
For the Year Ended December 31, ------------------------------------------------- 2004 2003 ---------------------- -------------------------- Aggregate Aggregate Number of Principal Number of Principal Loans Balance Loans Balance ----------- ----------- ------------ ----------- (dollars in thousands) Purchases: Loans: First Dakota National Bank 15 $ 3,532 - * $ - * USDA-guaranteed portions: Bath State Bank 43 6,894 37 8,691 First Dakota National Bank 12 2,081 - * - * * Farmer Mac did conduct business with First Dakota National Bank during 2003, though that institution was not a related party during 2003.
Farmer Mac earned the following guarantee fees with respect to transactions with other related parties:
For the Year Ended December 31, 2004 2003 2002 ----------- ---------- -------- (in thousands) Farm Credit West, ACA or its affiliates $ 2,799 $ 1,706 $ - Bath State Bank 52 45 50 First Dakota National Bank 188 - * - * * Farmer Mac did conduct business with First Dakota National Bank during 2003 and 2002, though that institution was not a related party during 2003 or 2002.
4. INVESTMENT SECURITIES Farmer Mac's investment portfolio is comprised of the following:
As of December 31, 2004 2003 ------------ ------------ (in thousands) Held-to-maturity $ 10,604 $ 10,604 Available-for-sale 1,035,695 1,039,673 Trading 9,844 14,505 ------------ ------------ $ 1,056,143 $ 1,064,782 ------------ ------------
The amortized cost and estimated fair values of investments as of December 31, 2004 and 2003 were as follows. Fair value was estimated based on quoted market prices.
2004 2003 ---------------------------------------------------- ------------------------------------------------- Amortized Unrealized Unrealized Amortized Unrealized Unrealized Cost Gain Loss Fair Value Cost Gain Loss Fair Value ------------ ------------ ------------ ------------- ----------- ------------ ----------- ----------- (in thousands) Held-to-maturity: Cash investment in fixed rate guaranteed investment contract $ 10,604 $ 282 $ - $ 10,886 $ 10,604 $ 342 $ - $ 10,946 ------------- ----------- ----------- --------------------------- ----------- ----------- ------------ Total held-to-maturity $ 10,604 $ 282 $ - $ 10,886 $ 10,604 $ 342 $ - $ 10,946 ------------- ----------- ----------- --------------------------- ----------- ----------- ------------ Available-for-sale: Floating rate asset-backed securities $ 113,394 $ 403 $ - $ 113,797 $ 78,817 $ 682 $ - $ 79,499 Floating rate corporate debt securities 372,272 398 (68) 372,602 370,145 573 (100) 370,618 Floating rate auction rate certificates 99,998 2 - 100,000 - - - - Fixed rate preferred stock 185,257 14,798 - 200,055 186,253 12,196 - 198,449 Fixed rate commercial paper 22,122 - - 22,122 120,452 - - 120,452 Floating rate municipal bonds - - - - 2,820 - - 2,820 Floating rate mortgage- backed securities 226,526 598 (5) 227,119 268,522 198 (885) 267,835 ------------- ----------- ----------- --------------------------- ----------- ----------- ------------ Total available-for-sale $1,019,569 $ 16,199 $ (73) $1,035,695 $ 1,027,009 $ 13,649 $ (985) $ 1,039,673 ------------- ----------- ----------- --------------------------- ----------- ----------- ------------ Trading: Adjustable rate mortgage- backed securities $ 9,679 $ 165 $ - $ 9,844 $ 14,296 $ 209 $ - $ 14,505 ------------- ----------- ----------- --------------------------- ----------- ----------- ------------- Total trading $ 9,679 $ 165 $ - $ 9,844 $ 14,296 $ 209 $ - $ 14,505 ------------- ----------- ----------- --------------------------- ----------- ----------- -------------
During 2004, Farmer Mac received proceeds of $121.1 million from the sale of securities from its available-for-sale portfolio, resulting in gross realized gains of approximately $153,000. Farmer Mac did not sell any securities from its available-for-sale portfolio during 2003. As of December 31, 2004 and 2003 there were no unrealized losses on Farmer Mac's held-to-maturity or trading securities. As of December 31, 2004 and 2003, unrealized losses on available-for-sale securities were as follows:
As of December 31, ------------------------------------------------------------ 2004 2003 ----------------------------- ----------------------------- Available-for-Sale Available-for-Sale Securities Securities ----------------------------- ----------------------------- Unrealized Unrealized Fair Value Loss Fair Value Loss ------------- ------------- --------------- -------------- (in thousands) Unrealized loss position for less than 12 months $ 100,070 $ (73) $ 258,893 $ (961) Unrealized loss position for more than 12 months - - 10,171 (24) ------------- ------------- ------------- ------------- Total $ 100,070 $ (73) $ 269,064 $ (985) ------------- ------------- ------------- -------------
The temporary unrealized losses presented above are principally due to changes in interest rates from the date of acquisition to December 31, 2004 and 2003. All investment securities in unrealized loss position are at least "A" rated and have not experienced any decline in credit rating during 2004 or 2003. The unrealized losses were on 12 and 20 individual investment securities as of December 31, 2004 and 2003, respectively. As of December 31, 2004, Farmer Mac owned one held-to-maturity investment that matures in 2006, with an amortized cost of $10.6 million, a fair value of $10.9 million, and a yield of 6.15 percent. As of December 31, 2004, Farmer Mac owned trading investment securities that mature after 10 years with an amortized cost of $9.7 million, a fair value of $9.8 million, and a weighted average yield of 3.38 percent. The amortized cost, fair value and yield of investments by remaining contractual maturity for available-for-sale investment securities as of December 31, 2004 are set forth below. Asset- 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.
As of December 31, 2004 -------------------------------------- Available-for-Sale Securities -------------------------------------- Amortized Cost Fair Value Yield ------------ --------------- ----------- (dollars in thousands) Due within one year $ 173,616 $ 173,724 2.50% Due after one year through five years 220,779 221,001 2.52% Due after five years through ten years 93,362 99,642 7.76% Due after ten years 531,812 541,328 3.68% ------------ -------------- ------------ Total $1,019,569 $ 1,035,695 3.60% ------------ -------------- ------------
5. FARMER MAC GUARANTEED SECURITIES As of December 31, 2004 and 2003, Farmer Mac on-balance sheet Guaranteed Securities included the following:
As of December 31, -------------------------------------------------------------------------------------------------- 2004 2003 ------------------------------------------------- ------------------------------------------------ Held-to- Available- Held-to- Available- Maturity for-Sale Total Maturity for-Sale Total -------------- ----------------- ---------------- ---------------- --------------- --------------- Farmer Mac I $ 42,911 $ 620,501 $ 663,412 $ 49,901 $ 779,560 $ 829,461 Farmer Mac II 713,435 - 713,435 678,673 - 678,673 -------------- ----------------- ---------------- ---------------- --------------- --------------- Total $ 756,346 $ 620,501 $1,376,847 $ 728,574 $ 779,560 $ 1,508,134 -------------- ----------------- ---------------- ---------------- --------------- ---------------
The following table sets forth the amortized cost, unrealized gains and losses and estimated fair values of the Farmer Mac Guaranteed Securities as of December 31, 2004 and 2003.
As of December 31, -------------------------------------------------------------------------------------------------- 2004 2003 ------------------------------------------------- ------------------------------------------------ Held-to- Available- Held-to- Available- Maturity for-Sale Total Maturity for-Sale Total -------------- ----------------- ---------------- ---------------- --------------- --------------- (in thousands) Amortized Cost $ 756,346 $ 585,021 $1,341,367 $ 728,574 $ 725,674 $ 1,454,248 Unrealized gains 12,225 35,660 47,885 14,434 53,886 68,320 Unrealized losses (2,038) (180) (2,218) - - - -------------- ----------------- ---------------- ---------------- --------------- --------------- Fair value $ 766,533 $ 620,501 $1,387,034 $ 743,008 $ 779,560 $ 1,522,568 -------------- ----------------- ---------------- ---------------- --------------- ---------------
As of December 31, 2004, the securities in unrealized loss positions had been in loss positions for less than 12 months. These temporary unrealized losses are principally due to changes in interest rates from the date of acquisition to December 31, 2004. Of the total Farmer Mac Guaranteed Securities held by Farmer Mac as of December 31, 2004, $999.5 million are fixed-rate or have floating rates that reset after one year. The table below presents a sensitivity analysis for Farmer Mac's retained Farmer Mac Guaranteed Securities as of December 31, 2004.
December 31, 2004 ------------------- (dollars in thousands) Fair value of beneficial interests retained in Farmer Mac Guaranteed Securities $ 1,387,034 Weighted-average remaining life (in years) 4.9 Weighted-average prepayment speed (annual rate) 9.2% Effect on fair value of a 10% adverse change $ (638) Effect on fair value of a 20% adverse change $ (1,225) Weighted-average discount rate 4.9% Effect on fair value of a 10% adverse change $ (18,154) Effect on fair value of a 20% adverse change $ (36,258)
These sensitivities are hypothetical. Changes in fair value based on a 10 percent variation in individual assumptions generally cannot be extrapolated because the relationship of the change in assumptions to the change in fair value may not be linear. Also, in this table the effect of a variation in a particular assumption on the fair value of the retained interest is calculated without changing any other assumption. In fact, changes in one factor may result in changes in another (for example, increases in market interest rates may result in lower prepayments), which might amplify or counteract the sensitivities. Farmer Mac securitizes two types of assets: agricultural mortgage loans and USDA-guaranteed portions. Farmer Mac manages the credit risk of its securitized agricultural mortgage loans, both on- and off-balance sheet, together with its on-balance sheet agricultural mortgage loans and the agricultural mortgage loans underlying its off-balance sheet LTSPCs. See Note 8 for more information regarding this credit risk. Due to the differing interest rate and funding risk characteristics of on- and off-balance sheet asset classes, Farmer Mac manages its on-balance sheet agricultural mortgage loans held and securitized differently from its off-balance sheet securitized agricultural mortgage loans and off-balance sheet agricultural mortgage loans underlying LTSPCs. Farmer Mac separately manages its securitized USDA-guaranteed portions and manages those held on its balance sheet differently from those that are off-balance sheet - also due to their differing interest rate and funding risk characteristics. 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 at the time of purchase, out of those securities and pools, and records the purchased loans as such on its balance sheet. The table below presents the outstanding principal balances, 90-day delinquencies and net credit losses as of and for the periods indicated for each managed asset class, both on- and off-balance sheet.
Outstanding Principal 90-Day Amount Delinquencies (1) Net Credit Losses ---------------------- --------------------- ------------------------------- As of December 31, For the Year Ended December 31, --------------------------------------------- ------------------------------- 2004 2003 2004 2003 2004 2003 2002 ----------- ---------- --------- ---------- -------- --------- --------- (in thousands) On-balance sheet assets: Farmer Mac I: Loans $ 876,866 $ 976,280 $ 24,800 $ 28,496 $ 3,161 $ 3,219 $ 3,728 Guaranteed Securities 626,952 777,134 - - 4 440 368 Farmer Mac II: Guaranteed Securities 712,653 678,229 - - - - - ----------- ------------ -------- --------- -------- -------- -------- Total on-balance sheet $ 2,216,471 $ 2,431,643 $ 24,800 $ 28,496 $ 3,165 $ 3,659 $ 4,096 ----------- ------------ -------- --------- -------- -------- -------- Off-balance sheet assets: Farmer Mac I: LTSPCs $ 2,295,103 $ 2,348,703 $ 483 $ 1,560 $ - $ - $ - Guaranteed Securities 882,282 952,134 - - - - - Farmer Mac II: Guaranteed Securities 55,889 51,241 - - - - - ----------- ------------ -------- --------- -------- -------- -------- Total off-balance sheet $3,233,274 $ 3,352,078 $ 483 $ 1,560 $ - $ - $ - ----------- ------------ -------- --------- -------- -------- -------- Total $ 5,449,745 $ 5,783,721 $ 25,283 $ 30,056 $ 3,165 $ 3,659 $ 4,096 ----------- ------------ -------- --------- -------- -------- -------- (1) Includes loans and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities 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). 90-day delinquencies do not include delinquencies on Farmer Mac II Guaranteed Securities because the guaranteed portion of loans underlying these securities are obligations backed by the full faith and credit of the United States.
6. 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 and 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 mortgage and other assets, and also to adjust the characteristics of its long-term debt to match more closely the cash flow and duration characteristics of its short-term assets, thereby reducing interest rate risk. These transactions also may provide an overall lower effective cost of borrowing than would otherwise be available in the conventional debt market. Farmer Mac is also required to recognize certain contracts and commitments as derivatives when the characteristics of those contracts and commitments meet the definition of a derivative as promulgated by SFAS 133. Market Risk: Market risk is the risk of an adverse effect resulting from changes in interest rates or spreads on the value of a financial instrument. Farmer Mac manages market risk associated with financial derivatives by establishing and monitoring limits as to the degree of risk that may be undertaken. This risk is periodically measured as part of Farmer Mac's overall risk monitoring processes, which include market value of equity measurements, net interest income modeling and other measures. Credit Risk: Credit risk is the risk that a counterparty will fail to perform according to the terms of a financial contract in which Farmer Mac has an unrealized gain. Credit losses could occur in the event of non-performance by counterparties to the financial derivative contracts. Farmer Mac mitigates this counterparty credit risk by contracting only with counterparties that have investment grade credit ratings (i.e., at least BBB), establishing and maintaining collateral requirements based upon credit ratings and entering into netting agreements. Netting agreements provide for the calculation of the net amount of all receivables and payables under all transactions covered by the netting agreement between Farmer Mac and a single counterparty. Farmer Mac's exposure to credit risk related to its financial derivatives is represented by those counterparties for which Farmer Mac has a net receivable, including the effect of any netting arrangements. As of December 31, 2004 and 2003, Farmer Mac's credit exposure, excluding netting arrangements, was $1.5 million and $1.0 million, respectively; however, including netting arrangements, Farmer Mac had no net receivables. Conversely, financial derivatives in a net payable position required Farmer Mac to pledge securities as collateral of approximately $3.2 million and $16.9 million as of December 31, 2004 and 2003, respectively. Interest Rate Risk: Farmer Mac uses financial derivatives to provide a cost- and capital-efficient way to manage its interest rate risk exposure by modifying the repricing or maturity characteristics of certain assets and liabilities and by locking in the rates for certain forecasted issuances of liabilities. The primary financial derivatives Farmer Mac uses include interest rate swaps and forward sale contracts. Farmer Mac uses interest-rate swaps to assume fixed rate interest payments in exchange for variable rate interest payments and vice versa. Depending on the hedging relationship, the effects of these agreements are (a) the conversion of variable rate liabilities to longer-term fixed rate liabilities, (b) the conversion of long-term fixed rate assets to shorter-term variable rate assets, or (c) the reduction of the variability of future changes in interest rates on forecasted issuances of liabilities. The net payments of these agreements are charged to either interest expense or interest income, depending on whether the agreement is designated to hedge an existing or forecasted liability or asset. Fair Value Hedges: Farmer Mac uses interest rate swaps primarily to offset the change in value of certain fixed rate investments and liabilities caused by movements in the benchmark interest rate (LIBOR). In calculating the effective portion of the fair value hedges under SFAS 133, the change in fair value of the financial derivative is recognized currently in earnings, as is the change in the value of the hedged items attributable to the risk being hedged. Accordingly, the net difference or hedge ineffectiveness, if any, is recognized currently in the consolidated statement of operations as a gain or loss on financial derivatives and trading assets. Fair value hedge ineffectiveness for each of the years ended December 31, 2004 and 2003 was not significant. The following table summarizes information related to Farmer Mac's financial derivatives in fair value hedge relationships as of December 31, 2004:
Weighted- Weighted- Weighted- Average Fair Value Average Average Remaining Notional ---------------------------- Pay Receive Life Amount Asset (Liability) Rate Rate (in Years) ------------- ------------ -------------- ------------- ------------- ------------- (dollars in thousands) Medium-term notes: Pay variable interest rate swaps $ 105,000 $ - $ (2,212) 3.37% 3.76% 4.31 ------------- ------------ -------------- ------------- ------------- Total fair value hedges $ 105,000 $ - $ (2,212) 3.37% 3.76% ------------- ------------ -------------- ------------- -------------
Cash Flow Hedges: Interest Rate Swaps: Farmer Mac uses interest rate swaps to hedge the variability of future cash flows associated with existing variable rate liabilities and forecasted issuances of liabilities. With respect to the variable rate liabilities (discount notes or medium-term notes) on its consolidated balance sheet, Farmer Mac uses interest rate swaps to hedge the risk of changes in the benchmark rate (LIBOR). With respect to the hedging of the forecasted issuance of discount notes or medium-term notes, Farmer Mac utilizes interest rate swaps with a longer maturity than the underlying liabilities. The use of interest rate swap contracts with longer maturities than the underlying liabilities allows Farmer Mac to hedge both the risk of changes in the benchmark rate (LIBOR) on existing liabilities and the replacement of such liabilities upon maturity. These cash flow hedge relationships are treated as effective hedges as long as the future issuances of liabilities remain probable and the hedges continue to meet the requirements of SFAS 133. Farmer Mac expects to hedge the forecasted issuance of liabilities over a period that ranges from a minimum of 1 year to a maximum of 15 years. Farmer Mac measures the ineffectiveness of cash flow hedges in accordance with SFAS 133 and reports this amount, if any, as a gain or loss on financial derivatives and trading assets in the consolidated statement of operations. The ineffectiveness for each of the years ended December 31, 2004 and 2003 was not significant. Basis Swaps: Farmer Mac uses basis swaps to create comparable asset-liability positions. Specifically, Farmer Mac uses basis swaps to hedge combined asset-liability positions in which an asset and a liability with variable cash flows have different interest rate bases. Basis swaps are used to convert the interest rate index of the asset to the same index as the variable rate liability or vice versa. These swaps are treated as effective hedge relationships if the index of one leg of the swap is the same as the index of the identified asset and the index of the other leg of the swap is the same as the index of the identified liability. Farmer Mac measures ineffectiveness for basis swaps in accordance with SFAS 133 and reports this amount as a gain or loss on financial derivatives and trading assets in the consolidated statement of operations. The ineffectiveness for each of the years ended December 31, 2004 and 2003 was not significant. A significant proportion of Farmer Mac's outstanding basis swaps are with a related party. See Note 3 for additional information on these related party transactions. Forward Sale Agreements and Future Contracts: Farmer Mac uses forward sale contracts involving government-sponsored enterprise debt instruments and mortgage backed securities and futures contracts involving U.S. Treasury securities to reduce the variability of future changes in interest rates on forecasted issuances of liabilities. Farmer Mac measures ineffectiveness in accordance with the provisions of SFAS 133. The ineffectiveness for each of the years ended December 31, 2004 and 2003 was not significant. The effective portion of the change in fair value of these contracts is recorded in accumulated other comprehensive income/(loss), net of tax. The amounts recorded in accumulated other comprehensive income/(loss) will be recognized in the statements of operations as the hedged transactions affect earnings. The following table summarizes information related to financial derivatives in cash flow hedging relationships, as of December 31, 2004:
Weighted- Weighted- Weighted- Weighted- Average Fair Value Average Average Average Remaining Notional -------------------------- Pay Receive Forward Life Amount Asset (Liability) Rate Rate Price (in Years) --------------- ------------ ------------ ------------ ------------ ------------ ----------- (dollars in thousands) Discount notes or medium-term notes: Pay fixed interest rate swaps $ 610,324 $ 891 $(44,277) 5.76% 2.16% - 6.93 Agency forwards 20,005 127 - - - 1.01 Loans or Farmer Mac Guaranteed Securities and discount notes: Basis swaps 261,985 - (780) 4.38% 2.31% - 10.82 --------------- ------------ ------------ ------------ ------------ Total cash flow hedges $ 892,314 $ 1,018 $(45,057) 5.35% 2.20% --------------- ------------ ------------ ------------ ------------
As of December 31, 2004, Farmer Mac had approximately $34.4 million of net after-tax unrealized losses on cash flow hedges included in accumulated other comprehensive income/(loss). These amounts will be reclassified into earnings in the same period or periods during which the hedged forecasted transactions (either the payment of interest or issuance of discount notes or medium-term notes) affect earnings or immediately when it becomes probable that the original hedged forecasted transaction will not occur within two months of the originally specified date. During the next 12 months, Farmer Mac expects to reclassify approximately $6.7 million of the net after-tax unrealized losses included in accumulated other comprehensive income/(loss) as of December 31, 2004. Other Financial Derivatives: Farmer Mac employs certain hedging strategies that do not meet the hedge accounting criteria in SFAS 133. These financial derivatives are recorded on the balance sheet at fair value and the related changes in fair value are recognized in the consolidated statements of operations as gains or losses on financial derivatives and trading assets. The following table summarizes information related to Farmer Mac's other financial derivatives as of December 31, 2004:
Weighted- Weighted- Weighted- Weighted- Average Fair Value Average Average Average Remaining Notional -------------------------- Pay Receive Forward Life Amount Asset (Liability) Rate Rate Price (in Years) ------------- ------------ ------------ ------------ ----------- ---------- --------- (dollars in thousands) Pay fixed callable interest rate swaps $ 29,152 $ 112 $ (123) 4.65% 2.08% 6.41 Pay variable callable interest rate swaps 100,000 - (272) 6.70% 4.40% 9.51 Basis swaps 389,679 355 (129) 2.46% 2.12% 0.65 Agency forwards 6,920 14 - 1.05 ----------- ---------- ------------ ----------- ------------ Total other financial derivatives $ 525,751 $ 481 $ (524) 3.40% 2.56% ----------- ---------- ------------ ----------- ------------
For the years ended December 31, 2004, 2003 and 2002, Farmer Mac reported $2.8 million of gains, $2.4 million of gains, and $8.4 million of losses, respectively, on financial derivatives that do not receive hedge accounting treatment and trading assets in the consolidated statements of operations. 7. NOTES PAYABLE Farmer Mac's borrowings consist of discount notes and medium-term notes, both of which are unsecured general obligations of the Corporation. Discount notes generally have maturities of one year or less, whereas medium-term notes have maturities of one to 15 years. The following table sets forth information related to Farmer Mac's borrowings for 2004 and 2003:
2004 2003 ----------------------------------------------------- --------------------------------------------------- Average Average Outstanding as of Outstanding During Maximum Outstanding as of Outstanding During Maximum December 31, 2004 the Year Outstanding December 31, 2003 the Year Outstanding ------------------- --------------------- at Any ------------------- ------------------- at Any Amount Rate Amount Rate Month End Amount Rate Amount Rate Month End ------------ ------ ------------ -------- ----------- ---------- -------- ---------- -------- ------------ (dollars in thousands) Due within one year: Discount notes $1,791,932 2.15% $2,050,934 1.35% $2,459,160 $2,645,624 1.04% $2,702,188 1.21% $2,781,377 Current portion of medium- term notes 828,240 3.01% 153,760 4.57% ------------ ------- ---------- ------- 2,620,172 2.42% 2,799,384 1.23% Due after one year: Medium-term notes due in: 2006 182,850 4.51% 2007 84,292 4.51% 2008 212,288 2.78% 2009 205,747 5.57% 2010 - - Thereafter 177,024 6.51% --------------------- 862,201 4.75% --------------------- Total $3,482,373 3.00% ---------------------
Callable medium-term notes give Farmer Mac the option to redeem the debt at par value on a specified call date or at any time on or after a specified call date. The following table summarizes the maturities, amounts and costs for Farmer Mac callable debt by call period as of December 31, 2004.
Callable Debt as of December 31, 2004 ----------------------------------------- Maturity Amount Rate ------------ -------------- ------------ (dollars in thousands) Callable in: 2005 2006-2013 $ 67,807 3.87% -------------- ------------ $ 67,807 3.87% -------------- ------------
The following schedule summarizes the earliest repricing date of total borrowings outstanding as of December 31, 2004, including callable and non-callable medium-term notes, assuming callable notes are redeemed at the initial call date.
Earliest Repricing Date of Borrowings Outstanding ----------------------------- Weighted- Average Amount Rate --------------- ----------- (dollars in thousands) Debt repricing in: 2005 $ 2,687,699 2.46% 2006 166,723 4.75% 2007 84,292 4.51% 2008 187,288 2.64% 2009 195,747 5.65% 2010 - - Thereafter 160,624 6.60% --------------- ----------- Total $ 3,482,373 3.00% --------------- -----------
During 2004 and 2003, Farmer Mac called $125.0 million and $83.7 million of callable medium-term notes, respectively. Authority to Borrow from the U.S. Treasury Farmer Mac's statutory charter authorizes Farmer Mac to borrow, in extreme circumstances, up to $1.5 billion from the U.S. Treasury, if necessary, to fulfill its obligations under any guarantee. The debt would bear interest at a rate determined by the U.S. Treasury based on the then current cost of funds to the United States. The charter requires the debt to be repaid within a reasonable time. As of December 31, 2004, Farmer Mac had not utilized this borrowing authority and does not expect to utilize this borrowing authority in the near future. Gains and Losses on the Repurchase of Outstanding Debt During 2002, Farmer Mac recognized $1.4 million of net gains on the repurchases of $103.7 million of outstanding Farmer Mac debt. All of the repurchases were from outstanding Farmer Mac debt that had a maturity date of October 14, 2011 and an interest rate of 5.4 percent. Those debt securities were replaced with new fixed-rate funding to the same maturity date at lower effective interest rates. 8. ALLOWANCE FOR LOSSES AND CONCENTRATIONS OF CREDIT RISK Allowance for Losses Farmer Mac maintains an allowance for losses to cover probable estimated principal and interest losses on all loans held and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs and real estate owned. No allowance for losses has been provided for Farmer Mac I Guaranteed Securities issued prior to the 1996 Act or for Farmer Mac II Guaranteed Securities. See Note 2(e), Note 2(j), Note 5 and Note 12 for more information about Farmer Mac Guaranteed Securities. Farmer Mac's allowance for losses is presented in four components on its consolidated balance sheet: o an "Allowance for loan losses" on loans held for investment; o a valuation allowance on real estate owned, which is included in the balance sheet under "Real estate owned, net of valuation allowance"; o a "Contingent obligation for probable losses" on loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs entered into or modified after January 1, 2003, for which inherent losses existed at the time of the guarantee or commitment and could be reasonably estimated, is included in the balance sheet as a portion of the amount reported as "Guarantee and commitment obligation"; and o an allowance for losses on loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs, which is included in the balance sheet under "Reserve 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 operating expense and is reduced by charge-offs for actual losses, net of recoveries. Negative provisions for loan losses or provisions for losses are recorded in the event that the estimate of probable losses as of the end of a period is lower than the estimate at the beginning of the period. Charge-offs represent losses on the outstanding principal balance, any interest payments previously accrued or advanced and expected costs of liquidation. The following is a summary of the changes in the allowance for losses for each year in the three-year period ended December 31, 2004:
------------------------------------------------------------------------- Contingent Allowance REO Obligation Total for Loan Valuation Reserve for Probable Allowance Losses Allowance for Losses Losses for Losses -------------- -------------- ------------- -------------- ------------- (in thousands) Balances as of January 1, 2002 $ 1,352 $ - $ 14,532 $ - $ 15,884 -------------- -------------- ------------- -------------- ------------- Provision for losses 1,340 - 6,907 - 8,247 Net allocation of allowance 3,221 1,308 (4,529) - - Net charge-offs (3,251) (716) (153) - (4,120) -------------- -------------- ------------- -------------- ------------- Balances as of December 31, 2002 $ 2,662 $ 592 $ 16,757 $ - $ 20,011 -------------- -------------- ------------- -------------- ------------- Provision for losses 6,524 1,230 (3,145) 2,676 7,285 Net charge-offs (3,219) (1,584) (440) - (5,243) -------------- -------------- ------------- -------------- ------------- Balances as of December 31, 2003 $ 5,967 $ 238 $ 13,172 $ 2,676 $ 22,053 -------------- -------------- ------------- -------------- ------------- Provision for losses 1,589 1,137 (2,439) (699) (412) Net charge-offs (3,161) (1,375) (4) - (4,540) -------------- -------------- ------------- -------------- ------------- Balances as of December 31, 2004 $ 4,395 $ - $ 10,729 $ 1,977 $ 17,101 -------------- -------------- ------------- -------------- -------------
All loans that Farmer Mac purchases, issues guarantees with respect to, or commits to purchase under an LTSPC in the Farmer Mac I program are underwritten for conformance to Farmer Mac's underwriting and appraisal standards and Farmer Mac believes the ultimate credit risk is substantially the same. Accordingly, management establishes allowances for loans held and loans underlying LTSPCs and Farmer Mac Guaranteed Securities collectively. The following table presents Farmer Mac's reserve for losses for all post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs on a pro rata basis as of December 31, 2004 and 2003.
Reserve for Losses on LTSPCs and Post-1996 Act Farmer Mac I Guaranteed Securities - ------------------------------------------------------------------------------------------------- December 31, December 31, 2004 2003 ----------------- ---------------- (in thousands) On-balance sheet Farmer Mac I Guaranteed Securities $ 1,973 $ 2,861 Off-balance sheet Farmer Mac I Guaranteed Securities 1,004 1,070 LTSPCs 7,752 9,241 ----------------- ---------------- Total reserve for losses $ 10,729 $ 13,172 ----------------- ----------------
When certain criteria are met, such as the default of the borrower, Farmer Mac may, in its sole discretion, repurchase the defaulted loans underlying Farmer Mac Guaranteed Securities and is obligated to purchase those underlying an LTSPC. These acquisitions are recorded in the consolidated financial statements at their fair value. Fair value is determined by appraisal or other appropriate valuation method. In September 2002, Farmer Mac adopted EITF 02-9, which requires that Farmer Mac record at acquisition the difference between each loan's acquisition cost and its fair value, if any, as a charge to the reserve for losses. Prior to the adoption of EITF 02-9, any specific allowance that had been established for the off-balance sheet obligation would be transferred from the reserve for losses to the allowance for loan losses (referred to as "net allocation of the allowance" in the summary of the changes in the allowance for losses). Upon the receipt of each loan's updated appraisal or estimation of value, the difference between the acquisition cost of the loan and its fair value, if any, was recorded as a charge to the allowance for loan losses. A portion of the allowance for losses is specifically allocated to impaired loans when the fair value of the collateral, less the estimated selling cost, is less than the cost basis in the loan. For this analysis and the allocation of specific reserves as of December 31, 2004 and 2003, Farmer Mac reviewed: o non-performing assets; o loans for which Farmer Mac had adjusted the timing of borrowers' payment schedules within the past three years, but still expects to collect all amounts due and has not made economic concessions; and o additional performing loans that have previously been delinquent or are secured by real estate that produces agricultural commodities or products currently under stress. The balance of impaired loans, both on- and off-balance sheet, and the related allowance specifically allocated to those impaired loans as of December 31, 2004 and 2003 are summarized in the following table:
December 31, 2004 December 31, 2003 --------------------------------------- ------------------------------------------ Specific Net Specific Net Balance Allowance Balance Balance Allowance Balance -------------- ----------- ------------ -------------- ------------ ------------- (in thousands) Assets specifically reviewed for impairment: Specific allowance for losses $ 12,871 $ (1,433) $ 11,438 $ 18,213 $ (3,762) $ 14,451 No specific allowance for losses 126,660 - 126,660 154,487 - 154,487 -------------- ----------- ----------- ------------ ------------- ------------- Total $ 139,531 $ (1,433) $ 138,098 $ 172,700 $ (3,762) $ 168,938 -------------- ----------- ----------- ------------ ------------- -------------
Farmer Mac recognized interest income of approximately $3.0 million and $1.7 million on impaired loans during the years ended December 31, 2004 and 2003, respectively. During 2004 and 2003, Farmer Mac's average investment in impaired loans was $63.5 million and $68.5 million, respectively. In accordance with the terms of all applicable trust agreements, Farmer Mac acquires all loans that collateralize Farmer Mac Guarantee Securities that become and remain 90 days or more past due on the next subsequent loan payment date. In accordance with the terms of all LTSPCs, Farmer Mac acquires loans that are 120 days delinquent upon the request of the counterparty. During 2004, Farmer Mac purchased 30 defaulted loans having a principal balance of $12.8 million from pools underlying Farmer Mac Guaranteed Securities and LTSPCs. During 2003, Farmer Mac made 81 such purchases for a total of $55.6 million. The following table presents Farmer Mac's purchases of defaulted loans underlying Farmer Mac I Guaranteed Securities and LTSPCs.
For the Year Ended December 31, ------------------------------ 2004 2003 -------------- -------------- (in thousands) Defaulted loans purchased underlying off-balance sheet Farmer Mac I Guaranteed Securities $ 2,186 $ 16,276 Defaulted loans underlying on-balance sheet Farmer Mac I Guaranteed Securities transferred to loans 8,305 35,100 Defaulted loans purchased underlying LTSPCs 2,292 4,266 -------------- -------------- Total $ 12,783 $ 55,642 -------------- --------------
Concentrations of Credit Risk The following table sets forth the geographic and commodity diversification, as well as the range of original loan-to-value ratios, for all loans held and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs as of December 31, 2004 and 2003:
As of December 31, --------------------------------- 2004 2003 --------------- --------------- (in thousands) By geographic region (1): Northwest $ 951,859 $ 1,066,399 Southwest 2,147,272 2,307,812 Mid-North 597,130 677,755 Mid-South 290,046 257,664 Northeast 379,502 397,231 Southeast 276,399 313,171 --------------- --------------- Total $ 4,642,208 $ 5,020,032 --------------- --------------- By commodity: Crops $ 2,033,146 $ 2,228,506 Livestock 1,052,585 1,355,070 Permanent plantings 1,234,311 1,025,245 Part-time farm 295,470 374,057 Other 26,696 37,154 --------------- --------------- Total $ 4,642,208 $ 5,020,032 --------------- --------------- By original loan-to-value ratio: 0.00% to 40.00% $ 1,145,909 $ 1,300,869 40.01% to 50.00% 978,057 1,082,540 50.01% to 60.00% 1,352,612 1,404,260 60.01% to 70.00% 1,049,547 1,107,888 70.01% to 80.00% 103,343 109,848 80.01% to 90.00% 12,740 14,627 --------------- --------------- Total $ 4,642,208 $ 5,020,032 --------------- --------------- (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, 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. 9. STOCKHOLDERS' EQUITY Common Stock Farmer Mac has three classes of common stock outstanding: o 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 Farm Credit System. 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; o Class B voting common stock, which may be held only by institutions of the Farm Credit System. There are no restrictions on the maximum holdings of Class B voting common stock; and o Class C non-voting common stock, which has no ownership restrictions. On October 7, 2004, Farmer Mac's board of directors declared a quarterly dividend on the Corporation's three classes of common stock. The quarterly dividend of $0.10 per common share was paid on December 31, 2004 to common stockholders of record as of December 15, 2004. Farmer Mac's ability to declare and pay a dividend could be restricted if it failed to comply with regulatory capital requirements. On August 4, 2004, Farmer Mac established a program to repurchase up to 10 percent of the Corporation's outstanding Class C non-voting common stock. The authority for this stock repurchase program expires in August 2006. During 2004, Farmer Mac repurchased 299,248 shares of its Class C non-voting common stock at an average price of $20.82 per share. All of the repurchased shares were purchased in open market transactions and were retired to become authorized but unissued shares available for future issuance. Preferred Stock The Corporation has outstanding 700,000 shares of 6.40 percent cumulative preferred stock, Series A, which has a redemption price and liquidation preference of $50.00 per share, plus accrued and unpaid dividends. The preferred stock does not have a maturity date. Beginning on June 30, 2012, Farmer Mac has the option to redeem the preferred stock at any time, in whole or in part, at the redemption price of $50.00 per share, plus accrued and unpaid dividends through and including the redemption date. Farmer Mac pays cumulative dividends on the preferred stock quarterly in arrears, when and if declared by the board of directors. Farmer Mac's ability to declare and pay a dividend could be restricted if it failed to comply with regulatory capital requirements. The costs of issuing the preferred stock were charged to additional paid-in capital. Stock Option Plan In 1997, Farmer Mac adopted a new stock option plan for directors, officers and other employees to acquire shares of Class C non-voting common stock. Under the plan, stock options awarded under the plan vest annually in thirds. Prior to January 2004, the first third vested upon grant; since January 2004, the first third vests one year after the date of grant. If not exercised, any options granted under the 1997 plan will expire 10 years from the date of grant, except that options issued to directors since June 1, 1998, if not exercised, will expire five years from the date of grant. Of the 3,750,000 shares authorized to be issued under the 1997 plan, 2,567,201 have been issued, net of cancellations. Options granted under the 1997 plan during 2004 have exercise prices ranging from $19.86 to $22.11 per share. For all stock options granted under Farmer Mac's plan, the exercise price is equal to the closing price of the Class C common stock on or immediately preceding the date of grant. The following table summarizes stock option activity for 2004 and 2003:
2004 2003 ------------------------------ -------------------------- Weighted- Weighted- Average Average Exercise Exercise Shares Price Shares Price ------------- --------------- ------------- ----------- Outstanding, beginning of year 1,575,980 $ 22.92 1,637,111 $ 19.45 Granted 341,984 20.49 366,104 22.67 Exercised (65,208) 17.15 (422,236) 9.14 Canceled (40,534) 22.79 (4,999) 28.07 ------------- --------------- ------------- ----------- Outstanding, end of year 1,812,222 $ 22.67 1,575,980 $ 22.92 ------------- --------------- ------------- ----------- Options exercisable at year end 1,352,648 1,247,658 ------------- -------------
The cancellations of stock options during 2004 and 2003 were due either to unvested options terminating in accordance with the provisions of the applicable stock option plans upon directors' or employees' departures from Farmer Mac or vested options terminating unexercised on their expiration date. For 2004 and 2003 the additional paid in capital received from the exercise of stock options was $1.1 million and $3.4 million, respectively. During 2004 and 2003 the reduction of income tax paid as a result of the deduction for the exercise of stock options was $0.2 million and $2.8 million, respectively. The following table summarizes information regarding options outstanding as of December 31, 2004:
Options Options Outstanding Exercisable ------------------------------ -------------- Weighted- Average Remaining Exercise Number of Contractual Number of Price Shares Life Shares ------------- -------------- --------------- -------------- $ 11.83 57,312 2.5 years 57,312 12.67 1,200 3.7 years 1,200 15.13 272,074 4.9 years 272,074 16.38 15,656 5.7 years 15,656 18.13 3,000 5.8 years 3,000 18.25 2,400 2.8 years 2,400 19.38 15,500 4.7 years 15,500 19.86 218,984 9.6 years - 20.00 77,586 3.4 years 77,586 20.01 5,000 9.7 years - 20.32 26,000 9.7 years - 21.19 3,000 5.9 years 3,000 22.08 137,064 4.4 years 137,064 22.11 90,000 4.4 years - 22.38 2,000 6.0 years 2,000 22.40 339,104 7.2 years 226,069 22.94 1,500 4.6 years 1,500 26.20 2,000 6.1 years 2,000 26.25 12,000 7.7 years 12,000 26.68 19,666 8.8 years 13,111 26.92 500 6.3 years 500 27.75 3,000 6.0 years 3,000 29.10 242,257 6.1 years 242,257 29.56 1,000 7.7 years 1,000 31.02 4,627 6.5 years 4,627 31.20 6,750 6.7 years 6,750 31.24 250,042 5.0 years 250,042 31.50 1,500 6.4 years 1,500 34.90 1,000 6.7 years 1,000 45.06 500 7.3 years 500 -------------- -------------- 1,812,222 1,352,648 -------------- --------------
The weighted-average fair values of options granted in 2004, 2003 and 2002 were $7.34, $10.68 and $13.50, respectively, which under the fair value-based method of accounting for stock-based compensation cost would have reduced net income available to common stockholders by $1.6 million, $2.5 million and $2.4 million for 2004, 2003 and 2002, respectively. The fair values were estimated using the Black-Scholes option pricing model based on the following assumptions:
2004 2003 2002 ----------- ---------- ---------- Risk-free interest rate 4.3% 2.9% 5.2% Expected years until exercise 7 years 5 years 5 years Expected stock volatility 46.0% 47.8% 40.0% Dividend yield 0.0% 0.0% 0.0%
Restricted Stock In addition to stock options, the Corporation, by authorization of the board of directors, issued restricted stock to employees during 2003 and 2002. Restricted stock entitles participants to all the rights of a stockholder, except that some of the shares awarded are subject to forfeiture if the participant is not employed by Farmer Mac at the end of the restriction period and other shares are not subject to forfeiture but may not be disposed of by the participant during the restriction period. The vesting or restriction period is usually one to two years. The value of restricted stock granted to employees is amortized over the vesting period. Farmer Mac granted no restricted stock shares during 2004. Farmer Mac granted 37,045 shares and 32,338 shares of restricted stock during 2003 and 2002, respectively, resulting in compensation expense of $0.8 million and $0.9 million during the respective years. Statutory and Regulatory Capital Requirements Farmer Mac is subject to three statutory and regulatory capital requirements: o Minimum capital - Farmer Mac's minimum capital level is an amount of core capital (stockholders equity less accumulated other comprehensive income) 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: o the unpaid principal balance of outstanding Farmer Mac Guaranteed Securities; o instruments issued or guaranteed by Farmer Mac that are substantially equivalent to Farmer Mac Guaranteed Securities, including LTSPCs; and o other off-balance sheet obligations of Farmer Mac. o Critical capital - 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. o Risk-based capital - The Act directs the Farm Credit Administration ("FCA") to establish a risk-based capital stress test for Farmer Mac, using specified stress-test parameters. While the Act does not specify the required level of risk-based capital, that level is permitted to exceed the statutory minimum capital requirement applicable to Farmer Mac, if so indicated by the risk-based capital stress test. Farmer Mac is required to comply with the higher of the minimum capital requirement or the risk-based capital requirement. As of December 31, 2004, Farmer Mac's minimum and critical capital requirements were $128.9 million and $64.5 million, respectively, and its actual core capital level was $237.7 million, $108.8 million above the minimum capital requirement and $173.2 million above the critical capital requirement. As of December 31, 2003, Farmer Mac's minimum and critical capital requirements were $142.0 million and $71.0 million, respectively, and its actual core capital level was $215.5 million, $73.5 million above the minimum capital requirement and $144.5 million above the critical capital requirement. Based on the risk-based capital stress test, Farmer Mac's risk-based capital requirement as of December 31, 2004 was $37.1 million and Farmer Mac's regulatory capital (core capital plus the allowance for losses) of $254.8 million exceeded that amount by approximately $217.7 million. Farmer Mac's risk-based capital requirement as of December 31, 2003 was $38.8 million and Farmer Mac's regulatory capital of $237.6 million exceeded that amount by approximately $198.8 million. 10. INCOME TAXES The components of the provision for federal income taxes for the years ended December 31, 2004, 2003 and 2002 were as follows:
2004 2003 2002 ------------- ------------- ------------- (in thousands) Current $ 11,580 $ 12,529 $ 12,768 Deferred 2,371 (221) (2,959) ------------- ------------- ------------- $ 13,951 $ 12,308 $ 9,809 ------------- ------------- -------------
A reconciliation of tax at the statutory federal tax rate to the income tax provision for the years ended December 31, 2004, 2003 and 2002 is as follows:
2004 2003 2002 ----------- ----------- ----------- (dollars in thousands) Tax expense at statutory rate $ 15,547 $ 13,852 $ 11,396 Effect of non-taxable dividend income (1,694) (1,694) (1,596) Other 98 150 9 ----------- ----------- ----------- Income tax expense $ 13,951 $ 12,308 $ 9,809 ----------- ----------- ----------- Statutory tax rate 35.0% 35.0% 35.0% Effective tax rate 31.4% 31.1% 30.1%
The components of the deferred tax assets and liabilities as of December 31, 2004 and 2003 were as follows:
2004 2003 ------------ ------------ (in thousands) Deferred tax assets: Allowance for losses $ 5,985 $ 8,216 Unrealized loss on financial derivatives designated as cash flow hedges 18,537 24,529 Other 58 1,439 ------------ ------------ Total deferred tax assets 24,580 34,184 Deferred tax liability: Unrealized gain on available-for-sale securities 18,062 23,293 ------------ ------------ Total deferred tax liability 18,062 23,293 ------------ ------------ Net deferred tax asset $ 6,518 $10,891 ------------ ------------
A valuation allowance is required to reduce the net deferred tax asset to an amount that is more likely than not to be realized. No valuation allowance was considered necessary as of December 31, 2004 and 2003. 11. EMPLOYEE BENEFITS On December 28, 1989, Farmer Mac adopted a defined contribution retirement plan for all of its employees. Through 2001, Farmer Mac contributed 13.2 percent of the lesser of an individual's gross salary or $170,000, plus 5.7 percent of the difference between (1) the lesser of the gross salary or $170,000 and (2) the Social Security Taxable Wage Base. The Economic Growth and Tax Relief Reconciliation Act of 2001 increased the $170,000 limit to $200,000 in 2002, to be adjusted from time to time for inflation. Employees are fully vested after having been employed for three years. Expense for this plan for the years ended December 31, 2004, 2003 and 2002 was $537,000, $464,000 and $384,000, respectively. 12. OFF-BALANCE SHEET GUARANTEES AND LTSPCs, COMMITMENTS AND CONTINGENCIES Farmer Mac offers approved agricultural and rural residential mortgage lenders two 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 either the Farmer Mac I program or the Farmer Mac II program, and (2) LTSPCs, which are available only through the Farmer Mac I program. Both of these alternatives result in off-balance sheet transactions for Farmer Mac. Off-Balance Sheet Farmer Mac Guaranteed Securities Periodically Farmer Mac transfers agricultural mortgage loans into trusts that are used as vehicles for the securitization of the transferred assets and the beneficial interests in the loans are sold to third party investors. The table below summarizes certain cash flows received from and paid to these trusts.
For the Year Ended December 31, --------------------------------------------- 2004 2003 2002 ------------- ------------- --------------- (in thousands) Proceeds from new securitizations $ 103,150 $ 78,254 $ 47,682 Guarantee fees received 1,428 1,988 775 Purchases of assets from the trusts 2,186 16,276 17,386 Servicing advances 23 503 1,235 Repayments of servicing advances 34 107 1,134
Farmer Mac is liable under its guarantee to ensure that the securities make timely payments to investors of principal and interest based on the underlying loans, regardless of whether the trust has actually received such scheduled loan payments. As consideration for Farmer Mac's assumption of the credit risk on these mortgage pass-through certificates, Farmer Mac receives guarantee fees that are recognized as earned on an accrual basis over the life of the loan and based upon the outstanding balance of the Farmer Mac Guaranteed Security. Farmer Mac is required to perform under its obligation when the underlying loans for the off-balance sheet Farmer Mac Guaranteed Securities do not make their scheduled installment payments. When a loan underlying a Farmer Mac I Guaranteed Security becomes 90 days or more past due, Farmer Mac may, in its sole discretion, repurchase the loan from the trust and generally does repurchase such loans, thereby reducing the principal balance of the outstanding Farmer Mac I Guaranteed Security. The following table presents the maximum principal amount of potential undiscounted future payments that Farmer Mac could be required to make under off-balance sheet Farmer Mac Guaranteed Securities as of December 31, 2004 and 2003, 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 - --------------------------------------------------------------------------- As of December 31, ---------------------------------- 2004 2003 ----------------- --------------- (in thousands) Farmer Mac I Guaranteed Securities: Post-1996 Act $ 882,282 $ 952,134 Pre-1996 Act - - ----------------- --------------- Total Farmer Mac I 882,282 952,134 Farmer Mac II Guaranteed Securities 55,889 51,241 ----------------- --------------- Total Farmer Mac I and II $ 938,171 $ 1,003,375 ----------------- ---------------
If Farmer Mac repurchases a loan that is collateral for a Farmer Mac I Guaranteed Security, Farmer Mac would have the right to enforce the terms of the loan, and in the event of a default, would have access to the underlying collateral. Farmer Mac typically recovers a significant portion of the value of defaulted loans purchased either through borrower payments, loan payoffs, payments by third parties or foreclosure and sale of the property securing the loans. Farmer Mac has recourse to the USDA for any amounts advanced for the timely payment of principal and interest on Farmer Mac II Guaranteed Securities. That recourse is the USDA guarantee, a full faith and credit obligation of the United States that becomes enforceable if a lender fails to repurchase the USDA-guaranteed portion from its owner within 30 days after written demand from the owner when (a) the borrower under the guaranteed loan is in default not less than 60 days in the payment of any principal or interest due on the USDA-guaranteed portion, or (b) the lender has failed to remit to the owner the payment made by the borrower on the USDA-guaranteed portion or any related loan subsidy within 30 days after the lender's receipt of the payment. As of December 31, 2004, the weighted-average remaining maturity of all loans underlying off-balance sheet Farmer Mac Guaranteed Securities was 15.9 years. As of December 31, 2004 and 2003, the portion of the allowance for losses attributable to off-balance sheet Farmer Mac Guaranteed Securities was $3.0 million and $3.7 million, respectively. These amounts include a portion of the reserve for losses and the contingent obligation for probable losses. For additional detail on Farmer Mac's methodology for determining the allowance for losses, see Note 2(j) and Note 8. Long-Term Standby Purchase Commitments An LTSPC is a commitment by Farmer Mac to purchase eligible loans, 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. An LTSPC permits a seller to nominate from its portfolio a segregated pool of loans, which are retained in the seller's portfolio and serviced by the seller. Upon nomination, Farmer Mac reviews the loan pool to confirm that it conforms to Farmer Mac's underwriting standards. Upon Farmer Mac's acceptance of the eligible loans, the seller effectively transfers the credit risk on those loans to Farmer Mac, thereby reducing the seller's credit and concentration risk exposures and, consequently, its regulatory capital requirements and its loss reserve requirements. Credit risk is transferred through Farmer Mac's commitment to purchase the segregated loans from the counterparty based upon Farmer Mac's original credit review and acceptance of the credit risk on the loans. The specific events or circumstances that would require Farmer Mac to purchase some or all of the segregated loans under its LTSPCs include: (1) the failure of the borrower under any loan to make installment payments under that loan for a period of at least four months; or (2) the determination by the holder of the LTSPC to sell or exchange some or all of the loans under the LTSPC to Farmer Mac. Farmer Mac generally purchases loans subject to an LTSPC at: o par plus accrued interest (if the loans become four months delinquent); o a mark-to-market price or in exchange for Farmer Mac I Guaranteed Securities (if the loans are not delinquent and are standard Farmer Mac loan products); or o either a mark-to-market negotiated price for all (but not some) loans in the pool, based on the sale of Farmer Mac I Guaranteed Securities in the capital markets or the funding obtained by Farmer Mac through the issuance of matching debt in the capital markets, or in exchange for Farmer Mac I Guaranteed Securities (if the loans are not four months delinquent). As of December 31, 2004 and 2003, the maximum principal amount of potential undiscounted future payments that Farmer Mac could be requested to make under LTSPCs, not including offsets provided by any recourse provisions, recoveries from third parties or collateral for the underlying loans, was $2.3 billion. In the event of loan default, Farmer Mac would have the right to enforce the terms of the loans including the right to foreclose upon the collateral underlying such loans. Farmer Mac believes that it will generally recover a significant portion of the value of the defaulted loans purchased either through borrower payments, loan payoffs, payments by third parties or foreclosure and sale of the collateral. As of December 31, 2004, the weighted-average remaining maturity of all loans underlying LTSPCs was 14.5 years. The portion of the reserve for losses that was attributable to LTSPCs was $7.8 million and $9.2 million as of December 31, 2004 and 2003, respectively. For additional detail on Farmer Mac's methodology for determining the reserve for losses, see Note 2(j) and Note 8. Commitments Farmer Mac enters into mandatory and optional delivery commitments to purchase loans. Most loan purchase commitments entered into by Farmer Mac are mandatory commitments, in which Farmer Mac charges a fee to extend or cancel the commitment. As of December 31, 2004 and 2003, commitments to purchase Farmer Mac I and II loans totaled $13.0 million and $11.2 million, respectively, all of which were mandatory commitments. Any optional loan purchase commitments are sold forward under optional commitments to deliver Farmer Mac Guaranteed Securities that may be cancelled by Farmer Mac without penalty. Farmer Mac is exposed to interest rate risk from the time it commits to purchase a loan to the time it either: (a) sells Farmer Mac Guaranteed Securities backed by the loan or (b) issues debt to retain the loan in its portfolio. There were no commitments to sell Farmer Mac Guaranteed Securities as of December 31, 2004 and 2003. Farmer Mac manages the interest rate risk related to loans not yet sold or funded as a retained investment through the use of forward sale contracts involving government sponsored enterprise debt and mortgage-backed securities and futures contracts involving U.S. Treasury securities. See Note 2(h) and Note 6 for information regarding financial derivatives. Rental expense for Farmer Mac's office space for each of the years ended December 31, 2004, 2003 and 2002 was $0.6 million, $0.5 million and $0.5 million, respectively. The future minimum lease payments under Farmer Mac's non-cancelable lease for its office space and other contractual obligations are as follows:
Other Future Minimum Contractual Lease Payments Obligations ------------------ --------------- (in thousands) 2005 $ 560 $ 497 2006 574 187 2007 588 160 2008 603 65 2009 618 - Thereafter 1,228 - ------------------ --------------- Total $ 4,171 $ 909 ------------------ ---------------
Other contractual obligations in the table above include minimum amounts due under non-cancelable agreements to purchase goods or services that are enforceable and legally binding and specify all significant terms. These agreements include agreements for the provision of internal audit services, consulting services, information technology support, equipment maintenance, and financial analysis software and services. The amounts actually paid under these agreements will likely be higher due to the variable components of some of these agreements under which the ultimate obligation owed is determined by reference to actual usage or hours worked. 13. FAIR VALUE DISCLOSURES The following table sets forth the estimated fair values and the carrying values for financial assets, liabilities and guarantees and commitments as of December 31, 2004 and 2003. Significant estimates, assumptions and present value calculations are used for the following disclosure, resulting in a high degree of subjectivity in the indicated fair values. Accordingly, these estimated fair values are not necessarily indicative of what Farmer Mac would realize in an actual sale or purchase.
As of December 31, ------------------------------------------------------- 2004 2003 --------------------------- --------------------------- Carrying Carrying Fair Value Amount Fair Value Amount ------------- ------------- -------------- ------------- (in thousands) Financial assets: Cash and cash equivalents $ 430,504 $ 430,504 $ 623,674 $ 623,674 Investment securities 1,056,425 1,056,143 1,065,124 1,064,782 Farmer Mac Guaranteed Securities 1,387,034 1,376,847 1,522,568 1,508,134 Loans 907,015 882,874 1,038,247 983,624 Financial derivatives 1,499 1,499 961 961 Guarantee and commitment fees receivable: * LTSPC's 9,274 9,704 7,333 7,333 Off-balance sheet Farmer Mac Guaranteed Securities 5,078 5,189 4,136 4,136 Financial liabilities: Notes payable: Due within one year 2,623,675 2,620,172 2,801,616 2,799,384 Due after one year 911,175 862,201 1,213,623 1,136,110 Financial derivatives 47,793 47,793 67,670 67,670 Guarantee and commitment obligation: * LTSPCs 9,274 9,704 7,333 7,333 Off-balance sheet Farmer Mac Guaranteed Securities 5,078 5,189 4,136 4,136 * Guarantee and commitment fees receivable and guarantee and commitment obligation are only for LTSPCs and Off-balance sheet Farmer Mac Guaranteed Securities extended after January 1, 2003.
Farmer Mac estimates the fair value of its loans, Farmer Mac Guaranteed Securities and notes payable by discounting the projected cash flows of these instruments at projected interest rates. 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. Interest rate contracts are valued using either a similar methodology or market quotes. For investment securities, futures contracts and commitments to purchase and sell government sponsored enterprise debt and mortgage-backed securities, fair values are based on market quotes. The carrying value of cash and cash equivalents approximates fair value. 14. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
2004 Quarter Ended 2003 Quarter Ended ------------------------------------------------ ------------------------------------------------ Dec. 31 Sept. 30 June 30 Mar. 31 Dec. 31 Sept. 30 June 30 Mar. 31 ----------- ------------ ----------- ----------- ----------- ------------------------------------ (in thousands, except per share amounts) Interest income $39,608 $38,386 $36,913 $39,087 $39,405 $39,320 $40,866 $41,968 Interest expense 31,636 30,417 29,074 29,620 30,311 30,402 31,501 32,093 ----------- ------------ ----------- ----------- ----------- ------------------------------------ Net interest income 7,972 7,969 7,839 9,467 9,094 8,918 9,365 9,875 Provision for loan losses 830 144 230 (2,793) (509) (3,391) (1,416) (1,208) ----------- ------------ ----------- ----------- ----------- ------------------------------------ Net interest income after provision for loan losses 8,802 8,113 8,069 6,674 8,585 5,527 7,949 8,667 Guarantee and commitment fees 5,235 5,269 5,251 5,222 5,424 5,056 5,111 5,094 Gains/(losses) on financial derivatives and trading assets 399 5,350 (6,152) 3,249 (1,297) (3,348) 3,669 3,333 Gain on sale of Farmer Mac Guaranteed Securities - - 367 - - - - - Gains/(losses) on the sale of real estate owned 642 133 30 (282) 201 79 (225) 123 Representation and warranty claims income 1,000 - 1,816 - - - - - Other income 126 703 144 522 69 354 138 251 ----------- ------------ ----------- ----------- ----------- ------------------------------------ Total revenues 16,204 19,568 9,525 15,385 12,982 7,668 16,642 17,468 Total operating expenses 822 5,964 6,299 3,178 5,292 2,325 3,532 4,033 ----------- ------------ ----------- ----------- ----------- ------------------------------------ Income before income taxes 15,382 13,604 3,226 12,207 7,690 5,343 13,110 13,435 Income tax expense 4,985 4,440 706 3,820 2,234 1,438 4,184 4,452 ----------- ------------ ----------- ----------- ----------- ------------------------------------ Net income 10,397 9,164 2,520 8,387 5,456 3,905 8,926 8,983 ----------- ------------ ----------- ----------- ----------- ------------------------------------ Preferred stock dividends (560) (560) (560) (560) (560) (560) (560) (560) ----------- ------------ ----------- ----------- ----------- ------------------------------------ Net income available to common stockholders $ 9,837 $ 8,604 $ 1,960 $ 7,827 $ 4,896 $ 3,345 $ 8,366 $ 8,423 ----------- ------------ ----------- ----------- ----------- ------------------------------------ Earnings per common share: Basic earnings per common share $ 0.83 $ 0.71 $ 0.16 $ 0.65 $ 0.42 $ 0.28 $ 0.72 $ 0.72 Diluted earnings per common share $ 0.82 $ 0.70 $ 0.16 $ 0.64 $ 0.40 $ 0.28 $ 0.70 $ 0.70 Common stock dividends $ 0.10 $ - $ - $ - $ - $ - $ - $ -
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure Not Applicable Item 9A. Controls and Procedures 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. Farmer Mac's Chief Executive Officer and Chief Financial Officer have 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 December 31, 2004. Based upon that evaluation, Farmer Mac's Chief Executive Officer and Chief Financial Officer have concluded that the Corporation's disclosure controls and procedures are adequate and effective. See Item 8 above for management's report on internal control over financial reporting and the accompanying report of independent registered public accounting firm. Changes in Internal Control Over Financial Reporting. There were no changes in Farmer Mac's internal control over financial reporting during the quarter ended December 31, 2004 that has materially affected, or is reasonably likely to materially affect, Farmer Mac's internal control over financial reporting. Item 9B. Other Information None PART III Item 10. Directors and Executive Officers of the Registrant Farmer Mac has adopted a code of business conduct and ethics (the "Code") that applies to all directors, officers, employees and agents of Farmer Mac, including Farmer Mac's principal executive officer, principal financial officer, principal accounting officer and other senior financial officers. A copy of the Code is available in the "Investors--Corporate Governance" section of Farmer Mac's Internet website (www.farmermac.com). Farmer Mac will post any amendment to, or waiver from, a provision of the Code in that same section of its Internet website. A print copy of the Code is available free of charge upon written request to Farmer Mac's Corporate Secretary. Additional information required by this item is incorporated by reference to the Corporation's Proxy Statement to be filed on or about April 28, 2005. Item 11. Executive Compensation The information required by this item is incorporated by reference to the Corporation's Proxy Statement to be filed on or about April 28, 2005. Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters The information required by this item is incorporated by reference to the Corporation's Proxy Statement to be filed on or about April 28, 2005. Item 13. Certain Relationships and Related Transactions The information required by this item is incorporated by reference to the Corporation's Proxy Statement to be filed on or about April 28, 2005. Item 14. Principal Accountant Fees and Services The information required by this item is incorporated by reference to the Corporation's Proxy Statement to be filed on or about April 28, 2005. PART IV Item 15. Exhibits and Financial Statement Schedules (a) (1) Financial Statements. Refer to Item 8 above. (2) Financial Statement Schedules. All schedules are omitted since they are not applicable, not required or the information required to be set forth therein is included in the consolidated financial statements or in notes thereto. (3) Exhibits. * 3.1 - Title VIII of the Farm Credit Act of 1971, as most recently amended by the Farm Credit System Reform Act of 1996, P.L. 104-105 (Form 10-K filed March 29, 1996). * 3.2 - Amended and restated By-Laws of the Registrant (Form 10-Q filed August 9, 2004). * 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 - Certificate of Designation of Terms and Conditions of Farmer Mac 6.40% Cumulative Preferred Stock, Series A (Form 10-Q filed May 15, 2003). +* 10.1 - Stock Option Plan (Previously filed as Exhibit 19.1 to Form 10-Q filed August 14, 1992). +* 10.1.1 - Amendment No. 1 to Stock Option Plan (Previously filed as Exhibit 10.2 to Form 10-Q filed August 16, 1993). +* 10.1.2 - 1996 Stock Option Plan (Form 10-Q filed August 14 1996). _________________ * 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. +* 10.1.3 - Amended and Restated 1997 Incentive Plan (Form 10-Q filed November 14, 2003). +**10.1.4 - Form of stock option award agreement under 1997 Incentive Plan. +* 10.2 - Employment Agreement dated May 5, 1989 between Henry D. Edelman and the Registrant (Previously filed as Exhibit 10.4 to Form 10-K filed February 14, 1990). +* 10.2.1 - Amendment No. 1 dated as of January 10, 1991 to Employment Contract between Henry D. Edelman and the Registrant (Previously filed as Exhibit 10.4 to Form 10-K filed April 1,1991). +* 10.2.2 - Amendment to Employment Contract dated as of June 1, 1993 between Henry D. Edelman and the Registrant (Previously filed as Exhibit 10.5 to Form 10-Q filed November 15, 1993). +* 10.2.3 - Amendment No. 3 dated as of June 1, 1994 to Employment Contract between Henry D. Edelman and the Registrant (Previously filed as Exhibit 10.6 to Form 10-Q filed August 15, 1994). +* 10.2.4 - Amendment No. 4 dated as of February 8, 1996 to Employment Contract between Henry D. Edelman and the Registrant (Form 10-K filed March 29, 1996). +* 10.2.5 - Amendment No. 5 dated as of June 13, 1996 to Employment Contract between Henry D. Edelman and the Registrant (Form 10-Q filed August 14, 1996). +* 10.2.6 - Amendment No. 6 dated as of August 7, 1997 to Employment Contract between Henry D. Edelman and the Registrant (Form 10-Q filed November 14, 1997). +* 10.2.7 - Amendment No. 7 dated as of June 4, 1998 to Employment Contract between Henry D. Edelman and the Registrant (Form 10-Q filed August 14, 1998). +* 10.2.8 - Amendment No. 8 dated as of June 3, 1999 to Employment Contract between Henry D. Edelman and the Registrant (Form 10-Q filed August 12, 1999). +* 10.2.9 - Amendment No. 9 dated as of June 1, 2000 to Employment Contract between Henry D. Edelman and the Registrant (Form 10-Q filed August 14, 2000). _________________ * 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. +* 10.2.10 - Amendment No. 10 dated as of June 7, 2001 to Employment Contract between Henry D. Edelman and the Registrant (Form 10-Q filed August 14, 2001). +* 10.2.11 - Amendment No. 11 dated as of June 6, 2002 to Employment Contract between Henry D. Edelman and the Registrant (Form 10-Q filed August 14, 2002). +* 10.2.12 - Amendment No. 12 dated as of June 5, 2003 to Employment Contract between Henry D. Edelman and the Registrant (Form 10-Q filed August 14, 2003). +* 10.2.13 - Amendment No. 13 dated as of August 3, 2004 to Employment Contract between Henry D. Edelman and the Registrant (Form 10-Q filed November 9, 2004). +* 10.3 - Employment Agreement dated May 11, 1989 between Nancy E. Corsiglia and the Registrant (Previously filed as Exhibit 10.5 to Form 10-K filed February 14, 1990). +* 10.3.1 - Amendment dated December 14, 1989 to Employment Agreement between Nancy E. Corsiglia and the Registrant (Previously filed as Exhibit 10.5 to Form 10-K filed February 14, 1990). +* 10.3.2 - Amendment No. 2 dated February 14, 1991 to Employment Agreement between Nancy E. Corsiglia and the Registrant (Previously filed as Exhibit 10.7 to Form 10-K filed April 1, 1991). +* 10.3.3 - Amendment to Employment Contract dated as of June 1, 1993 between Nancy E. Corsiglia and the Registrant (Previously filed as Exhibit 10.9 to Form 10-Q filed November 15, 1993). +* 10.3.4 - Amendment No. 4 dated June 1, 1993 to Employment Contract between Nancy E. Corsiglia and the Registrant (Previously filed as Exhibit 10.10 to Form 10-K filed March 31,1994). +* 10.3.5 - Amendment No. 5 dated as of June 1, 1994 to Employment Contract between Nancy E. Corsiglia and the Registrant (Previously filed as Exhibit 10.12 to Form 10-Q filed August 15, 1994). +* 10.3.6 - Amendment No. 6 dated as of June 1, 1995 to Employment Contract between Nancy E. Corsiglia and the Registrant (Form 10-Q filed August 14, 1995). _________________ * 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. +* 10.3.7 - Amendment No. 7 dated as of February 8, 1996 to Employment Contract between Nancy E. Corsiglia and the Registrant (Form 10-K filed March 29, 1996). +* 10.3.8 - Amendment No. 8 dated as of June 13, 1996 to Employment Contract between Nancy E. Corsiglia and the Registrant (Form 10-Q filed August 14, 1996). +* 10.3.9 - Amendment No. 9 dated as of August 7, 1997 to Employment Contract between Nancy E. Corsiglia and the Registrant (Form 10-Q filed November 14, 1997). +* 10.3.10 - Amendment No. 10 dated as of June 4, 1998 to Employment Contract between Nancy E. Corsiglia and the Registrant (Form 10-Q filed August 14, 1998). +* 10.3.11 - Amendment No. 11 dated as of June 3, 1999 to Employment Contract between Nancy E. Corsiglia and the Registrant (Form 10-Q filed August 12, 1999). +* 10.3.12 - Amendment No. 12 dated as of June 1, 2000 to Employment Contract between Nancy E. Corsiglia and the Registrant (Form 10-Q filed August 14, 2000). +* 10.3.13 - Amendment No. 13 dated as of June 7, 2001 to Employment Contract between Nancy E. Corsiglia and the Registrant (Form 10-Q filed August 14, 2001). +* 10.3.14 - Amendment No. 14 dated as of June 6, 2002 to Employment Contract between Nancy E. Corsiglia and the Registrant (Form 10-Q filed August 14, 2002). +* 10.3.15 - Amendment No. 15 dated as of June 5, 2003 to Employment Contract between Nancy E. Corsiglia and the Registrant (Form 10-Q filed August 14, 2003). +* 10.3.16 - Amendment No. 16 dated as of August 3, 2004 to Employment Contract between Nancy E. Corsiglia and the Registrant (Form 10-Q filed November 9, 2004). _________________ * 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. +* 10.4 - Employment Contract dated as of September 1, 1997 between Tom D. Stenson and the Registrant (Previously filed as Exhibit 10.8 to Form 10-Q filed November 14, 1997). +* 10.4.1 - Amendment No. 1 dated as of June 4, 1998 to Employment Contract between Tom D. Stenson and the Registrant (Previously filed as Exhibit 10.8.1 to Form 10-Q filed August 14, 1998). +* 10.4.2 - Amendment No. 2 dated as of June 3, 1999 to Employment Contract between Tom D. Stenson and the Registrant (Form 10-Q filed August 12, 1999). +* 10.4.3 - Amendment No. 3 dated as of June 1, 2000 to Employment Contract between Tom D. Stenson and the Registrant (Form 10-Q filed August 14, 2000). +* 10.4.4 - Amendment No. 4 dated as of June 7, 2001 to Employment Contract between Tom D. Stenson and the Registrant (Form 10-Q filed August 14, 2001). +* 10.4.5 - Amendment No. 5 dated as of June 6, 2002 to Employment Contract between Tom D. Stenson and the Registrant (Form 10-Q filed August 14, 2002). +* 10.4.6 - Amendment No. 6 dated as of June 5, 2003 to Employment Contract between Tom D. Stenson and the Registrant (Form 10-Q filed August 14, 2003). +* 10.4.7 - Amendment No. 7 dated as of August 3, 2004 to Employment Contract between Tom D. Stenson and the Registrant (Form 10-Q filed November 9, 2004). +* 10.5 - Employment Contract dated February 1, 2000 between Jerome G. Oslick and the Registrant (Previously filed as Exhibit 10.6 to Form 10-Q filed May 11, 2000). +* 10.5.1 - Amendment No. 1 dated as of June 1, 2000 to Employment Contract between Jerome G. Oslick and the Registrant (Previously filed as Exhibit 10.6.1 to Form 10-Q filed August 14, 2000). +* 10.5.2 - Amendment No. 2 dated as of June 7, 2001 to Employment Contract between Jerome G. Oslick and the Registrant (Previously filed as Exhibit 10.6.2 to Form 10-Q filed August 14, 2001). _________________ * 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. +* 10.5.3 - Amendment No. 3 dated as of June 6, 2002 to Employment Contract between Jerome G. Oslick and the Registrant (Form 10-Q filed August 14, 2002). +* 10.5.4 - Amendment No. 4 dated as of June 5, 2003 to Employment Contract between Jerome G. Oslick and the Registrant (Form 10-Q filed August 14, 2003). +* 10.6 - Employment Contract dated June 5, 2003 between Timothy L. Buzby and the Registrant (Form 10-Q filed August 14, 2003). +* 10.6.1 - Amendment No. 1 dated as of August 3, 2004 to Employment Contract between Timothy L. Buzby and the Registrant (Form 10-Q filed November 9, 2004). * 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 - Master Central Servicing Agreement dated as of December 17, 1996 between Zions First National Bank and the Registrant Form 10-Q (filed November 14, 2002). *# 10.11.1 - Amendment No. 1 dated as of February 26, 1997 to Master Central Servicing Agreement dated as of December 17, 1996 between Zions First National Bank and the Registrant (Form 10-Q filed November 14, 2002). *# 10.11.2 - Amended and Restated Master Central Servicing Agreement dated as of May 1, 2004 between Zions First National Bank and the Registrant (Form 10-Q filed August 9, 2004). _________________ * 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. *# 10.12 - Loan File Review and Underwriting Agreement dated as of December 17, 1996 between Zions First National Bank and the Registrant (Form 10-Q filed November 14, 2002). *# 10.12.1 - Amendment No. 1 dated as of January 20, 2000 to Loan File Review and Underwriting Agreement dated as of December 17, 1996 between Zions First National Bank and the Registrant (Form 10-Q filed November 14, 2002). *# 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 - Lease Agreement, dated June 28, 2001 between EOP - Two Lafayette, L.L.C. and the Registrant (Previously filed as Exhibit 10.10 to Form 10-K filed March 27, 2002). +* 10.15 - Employment Contract dated October 31, 2003 between Michael P. Morris and the Registrant. +* 10.15.1 - Amendment No. 1 dated August 3, 2004 to Employment Contract between Michael P. Morris and the Registrant (Form 10-Q filed November 9, 2004). *# 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). *# 10.17 - 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). 21 - Farmer Mac Mortgage Securities Corporation, a Delaware corporation. _________________ * 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. ** 31.1 - Certification of Chief Executive Officer relating to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 2004, pursuant to Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. ** 31.2 - Certification of Chief Financial Officer relating to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 2004, pursuant to Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. ** 32 - Certification of Chief Executive Officer and Chief Financial Officer relating to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 2004, pursuant to 18 U.S.C. section 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. 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 /s/ Henry D. Edelman March 16, 2005 - ------------------------------------ ------------------------------------- By: Henry D. Edelman Date President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Name Title Date /s/ Fred L. Dailey Chairman of the Board and March 16, 2005 - -------------------------------- Director Fred L. Dailey /s/ Henry D. Edelman President and Chief Executive March 16, 2005 - -------------------------------- Officer (Principal Executive Henry D. Edelman Officer) /s/ Nancy E. Corsiglia Vice President - Finance, March 16, 2005 - -------------------------------- Chief Financial Officer Nancy E. Corsiglia and Treasurer (Principal Financial Officer) /s/ Timothy L. Buzby Vice President - Controller March 16, 2005 - -------------------------------- (Principal Accounting Officer) Timothy L. Buzby Name Title Date /s/ Julia Bartling Director March 16, 2005 - --------------------------------------- Julia Bartling /s/ Dennis L. Brack Director March 16, 2005 - --------------------------------------- Dennis L. Brack /s/ Ralph W. Cortese Director March 16, 2005 - --------------------------------------- Ralph W. Cortese /s/ Grace T. Daniel Director March 16, 2005 - --------------------------------------- Grace T. Daniel /s/ Paul A. DeBriyn Director March 16, 2005 - --------------------------------------- Paul A. DeBriyn /s/ Dennis A. Everson Director March 16, 2005 - --------------------------------------- Dennis A. Everson /s/ Kenneth E. Graff Director March 16, 2005 - --------------------------------------- Kenneth E. Graff /s/ Mitchell A. Johnson Director March 16, 2005 - --------------------------------------- Mitchell A. Johnson /s/ Lowell L. Junkins Vice Chairman March 16, 2005 - --------------------------------------- and Director Lowell L. Junkins /s/ Timothy F. Kenny Director March 16, 2005 - --------------------------------------- Timothy F. Kenny /s/ Glen O. Klippenstein Director March 16, 2005 - --------------------------------------- Glen O. Klippenstein /s/ Charles E. Kruse Director March 16, 2005 - --------------------------------------- Charles E. Kruse /s/ John G. Nelson Director March 16, 2005 - --------------------------------------- John G. Nelson /s/ John Dan Raines, Jr. Director March 16, 2005 - --------------------------------------- John Dan Raines, Jr. EX-10 2 ex10-1_4.txt Exhibit 10.1.4 FEDERAL AGRICULTURAL MORTGAGE CORPORATION 1997 INCENTIVE PLAN Form of Common Stock Option Award Agreement A. A COMMON STOCK OPTION for a total of [ ] shares of Class C Non-Voting Common Stock, par value $1.00, of the Federal Agricultural Mortgage Corporation, a federally chartered instrumentality of the United States established by Title VIII of the Farm Credit Act of 1971, as amended (herein the "Company"), is hereby granted to (herein the "Optionee"), subject in all respects to the terms and provisions of the Federal Agricultural Mortgage Corporation 1997 Incentive Plan, as the same may be amended as of the date hereof (herein the "Plan"), which is incorporated herein by reference, and the following additional terms and conditions. B. The Exercise Price is $____ per share. C. Subject to the provisions of Section 9 of the Plan, if the Optionee is an employee of the Company or any of its Subsidiaries on the following dates, this Option may be exercised to purchase up to the following additional number of shares of Common Stock: - ------------------------------------------------------------------------------ [vesting date #1] [# of shares] - ------------------------------------------------------------------------------ [vesting date #2] [# of shares] - ------------------------------------------------------------------------------ [vesting date #3] [# of shares] - ------------------------------------------------------------------------------ D. The shares of Common Stock to be acquired upon exercise of this Option are subject to the Company's Right of First Refusal, as described in Section 7 of the Plan; such Right of First Refusal shall terminate upon Optionee's death. E. This Option may not be exercised if the issuance of shares of Common Stock of the Company upon such exercise would constitute a violation of any applicable Federal or State securities or other law or valid regulation. The Optionee, as a condition to his exercise of this Option, shall represent to the Company that the shares of Common Stock of the Company that the Optionee acquires under this Option are being acquired by the Optionee for investment and not with a present view to distribution or resale, unless counsel for the Company is then of the opinion that such a representation is not required under the Securities Act of 1933 or any other applicable law, regulation, or rule of any governmental agency. F. This Option may not be transferred in any manner otherwise than by will or the laws of descent and distribution, and may be exercised during the lifetime of the Optionee only by Optionee; provided, however, that the Committee may authorize a transfer, but only in accordance with and under the circumstances specified in Section 8 of the Plan. The terms of this Option shall be binding upon the executors, administrators, heirs, successors, and assigns of the Optionee. G. This Option may not be exercised more than [five (5)/ten (10)] years from the date of its grant, and may be exercised during such term only in accordance with the terms of the Plan. Dated: . ------------------ Federal Agricultural Mortgage Corporation By: ------------------------------- President ATTEST: - ------------------------- EX-31 3 ex31-1_hde.txt Exhibit 31.1 CERTIFICATION I, Henry D. Edelman, certify that: 1. I have reviewed this annual report on Form 10-K of the Federal Agricultural Mortgage Corporation for the fiscal year ended December 31, 2004; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; (c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): (a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: March 16, 2004 /s/ Henry D. Edelman ----------------------- Henry D. Edelman Chief Executive Officer EX-31 4 ex31-2_nec.txt Exhibit 31.2 CERTIFICATION I, Nancy E. Corsiglia, certify that: 1. I have reviewed this annual report on Form 10-K of the Federal Agricultural Mortgage Corporation for the fiscal year ended December 31, 2004; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; (c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: March 16, 2004 /s/ Nancy E. Corsiglia ------------------------- Nancy E. Corsiglia Chief Financial Officer EX-32 5 ex32.txt Exhibit 32 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report on Form 10-K of the Federal Agricultural Mortgage Corporation (the "Corporation") for the annual period ended December 31, 2004 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), the undersigned, Henry D. Edelman, Chief Executive Officer of the Corporation, and Nancy E. Corsiglia, Chief Financial Officer of the Corporation, each hereby certifies pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to his or her knowledge: (1) the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Corporation. /s/ Henry D. Edelman - -------------------- Henry D. Edelman Chief Executive Officer /s/ Nancy E. Corsiglia - ----------------------- Nancy E. Corsiglia Chief Financial Officer Date: March 16, 2004 -----END PRIVACY-ENHANCED MESSAGE-----