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AGM-A > SEC Filings for AGM-A > Form 10-Q on 8-Nov-2012All Recent SEC Filings

Show all filings for FEDERAL AGRICULTURAL MORTGAGE CORP

Form 10-Q for FEDERAL AGRICULTURAL MORTGAGE CORP


8-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

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

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

The discussion below is not necessarily indicative of future results.

Forward-Looking Statements

Some statements made in this report are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 pertaining to management's current expectations as to Farmer Mac's future financial results, business prospects and business developments. Forward-looking statements include, without limitation, any statement that may predict, forecast, indicate or imply future results, performance or achievements, and typically are accompanied by, and identified with, such terms as "anticipates," "believes," "expects," "intends," "should" and similar phrases. The following management's discussion and analysis includes forward-looking statements addressing Farmer Mac's:

prospects for earnings;

prospects for growth in loan purchase, guarantee, securitization, and LTSPC volume;

trends in net interest income and net effective spread;

trends in portfolio credit quality, delinquencies, and provisions for losses;

trends in expenses;

trends in investment securities;

prospects for asset impairments and allowance for losses;

changes in capital position; and

other business and financial matters.


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Management's expectations for Farmer Mac's future necessarily involve a number of assumptions and estimates and the evaluation of risks and uncertainties. Various factors or events could cause Farmer Mac's actual results to differ materially from the expectations as expressed or implied by the forward-looking statements, including the factors discussed under "Risk Factors" in Part I, Item 1A of Farmer Mac's Annual Report on Form 10-K for the year ended December 31, 2011 filed with the SEC on March 15, 2012, as well as uncertainties regarding:

         the availability to Farmer Mac and Farmer Mac II LLC of debt financing
          and, if available, the reasonableness of rates and terms;


         legislative or regulatory developments that could affect Farmer Mac,
          including but not limited to developments in relation to agricultural
          policies and programs contained in the 2008 Farm Bill, many of which
          expired this year;


         fluctuations in the fair value of assets held by Farmer Mac and Farmer
          Mac II LLC;


         the rate and direction of development of the secondary market for
          agricultural mortgage and rural utilities loans, including lender
          interest in Farmer Mac credit products and the Farmer Mac secondary
          market;


         the general rate of growth in agricultural mortgage and rural utilities
          indebtedness;


         the impact of economic conditions, including the effects of drought and
          other weather-related conditions and fluctuations in agricultural real
          estate values, on agricultural mortgage lending and borrower repayment
          capacity;


         developments in the financial markets, including possible investor,
          analyst and rating agency reactions to events involving GSEs, including
          Farmer Mac;


         financial market volatility, including the future level and direction
          of interest rates; and


         volatility in commodity prices and/or export demand for U.S.
          agricultural products.

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


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Overview

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

Beginning in third quarter 2012, Farmer Mac designated $950.0 million notional amount of interest rate swaps in fair value hedge relationships. Accordingly, Farmer Mac recorded in earnings offsetting fair value adjustments on the hedged items attributable to the risk being hedged. For third quarter 2012, Farmer Mac recorded unrealized fair value gains of $5.3 million on its financial derivatives and hedging activities. This compares to unrealized fair value losses of $21.6 million for second quarter 2012 and $55.2 million for third quarter 2011. Because Farmer Mac expects its fair value hedge relationships to remain highly effective through maturity, a substantial portion of the volatility caused from changes in the fair values of financial derivatives is expected to be eliminated in future periods.

Farmer Mac's non-GAAP core earnings for third quarter 2012 were $13.4 million, up from $12.9 million in second quarter 2012 and $11.2 million in third quarter 2011. Core earnings for third quarter 2012 benefited from higher net effective spread of $27.3 million (95 basis points), compared to $27.2 million (99 basis points) in second quarter 2012 and $22.8 million (93 basis points) in third quarter 2011. This higher net effective spread was partially offset by net provisions to the allowance for losses of $0.1 million and $0.2 million in third quarter 2012 and second quarter 2012, respectively, compared to net releases of $0.8 million for third quarter 2011.

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

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


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

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

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

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

Critical Accounting Policies and Estimates

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

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


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Results of Operations

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

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


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

Reconciliation of GAAP Net Income/(Loss) Attributable to Common Stockholders to Core Earnings

                                                              For the Three Months Ended
                                                     September 30, 2012       September 30, 2011
                                                       (in thousands, except per share amounts)
GAAP net income/(loss) attributable to common
stockholders                                        $           16,381       $           (23,032 )
Less the after-tax effects of:
Unrealized gains/(losses) on financial derivatives
and hedging activities                                           3,456                   (35,857 )
Unrealized losses on trading assets                               (286 )                  (2,361 )
Amortization of premiums and deferred gains on
assets consolidated at fair value                                 (873 )                  (1,154 )
Net effects of settlements on agency forward
contracts                                                          699                    (1,291 )
Lower of cost or fair value adjustment on loans
held for sale                                                        -                     6,403
   Sub-total                                                     2,996                   (34,260 )
Core earnings                                       $           13,385       $            11,228

Core earnings per share:
 Basic                                              $             1.28       $              1.08
 Diluted                                                          1.22                      1.04
Weighted-average shares:
 Basic                                                          10,492                    10,354
 Diluted                                                        10,996                    10,760

                                                              For the Nine Months Ended
                                                     September 30, 2012       September 30, 2011
                                                       (in thousands, except per share amounts)
GAAP net income attributable to common stockholders $           34,293       $               461
Less the after-tax effects of:
Unrealized losses on financial derivatives and
hedging activities                                                (394 )                 (31,316 )
Unrealized losses on trading assets                             (1,578 )                    (230 )
Amortization of premiums and deferred gains on
assets consolidated at fair value                               (2,732 )                  (1,817 )
Net effects of settlements on agency forward
contracts                                                          958                    (2,283 )
Lower of cost or fair value adjustment on loans
held for sale                                                        -                     5,776
   Sub-total                                                    (3,746 )                 (29,870 )
Core earnings                                       $           38,039       $            30,331

Core earnings per share:
 Basic                                              $             3.64       $              2.94
 Diluted                                                          3.47                      2.83
Weighted-average shares:
 Basic                                                          10,442                    10,328
 Diluted                                                        10,974                    10,715

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


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with no fair value adjustments on the corresponding hedged items. In an effort to mitigate volatility in GAAP earnings caused from these fair value changes, Farmer Mac previously elected the fair value option for certain investment securities and Farmer Mac Guaranteed Securities that were funded or hedged principally with financial derivatives. Farmer Mac classifies these assets as trading and measures them at fair value, with changes in fair value recorded in earnings as they occur.

Effective July 1, 2012, Farmer Mac designated $950.0 million notional amount of interest rate swaps in fair value hedge relationships. Beginning in third quarter 2012, Farmer Mac recorded in earnings offsetting fair value adjustments on the hedged items attributable to the risk being hedged. Any differences arising from fair value changes that are not offset result in hedge ineffectiveness and affect GAAP earnings. Farmer Mac excludes the after-tax effect of unrealized gains and losses resulting from changes in the fair values of financial derivatives and hedging activities from core earnings.

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

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

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


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

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

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

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

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

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


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

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