form10q.htm
As filed with the Securities and Exchange Commission on
August 12, 2008
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549

FORM 10-Q
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2008

Commission File Number 001-14951

FEDERAL AGRICULTURAL MORTGAGE CORPORATION
(Exact name of registrant as specified in its charter)

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

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

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

Yes    S
No    £

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

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

Yes    £
No    S

As of August 1, 2008, the registrant had 1,030,780 shares of Class A Voting Common Stock, 500,301 shares of Class B Voting Common Stock and 8,499,698 shares of Class C Non-Voting Common Stock outstanding.
 
 
 
 

PART I - FINANCIAL INFORMATION

Item 1.
Condensed Consolidated Financial Statements

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

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

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

 
-2-
 

FEDERAL AGRICULTURAL MORTGAGE CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)

   
June 30,
    
December 31,
  
   
2008
    
2007
  
   
(in thousands)
  
Assets:
            
Cash and cash equivalents
   $ 712,374     $ 101,445  
Investment securities:
                
Available-for-sale, at fair value (includes securities pledged to counterparties of $3.7 million and $7.2 million, respectively, as of June 30, 2008 and December 31, 2007)
     1,503,473       2,616,187  
Trading, at fair value
     186,514       8,179  
Total investment securities
     1,689,987       2,624,366  
Farmer Mac Guaranteed Securities:
                
Held-to-maturity, at amortized cost
     518,792       959,865  
Available-for-sale, at fair value
     1,293,543       338,958  
Trading, at fair value
     892,247       -  
Total Farmer Mac Guaranteed Securities
     2,704,582       1,298,823  
Loans:
                
Loans held for sale, at lower of cost or fair value
     142,695       118,629  
Loans held for investment, at amortized cost
     640,864       649,280  
Allowance for loan losses
     (1,592 )     (1,690 )
Total loans, net of allowance
     781,967       766,219  
                 
Real estate owned, at lower of cost or fair value
     590       590  
Financial derivatives, at fair value
     3,184       2,288  
Interest receivable
     76,436       91,939  
Guarantee and commitment fees receivable
     55,623       57,804  
Deferred tax asset, net
     34,477       30,239  
Prepaid expenses and other assets
     5,170       3,900  
Total Assets
   $ 6,064,390     $ 4,977,613  
                 
Liabilities and Stockholders' Equity:
                
Liabilities:
                
Notes payable:
                
Due within one year
   $ 5,006,317     $ 3,829,698  
Due after one year
     651,267       744,649  
Total notes payable
     5,657,584       4,574,347  
                 
Financial derivatives, at fair value
     56,420       55,273  
Accrued interest payable
     47,933       50,004  
Guarantee and commitment obligation
     50,631       52,130  
Accounts payable and accrued expenses
     12,134       20,069  
Reserve for losses
     2,197       2,197  
Total Liabilities
     5,826,899       4,754,020  
                 
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, 8,491,482 and 8,363,580 shares issued and outstanding as of June 30, 2008 and December 31, 2007, respectively
     8,491       8,364  
Additional paid-in capital
     92,669       87,134  
Accumulated other comprehensive loss
     (17,337 )     (2,793 )
Retained earnings
     117,137       94,357  
Total Stockholders' Equity
     237,491       223,593  
                 
Total Liabilities and Stockholders' Equity
   $ 6,064,390     $ 4,977,613  

See accompanying notes to condensed consolidated financial statements.

 
-3-
 

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

   
Three Months Ended
    
Six Months Ended
  
   
June 30, 2008
    
June 30, 2007
    
June 30, 2008
    
June 30, 2007
  
Interest income:
                        
Investments and cash equivalents
   $ 35,402     $ 41,530     $ 76,910     $ 80,522  
Farmer Mac Guaranteed Securities
     19,767       18,782       38,537       38,185  
Loans
     11,643       11,199       23,474       22,518  
Total interest income
     66,812       71,511       138,921       141,225  
Total interest expense
     42,454       63,032       96,625       123,664  
                                 
Net interest income
     24,358       8,479       42,296       17,561  
Recovery/(provision) for loan losses
     -       -       -       215  
Net interest income after recovery/(provision) for loan losses
     24,358       8,479       42,296       17,776  
                                 
Non-interest income/(loss):
                                
Guarantee and commitment fees
     6,659       6,354       13,293       12,212  
Gains/(losses) on financial derivatives
     31,050       19,892       (10,670 )     15,866  
Losses on trading assets
     (17,268 )     (67 )     (7,157 )     (74 )
Impairment losses on available-for-sale investment securities
     (5,344 )     -       (5,344 )     -  
Gains on sale of available-for-sale investment securities
     150       21       150       21  
Gains on the sale of real estate owned
     -       32       -       32  
Other income
     662       42       1,123       451  
Non-interest income/(loss)
     15,909       26,274       (8,605 )     28,508  
                                 
Non-interest expense:
                                
Compensation and employee benefits
     3,929       3,719       7,579       6,856  
General and administrative
     2,242       2,237       4,270       4,574  
Regulatory fees
     512       550       1,025       1,100  
Real estate owned operating costs, net
     38       -       87       -  
Provision/(recovery) for losses
     -       100       -       (313 )
Non-interest expense
     6,721       6,606       12,961       12,217  
                                 
Income before income taxes
     33,546       28,147       20,730       34,067  
                                 
Income tax expense
     11,555       9,218       6,436       10,656  
Net income
     21,991       18,929       14,294       23,411  
Preferred stock dividends
     (560 )     (560 )     (1,120 )     (1,120 )
Net income available to common stockholders
   $ 21,431     $ 18,369     $ 13,174     $ 22,291  
                                 
Earnings per common share and dividends:
                                
Basic earnings per common share
   $ 2.15     $ 1.79     $ 1.33     $ 2.15  
Diluted earnings per common share
   $ 2.13     $ 1.74     $ 1.31     $ 2.10  
Common stock dividends per common share
   $ 0.10     $ 0.10     $ 0.20     $ 0.20  

See accompanying notes to condensed consolidated financial statements.

 
-4-
 

FEDERAL AGRICULTURAL MORTGAGE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
   
Six Months Ended
  
   
June 30, 2008
    
June 30, 2007
  
   
(in thousands)
  
Cash flows from operating activities:
            
Net income
   $ 14,294     $ 23,411  
Adjustments to reconcile net income to net cash provided by operating activities:
                
Net amortization of premiums and discounts on loans and investments
     2,752       (803 )
Amortization of debt premiums, discounts and issuance costs
     47,430       62,956  
Proceeds from repayment of trading investment securities
     628       5,091  
Purchases of loans held for sale
     (30,685 )     (27,222 )
Proceeds from repayment of loans held for sale
     5,792       4,201  
Net change in fair value of trading securities and financial derivatives
     7,408       (14,654 )
Amortization of SFAS 133 transition adjustment on financial derivatives
     156       209  
Impairment losses on available-for-sale investment securities
     5,344       -  
Gains on sale of available-for-sale investment securities
     (150 )     (21 )
Gains on the sale of real estate owned
     -       (32 )
Total (recovery)/provision for losses
     -       (528 )
Deferred income taxes
     (3,537 )     (2,231 )
Stock-based compensation expense
     2,284       1,508  
Decrease/(increase) in interest receivable
     15,503       (9,321 )
Decrease/(increase) in guarantee and commitment fees receivable
     2,181       (16,283 )
Decrease in other assets
     131       2,502  
(Decrease)/increase in accrued interest payable
     (2,071 )     18,861  
(Decrease)/increase in other liabilities
     (8,122 )     20,716  
Net cash provided by operating activities
     59,338       68,360  
                 
Cash flows from investing activities:
                
Purchases of available-for-sale investment securities (1)
     (1,017,845 )     (2,238,930 )
Purchases of Farmer Mac II Guaranteed Securities and AgVantage Farmer Mac Guaranteed Securities
     (221,053 )     (122,122 )
Purchases of loans held for investment
     (60,621 )     (34,278 )
Purchases of defaulted loans
     (1,189 )     (1,483 )
Proceeds from repayment of investment securities (2)
     296,048       1,567,668  
Proceeds from repayment of Farmer Mac Guaranteed Securities
     152,670       131,609  
Proceeds from repayment of loans held for investment
     65,262       84,931  
Proceeds from sale of available-for-sale investment securities
     288,275       32,109  
Proceeds from sale of real estate owned
     -       230  
Proceeds from sale of Farmer Mac Guaranteed Securities
     13,876       1,324  
Net cash used in investing activities
     (484,577 )     (578,942 )
                 
Cash flows from financing activities:
                
Proceeds from issuance of discount notes
     74,710,734       56,058,511  
Proceeds from issuance of medium-term notes
     1,011,944       795,000  
Payments to redeem discount notes
     (73,636,115 )     (56,100,859 )
Payments to redeem medium-term notes
     (1,050,000 )     (537,083 )
Tax benefit from tax deductions in excess of compensation cost recognized
     175       346  
Proceeds from common stock issuance
     3,368       5,589  
Purchases of common stock
     (830 )     (13,186 )
Dividends paid on common and preferred stock
     (3,108 )     (3,189 )
Net cash provided by financing activities
     1,036,168       205,129  
Net increase/(decrease) in cash and cash equivalents
     610,929       (305,453 )
                 
Cash and cash equivalents at beginning of period
     101,445       877,714  
Cash and cash equivalents at end of period
   $ 712,374     $ 572,261  

(1)
Includes purchases of $349.0 million and $1.3 billion related to auction-rate certificates for the six months ended June 30, 2008 and 2007, respectively.  See Note 2 to the condensed consolidated financial statements.
 
(2)
Includes proceeds, through the normal auction process, of $268.0 million and $1.3 billion related to auction-rate certificates for the six months ended June 30, 2008 and 2007, respectively.  See Note 2 to the condensed consolidated financial statements.

See accompanying notes to condensed consolidated financial statements.

 
-5-
 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 1.
Accounting Policies

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

Farmer Mac considers highly liquid investment securities with original maturities of three months or less at the time of purchase to be cash equivalents.  Changes in the balance of cash and cash equivalents are reported in the condensed consolidated statements of cash flows.  The following table sets forth information regarding certain cash and non-cash transactions for the six months ended June 30, 2008 and 2007.
 
 
   
Six Months Ended
  
   
June 30, 2008
    
June 30, 2007
  
   
(in thousands)
  
Cash paid for:
            
Interest
   $ 57,410     $ 49,164  
Income taxes
     21,500       7,000  
Non-cash activity:
                
Loans acquired and securitized as Farmer Mac Guaranteed Securities
     1,390       1,324  
Transfers of investment securities from available-for-sale to trading from the effect of adopting SFAS 159
     600,468       -  
Transfers of Farmer Mac II Guaranteed Securities from held-to-maturity to trading from the effect of adopting SFAS 159
     428,670       -  
Transfers of available-for-sale investment securities to available-for-sale Farmer Mac Guaranteed Securities - Rural Utilities
     902,420       -  
Transfers of trading investment securities to trading Farmer Mac Guaranteed Securities - Rural Utilities
     459,026       -  
 
(b) 
Allowance for Losses

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

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

 
-6-
 

Farmer Mac’s methodology for determining its allowance for losses incorporates the Corporation’s proprietary automated loan classification system.  That system scores loans based on criteria such as historical repayment performance, loan seasoning, loan size and loan-to-value ratio.  For the purposes of the loss allowance methodology, the loans in Farmer Mac’s portfolio of loans and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs have been scored and classified for each calendar quarter since first quarter 2000.  The allowance methodology captures the migration of loan scores across concurrent and overlapping three-year time horizons and calculates loss rates separately within each loan classification for (1) loans underlying LTSPCs and (2) loans held and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities.  The calculated loss rates are applied to the current classification distribution of Farmer Mac’s portfolio to estimate inherent losses, on the assumption that the historical credit losses and trends used to calculate loss rates will continue in the future.  Management evaluates this assumption by taking into consideration factors including:
 
 
·
economic conditions;
 
·
geographic and agricultural commodity/product concentrations in the portfolio;
 
·
the credit profile of the portfolio;
 
·
delinquency trends of the portfolio;
 
·
historical charge-off and recovery activities of the portfolio; and
 
·
other factors to capture current portfolio trends and characteristics that differ from historical experience.
 
Management believes that its use of this methodology produces a reliable estimate of probable losses, as of the balance sheet date, for all loans held, real estate owned and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs in accordance with SFAS 5 and SFAS 114.

 
-7-
 
 
The following table summarizes the changes in the components of Farmer Mac’s allowance for losses for the three and six months ended June 30, 2008 and 2007:
 
 
   
June 30, 2008
  
   
Allowance
for Loan
Losses
    
REO
Valuation
Allowance
    
Reserve
for Losses
    
Total
Allowance
for Losses
  
   
(in thousands)
  
Three Months Ended:
                        
Beginning balance
   $ 1,651     $ -     $ 2,197     $ 3,848  
Provision/(recovery) for losses
     -       -       -       -  
Charge-offs
     (69 )     -       -       (69 )
Recoveries
     10       -       -       10  
Ending balance
   $ 1,592     $ -     $ 2,197     $ 3,789  
                                 
Six Months Ended:
                                
Beginning balance
   $ 1,690     $ -     $ 2,197     $ 3,887  
Provision/(recovery) for losses
     -       -       -       -  
Charge-offs
     (108 )     -       -       (108 )
Recoveries
     10       -       -       10  
Ending balance
   $ 1,592     $ -     $ 2,197     $ 3,789  


   
June 30, 2007
  
   
Allowance
for Loan
Losses
    
REO
Valuation
Allowance
    
Reserve
for Losses
    
Total
Allowance
for Losses
  
   
(in thousands)
  
Three Months Ended:
                        
Beginning balance
   $ 1,730     $ -     $ 2,197     $ 3,927  
Provision/(recovery) for losses
     -       100       -       100  
Charge-offs
     (49 )     (100 )     -       (149 )
Recoveries
     -       -       -       -  
Ending balance
   $ 1,681     $ -     $ 2,197     $ 3,878  
                                 
Six Months Ended:
                                
Beginning balance
   $ 1,945     $ -     $ 2,610     $ 4,555  
Provision/(recovery) for losses
     (215 )     100       (413 )     (528 )
Charge-offs
     (49 )     (100 )     -       (149 )
Recoveries
     -       -       -       -  
Ending balance
   $ 1,681     $ -     $ 2,197     $ 3,878  


Prior to third quarter 2007, no allowance for losses had been made for loans underlying Farmer Mac I Guaranteed Securities issued prior to the 1996 Act (“Pre-1996 Act Farmer Mac I Guaranteed Securities”), AgVantage securities or securities issued under the Farmer Mac II program (“Farmer Mac II Guaranteed Securities”).  Pre-1996 Act Farmer Mac I Guaranteed Securities are supported by unguaranteed first loss subordinated interests, which are expected to exceed the estimated credit losses on those loans.  Through June 30, 2008, Farmer Mac had charged off $0.4 million related to one loan underlying Pre-1996 Act Farmer Mac I Guaranteed Securities.  The remaining $2.4 million of Pre-1996 Act Farmer Mac I Guaranteed Securities represent interests in seasoned performing loans with low loan-to-value ratios.  Farmer Mac does not expect to incur any further losses on the remaining Pre-1996 Act Farmer Mac I Guaranteed Securities in the future.  Each AgVantage security is a general obligation of an issuing institution approved by Farmer Mac and is collateralized by eligible mortgage loans.  As of June 30, 2008, there were no probable losses inherent in Farmer Mac’s AgVantage securities due to the high credit quality of the obligors, as well as the underlying collateral.  As of June 30, 2008, Farmer Mac had not experienced any credit losses on any AgVantage Securities and does not expect to incur any such losses in the future.  The guaranteed portions collateralizing Farmer Mac II Guaranteed Securities are guaranteed by the United States Department of Agriculture (“USDA”).  Each USDA guarantee is an obligation backed by the full faith and credit of the United States.  As of June 30, 2008, Farmer Mac had not experienced any credit losses on any Farmer Mac II Guaranteed Securities and does not expect to incur any such losses in the future.

 
-8-
 
 
On May 22, 2008, Congress enacted into law the Food, Conservation and Energy Act of 2008 (the “Farm Bill”), which expanded Farmer Mac’s authorities to include providing a secondary market for rural electric and telephone loans made by cooperative lenders.  During second quarter 2008, Farmer Mac placed its guarantee on $430.7 million of securities representing interests in rural electric cooperative loans and $900.0 million principal amount of obligations collateralized by rural electric cooperative loans previously held as mission-related investments under authority granted by the Farm Credit Administration (“FCA”).  Farmer Mac evaluated these $1.3 billion of Farmer Mac Guaranteed Securities – Rural Utilities and determined that there were no probable losses inherent in the securities or the underlying rural utilities loans.  Accordingly, no allowance for losses was recorded as of June 30, 2008 with respect to those securities.

The table below summarizes the components of Farmer Mac’s allowance for losses as of June 30, 2008 and December 31, 2007:
 
 
   
June 30,
    
December 31,
  
   
2008
    
2007
  
   
(in thousands)
  
Allowance for loan losses
   $ 1,592     $ 1,690  
Real estate owned valuation allowance
     -       -  
Reserve for losses:
                
On-balance sheet Farmer Mac I Guaranteed Securities
     857       857  
Off-balance sheet Farmer Mac I Guaranteed Securities
     645       655  
LTSPCs
     695       685  
Farmer Mac Guaranteed Securities - Rural Utilities
     -       -  
Total
   $ 3,789     $ 3,887  


As of June 30, 2008, Farmer Mac individually analyzed $10.1 million of its $46.0 million of impaired assets for collateral shortfalls against updated appraised values, other updated collateral valuations or discounted values.  Farmer Mac evaluated the remaining $35.9 million of impaired assets, for which updated valuations were not available, in the aggregate in consideration of their similar risk characteristics and historical statistics.  All of the $10.1 million of assets analyzed individually were adequately collateralized.  Accordingly, Farmer Mac did not record any specific allowances for any of its impaired assets as of June 30, 2008.  Similarly, as of December 31, 2007, Farmer Mac did not record any specific allowances related to its $36.6 million of impaired assets as of that date.

 
-9-
 
 
Farmer Mac recognized interest income of approximately $0.9 million and $2.1 million on impaired loans during the three and six months ended June 30, 2008, respectively, compared to $0.8 million and $1.7 million, respectively, during the same periods in 2007.  During the three and six months ended June 30, 2008, Farmer Mac’s average investment in impaired loans was $43.6 million and $41.3 million, respectively, compared to $50.4 million and $51.3 million, respectively, for the same periods in 2007.
 
 
(c)
Adoption of Fair Value Accounting Standards

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

Fair Value Measurements

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

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

Basis of Fair Value Measurement

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

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

 
-10-
 
 
 
Level 3
Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable.  Level 3 inputs include situations where there is little, if any, market activity for the financial instrument.  For financial instruments that are thinly traded, Farmer Mac uses as its primary fair value source analytical models that project cash flows based on internal and external inputs, including transaction terms, yield curves, benchmark data, volatility data, prepayment assumptions and default assumptions.  Financial instruments requiring Level 3 inputs include available-for-sale Farmer Mac I Guaranteed Securities, trading Farmer Mac II Guaranteed Securities, available-for-sale and trading Farmer Mac Guaranteed Securities – Rural Utilities, auction-rate certificates, basis swaps and loans held for sale.

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

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

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

 
-11-
 

 
Assets and Liabilities Measured at Fair Value as of June 30, 2008
  
                         
   
Level 1
    
Level 2
    
Level 3
    
Total
  
Recurring:
  
(in thousands)
  
Assets:
                        
Investment Securities:
                        
Available-for-sale:
                        
Fixed rate certificates of deposit
   $ -     $ 142,086     $ -     $ 142,086  
Fixed rate commercial paper
     -       9,939       -       9,939  
Floating rate auction-rate certificates backed by Government guaranteed student loans
     -       -       209,360       209,360  
Floating rate asset-backed securities
     -       97,935       -       97,935  
Floating rate corporate debt securities
     -       537,110       -       537,110  
Floating rate Government/GSE guaranteed mortgage-backed securities
     -       396,805       -       396,805  
Fixed rate GSE guaranteed mortgage-backed securities
     -       7,577       -       7,577  
Floating rate GSE subordinated debt
     -       55,505       -       55,505  
Floating rate GSE preferred stock
     -       47,156       -       47,156  
Total available-for-sale
     -       1,294,113       209,360       1,503,473  
                                 
Trading:
                                
Floating rate asset-backed securities
     -       -       7,414       7,414  
Fixed rate GSE preferred stock
     -       179,100       -       179,100  
Total trading
     -       179,100       7,414       186,514  
Total investment securities
     -       1,473,213       216,774       1,689,987  
                                 
Farmer Mac Guaranteed Securities:
                                
Available-for-sale:
                                
Farmer Mac I
     -       -       391,904       391,904  
Rural Utilities
     -       -       901,639       901,639  
Total available-for-sale
     -       -       1,293,543       1,293,543  
                                 
Trading:
                                
Farmer Mac II
     -       -       450,562       450,562  
Rural Utilities
     -       -       441,685       441,685  
Total trading
     -       -       892,247       892,247  
Total Farmer Mac Guaranteed Securities
     -       -       2,185,790       2,185,790  
                                 
Financial Derivatives
     -       3,184       -       3,184  
Total Assets at fair value
   $ -     $ 1,476,397     $ 2,402,564     $ 3,878,961  
                                 
Liabilities:
                                
Financial Derivatives
   $ 5     $ 54,958     $ 1,457     $ 56,420  
Total Liabilities at fair value
   $ 5     $ 54,958     $ 1,457     $ 56,420  
                                 
Nonrecurring:
                                
Loans held for sale
   $ -     $ -     $ 142,695     $ 142,695  

 
-12-
 
 
The following tables present additional information about assets and liabilities measured at fair value on a recurring and nonrecurring basis and for which Farmer Mac has used Level 3 inputs to determine fair value for the three and six months ended June 30, 2008.
 
Level 3 Assets and Liabilities Measured at Fair Value for the Three Months Ended June 30, 2008
  
   
Beginning Balance
    
Purchases, Sales, Issuances and Settlements, Net
    
Realized and Unrealized Gains/(Losses) included in Income
    
Unrealized Gains/(Losses) included in Other Comprehensive Income
    
Net Transfers In and/or Out
    
Ending Balance
  
Recurring:
  
(in thousands)
  
Assets:
                                    
Investment Securities:
                                    
Available-for-sale:
                                    
Floating rate auction-rate certificates backed by Government guaranteed student loans
   $ 229,360     $ (20,000 )   $ -     $ -     $ -     $ 209,360  
Floating rate corporate debt securities
     399,331       -       -       -       (399,331 )     -  
Fixed rate corporate debt securities
     503,089       -       -       -       (503,089 )     -  
Total available-for-sale
     1,131,780       (20,000 )     -       -       (902,420 )     209,360  
                                                 
Trading:
                                                
Floating rate asset-backed securities (1)
     7,179       (205 )     440       -       -       7,414  
Fixed rate mortgage-backed securities (1)
     459,026       -       -       -       (459,026 )     -  
Total trading
     466,205       (205 )     440       -       (459,026 )     7,414  
Total investment securities
     1,597,985       (20,205 )     440       -       (1,361,446 )     216,774  
Farmer Mac Guaranteed Securities:
                                                
Available-for-sale:
                                                
Farmer Mac I
     325,272       68,979       -       (2,347 )     -       391,904  
Rural Utilities
     -       -       -       (781 )     902,420       901,639  
Total available-for-sale
     325,272       68,979       -       (3,128 )     902,420       1,293,543  
                                                 
Trading:
                                                
Farmer Mac II (2)
     445,202       9,515       (4,155 )     -       -       450,562  
Rural Utilities (1)
     -       -       (17,341 )     -       459,026       441,685  
Total trading
     445,202       9,515       (21,496 )     -       459,026       892,247  
Total Farmer Mac Guaranteed Securities
     770,474       78,494       (21,496 )     (3,128 )     1,361,446       2,185,790  
                                                 
Total Assets at fair value
   $ 2,368,459     $ 58,289     $ (21,056 )   $ (3,128 )   $ -     $ 2,402,564  
Liabilities:
                                                
Financial Derivatives (3)
   $ (3,507 )   $ -     $ 2,050     $ -     $ -     $ (1,457 )
Total Liabilities at fair value
   $ (3,507 )   $ -     $ 2,050     $ -     $ -     $ (1,457 )
                                                 
Nonrecurring:
                                                
Loans held for sale
   $ -     $ -     $ (61 )   $ -     $ 142,756     $ 142,695  

(1)
Unrealized gains/(losses) are attributable to assets still held as of June 30, 2008 and are recorded in losses on trading assets.
(2)
Includes unrealized gains of approximately $1.8 million attributable to assets still held as of June 30, 2008 that are recorded in losses on trading assets.
(3)
Unrealized gains are attributable to liabilities still held as of June 30, 2008 and are recorded in gains/(losses) on financial derivatives.

 
-13-
 
 
Level 3 Assets and Liabilities Measured at Fair Value for the Six Months Ended June 30, 2008
  
   
Beginning Balance
    
Purchases, Sales, Issuances and Settlements, Net
    
Realized and Unrealized Gains/(Losses) included in Income
    
Unrealized Gains/(Losses) included in Other Comprehensive Income
    
Net Transfers In and/or Out
    
Ending Balance
  
Recurring:
  
(in thousands)
  
Assets:
                                    
Investment Securities:
                                    
Available-for-sale:
                                    
Floating rate auction-rate certificates backed by Government guaranteed student loans
   $ -     $ 79,931     $ -     $ (2,115 )   $ 131,544     $ 209,360  
Floating rate corporate debt securities
     -       400,000       -       (669 )     (399,331 )     -  
Fixed rate corporate debt securities
     500,138       -       -       2,951       (503,089 )     -  
Total available-for-sale
     500,138       479,931       -       167       (770,876 )     209,360  
                                                 
Trading:
                                                
Floating rate asset-backed securities (1)
     8,179       (628 )     (137 )     -       -       7,414  
Fixed rate mortgage-backed securities (1)
     415,813       29,367       13,846       -       (459,026 )     -  
Total trading
     423,992       28,739       13,709       -       (459,026 )     7,414  
Total investment securities
     924,130       508,670       13,709       167       (1,229,902 )     216,774  
Farmer Mac Guaranteed Securities:
                                                
Available-for-sale:
                                                
Farmer Mac I
     338,958       49,226       -       3,720       -       391,904  
Rural Utilities
     -       -       -       (781 )     902,420       901,639  
Total available-for-sale
     338,958       49,226       -       2,939       902,420       1,293,543  
                                                 
Trading:
                                                
Farmer Mac II (2)
     428,670       20,497       1,395       -       -       450,562  
Rural Utilities (1)
     -       -       (17,341 )     -       459,026       441,685  
Total trading
     428,670       20,497       (15,946 )     -       459,026       892,247  
Total Farmer Mac Guaranteed Securities
     767,628       69,723       (15,946 )     2,939       1,361,446       2,185,790  
                                                 
Total Assets at fair value
   $ 1,691,758     $ 578,393     $ (2,237 )   $ 3,106     $ 131,544     $ 2,402,564  
Liabilities:
                                                
Financial Derivatives (3)
   $ (1,106 )   $ -     $ (351 )   $ -     $ -     $ (1,457 )
Total Liabilities at fair value
   $ (1,106 )   $ -     $ (351 )   $ -     $ -     $ (1,457 )
                                                 
Nonrecurring:
                                                
Loans held for sale
   $ -     $ -     $ (61 )   $ -     $ 142,756     $ 142,695  

(1)
Unrealized gains/(losses) are attributable to assets still held as of June 30, 2008 and are recorded in losses on trading assets.
(2)
Includes unrealized gains of approximately $1.8 million attributable to assets still held as of June 30, 2008 that are recorded in losses on trading assets.
(3)
Unrealized losses are attributable to liabilities still held as of June 30, 2008 and are recorded in gains/(losses) on financial derivatives.
 
 
Fair Value Option

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

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

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

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

Farmer Mac enters into financial derivative transactions principally to protect against risk from the effects of market price or interest rate movements on the value of certain assets, future cash flows or debt issuance, not for trading or speculative purposes.  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 and also to derive an overall lower effective cost of borrowing than would otherwise be available to Farmer Mac in the conventional debt market.  Farmer Mac is required also to recognize certain contracts and commitments as derivatives when the characteristics of those contracts and commitments meet the definition of a derivative as promulgated by Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended (“SFAS 133”).

 
-15-
 
 
Farmer Mac manages the interest rate risk related to loans it has committed to acquire, but has not yet purchased and permanently funded, through the use of forward sale contracts on mortgage-backed securities and the debt of other government-sponsored enterprises (“GSEs”), futures contracts involving U.S. Treasury securities and interest rate swaps.  Farmer Mac uses forward sale contracts on GSE securities to reduce its interest rate exposure to changes in both Treasury rates and spreads on Farmer Mac debt and Farmer Mac Guaranteed Securities.  The notional amounts of these contracts are determined based on a duration-matched hedge ratio between the hedged item and the hedge instrument.  Gains or losses generated by these hedge transactions should offset changes in funding costs or Farmer Mac Guaranteed Securities sale prices that occur during the hedge period.

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

The following table summarizes information related to Farmer Mac’s financial derivatives as of June 30, 2008 and December 31, 2007:
 

   
June 30, 2008
    
December 31, 2007
  
   
Notional
    
Fair
    
Notional
    
Fair
  
   
Amount
    
Value
    
Amount
    
Value
  
   
(in thousands)
  
Interest rate swaps:
                        
Pay-fixed
   $ 1,547,344     $ (48,382 )   $ 1,411,772     $ (52,941 )
Receive-fixed
     1,775,000       (3,386 )     1,098,000       1,065  
Basis
     150,172       (1,457 )     161,967       (1,106 )
Agency forwards
     1,125       (6 )     4,233       (2 )
Treasury futures
     3,000       (5 )     1,000       (1 )
                                 
Total
   $ 3,476,641     $ (53,236 )   $ 2,676,972     $ (52,985 )


As of June 30, 2008, Farmer Mac had approximately $0.3 million of net after-tax unrealized losses on financial derivatives included in accumulated other comprehensive loss related to the SFAS 133 transition adjustment.  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 the issuance of discount 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.  Over the next 12 months, Farmer Mac estimates that $0.2 million of the amount currently reported in accumulated other comprehensive loss will be reclassified into earnings.

As of June 30, 2008, Farmer Mac had outstanding basis swaps with a related party with a notional amount of $150.2 million and a fair value of $(1.5) million.  As of December 31, 2007, these swaps had an outstanding notional amount of $162.0 million and a fair value of $(1.1) million.  Under the terms of those basis swaps, which are not in designated hedge relationships, Farmer Mac pays Constant Maturity Treasury-based rates and receives London Interbank Offered Rate, or LIBOR.  Those swaps hedge most of the interest rate basis risk related to loans Farmer Mac purchases that pay a Constant Maturity Treasury-based rate and the discount notes Farmer Mac issues to fund the loan purchases.  Historically, the pricing of discount notes has correlated to LIBOR rates.  Farmer Mac recorded an unrealized gain on those basis swaps of $2.1 million during second quarter 2008 and a $0.4 million unrealized loss for the six month period ended June 30, 2008.  See Note 3 “Related Party Transactions” in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2007, as filed with the SEC on March 17, 2008, for additional information on these related party transactions.

 
-16-
 
 
 
(e)
Earnings Per Common Share

Basic earnings per common share are based on the weighted-average number of shares of common stock outstanding.  Diluted earnings per common share are based on the weighted-average number of shares of common stock outstanding adjusted to include all potentially dilutive common stock options and stock appreciation rights (“SARs”).  The following schedule reconciles basic and diluted earnings per common share (“EPS”) for the three and six months ended June 30, 2008 and 2007:
 
 
-17-
 
 
   
Three Months Ended
  
   
June 30, 2008
    
June 30, 2007
  
                                     
   
Net Income
    
Shares
    
$ per Share
    
Net Income
    
Shares
    
$ per Share
  
   
(in thousands, except per share amounts)
  
Basic EPS
                                    
                                     
Net income available to common stockholders
   $ 21,431       9,964     $ 2.15     $ 18,369       10,287     $ 1.79  
                                                 
Effect of dilutive securities:
                                                
Stock options and SARs (1)
             108                       255          
Diluted EPS
   $ 21,431       10,072     $ 2.13     $ 18,369       10,542     $ 1.74  

(1)
For the three months ended June 30, 2008 and 2007, stock options and SARs of 1,546,664 and 230,168, respectively, were outstanding but not included in the computation of diluted earnings per share of common stock because they were anti-dilutive.
 
 
   
Six Months Ended
  
   
June 30, 2008
    
June 30, 2007
  
                                     
   
Net Income
    
Shares
    
$ per Share
    
Net Income
    
Shares
    
$ per Share
  
   
(in thousands, except per share amounts)
  
Basic EPS