AGM-9.30.2012-10Q
Table of Contents

As filed with the Securities and Exchange Commission on November 8, 2012
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q

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

For the quarterly period ended September 30, 2012
Commission File Number 001-14951 
 ____________________________________________________________
FEDERAL AGRICULTURAL MORTGAGE CORPORATION
(Exact name of registrant as specified in its charter)
Federally chartered instrumentality
of the United States
52-1578738
(State or other jurisdiction of
incorporation or organization)
(I.R.S. employer identification number)
 
 
1999 K Street, N.W., 4th Floor,
Washington, D.C.
20006
(Address of principal executive offices)
(Zip code)
(202) 872-7700
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes        x                               No           o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes        x                                No          o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. 
Large accelerated filer
o
Accelerated filer
x
Non-accelerated filer
o
Smaller reporting company
o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes        o                                No           x
As of November 1, 2012, the registrant had outstanding 1,030,780 shares of Class A voting common stock, 500,301 shares of Class B voting common stock and 8,977,818 shares of Class C non-voting common stock.

Table of Contents

Table of Contents

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2
Table of Contents

PART I - FINANCIAL INFORMATION

Item 1.
Consolidated Financial Statements

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

 
$
817,046

Investment securities:
 

 
 

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

 
2,182,694

Trading, at fair value
1,344

 
1,796

Total investment securities
2,636,328

 
2,184,490

Farmer Mac Guaranteed Securities:
 

 
 

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

 
4,289,272

USDA Guaranteed Securities:
 

 
 

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

 
1,279,546

Trading, at fair value
122,587

 
212,359

Total USDA Guaranteed Securities
1,590,628

 
1,491,905

Loans:
 

 
 

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

 
541,447

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

 
1,241,311

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

 
1,121,559

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

 
2,894,156

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

 
3,136

Financial derivatives, at fair value
36,190

 
40,250

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

 
110,339

Guarantee and commitment fees receivable
37,740

 
31,384

Prepaid expenses and other assets
59,932

 
21,530

Total Assets
$
12,502,481

 
$
11,883,508


 
 
 
Liabilities and Equity:
 

 
 

Liabilities:
 

 
 

Notes payable:
 

 
 

Due within one year
$
6,775,226

 
$
6,087,879

Due after one year
4,700,680

 
4,104,882

Total notes payable
11,475,906

 
10,192,761

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

 
701,583

Financial derivatives, at fair value
164,949

 
160,024

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

 
60,854

Guarantee and commitment obligation
34,393

 
27,440

Accounts payable and accrued expenses
12,915

 
178,708

Deferred tax liability, net
5,873

 
250

Reserve for losses
8,736

 
7,355

Total Liabilities
11,902,168

 
11,328,975

Commitments and Contingencies (Note 6)


 


Equity:
 

 
 

Preferred stock:
 

 
 

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

 
57,578

Common stock:
 

 
 

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

 
1,031

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

 
500

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

 
8,826

Additional paid-in capital
104,869

 
102,821

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

 
79,370

Retained earnings
93,712

 
62,554

Total Stockholders' Equity
358,460

 
312,680

Non-controlling interest - preferred stock
241,853

 
241,853

Total Equity
600,313

 
554,533

Total Liabilities and Equity
$
12,502,481

 
$
11,883,508

See accompanying notes to consolidated financial statements.

3
Table of Contents

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

 
$
6,880

 
$
18,693

 
$
21,100

Farmer Mac Guaranteed Securities and USDA Guaranteed Securities
33,261

 
34,398

 
108,530

 
91,531

Loans
24,112

 
29,843

 
81,296

 
89,414

Total interest income
63,810

 
71,121

 
208,519

 
202,045

Total interest expense
33,448

 
39,412

 
109,332

 
114,105

Net interest income
30,362

 
31,709

 
99,187

 
87,940

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

 
663

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

 
32,058

 
99,850

 
86,848

Non-interest income/(loss):
 

 
 

 
 

 
 

Guarantee and commitment fees
6,401

 
6,148

 
18,395

 
18,855

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

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


74

 
28

 
269

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

 
720

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

 
9,851

 
—

 
8,887

Other income
959

 
726

 
2,451

 
5,748

Non-interest income/(loss)
8,464

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

 
 

 
 

 
 

Compensation and employee benefits
4,375

 
4,805

 
13,434

 
13,968

General and administrative
2,788

 
2,505

 
8,210

 
7,417

Regulatory fees
562

 
550

 
1,687

 
1,714

Real estate owned operating costs, net
66

 
142

 
87

 
741

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

 
(3,321
)
Other expense
—

 
—

 
—

 
900

Non-interest expense
7,748

 
7,550

 
24,799

 
21,419

Income/(loss) before income taxes
30,941

 
(30,897
)
 
70,412

 
17,186

Income tax expense/(benefit)
8,294

 
(14,131
)
 
17,319

 
(2,075
)
Net income/(loss)
22,647

 
(16,766
)
 
53,093

 
19,261

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

 
(22,313
)
 
36,452

 
2,620

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

 
$
(23,032
)
 
$
34,293

 
$
461

 
 
 
 
 
 
 
 
Earnings/(loss) per common share and dividends:
 

 
 

 
 

 
 

Basic earnings/(loss) per common share
$
1.56

 
$
(2.22
)
 
$
3.28

 
$
0.04

Diluted earnings/(loss) per common share
$
1.49

 
$
(2.22
)
 
$
3.12

 
$
0.04

Common stock dividends per common share
$
0.10

 
$
0.05

 
$
0.30

 
$
0.15

See accompanying notes to consolidated financial statements.

4
Table of Contents

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

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

 
$
(16,766
)
 
$
53,093

 
$
19,261

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

 
49,661

 
16,370

 
70,573

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

 
49,278

 
12,435

 
67,440

Comprehensive income
24,739

 
32,512

 
65,528

 
86,701

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

 
$
26,965

 
$
48,887

 
$
70,060


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

See accompanying notes to consolidated financial statements.

5
Table of Contents

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

 
$
57,578

 
58

 
$
57,578

Issuance of Series C preferred stock
—

 
—

 
—

 
—

Balance, end of period
58

 
$
57,578

 
58

 
$
57,578

Common stock:
 

 
 

 
 

 
 

Balance, beginning of period
10,357

 
$
10,357

 
10,284

 
$
10,284

Issuance of Class C common stock
43

 
43

 
59

 
59

Exercise of stock options and SARs
96

 
96

 
14

 
14

Balance, end of period
10,496

 
$
10,496

 
10,357

 
$
10,357

Additional paid-in capital:
 

 
 

 
 

 
 

Balance, beginning of period
 

 
$
102,821

 
 

 
$
100,050

Stock-based compensation expense
 

 
2,721

 
 

 
2,254

Issuance of Class C common stock
 

 
11

 
 

 
19

Tax effect of stock-based awards
 

 
(684
)
 
 

 
(514
)
Balance, end of period
  

 
$
104,869

 
  

 
$
101,809

Retained earnings:
 

 
 

 
 

 
 

Balance, beginning of period
 

 
$
62,554

 
 

 
$
50,837

Net income attributable to Farmer Mac
 

 
36,452

 
 

 
2,620

Cash dividends:
 

 
 

 
 

 
 

Preferred stock, Series C ($37.50 per share)
 

 
(2,159
)
 
 

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

 
(3,135
)
 
 

 
(1,549
)
Balance, end of period
 

 
$
93,712

 
 

 
$
49,749

Accumulated other comprehensive income:
 

 
 

 
 

 
 

Balance, beginning of period
 

 
$
79,370

 
 

 
$
18,275

Other comprehensive income, net of tax
 

 
12,435

 
 

 
67,440

Balance, end of period
 

 
$
91,805

 
 

 
$
85,715

Total Stockholders' Equity
 

 
$
358,460

 
 

 
$
305,208

Non-controlling interest - preferred stock:
 

 
 

 
 

 
 

Balance, beginning of period
 

 
$
241,853

 
 

 
$
241,853

Issuance of Preferred stock - Farmer Mac II LLC
 

 
—

 
 

 
—

Balance, end of period
 

 
$
241,853

 
 

 
$
241,853

Total Equity
 
 
$
600,313

 
 

 
$
547,061

See accompanying notes to consolidated financial statements.



6
Table of Contents

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

 
$
19,261

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

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

 
9,707

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

 
8,822

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

 
48,538

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

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

 
2,254

Proceeds from repayment and sale of trading investment securities
663

 
686

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

 
83,361

Net change in:
 
 
 

Interest receivable
40,603

 
10,778

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

Other assets
(37,388
)
 
2,269

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

 
2,838

Net cash provided by operating activities
83,791

 
8,817

Cash flows from investing activities:
 

 
 

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

 
675,566

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

 
699,263

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

 
251,471

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


447,864

Proceeds from sale of Farmer Mac Guaranteed Securities
29,334

 
13,869

Proceeds from sale of real estate owned
1,062

 
1,361

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

 
 

Proceeds from issuance of discount notes
51,844,862

 
52,174,214

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

 
1,981,109

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

 
243

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

 
20

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

 
1,797,803

Net increase in cash and cash equivalents
52,994

 
95,094

Cash and cash equivalents at beginning of period
817,046

 
729,920

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

 
$
825,014

 See accompanying notes to consolidated financial statements.

7
Table of Contents

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

1.
ACCOUNTING POLICIES

The interim unaudited consolidated financial statements of the Federal Agricultural Mortgage Corporation ("Farmer Mac" or the "Corporation") and subsidiaries have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the "SEC"). These interim unaudited consolidated financial statements reflect all normal and recurring adjustments that are, in the opinion of management, necessary to present a fair statement of the financial position and the results of operations and cash flows of Farmer Mac and subsidiaries for the interim periods presented. Certain information and footnote disclosures normally included in the annual consolidated financial statements have been omitted as permitted by SEC rules and regulations. The December 31, 2011 consolidated balance sheet presented in this report has been derived from the Corporation's audited 2011 consolidated financial statements. Management believes that the disclosures are adequate to present fairly the consolidated financial statements as of the dates and for the periods presented. These interim unaudited consolidated financial statements should be read in conjunction with the 2011 consolidated financial statements of Farmer Mac and subsidiaries included in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2011 filed with the SEC on March 15, 2012. Results for interim periods are not necessarily indicative of those that may be expected for the fiscal year. Below is a summary of Farmer Mac's significant accounting policies.

Principles of Consolidation

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

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


8
Table of Contents

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

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

The following table sets forth information regarding certain cash and non-cash transactions for the nine months ended September 30, 2012 and 2011:

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

 
$
78,598

Income taxes
16,500

 
20,568

Non-cash activity:
 

 
 

Real estate owned acquired through loan liquidation
1,130

 
2,723

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

 
10,656

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

 
10,656

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

 
—

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

 
878,798


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

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


9
Table of Contents

(b)
Allowance for Losses

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

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

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

General Allowance for Losses

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

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

Management believes that its use of this methodology produces a reasonable estimate of probable losses, as of the balance sheet date, for all loans held in the Farmer Mac I portfolio and loans underlying Farmer Mac I Guaranteed Securities and LTSPCs. There were no purchases or sales during the first nine

10
Table of Contents

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

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

Farmer Mac II

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

Rural Utilities

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

Specific Allowance for Impaired Loans

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

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

11
Table of Contents

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

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

(c)
Financial Derivatives

Farmer Mac enters into financial derivative transactions principally to protect against risk from the effects of market price or interest rate movements on the value of certain assets, future cash flows or debt
issuance, not for trading or speculative purposes. Farmer Mac enters into interest rate swap contracts
principally to adjust the characteristics of its short-term debt to match more closely the cash flow and
duration characteristics of its longer-term loans and other assets, and also to adjust the characteristics of its
long-term debt to match more closely the cash flow and duration characteristics of its short-term assets,
thereby reducing interest rate risk and often times deriving an overall lower effective cost of borrowing
than would otherwise be available to Farmer Mac in the conventional debt market. Farmer Mac is
required to recognize certain contracts and commitments as derivatives when the characteristics of those
contracts and commitments meet the definition of a derivative.

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

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

12
Table of Contents

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

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

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


13
Table of Contents

(d)
Earnings/Loss Per Common Share

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

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

 
10,492

 
$
1.56

 
$
(23,032
)
 
10,354

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

 
 

 
 

 
 

 
 

 
 

Stock options, SARs and restricted stock
 
 
504

 
(0.07
)
 
 
 
—

 
—

Diluted EPS
$
16,381

 
10,996

 
$
1.49

 
$
(23,032
)
 
10,354

 
$
(2.22
)

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

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

 
10,442

 
$
3.28

 
$
461

 
10,328

 
$
0.04

Effect of dilutive securities(1):
 

 
 

 
 

 
 

 
 

 
 

Stock options, SARs and restricted stock
 
 
532

 
(0.16
)
 


 
387

 
—

Diluted EPS
$
34,293

 
10,974

 
$
3.12

 
$
461

 
10,715

 
$
0.04


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


14
Table of Contents

(e)
Fair Value Measurement

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

Farmer Mac's assessment of the significance of the input to the fair value measurement requires judgment and considers factors specific to the financial instrument.  Both observable and unobservable inputs may be used to determine the fair value of financial instruments that Farmer Mac has classified within the level 3 category.  As a result, the unrealized gains and losses for assets and liabilities within the level 3 category may include changes in fair value that were attributable to both observable (e.g., changes in market interest rates) and unobservable (e.g., changes in projected prepayment rates) inputs. See Note 8 for more information regarding fair value measurement.

(f)
Consolidation of Variable Interest Entities

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

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

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


15
Table of Contents

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

(g)
New Accounting Standards

Offsetting Assets and Liabilities

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

(h)
Reclassifications

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


16
Table of Contents

2.
INVESTMENT SECURITIES

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

 
$
—

 
$
(14,066
)
 
$
60,034

Floating rate asset-backed securities
166,483

 
596

 
(34
)
 
167,045

Fixed rate asset-backed securities
9,735

 
—

 
—

 
9,735

Floating rate corporate debt securities
78,308

 
511

 
—

 
78,819

Fixed rate corporate debt securities
52,462

 
219

 
—

 
52,681

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

 
9,168

 
(130
)
 
743,444

Fixed rate GSE guaranteed mortgage-backed securities
2,331

 
206

 
—

 
2,537

Floating rate GSE subordinated debt
70,000

 
—

 
(12,830
)
 
57,170

Fixed rate commercial paper
19,995

 
2

 
—

 
19,997

Fixed rate GSE preferred stock
79,382

 
6,477

 
—

 
85,859

Floating rate senior agency debt
49,992

 
64

 
—

 
50,056

Fixed rate senior agency debt
127,572

 
143

 
—

 
127,715

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

 
139

 
(1
)
 
1,179,892

Total available-for-sale
2,644,520

 
17,525

 
(27,061
)
 
2,634,984

Trading:
 

 
 

 
 

 
 

Floating rate asset-backed securities
4,474

 
—

 
(3,130
)
 
1,344

Total investment securities
$
2,648,994

 
$
17,525

 
$
(30,191
)
 
$
2,636,328


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

 
$
—

 
$
(13,887
)
 
$
60,213

Floating rate asset-backed securities
178,443

 
219

 
(102
)
 
178,560

Floating rate corporate debt securities
74,152

 
69

 
(388
)
 
73,833

Fixed rate corporate debt securities
38,678

 
27

 
(6
)
 
38,699

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

 
4,852

 
(381
)
 
764,038

Fixed rate GSE guaranteed mortgage-backed securities
3,106

 
254

 
—

 
3,360

Floating rate GSE subordinated debt
70,000

 
—

 
(17,438
)
 
52,562

Fixed rate commercial paper
9,999

 
1

 
—

 
10,000

Fixed rate GSE preferred stock
79,662

 
5,216

 
—

 
84,878

Floating rate senior agency debt
38,000

 
32

 
—

 
38,032

Fixed rate senior agency debt
79,255

 
19

 
(21
)
 
79,253

Fixed rate U.S. Treasuries
798,966

 
304

 
(4
)
 
799,266

Total available-for-sale
2,203,928

 
10,993

 
(32,227
)
 
2,182,694

Trading:
 

 
 

 
 

 
 

Floating rate asset-backed securities
5,138

 
—

 
(3,342
)
 
1,796

Total investment securities
$
2,209,066

 
$
10,993

 
$
(35,569
)
 
$
2,184,490


17
Table of Contents

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

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

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

 
$
—

 
$
60,034

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

 
(34
)
 
—

 
—

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

 
(126
)
 
840

 
(4
)
Floating rate GSE subordinated debt
—

 
—

 
57,170

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

 
(1
)
 
—

 
—

Total
$
144,313

 
$
(161
)
 
$
118,044

 
$
(26,900
)

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

 
$
—

 
$
60,213

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

 
(102
)
 
—

 
—

Floating rate corporate debt securities
41,061

 
(388
)
 
—

 
—

Fixed rate corporate debt securities
18,189

 
(6
)
 
—

 
—

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

 
(359
)
 
17,409

 
(22
)
Floating rate GSE subordinated debt
—

 
—

 
52,562

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

 
(21
)
 
—

 
—

Fixed rate U.S. Treasuries
50,160

 
(4
)
 
—

 
—

Total
$
453,336

 
$
(880
)
 
$
130,184

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

18
Table of Contents

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

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

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

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

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

 
$
1,370,517

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

 
169,159

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

 
425,640

 
1.13%
Due after ten years
670,328

 
669,668

 
2.54%
Total
$
2,644,520

 
$
2,634,984

 
1.21%


19
Table of Contents

3.
FARMER MAC GUARANTEED SECURITIES AND USDA GUARANTEED SECURITIES

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

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

 
$
98,532

 
$
(6,312
)
 
$
3,431,588

Farmer Mac II
28,342

 
1,639

 
(6
)
 
29,975

Rural Utilities
1,165,100

 
21,844

 
—

 
1,186,944

USDA Guaranteed Securities
1,429,196

 
38,989

 
(144
)
 
1,468,041

Total available-for-sale
5,962,006

 
161,004

 
(6,462
)
 
6,116,548

Trading:
 

 
 

 
 

 
 

USDA Guaranteed Securities
125,998

 
830

 
(4,241
)
 
122,587

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

 
$
161,834

 
$
(10,703
)
 
$
6,239,135


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

 
$
67,895

 
$
(1,460
)
 
$
2,807,627

Farmer Mac II
34,692

 
924

 
(17
)
 
35,599

Rural Utilities
1,410,800

 
35,246

 
—

 
1,446,046

USDA Guaranteed Securities
1,244,519

 
35,149

 
(122
)
 
1,279,546

Total available-for-sale
5,431,203

 
139,214

 
(1,599
)
 
5,568,818

Trading:
 

 
 

 
 

 
 

USDA Guaranteed Securities
213,130

 
1,804

 
(2,575
)
 
212,359

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

 
$
141,018

 
$
(4,174
)
 
$
5,781,177


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

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


20
Table of Contents

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

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

 
$
539,070

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

 
3,510,665

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

 
784,685

 
2.61
%
Due after ten years
1,246,823

 
1,282,128

 
3.53
%
Total
$
5,962,006

 
$
6,116,548

 
2.61
%

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

4.
FINANCIAL DERIVATIVES

Farmer Mac enters into financial derivative transactions principally to protect against risk from the effects of market price or interest rate movements on the value of certain assets, future cash flows or debt issuance, not for trading or speculative purposes.  Farmer Mac enters into interest rate swap contracts to adjust the characteristics of its short-term debt to match more closely the cash flow and duration characteristics of its longer-term loans and other assets, and also to adjust the characteristics of its long-term debt to match more closely the cash flow and duration characteristics of its short-term assets, thereby reducing interest rate risk and often times deriving an overall lower effective cost of borrowing than would otherwise be available to Farmer Mac in the conventional debt market.  Certain financial derivatives are designated as fair value hedges of fixed rate assets classified as available-for-sale to protect against fair value changes in the assets related to a benchmark interest rate (i.e., LIBOR).

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

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

21
Table of Contents

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

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

  
September 30, 2012
  

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

 
$
—

 
$
(63,496
)
 
2.20%
 
0.44%
 
 
 
4.33

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

 
47

 
(100,814
)
 
4.85%
 
0.41%
 
 
 
4.31

Receive fixed non-callable
3,668,717

 
35,632

 
—

 
0.36%
 
0.95%
 
 
 
0.77

Receive fixed callable
90,000

 
7

 
(21
)
 
0.17%
 
0.60%
 
 
 
3.99

Basis swaps
564,262

 
508

 
(945
)
 
0.53%
 
0.38%
 
 
 
1.19

Agency forwards
20,048

 
—

 
(58
)
 
 
 
 
 
101.17

 
 
Treasury futures
6,400

 
—

 
(3
)
 
 
 
 
 
133.44

 
 
Credit valuation adjustment
 
 
(4
)
 
388

 
 
 
 
 
 
 
 

Total financial derivatives
$
6,107,033

 
$
36,190

 
$
(164,949
)
 
  
 
  
 
 
 
  


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

 
$
—

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

 
41,006

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

 
—

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

 
17

 
—

 
1.00
%
 
—

 
0.72
Credit valuation adjustment
 
 
(773
)
 
935

 
 

 
 

 
 
Total financial derivatives
$
6,586,530

 
$
40,250

 
$
(160,024
)
 
  

 
  

 
  



22
Table of Contents

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

 
$
(5,142
)
 
$
—

Hedged items
8,378

 
—

 
8,378

 
—

Gains on hedging activities (1)
3,236

 
—

 
3,236

 
—

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

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

 
(93
)
 
80

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

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

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

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


23
Table of Contents

5.
ALLOWANCE FOR LOSSES AND CONCENTRATIONS OF CREDIT RISK

Allowance for Losses

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

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

 
$
8,779

 
$
18,140

 
$
11,053

 
$
7,443

 
$
18,496

Provision for/(release of) losses
137

 
(43
)
 
94

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

 
(448
)
 
(5
)
 
—

 
(5
)
Ending Balance
$
9,050

 
$
8,736

 
$
17,786

 
$
10,699

 
$
6,991

 
$
17,690

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

 
$
7,355

 
$
17,516

 
$
9,803

 
$
10,312

 
$
20,115

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

 
718

 
1,092

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

 
(448
)
 
(196
)
 
—

 
(196
)
Ending Balance
$
9,050

 
$
8,736

 
$
17,786

 
$
10,699

 
$
6,991

 
$
17,690

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


24
Table of Contents

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