Lending support to rural America

Transcription

1 2012 annual report Aggeorgia Farm credit Lending support to rural America

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3 Table of Contents 3 AgGeorgia Territory Map & Branch Locations 4 Board of Directors 6 Message from the Chief Executive Officer 7 Management Team 8 Report of Management 9 Report on Internal Control Over Financial Reporting 10 Consolidated Five-Year Summary of Selected Financial Data 11 Management s Discussion & Analysis of Financial Condition & Results of Operations 21 Disclosure Required by Farm Credit Administration Regulations 26 Report of the Audit Committee 27 Report of Independent Certified Public Accountants 28 Consolidated Balance Sheets 29 Consolidated Statements of Income 30 Consolidated Statements of Comprehensive Income 31 Consolidated Statements of Changes in Members Equity 32 Consolidated Statements of Cash Flows 33 Notes to Consolidated Financial Statements 1

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5 3 AgGeorgia Territory & Branch Locations Appling Atkinson Bacon Baker Brantley Bryan Bulloch Butts Calhoun Camden Candler Carroll Charleton Chatham Chatahoochee Clay Clayton Clinch Coffee Coweta Decatur DeKalb Dougherty Douglas Early Effingham Emanuel Evans Fayette Fulton Glynn Grady Greene Gwinnett Haralson Harris Heard Henry Jasper Jeff Davis Jenkins Lamar Lee Liberty Long McIntosh Marion Meriwether Miller Mitchell Monroe Montgomery Morgan Muscogee Newton Oconee Pierce Pike Putnam Quitman Randolph Rockdale Schley Screven Seminole Spalding Stewart Sumter Talbot Tattnall Terrell Thomas Toombs Troup Upson Walton Ware Wayne Webster Wheeler Baldwin Banks Barrow Bartow Ben Hill Berrien Bibb Bleckley Brooks Burke Catoosa Chattooga Cherokee Clarke Cobb Colquitt Columbia Cook Crawford Crisp Dade Dawson Dodge Dooly Echols Elbert Fannin Floyd Forsyth Franklin Gilmer Glascock Gordon Habersham Hall Hancock Hart Houston Irwin Jackson Jefferson Johnson Jones Lanier Laurens Lincoln Lowndes Lumpkin McDuffie Macon Madison Murray Oglethorpe Paulding Peach Pickens Polk Pulaski Rabun Richmond Stephens Taliaferro Taylor Telfair Tift Towns Treutlen Turner Twiggs Union Walker Warren Washington White Whitfield Wilcox Wilkes Wilkinson Worth LaFayette Rome Cartersville Chatsworth Gainesville Clarkesville Royston Washington Waynesboro Sandersville Perry Dublin Cordele Tifton Sylvester Moultrie Quitman Nashville Ocilla Montezuma LaFayette Rome Cartersville Chatsworth Gainesville Clarkesville Royston Washington Waynesboro Sandersville Perry Dublin Cordele Tifton Sylvester Moultrie Quitman Nashville Ocilla Montezuma

6 AgGeorgia Board of Directors Chairperson Anne G. Sisk Madison County Gerald D. Andrews Washington County John W. Bagwell Jr. Floyd County Edward M. Beckham II Houston County Jack W. Bentley Jr. Wilkes County Vice Chairperson J. Dan Raines Jr. Turner County William L. Brown Macon County James B. Carlton Hart County Billy J. Clary Crisp County Dan N. Crumpton Warren County Guy A. Daughtrey Cook County J.E. Bud Jones Wilcox County Howard Lawson Brooks County Ronney S. Ledford Dooly County Joseph Marion Meeks Washington County Robert G. Bobby Miller Hall County Richard David Dave Neff Hall County George R. Reeves McDuffie County David H. Smith Bartow County J.T. Woodard Sr. Dodge County Franklin B. Wright Gilmer County 4

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8 Message From the Chief Executive Officer After several years of financial stress in this unpredictable economy, I am pleased to report that in 2012 AgGeorgia Farm Credit achieved solid financial results that effectively launched our much anticipated Jack C. Drew Jr. stabilization in operations and Chief Executive Officer set forth a firm direction for your Association. Our positive operating results for 2012 were achieved by the dedication of the AgGeorgia Board of Directors and its staff as we all put into practice the principles needed to successfully navigate in this economy. At the end of the day, we are humbled but proud to state that we have managed well against obstacles, positioned the Association for long term success and, overall, have made significant progress over While we recognize that an economic recovery will not be swift and that challenges continue to be prevalent, we are confident that the steps taken by the Board and staff have positioned AgGeorgia for a bright future. Included in our accomplishments for 2012, your Association generated final net income of $11.9 million exceeding both the 2012 budget of $9.3 million and 2011 final net income of $7.56 million. Our overall credit quality remains satisfactory with a noted improvement in the reduction of nonearning assets. The Association was fortunate to recognize an 11% decrease in nonaccrual assets and positive results in the liquidation of other property owned in a depressed real estate market. As noted at the 2012 Annual Stockholder s meetings, operating expenses have and remain under budget as the Board and staff work diligently to manage costs. Since January 2010, your Association has realized savings in operating expenses of $4.2 million against projections, and for the third consecutive year seen a reduction in actual operating expense compared to the previous 12 months. In comparing our key financial ratios from 12/31/2011 to 12/31/2012, AgGeorgia s return on assets improved from.64% to 1.11% while return on equity improved from 3.90% to 6.08%. In addition, permanent capital remains satisfactory at 18.20% which exceeds our 2012 projection of 15.51% and the actual 2011 year end permanent capital of 14.98%. Looking ahead, our goal is to continue the significant progress we have made utilizing concentrated efforts on managed quality loan growth, customer service and resolution of our remaining nonearning assets. To the benefit of all, we continue to anticipate a favorable consumer interest rate market in 2013 and, with our favorable terms and variety of loan products, look to seize new opportunities for growth despite weak borrowing demand and significant competition. As to operations, our business model offers a conservative but realistic approach to earnings, provisions for losses and chargeoffs as we continue to improve our financial performance. The principle of successful risk management complimented with targeted growth and active business development will serve as the core of our focus in As in prior years, we have been fortunate to continue payment of patronage to our stockholders. Since 1988, AgGeorgia and its predecessor Associations have returned cash each year representing patronage and/or surplus revolvement totaling $276.8 million. In an effort to preserve the financial strength of the Association during these difficult economic times, revolvement of surplus was temporarily suspended in In the interim, I am very pleased to report that we will continue the long-standing tradition of patronage payment for the 2012 fiscal year. On behalf of AgGeorgia s Board of Directors and employees, I would like to express my gratitude for your support, understanding and trust you have demonstrated in 2012 and prior years. Your Association continues to recognize and share the challenges you face as you manage your business and personal finances in these difficult times. AgGeorgia greatly appreciates the business you have conducted with us in the past and we look forward to many more years of serving as not only a dependable source of credit, but your choice of lender as well. Jack C. Drew Jr. Chief Executive Officer 6

9 AgGeorgia Management Team AgGeorgia Branch Offices Perry Corporate Office 468 Perry Parkway Perry, Georgia (478) Cartersville 1300 East Main Street Cartersville, GA (770) Gainesville 501 Broad Street Gainesville, GA (770) Stephen Connelly Director of Information Technology Timothy H. Dean Chief Appraiser Chatsworth 19 Woodlake Drive Chatsworth, GA (706) LaFayette 700 East Villanow Street LaFayette, GA (706) Clarkesville 102 Blacksnake Road Mt. Airy, GA (706) Montezuma 317 Walnut Street Montezuma, GA (478) John P. Lowry III Director of Risk Management Thomas Kight Marketing Officer Cordele 1207 South Greer Street Cordele, GA (229) Dublin 826 Bellevue Avenue Dublin, GA (478) Moultrie 22 5th Avenue, S.E. Moultrie, GA (229) Nashville 707 North Davis Street Nashville, GA (229) Ocilla 302 South Cherry Street Ocilla, GA (229) Sandersville 775 Sparta Road Sandersville, GA (478) Carrie B. McCall Chief Financial Officer Marvin J. Moore Chief Lending Officer Perry 468 Perry Parkway Perry, GA (478) Quitman 504 East Screven Street Quitman, GA (229) Sylvester 105 Dexter Wilson Boulevard Sylvester, GA (229) Tifton 1807 King Road Tifton, GA (229) Rome 701 East 2nd Avenue Rome, GA (706) Washington US 78, 311 North Bypass Washington, GA (706) T. Lacy Royal Retail Lending Manager Stephen M. Yearta Commercial Loan Manager Royston 675 Church Street Royston, GA (706) Waynesboro 176 Hwy. 80 West Waynesboro, GA (706)

10 Report of Management The accompanying Consolidated Financial Statements and related financial information appearing throughout this annual report have been prepared by management of AgGeorgia Farm Credit, ACA (Association) in accordance with generally accepted accounting principles appropriate in the circumstances. Amounts which must be based on estimates represent the best estimates and judgments of management. Management is responsible for the integrity, objectivity, consistency, and fair presentation of the consolidated financial statements and financial information contained in this report. Management maintains and depends upon an internal accounting control system designed to provide reasonable assurance that transactions are properly authorized and recorded, that the financial records are reliable as the basis for the preparation of all financial statements, and that the assets of the Association are safeguarded. The design and implementation of all systems of internal control are based on judgments required to evaluate the costs of controls in relation to the expected benefits and to determine the appropriate balance between these costs and benefits. The Association maintains an internal audit program to monitor compliance with the systems of internal accounting control. Audits of the accounting records, accounting systems and internal controls are performed and internal audit reports, including appropriate recommendations for improvement, are submitted to the Board of Directors. The Consolidated Financial Statements have been examined by independent certified public accountants, whose report appears elsewhere in this annual report. The Association is also subject to examination by the Farm Credit Administration. The consolidated financial statements, in the opinion of management, fairly present the financial condition of the Association. The undersigned certify that we have reviewed the 2012 Annual Report of AgGeorgia Farm Credit, ACA, that the report has been prepared under the oversight of the audit committee of the Board of Directors and in accordance with all applicable statutory or regulatory requirements, and that the information contained herein is true, accurate, and complete to the best of our knowledge and belief. Anne G. Sisk Chairman of the Board Jack C. Drew, Jr. Chief Executive Officer Carrie B. McCall Chief Financial Officer March 13,

11 Report on Internal Control Over Financial Reporting The Association s principal executives and principal financial officers, or persons performing similar functions, are responsible for establishing and maintaining adequate internal control over financial reporting for the Association s Consolidated Financial Statements. For purposes of this report, internal control over financial reporting is defined as a process designed by, or under the supervision of the Association s principal executives and principal financial officers, or persons performing similar functions, and effected by its Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting information and the preparation of the Consolidated Financial Statements for external purposes in accordance with accounting principles generally accepted in the United States of America and includes those policies and procedures that: (1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Association, (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial information in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures are being made only in accordance with authorizations of management and directors of the Association, and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Association s assets that could have a material effect on its Consolidated Financial Statements. The Association s management has completed an assessment of the effectiveness of internal control over financial reporting as of December 31, In making the assessment, management used the framework in Internal Control Integrated Framework, promulgated by the Committee of Sponsoring Organizations of the Treadway Commission, commonly referred to as the COSO criteria. Based on the assessment performed, the Association s management concluded that as of December 31, 2012, the internal control over financial reporting was effective based upon the COSO criteria. Additionally, based on this assessment, the Association determined that there were no material weaknesses in the internal control over financial reporting as of December 31, Jack C. Drew, Jr. Chief Executive Officer Carrie B. McCall Chief Financial Officer March 13,

12 Consolidated Five-Year Summary of Selected Financial Data December 31, (dollars in thousands) Balance Sheet Data Cash $ 1,371 $ 1,479 $ 433 $ 664 $ 5,181 Loans 924,304 1,065,755 1,111,650 1,060,819 1,000,658 Less: allowance for loan losses 10,976 13,182 11,943 8,874 7,220 Net loans 913,328 1,052,573 1,099,707 1,051, ,438 Investments in other Farm Credit institutions 16,628 21,924 22,314 22,440 23,982 Other property owned 10,672 16,865 9,757 3, Other assets 37,859 42,663 45,092 44,555 47,596 Total assets $ 979,858 $ 1,135,504 $ 1,177,303 $ 1,122,940 $ 1,070,633 Notes payable to AgFirst Farm Credit Bank* $ 759,981 $ 926,894 $ 969,723 $ 923,243 $ 870,924 Accrued interest payable and other liabilities with maturities of less than one year 18,502 17,610 20,245 22,587 27,864 Total liabilities 778, , , , ,788 Protected borrower stock Capital stock and participation certificates 3,889 4,265 4,162 3,955 3,797 Retained earnings Allocated 89,580 86,243 86,521 82,515 86,638 Unallocated 107, ,462 96,546 90,692 81,134 Accumulated other comprehensive income (loss) (106) (53) (25) (235) 7 Total members' equity 201, , , , ,845 Total liabilities and members' equity $ 979,858 $ 1,135,504 $ 1,177,303 $ 1,122,940 $ 1,070,633 Statement of Income Data Net interest income $ 34,405 $ 35,851 $ 33,572 $ 30,081 $ 30,721 Provision for (reversal of allowance for) loan losses 8,329 14,849 7,115 2,790 (56) Noninterest income (expense), net (14,156) (13,441) (6,725) (8,600) (5,403) Net income $ 11,920 $ 7,561 $ 19,732 $ 18,691 $ 25,374 Key Financial Ratios Rate of return on average: Total assets 1.11% 0.64% 1.70% 1.70% 2.42% Total members' equity 6.08% 3.90% 10.68% 10.61% 14.58% Net interest income as a percentage of average earning assets 3.38% 3.18% 3.04% 2.88% 3.13% Net (chargeoffs) recoveries to average loans (1.035)% (1.207)% (0.367)% (0.109)% (0.001)% Total members' equity to total assets 20.55% 16.82% 15.91% 15.77% 16.05% Debt to members' equity (:1) Allowance for loan losses to loans 1.19% 1.24% 1.07% 0.84% 0.72% Permanent capital ratio 18.20% 14.98% 13.84% 13.75% 14.15% Total surplus ratio 17.80% 14.61% 13.61% 13.50% 13.84% Core surplus ratio 16.48% 12.20% 11.27% 10.47% 10.71% Net Income Distribution Estimated patronage refunds: Cash $ 989 $ 807 $ 3,904 $ 3,509 $ 5,872 Qualified allocated retained earnings 3,131 2,757 9,035 7,816 12,024 Nonqualified allocated retained earnings ,678 * General financing agreement is renewable on a one-year cycle. The next renewal date is December 31,

13 Management s Discussion & Analysis of Financial Condition & Results of Operations (dollars in thousands, except as noted) GENERAL OVERVIEW The following commentary summarizes the financial condition and results of operations of AgGeorgia Farm Credit, ACA, (Association) for the year ended December 31, 2012 with comparisons to the years ended December 31, 2011 and December 31, This information should be read in conjunction with the Consolidated Financial Statements, Notes to the Consolidated Financial Statements and other sections in this Annual Report. The accompanying Consolidated Financial Statements were prepared under the oversight of the Audit Committee of the Board of Directors. For a list of the Audit Committee members, refer to the Report of the Audit Committee reflected in this Annual Report. Information in any part of this Annual Report may be incorporated by reference in answer or partial answer to any other item of the Annual Report. The Association is an institution of the Farm Credit System (System), which was created by Congress in 1916 and has served agricultural producers for over 90 years. The System s mission is to maintain and improve the income and well-being of American farmers, ranchers, and producers or harvesters of aquatic products and farm-related businesses. The System is the largest agricultural lending organization in the United States. The System is regulated by the Farm Credit Administration, (FCA), which is an independent safety and soundness regulator. The Association is a cooperative, which is owned by the members (also referred to throughout this Annual Report as stockholders or shareholders) served. The territory of the Association extends across a diverse agricultural region of Georgia. Refer to Note 1, Organization and Operations, of the Notes to the Consolidated Financial Statements for counties in the Association s territory. The Association provides credit to farmers, ranchers, rural residents, and agribusinesses. Our success begins with our extensive agricultural experience and knowledge of the market. The Association obtains funding from AgFirst Farm Credit Bank (AgFirst or Bank). The Association is materially affected and shareholder investment in the Association could be materially affected by the financial condition and results of operations of the Bank. Copies of the Bank s Annual and Quarterly Reports are on the AgFirst website, or may be obtained at no charge by calling , extension 2832, or writing Susanne Caughman, AgFirst Farm Credit Bank, P. O. Box 1499, Columbia, SC Copies of the Association s Annual and Quarterly reports are also available upon request free of charge on the Association s website, or by calling , or writing Carrie B. McCall, AgGeorgia Farm Credit, P.O. Box 1820, Perry, GA The Association prepares an electronic version of the Annual Report, which is available on the website, within 75 days after the end of the fiscal year and distributes the Annual Reports to shareholders within 90 days after the end of the fiscal year. The Association prepares an electronic version of the Quarterly report, which is available on the internet, within 40 days after the end of each fiscal quarter, except that no report needs to be prepared for the fiscal quarter that coincides with the end of the fiscal year of the Association. FORWARD LOOKING INFORMATION This annual information statement contains forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict. Words such as anticipates, believes, could, estimates, may, should, will, or other variations of these terms are intended to identify the forward-looking statements. These statements are based on assumptions and analyses made in light of experience and other historical trends, current conditions, and expected future developments. However, actual results and developments may differ materially from our expectations and predictions due to a number of risks and uncertainties, many of which are beyond our control. These risks and uncertainties include, but are not limited to: political, legal, regulatory and economic conditions and developments in the United States and abroad; economic fluctuations in the agricultural, rural utility, international, and farm-related business sectors; weather-related, disease, and other adverse climatic or biological conditions that periodically occur that impact agricultural productivity and income; changes in United States government support of the agricultural industry and the Farm Credit System, as a government-sponsored enterprise, as well as investor and rating-agency reactions to events involving other government-sponsored enterprises and other financial institutions; and actions taken by the Federal Reserve System in implementing monetary policy. AGRICULTURAL OUTLOOK The following United States Department of Agriculture (USDA) analysis provides a general understanding of the U.S. agricultural economic outlook. However, this outlook does not take into account all aspects of Association s business. References to USDA information in this section refer to the U.S. agricultural market data and are not limited to conditions in the Association. The February 2013 USDA forecast estimates 2012 farmers net cash income, which is a measure of the cash income after payment of business expenses, at $135.6 billion, up $900 million 11

14 Management s Discussion & Analysis of Financial Condition & Results of Operations continued from 2011 and up $51.8 billion from its 10-year average of $83.8 billion. The improvement in net cash income in 2012 was primarily due to increases in crop receipts of $11.3 billion, livestock receipts of $5.7 billion, and farm-related income of $5.2 billion, principally offset by a $21.7 billion increase in cash expenses. The February 2013 USDA forecast for the farm economy, as a whole, forecasts 2013 farmers net cash income to decrease to $123.5 billion, a $12.1 billion decrease from 2012, but $39.7 billion above the 10-year average. The forecasted decrease in farmers net cash income for 2013 is primarily due to an expected increase in cash expenses of $18.8 billion. For 2013, the USDA projects crop receipts will decrease, which would be the first decline since Crop yields, especially for corn, are anticipated to return to more normal levels as U.S. farmers recover from the 2012 drought. As a result, corn inventory is forecasted to grow significantly, putting downward pressure on prices. Livestock receipts are predicted to increase in 2013 primarily due to price increases. The following table sets forth the commodity prices per bushel for certain crops and by hundredweight for beef cattle from December 31, 2009 to December 31, 2012: Commodity 12/31/12 12/31/11 12/31/10 12/31/09 Corn $6.87 $5.86 $4.82 $3.60 Soybeans $14.30 $11.50 $11.60 $9.80 Wheat $8.29 $7.19 $6.45 $4.87 Beef Cattle $ $ $98.10 $78.50 crops stored, machinery/equipment, purchased inputs and financial assets are expected to rise modestly in Despite the 2011 and 2012 droughts in various parts of the U.S., farmland values are expected to continue to rise, given the continued strength of commodity prices, low interest rates, and expectations of continued favorable net returns. Farm business equity (assets minus debt) is expected to rise from $2.27 trillion in 2012 to $2.46 trillion in 2013 (an 8.4 percent increase). One measure of the financial health of the agricultural sector used by the USDA is farmers utilization of their capacity to repay debt (actual debt as a percentage of maximum debt that can be supported by farmers current income). Higher capacity utilization rates indicate tighter cash flow positions and, consequently, higher exposure to financial risk, while lower rates indicate healthier cash flow and financial positions. However, these estimates do not take into account off-farm income sources. Since 1970, debt repayment capacity utilization has ranged from a low of 37 percent in 1973 to a high of 110 percent in 1981, and has remained relatively stable since 1987, averaging about 50 percent. The forecast for 2013 predicts farmers utilization to increase to approximately 41 percent. As estimated by the USDA in February 2013, the System s market share of farm business debt (defined as debt incurred by those involved in on-farm agricultural production) grew to 42.8 percent at December 31, 2011 (the latest available data), as compared with 41.4 percent at December 31, Overall, farm sector debt is estimated to increase from $268.9 billion in 2012 to $277.4 billion in The USDA s income outlook varies depending on farm size and commodity specialties. The USDA classifies all farms into three primary categories: commercial farms, intermediate farms and rural residential farms. Commercial farms (with more than $250 thousand in gross sales) represent about 10 percent of U.S. farms by number but represent over 80 percent of total U.S. farm production. Intermediate farms (where the primary occupation is farming and gross sales are between $10 thousand and $250 thousand) represent about 30 percent of U.S. farms by number and account for 18 percent of total production. About 60 percent of U.S. farms are classified as rural residential farms where the primary occupation is not farming and the farms produce less than $10 thousand in sales and only account for 2 percent of total production. In addition to farmers net cash income, off-farm income is an important source of funds for the repayment of farm debt obligations and is less subject to cycles in agriculture, but is more subject to general U.S. economic conditions. The USDA measures farm household income, which is defined as earnings from farming activities plus off-farm income. All farm household income for operators of rural residential farms and approximately 90 percent of farm household income for intermediate farms is generated from off-farm sources. Further, USDA data suggests that approximately 24 percent of farm household income for commercial farms is generated from off-farm income. According to the USDA February 2013 forecast, the values of farm sector assets and farm debt are forecasted to rise in Farm sector assets are expected to rise from $2.54 trillion for 2012 to $2.73 trillion in 2013 (a 7.5 percent increase) primarily due to an increase in the value of farm real estate. The values of In general, agriculture has experienced a sustained period of favorable economic conditions due to stronger commodity prices, higher farm land values, and, to a lesser extent, government support programs. The Association s financial results remain favorable as a result of these agricultural economic conditions. Production agriculture; however, remains a cyclical business that is heavily influenced by commodity prices. In an environment of less favorable economic conditions in agriculture and without sufficient government support programs, the Association s financial performance and credit quality measures would likely be negatively impacted. Conditions in the general economy remain more volatile given the state of the global economy. Certain agriculture sectors, as described more fully in this Management s Discussion and Analysis, recently have experienced significant financial stress and could continue to experience financial stress in Any negative impact from these less favorable conditions should be lessened by geographic and commodity diversification and the influence of off-farm income sources supporting agricultural-related debt. However, agricultural borrowers who are more reliant on off-farm income sources may be adversely impacted by the continuing weak general economy. CRITICAL ACCOUNTING POLICIES The financial statements are reported in conformity with accounting principles generally accepted in the United States of America. Our significant accounting policies are critical to the understanding of our results of operations and financial position because some accounting policies require us to make complex or subjective judgments and estimates that may affect the value of certain assets or liabilities. We consider these policies critical because management must make judgments about matters that are 12

15 inherently uncertain. For a complete discussion of significant accounting policies, see Note 2, Summary of Significant Accounting Policies, of the Notes to the Consolidated Financial Statements. The following is a summary of certain critical policies. Allowance for loan losses The allowance for loan losses is maintained at a level considered adequate by management to provide for probable and estimable losses inherent in the loan portfolio. The allowance for loan losses is increased through provisions for loan losses and loan recoveries and is decreased through allowance reversals and loan charge-offs. The allowance for loan losses is determined based on a periodic evaluation of the loan portfolio by management in which numerous factors are considered, including economic and political conditions, loan portfolio composition, credit quality and prior loan loss experience. Significant individual loans are evaluated based on the borrower s overall financial condition, resources, and payment record, the prospects for support from any financially responsible guarantor, and, if appropriate, the estimated net realizable value of any collateral. The allowance for loan losses encompasses various judgments, evaluations and appraisals with respect to the loans and their underlying security that, by nature, contains elements of uncertainty and imprecision. Changes in the agricultural economy and their borrower repayment capacity will cause these various judgments, evaluations and appraisals to change over time. Accordingly, actual circumstances could vary from the Association s expectations and predictions of those circumstances. Management considers the following factors in determining and supporting the levels of allowance for loan losses: the concentration of lending in agriculture, combined with uncertainties in farmland values, commodity prices, exports, government assistance programs, regional economic effects and weather-related influences. Changes in the factors considered by management in the evaluation of losses in the loan portfolios could result in a change in the allowance for loan losses and could have a direct impact on the provision for loan losses and the results of operations. Valuation methodologies Management applies various valuation methodologies to assets and liabilities that often involve a significant degree of judgment, particularly when liquid markets do not exist for the particular items being valued. Quoted market prices are referred to when estimating fair values for certain assets for which an observable liquid market exists, such as most investment securities. Management utilizes significant estimates and assumptions to value items for which an observable liquid market does not exist. Examples of these items include impaired loans, other property owned, pension and other postretirement benefit obligations, and certain other financial instruments. These valuations require the use of various assumptions, including, among others, discount rates, rates of return on assets, repayment rates, cash flows, default rates, costs of servicing and liquidation values. The use of different assumptions could produce significantly different results, which could have material positive or negative effects on the Association s results of operations. Pensions The Bank and its related Associations participate in defined benefit retirement plans. These plans are noncontributory and benefits are based on salary and years of service. In addition, the Bank and its related Associations also participate in defined contribution retirement savings plans. Pension expense for all plans is recorded as part of salaries and employee benefits. Pension expense for the defined benefit retirement plans is determined by actuarial valuations based on certain assumptions, including expected long-term rate of return on plan assets and discount rate. The expected return on plan assets for the year is calculated based on the composition of assets at the beginning of the year and the expected long-term rate of return on that portfolio of assets. The discount rate is used to determine the present value of our future benefit obligations. The discount rate was selected by reference to analysis and yield curves of the plans actuary and industry norms. ECONOMIC CONDITIONS During 2012, agricultural economic conditions in the AgGeorgia territory were mixed. Despite drought conditions across much of the state, crops produced record high yields; however, drought conditions in the Midwest led to record high feed costs that resulted in stress in the poultry industry. Georgia s peanut crop yielded an average of 4,058 pounds per acre in 2012, which, at 735,000 acres planted, led to a record large peanut crop that drove prices down. Corn production yielded, for the third year in a row, record high levels at 190 bushels per acre with average prices ranging from $6.80 to $8.00 per bushel; however, nationally, corn yields suffered due to the Midwest drought. The outlook for 2013 continues to reflect high demand for corn and a tight supply, keeping prices near $6.00 per bushel. In 2012, cotton acreage was down 16 percent from 2011 at million acres. For 2013, cotton acreage is expected to be down by 20 percent as a result of weak demand, more favorable forecasts for soybeans and corn, and large existing supply. The outlook for the poultry industry, which represents approximately 40 percent of Georgia s Farm Gate Value is uncertain for 2013 as the industry struggles with production cuts, capacity reduction and high input costs. AgGeorgia territory is home to approximately 75 percent of the producers and integrators responsible for the poultry Farm Gate Value in Georgia. Due to the diminishing feed supply and the effects of the drought in the Midwest, feed ingredients and input costs of the poultry industry are projected to average around 25 percent higher. In 2013, production in all sectors of the poultry market is expected to decline, which could result in further contraction and loss of contracts for some growers. For the year December 31, 2012, the credit quality of the loan portfolio has declined slightly from The Association has tightened loan underwriting standards as a result of losses experienced in the loan portfolio. Specifically, advance rates have been lowered as a result of declining collateral values and a requirement was implemented to pursue loan guarantees on specialized facilities such as poultry houses. As a result of this tightening, the Association has had a decline in volume in 2012, and expects growth to be flat and, possibly, a continued decline in volume in The tightened underwriting standards and decline in growth should result in building capital reserves and positioning the Association well for an eventual rebound in the economy. 13

16 Management s Discussion & Analysis of Financial Condition & Results of Operations continued LOAN PORTFOLIO The Association provides funds to farmers, rural homeowners, and farm-related businesses for financing of short and intermediate-term loans and long-term real estate mortgage loans through numerous product types. The diversification of the Association loan volume by type for each of the past three years is shown below. December 31, Loan Type (dollars in thousands) Real estate mortgage $ 448, % $ 522, % $ 519, % Production and intermediate-term 444, , , Loans to Cooperatives 1, , , Processing and marketing 11, , , Farm-related business 9, , , Rural residential real estate 9, , , Total $ 924, % $ 1,065, % $ 1,111, % While we make loans and provide financially related services to qualified borrowers in the agricultural and rural sectors and to certain related entities, our loan portfolio is diversified. The geographic distribution of the loan volume by branch/city for the past three years is as follows: December 31, Branch Cartersville 6.31 % 6.16 % 5.62 % Chatsworth Clarkesville Cordele Dublin Gainesville Moultrie Nashville Ocilla Perry Quitman Royston Sandersville Sylvester Tifton Washington Waynesboro Participations Purchased Special Assets % % % Commodity and industry categories are based upon the Standard Industrial Classification (SIC) system published by the federal government. The system is used to assign commodity or industry categories based upon the largest agricultural commodity of the customer. The major commodities in the Association loan portfolio are shown below. The predominant commodities are Poultry, Forestry, Cotton, and Row Crops, which constitute approximately 75 percent of the entire portfolio. December 31, Commodity Group (dollars in thousands) Poultry $ 363,573 39% $ 411,376 39% $ 420,074 38% Forestry 136, , , Cotton 123, , , Row Crops 80, , ,975 8 Livestock 76, , ,779 8 Horticulture 32, , ,864 7 Landlords 33, , ,064 3 Dairy 22, , ,319 2 Peanuts 23, , ,234 2 Rural Home 9, , ,628 1 Other 23, , ,550 2 Total $ 924, % $ 1,065, % $ 1,111, % Repayment ability is closely related to the commodities produced by our borrowers, and increasingly, the income of borrowers that is not associated with farming. The Association s loan portfolio contains a concentration of poultry producers. Although a large percentage of the loan portfolio is concentrated in these enterprises, many of these operations have diversified income sources that reduce overall risk exposure. Demand for poultry products, prices of feed, energy, and other inputs, as well as international trade are some of the factors affecting the income producing capacity in the poultry industry. Even though the concentration of large loans has increased over the past several years, the agricultural enterprise mix of these loans is diversified and similar to that of the overall portfolio. The risk in the portfolio associated with commodity concentration and large loans is reduced by the range of diversity of enterprises in the Association s territory. Commodity concentration risk is also mitigated by the use of loan guarantees. The decrease in gross loan volume for the twelve months ended December 31, 2012, is primarily attributed to a decline in demand caused by the slow economy and a tightening of loan underwriting standards during

17 For the past few years, the Association has experienced a fairly balanced portfolio of long-term and short-term loan assets. The short-term portfolio, which is heavily influenced by operatingtype loans, normally reaches a peak balance in August and rapidly declines in the fall months as commodities are marketed and proceeds are applied to repay operating type loans. During 2012, the Association maintained activity in the buying and selling of loan participations within and outside of the System. This provides a means for the Association to spread credit concentration risk and realize non-patronage sourced interest and fee income, which may strengthen capital position. December 31, Loan Participations: (dollars in thousands) Participations Purchased FCS Institutions $ 22,915 $ 33,592 $ 55,255 Participations Purchased Non-FCS Institutions 35,010 44,663 38,473 Participations Sold (78,616) (135,206) (141,912) Total $ (20,691) $ (56,951) $ (48,184) The Association did not have any loans sold with recourse, retained subordinated participation interests in loans sold, or interests in pools of subordinated participation interests for the period ended December 31, CREDIT RISK MANAGEMENT Credit risk arises from the potential inability of an obligor to meet its repayment obligation. As part of the process to evaluate the success of a loan, the Association continues to review the credit quality of the loan portfolio on an ongoing basis. With the approval of the Association Board of Directors, the Association establishes underwriting standards and lending policies that provide direction to loan officers. Underwriting standards include, among other things, an evaluation of: Character borrower integrity and credit history Capacity repayment capacity of the borrower based on cash flows from operations or other sources of income Collateral protection for the lender in the event of default and a potential secondary source of repayment Capital ability of the operation to survive unanticipated risks Conditions intended use of the loan funds The credit risk management process begins with an analysis of the borrower s credit history, repayment capacity, and financial position. Repayment capacity focuses on the borrower s ability to repay the loan based upon cash flows from operations or other sources of income, including non-farm income. Real estate loans must be collateralized by first liens on the real estate (collateral). As required by FCA regulations, each institution that makes loans on a collateralized basis must have collateral evaluation policies and procedures. Regulatory limits allow for real estate mortgage loans in amounts up to 85 percent of the original appraised value of the property taken as collateral or up to 97 percent of the appraised value if guaranteed by a state, federal, or other governmental agency; however, the Association limits real estate mortgage loans to 75 percent of the original appraised value of collateral or 97 percent of the appraised value if guaranteed. Appraisals are required for loans of more than $250,000. In addition, each loan is assigned a credit risk rating based upon the underwriting standards. This credit risk rating process incorporates objective and subjective criteria to identify inherent strengths, weaknesses, and risks in a particular relationship. We review the credit quality of the loan portfolio on an ongoing basis as part of our risk management practices. Each loan is classified according to the Uniform Classification System, which is used by all Farm Credit System institutions. Below are the classification definitions. Acceptable Assets are expected to be fully collectible and represent the highest quality. Other Assets Especially Mentioned (OAEM) Assets are currently collectible but exhibit some potential weakness. Substandard Assets exhibit some serious weakness in repayment capacity, equity, and/or collateral pledged on the loan. Doubtful Assets exhibit similar weaknesses to substandard assets. However, doubtful assets have additional weaknesses in existing facts, conditions and values that make collection in full highly questionable. Loss Assets are considered uncollectible. The following table presents selected statistics related to the credit quality of loans including accrued interest at December 31. Credit Quality Acceptable & OAEM 90.45% 92.56% 92.00% Substandard 9.55% 7.44% 7.99% Doubtful % % 0.01% Loss % % % Total % % % Nonperforming Assets The Association s loan portfolio is divided into performing and high-risk categories. A Special Assets Management Department is responsible for servicing loans classified as high-risk. The high-risk assets, including accrued interest, are detailed below: December 31, High-risk Assets (dollars in thousands) Nonaccrual loans $ 52,681 $ 59,243 $ 57,439 Restructured loans 14,019 6, Accruing loans 90 days past due Total high-risk loans 66,700 65,890 57,956 Other property owned 10,672 16,865 9,757 Total high-risk assets $ 77,372 $ 82,755 $ 67,713 Ratios Nonaccrual loans to total loans 5.70% 5.56% 5.17% High-risk assets to total assets 8.28% 7.29% 5.75% Nonaccrual loans represent all loans where there is a reasonable doubt as to the collection of principal and/or future interest accruals, under the contractual terms of the loan. In substance, nonaccrual loans reflect loans where the accrual of interest has been suspended. Nonaccrual loans decreased $6,562 or percent in This decrease resulted from aggressive management of nonearning assets. Of the $52,681 in nonaccrual 15

18 Management s Discussion & Analysis of Financial Condition & Results of Operations continued volume at December 31, 2012, $19,868 or 38 percent, compared to 30 percent and 21 percent at December 31, 2011 and 2010, respectively, was current as to scheduled principal and interest payments, but did not meet all regulatory requirements to be transferred into accrual status. Other property owned decreased in 2012 from $16,865 to $10,672. This is related to sales of several large properties in inventory in The Association currently owns 12 properties foreclosed upon in 2012, 6 foreclosed upon in 2011, and 1 foreclosed upon in The allowance for loan losses by loan type for the most recent three years is as follows: Allowance for Loan December 31, Losses by Type (dollars in thousands) Real estate mortgage $ 4,589 $ 4,629 $ 5,370 Production and intermediate-term 5,996 8,208 5,927 Agribusiness Rural residential real estate Total $ 10,976 $ 13,182 $ 11,943 Loan restructuring is available to financially distressed borrowers. Restructuring of loans occurs when the Association grants a concession to a borrower based on either a court order or good faith in a borrower s ability to return to financial viability. The concessions can be in the form of a modification of terms or rates, a compromise of amounts owed, or deed in lieu of foreclosure. Other receipts of assets and/or equity to pay the loan in full or in part are also considered restructured loans. The type of alternative financing structure chosen is based on minimizing the loss incurred by both the Association and the borrower. Allowance for Loan Losses The allowance for loan losses at each period end was considered by Association management to be adequate to absorb probable losses existing in and inherent to its loan portfolio. The following table presents the activity in the allowance for loan losses for the most recent three years: Year Ended December 31, Allowance for Loan Losses Activity: (dollars in thousands) Balance at beginning of year $ 13,182 $ 11,943 $ 8,874 Charge-offs: Real estate mortgage (5,627) (7,887) (1,256) Production and intermediate-term (4,511) (5,529) (3,092) Agribusiness (715) (492) Rural residential real estate (5) Total charge-offs (10,853) (13,913) (4,348) Recoveries: Real estate mortgage Production and intermediate-term Agribusiness 1 Other 5 Total recoveries Net (charge-offs) recoveries (10,535) (13,610) (4,046) Provision for (reversal of allowance for) loan losses 8,329 14,849 7,115 Balance at end of year $ 10,976 $ 13,182 $ 11,943 Ratio of net (charge-offs) recoveries during the period to average loans outstanding during the period (1.035)% (1.207)% (0.367)% The allowance for loan losses as a percentage of loans outstanding and as a percentage of certain other credit quality indicators is shown below: Allowance for Loan Losses December 31, as a Percentage of: Total loans 1.19% 1.24% 1.07% Nonperforming loans 16.46% 20.01% 20.61% Nonaccrual loans 20.83% 22.25% 20.79% Please refer to Note 3, Loans and Allowance for Loan Losses, of the Notes to the Consolidated Financial Statements, for further information concerning the allowance for loan losses. RESULTS OF OPERATIONS Net Interest Income Net interest income was $34 million, $36 million and $34 million in 2012, 2011 and 2010, respectively. Net interest income is the difference between interest income and interest expense. Net interest income is the principal source of earnings for the Association and is impacted by volume, yields on assets and cost of debt. The effects of changes in average volume and interest rates on net interest income over the past three years are presented in the following table: Change in Net Interest Income: Volume* Rate Nonaccrual Income Total (dollars in thousands) 12/31/12-12/31/11 Interest income $ (6.257) $ (819) $ 178 $ (6,898) Interest expense 3,282 2,171 5,453 Change in net interest income $ (2,975) $ 1,352 $ 178 $ (1,445) 12/31/11-12/31/10 Interest income $ 352 $ (809) $ (445) $ (902) Interest expense (507) 3,707 3,200 Change in net interest income $ (155) $ 2,898 $ (445) $ 2,298 * Volume variances can be the result of increased/decreased loan volume or from changes in the percentage composition of assets and liabilities between periods. The net loan charge-offs were primarily associated with real estate and production and intermediate term loans and were primarily the result of declines in real estate value of the underlying collateral. 16