R E C L A I M I N G T H E R A N C H

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1 R E C L A I M I N G T H E R A N C H F I R S T Q U A R T E R R E P O R T M A R C H 3 1, T E N T H F A R M C R E D I T D I S T R I C T

2 FIRST QUARTER 2005 Table of Contents Management s Discussion and Analysis of Financial Condition and Results of Operations... 1 Combined Financial Statements: Combined Balance Sheets... 4 Combined Statements of Income... 5 Combined Statements of Changes in Members Equity... 6 Combined Statements of Cash Flows... 7 Notes to Combined Financial Statements... 8 May 4, 2005

3 Management s Discussion and Analysis of Combined Financial Condition and Results of Operations (dollars in thousands, except as noted) The following discussion reviews the combined financial condition and results of operations of the Farm Credit Bank of Texas (bank), the Federal Land Credit Associations (FLCAs) and the Agricultural Credit Associations (ACAs) of the Tenth Farm Credit District (district) for the three months ended March 31, FLCAs and ACAs are collectively referred to as associations. These comments should be read in conjunction with the accompanying combined financial statements and footnotes, along with the 2004 Annual Report to stockholders. RESULTS OF OPERATIONS Net Interest Income Net interest income for the three months ended March 31, 2005, was $81,300, an increase of $9,380, or 13.0 percent, from the three months ended March 31, The increase is primarily the result of an increase in the district s loan portfolio, partially offset by increases in the cost of debt, which outpaced the increases in the rate of return on assets. Provision for Loan Losses The district s negative provision for loan losses for the quarter ended March 31, 2005, was $449, representing a decrease of $808 compared to the $359 provision for loan losses reported for the first quarter of This decrease reflects the effects of refinement in the allowance for loan loss methodologies implemented during the latter part of Noninterest Income Noninterest income for the three months ended March 31, 2005, was $3,440, an increase of $607, or 21.4 percent, from the $2,833 reported for the same period of This increase is due primarily to a $1,303 increase in noncapitalized loan-related fees and a $109 increase in patronage received, partially offset by a $610 decrease in surplus distributed from the Farm Credit System Association Captive Insurance Company. Noninterest Expense Noninterest expense for the three months ended March 31, 2005, was $34,701, a decrease of $881, or 2.5 percent, over the first quarter of The decrease is due primarily to a decrease of $1,016 in premiums accrued to the Farm Credit System Insurance Corporation (FCSIC), a decrease of $183 in salaries and employee benefits, and a decrease of $172 in occupancy and equipment expenses, partially offset by a $407 increase in other operating expenses, and an $81 increase in losses, net, on other property owned. Premiums to the FCSIC decreased due to decreases in rates effective for the quarter ended March 31, 2005, as compared to the same period of the prior year. The $183 decrease in salaries and benefits was due to a $1,351 decrease in nonretirement employee benefits and a $658 decrease in pension and retirement benefits, largely offset by an increase of $1,663 in compensation and a $163 increase in payroll-related taxes. The decrease in nonretirement benefits was primarily due to a change in plans for nonpension postretirement benefits by the bank and most of the district s associations, which resulted in a $1,231 decrease in those expenses. Pension and retirement expenses included a $261 decrease in net periodic pension expense of the district s defined benefit pension plan. Compensation and payroll-related taxes increased primarily as a result of increases in compensation rates and in the number of employees at 1

4 district associations. The increase in other operating expenses was mainly attributable to an increase of $361 in professional fees and contract services. Key results of operations comparisons: Annualized for the Annualized for the Three Months Ended Three Months Ended 3/31/2005 3/31/2004 Return on average assets 1.93% 1.76% Return on average members' equity 11.49% 10.26% Net interest income as a percentage of average earning assets 3.20% 3.28% Charge-offs, net of recoveries, to average loans 0.00% 0.01% FINANCIAL CONDITION Loan Portfolio Gross loan volume at March 31, 2005, was $8,634,201, an increase of $189,854, or 2.2 percent, from $8,444,347 at December 31, The increase is attributable to competitive pricing, continued demand for real estate in most areas of the district, increased activity in loan participations with outside entities, and marketing and customer service efforts by district associations. The district s agricultural portfolio also benefits from continued government support to farmers, and the availability of off-farm income sources. District credit quality remained strong, with 98.5 percent of gross loan volume rated acceptable at March 31, 2005, increasing slightly from 98.3 percent at December 31, Nonaccrual loans for the district were 0.41 percent of total loans at March 31, 2005, compared to 0.45 percent at December 31, The $10,073 allowance for loan losses at March 31, 2005, constituted 0.12 percent of total loans, and was considered by management to be adequate to absorb the losses inherent in the existing loan portfolio. Total district high-risk asset volume decreased by $2.9 million, or 5.8 percent, to $47,094 at March 31, 2005, from $49,865 at December 31, Comparative balances of high-risk assets follow (in millions): Increase (Decrease) March 31, 2005 $ % December 31, 2004 Nonaccrual loans $ 35.3 $ (2.5) (6.6) % $ 37.8 Formally restructured loans 3.5 (0.4) (10.3) 3.9 Loans 90 days past due and still accruing interest Total impaired loans 42.8 (2.0) (4.5) 44.8 Other property owned, net 4.3 (0.9) (17.3) 5.2 Total high-risk assets $ 47.1 $ (2.9) (5.8) % $

5 Impaired loans, consisting of nonaccrual loans, formally restructured loans and loans past due 90 days or more and still accruing interest, constituted 0.5 percent of gross loans at March 31, 2005, and 0.5 percent of gross loans at December 31, Liquidity and Funding Sources As of March 31, 2005, the Farm Credit Bank of Texas and all district associations exceeded all regulatory liquidity requirements. Cash and investment securities totaled $1,898,983, or 17.7 percent, of total assets at March 31, 2005, compared to $1,879,375, or 17.9 percent, at December 31, 2004, reflecting an increase of $19,608, or 1.0 percent. Interest-bearing liabilities, consisting of bonds and notes, increased by $168,705, or 2.0 percent, in order to fund the increases in loan volume. Capital Resources Total members equity increased $29,968, or 1.7 percent, from December 31, 2004, to the March 31, 2005, total of $1,766,097. This increase is the result of net income of $50,192 for the three months ended March 31, 2005, and a $527 increase in unrealized gains on cash flow derivatives, offset by a $13,111 increase in unrealized losses on investment securities, net retirements of stock of $5,194, and $2,446 in cash patronage payments. Key financial condition comparisons: March 31, 2005 December 31, 2004 Members' equity to assets 16.51% 16.54% Total liabilities to members' equity 5.06:1 5.05:1 Allowance for loan losses to total loans 0.12% 0.13% Larry R. Doyle Chief Executive Officer Ralph W. Cortese Chairman of the Board 3

6 Combined Balance Sheets March 31, 2005 December 31, (dollars in thousands) (Unaudited) 2004 Assets Cash $ 26,853 $ 44,169 Federal funds sold and securities purchased under resale agreements 49,100 47,500 Investment securities 1,823,030 1,787,706 Loans 8,634,201 8,444,347 Less allowance for loan losses 10,073 10,617 Net loans 8,624,128 8,433,730 Accrued interest receivable 112, ,209 Other property owned, net 4,268 5,184 Premises and equipment, net 35,788 34,983 Other assets 23,088 39,458 Total assets $ 10,698,952 $ 10,498,939 Liabilities and members' equity Liabilities Bonds and notes, net $ 8,701,238 $ 8,532,533 Accrued interest payable 41,817 37,551 Intra-system financial assistance payable Other liabilities 189, ,649 Total liabilities 8,932,855 8,762,810 Commitments and contingent liabilities (Note 3) Members' equity Preferred stock, net 102, ,607 Capital stock and participation certificates 83,768 88,962 Allocated retained earnings 32,781 32,662 Unallocated retained earnings 1,580,486 1,532,859 Accumulated other comprehensive loss (33,545) (20,961) Total members' equity 1,766,097 1,736,129 Total liabilities and members' equity $ 10,698,952 $ 10,498,939 The accompanying notes are an integral part of these combined financial statements. 4

7 Combined Statements of Income (unaudited) Quarter Ended March 31, (dollars in thousands) Interest Income Investment securities $ 15,436 $ 10,437 Loans 128,214 96,717 Total interest income 143, ,154 Interest Expense Bonds and notes 58,950 33,850 Notes payable and other 3,400 1,384 Total interest expense 62,350 35,234 Net interest income 81,300 71,920 (Negative provision) provision for loan losses (449) 359 Net interest income after provision for loan losses 81,749 71,561 Noninterest Income Loan-related fees 2,747 1,444 Miscellaneous income, net 693 1,389 Total noninterest income 3,440 2,833 Noninterest Expense Salaries and employee benefits 21,012 21,195 Occupancy and equipment 2,436 2,608 Insurance Fund premiums 842 1,858 Gains (losses) on other property owned, net 23 (58) Intra-system financial assistance expenses Other operating expenses 9,482 9,075 Total noninterest expense 34,701 35,582 Income before provision for income taxes 50,488 38,812 Provision for income taxes Net Income $ 50,192 $ 38,554 The accompanying notes are an integral part of these combined financial statements. 5

8 Combined Statements of Changes in Members' Equity (unaudited) Accumulated Allocated Unallocated Other Total Preferred Retained Retained Comprehensive Members' (dollars in thousands) Stock Capital Stock Earnings Earnings Income (Loss) Equity Balance at December 31, 2003 $ 102,642 $ 101,168 $ 35,328 $ 1,237,366 $ (4,449) $ 1,472,055 Comprehensive income Net income ,554-38,554 Unrealized net gains on investment securities ,791 10,791 Unrealized net losses on cash flow derivatives (569) (569) Total comprehensive income ,554 10,222 48,776 Capital stock/participation certificates issued - 3, ,741 Capital stock/participation certificates and allocated retained earnings retired - (13,324) (13,324) Patronage distributions Cash (4,291) - (4,291) Members' equity - - (1,572) 1, Balance at March 31, 2004 $ 102,642 $ 91,585 $ 33,756 $ 1,273,201 $ 5,773 $ 1,506,957 Balance at December 31, 2004 $ 102,607 $ 88,962 $ 32,662 $ 1,532,859 $ (20,961) $ 1,736,129 Comprehensive income Net income ,192-50,192 Unrealized net losses on investment securities (13,111) (13,111) Unrealized net gains on cash flow derivatives Total comprehensive income ,192 (12,584) 37,608 Capital stock/participation certificates issued - 7, ,416 Capital stock/participation certificates and allocated retained earnings retired - (12,610) (12,610) Patronage distributions Cash (2,446) - (2,446) Members' equity (119) - - Balance at March 31, 2005 $ 102,607 $ 83,768 $ 32,781 $ 1,580,486 $ (33,545) $ 1,766,097 The accompanying notes are an integral part of these combined financial statements. 6

9 Combined Statements of Cash Flows (unaudited) Three Months Ended March 31, (dollars in thousands) Operating activities Net income $ 50,192 $ 37,953 Reconciliation of net income to net cash provided by operating activities (Negative provision) provison for loan losses (449) 359 Provision for losses on other property owned Depreciation and amortization on premises and equipment 1,130 1,161 Accretion of net discount on loans (291) (353) Amortization and accretion on debt instruments 3,850 (74) Amortization of net discount (premium) on investment securities 1,299 (875) Losses from sales of other property owned, net (69) (33) Gains from sales of premises and equipment (1,831) (265) (Increase) decrease in accrued interest receivable (6,488) 2,985 Decrease (increase) in other assets 15,892 (966) Decrease in accrued interest payable 4,266 (8,602) Increase in intra-system financial assistance payable Increase in other liabilities (21,537) (5,809) Net cash provided by operating activities 46,502 26,457 Investing activities Net (increase) decrease in federal funds sold and securities purchased under resale agreements (1,600) (15,100) Investment securities Purchases (704,031) (1,470,431) Proceeds from maturities, calls and prepayments 654,296 1,473,121 Increase in loans, net (188,726) (76,383) Proceeds from sale of loans 100,000 - Proceeds from sales of other property owned, net - 1,173 Proceeds from sales of premises and equipment 2, Expenditures for premises and equipment (2,950) (3,099) Net cash used in investing activities (140,165) (90,084) Financing activities Bonds and notes issued 6,589,245 14,766,860 Bonds and notes retired (6,515,657) (14,716,578) Increase in advanced conditional payments 10,399 4,329 Capital stock and participation certificates issued 7,416 3,741 Capital stock and participation certificates retired (12,610) (13,324) Cash patronage distributions paid (2,446) (14,616) Net cash provided by financing activities 76,347 30,412 Net decrease in cash (17,316) (33,215) Cash at beginning of year 44,169 47,417 Cash at end of quarter $ 26,853 $ 14,202 Supplemental schedule of noncash investing and financing activities Financed sales of other property owned $ 602 $ 10 Loan assets transferred to other property owned 1, Unrealized net (gains) losses on investment securities (13,112) 10,791 Cash dividends or patronage distributions payable 15,085 8,744 Supplemental information Cash paid for: Interest 50,735 43,120 Income taxes The accompanying notes are an integral part of these combined financial statements. 7

10 Notes to Combined Financial Statements Unaudited (dollar amounts in thousands unless otherwise noted) NOTE 1 ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES The accompanying combined financial statements (financial statements) include the accounts of the Farm Credit Bank of Texas (bank) and the accounts of the Agricultural Credit Associations (ACAs) and Federal Land Credit Associations (FLCAs) of the Tenth Farm Credit District (district) of the Farm Credit System (System). The ACAs and FLCAs are collectively referred to as associations. The financial statements also reflect the investments in and allocated earnings of the service organizations in which the bank has a partial ownership interest. All significant transactions and balances between the bank and the associations have been eliminated in combination. The significant accounting policies followed and the financial condition and results of operations of the combined bank and associations as of and for the year ended December 31, 2004, are contained in the 2004 Annual Report to stockholders (Annual Report). These unaudited first quarter 2005 financial statements should be read in conjunction with the Annual Report. The accompanying financial statements contain all adjustments necessary for a fair presentation of the interim financial condition and results of operations of the district and conform to generally accepted accounting principles. The preparation of these financial statements required the use of management s estimates. The results of operations for any interim period are not necessarily indicative of the results to be expected for the entire year. Certain amounts in the prior period s financial statements have been reclassified to conform to the current period s financial statement presentation. NOTE 2 ALLOWANCE FOR LOAN LOSS An analysis of the allowance for loan losses follows: Three Months Ended March 31, Balance at beginning of period $ 10,617 $ 173,980 Provision for loan losses (449) 359 Loans charged off (562) (317) Recoveries Balance at end of period $ 10,073 $ 174,108 As discussed in the 2004 Annual Report, the bank and its affiliated associations recorded a loan loss reversal of $157.3 million in the fourth quarter of 2004 that resulted in a decrease in the allowance for loan losses. 8

11 NOTE 3 COMMITMENTS AND CONTINGENT LIABILITIES The bank is primarily liable for its portion of systemwide debt obligations. Additionally, the bank is jointly and severally liable for the consolidated systemwide bonds and notes of the other System banks. Total consolidated bank and systemwide obligations of the System at March 31, 2005, were approximately $100.8 billion. Other actions are pending against the bank and associations in which claims for monetary damage are asserted. Upon the basis of current information, management and legal counsel are of the opinion that the ultimate liability, if any, resulting therefrom will not be material in relation to the combined financial positions or results of operations of the bank and associations. NOTE 4 EMPLOYEE BENEFIT PLANS The multi-employer structure of certain of the district s retirement and benefit plans results in the recording of these plans only upon combination. The following table summarizes the components of net periodic benefit costs for the three months ended March 31: Pension Benefits Other Benefits Service cost $ 1,267 $ 1,167 $ 463 $ 662 Interest cost 2,788 2, ,050 Expected return on plan assets (2,482) (1,990) - (6) Amortization of transition obligation - - (224) - Amortization of prior service costs (182) Amortization of net loss Net periodic benefit cost $ 2,578 $ 2,840 $ 1,007 $ 2,237 As of March 31, 2005, $6.9 million of contributions have been made to the district s defined benefit pension plan. The district presently anticipates no additional contributions to fund its pension plan in

12 NOTE 5 BANK-ONLY FINANCIAL DATA Condensed financial information for the bank follows. All significant transactions and balances between the bank and associations are eliminated in combination. Balance sheet data March 31, 2005 December 31, 2004 Cash $ 1,804 $ 3,614 Federal funds sold and securities purchased under resale agreements 49,100 47,500 Investment securities 1,823,030 1,787,706 Loans 6,962,713 6,918,236 Less allowance for loan losses Net loans 6,962,570 6,917,997 Accrued interest receivable 28,851 26,032 Premises and equipment, net 2,527 2,416 Other assets 12,586 15,940 Total assets $ 8,880,468 $ 8,801,205 Bonds and notes $ 8,301,238 $ 8,232,533 Accrued interest payable 40,738 36,850 Intra-system financial assistance payable Other liabilities 37,680 30,391 Total liabilities 8,380,001 8,299,774 Preferred stock 98,644 98,644 Capital stock 118, ,323 Retained earnings 303, ,022 Accumulated other comprehensive loss (20,142) (7,558) Total shareholders' equity 500, ,431 Total liabilities and shareholders' equity $ 8,880,468 $ 8,801,205 Three Months Ended March 31, Statement of income data Interest income $ 77,500 $ 49,184 Interest expense 58,961 33,858 Net interest income 18,539 15,326 Negative provision for loan losses (96) - Net interest income after provision for loan losses 18,635 15,326 Noninterest income 3,741 3,218 Noninterest expense 9,754 9,251 Net income $ 12,622 $ 9,293 10