AgriBank, FCB and Affiliated Associations

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1 Quarterly Report June 30, 2005 Copies of quarterly and annual reports are available upon request by contacting AgriBank, FCB, 375 Jackson Street, St. Paul, Minnesota or by calling (651) Reports are also available at Information regarding the year-to-date average daily balances (ADBs) and annualized average rates earned and paid on our portfolio follows (dollars in millions): MANAGEMENT'S DISCUSSION AND ANALYSIS The following discussion is a review of the combined financial position and results of operations of AgriBank, FCB and Affiliated Associations. This information should be read in conjunction with the accompanying financial statements, the notes to the financial statements and the 2004 annual report. We serve customers in states across America s heartland. AgriBank provides funding to and is owned by its affiliated Associations and other financial institutions. AgriBank and its affiliated Associations are collectively referred to as the District. The Associations are chartered to service customers in substantially all of Arkansas, Illinois, Indiana, Iowa, Kentucky, Michigan, Minnesota, Missouri, Nebraska, North Dakota, Ohio, South Dakota, Tennessee, Wisconsin and Wyoming. The Associations provide credit and services to farmers, ranchers, rural residents and agribusinesses. RESULTS OF OPERATIONS Our net income for the six months ended June 30, 2005 totaled $283.3 million compared to $245.2 million for the same period in The return on average assets increased to 1.33% for the six months ended June 30, 2005 from 1.25% for the comparable period in The following table illustrates changes in the significant components of net income (in millions): Increase (decrease) in net income 2005 vs Six months ended June Net interest income $54.4 Provision for loan losses 1.8 Non-interest income (4.2) Operating expenses (13.4) Loss on debt extinguishment (1.9) Income taxes 1.4 Total change in net income $38.1 Net interest income for the six months ended June 30, 2005 increased $54.4 million or 11.9% compared to the six months ended June 30, The increase in net interest income was due to the effects of changes in rates of $19.6 million, changes in volume of $37.7 million and a $2.9 million decrease in nonaccrual income. Six months ended June 30, 2005 ADB Rate Earning assets: Accrual loans $33, % Nonaccrual loans % Investments and federal funds 8, % Total earning assets 41, % Total interest bearing liabilities 34, % Total interest rate spread 1.89% Impact of equity financing $7, % Net interest margin 2.46% Six months ended June 30, 2004 ADB Rate Earning assets: Accrual loans $30, % Nonaccrual loans % Investments and federal funds 7, % Total earning assets 38, % Total interest bearing liabilities 32, % Total interest rate spread 1.94% Impact of equity financing $6, % Net interest margin 2.36% Net interest margin has increased by 10 basis points from the same period last year due to a 15 basis point increase in the impact of equity financing and a 5 basis point decline in interest rate spread. Equity financing represents the benefit of not requiring debt to fund every dollar of earning assets. Equity financing is positively impacted by increased interest rates as well as increased volume of equity; accordingly, the impact of equity financing in 2005 is greater than in The average interest rate spread was 1.89% for the first six months of 2005, compared to 1.94% during the same period in The positive impact of increased nonaccrual and investment spreads and improved funding results were offset by a decline in accrual spreads. An increasing competitive environment resulted in a narrowing of loan spreads to date which is expected to continue through the end of 2005, with competitive pressure increasing as rates rise. The increase in investments and federal funds was due to levels of loan volume that allowed for an increase in the investment portfolio while continuing to remain within targeted leverage ratios. Changes in loan volumes are discussed in the Loan Portfolio section of this discussion. 1

2 Other significant changes in net income are as follows: The decline in provision for loan losses is reflective of changes in portfolio risk. First quarter 2005 provision expense was a reversal of $3.0 million as a result of reduced risk in the portfolios. This was offset by $3.2 million of provision expense in the second quarter of 2005 related in part to specific reserves established when a large borrower was transferred to nonaccrual status. The decrease in non-interest income reflects a reduction in prepayment fees as rates have been low for an extended period of time, and many borrowers have previously taken advantage of the low rates. The increase in operating expenses is due to higher salary and benefits expense resulting from incentive and merit increases and changes in head count. These additions reflect increased workloads due to actual and planned growth and higher Association investments in technology resources and related service programs. Benefits expense also increased due to increased pension expenses resulting from lower returns on plan assets and a decrease in the discount rate. Loss on debt extinguishment has increased due to $1.9 million of expense related to the June 2005 transfer to another Farm Credit bank certain longer term fixed rate debt that had previously supported prepaying loans. There was no debt transferred in the first half of LOAN PORTFOLIO The following table presents the components of loan volume at June 30, 2005 and December 31, 2004 (in millions): Accrual loans Mortgage $21,354.7 $20,607.8 Commercial 9, ,532.6 Participations purchased, net 3, ,838.9 Nonaccrual loans Total loan volume $34,714.1 $33,151.2 District loan volume totaled $34.7 billion at June 30, 2005, an increase of $1.6 billion from December 31, The increase reflects the impact of seasonality and strong rural home loan growth. The components of risk asset volume follow (in millions): Nonaccrual $159.2 $171.9 Accruing restructured Past due 90 days or more still accruing Total risk loans $192.3 $200.5 Other property owned Comparative allowance coverage of various loan categories follows: Allowance as a percentage of: Loans 0.3% 0.3% Nonaccrual loans 58.3% 55.5% Total risk loans 48.3% 47.6% The District s allowance for loan losses is an estimate of losses on loans in the AgriBank and association portfolios as of the financial statement date. AgriBank and association managements determine the appropriate allowance levels based on periodic evaluation of factors such as loan loss history, portfolio quality and current economic and environmental conditions. AgriBank and association managements consider the allowance for loan losses at June 30, 2005 to be reasonable in relation to the risk in the loan portfolios. AGRICULTURAL CONDITIONS Strong agricultural economic conditions continue into Agricultural economic conditions were excellent in 2004 as a result of price increases during the second half of 2004, strong livestock receipts, and the continued positive impact of government programs. USDA projected record net farm income for 2004 and forecasts 2005 to be the second highest on record; however recent dryness and heat may reduce crop yields over a portion of the AgriBank District. The interest rate environment in recent years has also allowed many District borrowers to lower their borrowing costs, which improves their profitability. The Farm Security and Rural Investment Act of 2002 is now in the fourth of six years. The Act continued significant federal financial support for wheat, feed grains, cotton, rice, and oilseeds, and expanded assistance to certain specialty crops and certain livestock operations, particularly smaller dairy farms. The Act provides income support for major crops important within the District s geography, which helps support credit quality. The Act removed some of the uncertainty around continued government support and decreases the volatility of overall farm income. Management believes that both the current U.S. national deficit and world trade negotiations may result in reduced government support of agriculture in the next farm bill. FUNDING, LIQUIDITY AND MEMBERS EQUITY AgriBank is responsible for meeting the District's funding, liquidity and asset/liability management needs. Association funding is provided through loans from AgriBank. Total members equity at June 30, 2005 was $7.6 billion, compared to $7.3 billion at December 31, The increase in members equity of $263.9 million reflects net income as well as an increase in capital stock and participation certificates outstanding. These increases were partially offset by earnings reserved for patronage distributions and other comprehensive losses. At June 30, 2005, AgriBank and each Association exceeded the regulatory minimum capital ratios, which are further discussed in Note 3 to the financial statements. Total risk assets $198.6 $210.6 Risk loans as % of total loans 0.5% 0.6% Delinquencies as a % of total loans 0.5% 0.5% James B. McElroy Chairperson of the Board AgriBank, FCB The District s total risk assets have decreased from December 31, 2004, and are at acceptable levels. Loans 90 days or more past due and still accruing interest were adequately secured and in the process of collection. The increase in loans 90 days or more past due and still accruing interest is reflective of the seasonal payment patterns of annual pay loans. Loans 90 days or more past due and still accruing interest at June 30, 2004 were $8.1 million. At June 30, 2005, 68.6% of nonaccrual volume was current in payment. 2 William J. Collins Chief Executive Officer AgriBank, FCB July 31, 2005

3 COMBINED STATEMENT OF CONDITION (Dollars in thousands) (Unaudited) Assets Loans $34,714,066 $33,151,165 Allowance for loan losses 92,834 95,469 Net loans 34,621,232 33,055,696 Investment securities 7,748,037 7,273,908 Cash 53, ,447 Federal funds 455, ,000 Accrued interest receivable 485, ,160 Premises and equipment, net 214, ,333 Assets held for lease, net 246, ,111 Derivative assets Deferred tax assets, net Other assets 142, ,480 Total assets $43,968,312 $41,716,455 Liabilities Bonds and notes $35,743,605 $33,784,537 Accrued interest payable 237, ,188 Derivative liabilities 87,147 54,402 Deferred tax liabilities, net 58,642 66,610 Other liabilities 278, ,808 Total liabilities 36,404,541 34,416,545 Contingent liabilities Members' equity Protected capital stock and participation certificates 9,582 11,076 Capital stock and participation certificates 191, ,738 Allocated surplus 98,337 98,289 Unallocated surplus 7,276,691 7,009,482 Accumulated other comprehensive loss (12,280) (6,675) Total members' equity 7,563,771 7,299,910 Total liabilities and members' equity $43,968,312 $41,716,455 The accompanying notes are an integral part of these combined financial statements. 3

4 COMBINED STATEMENT OF INCOME (Dollars in thousands) (Unaudited) Three months Six months Period ended June 30, Interest income Loans 500,092 $410,007 $967,389 $813,163 Investment securities and federal funds 66,798 28, ,320 54,679 Total interest income 566, ,222 1,091, ,842 Interest expense 307, , , ,569 Net interest income 259, , , ,273 Provision for loan losses 3,154 1, ,017 Net interest income after provision for loan losses 256, , , ,256 Non-interest income Financially related services 11,938 10,202 23,788 21,098 Loan prepayment fee income 1,339 5,564 4,762 9,874 Miscellaneous income and other gains, net 5,447 6,966 13,468 15,218 Total non-interest income 18,724 22,732 42,018 46,190 Non-interest expense Salaries and employee benefits 79,181 70, , ,349 Other operating 45,318 46,452 89,252 92,578 Loss on debt extinguishment 1, , Financial assistance 3,416 3,763 7,503 7,473 Total non-interest expense 129, , , ,400 Income before income taxes 145, , , ,046 Provision for income taxes 6,018 7,203 13,493 14,896 Net income 139,469 $125,363 $283,257 $245,150 The accompanying notes are an integral part of these combined financial statements. 4

5 COMBINED STATEMENT OF CHANGES IN MEMBERS' EQUITY (Dollars in thousands) (Unaudited) Capital Stock and Accumulated Other Comprehensive Comprehensive Protected Participation Allocated Unallocated Income (Loss) Income Capital Certificates Surplus Surplus Investments Derivatives Total Balance at December 31, 2003 $13,968 $185,816 $73,629 $6,063,177 $1,926 $(15,104) $6,323,412 Comprehensive Income Net income $245, , ,150 Other comprehensive loss, net of tax: Change in net unrealized gains on investment securities, net of reclassification adjustment of $0 (17,384) (17,384) (17,384) Change in net unrealized losses on cash flow hedges, net of reclassification adjustment of ($6,212) 14,126 Other comprehensive loss, net of tax (3,258) 14,126 14,126 Total comprehensive income $241,892 Patronage reserve (5,719) (5,719) Distribution of allocated surplus (3) (3) Capital stock/participation certificates issued 11,936 11,936 Capital stock/participation certificates retired (1,845) (11,977) (13,822) Balance at June 30, 2004 $12,123 $185,775 $73,626 $6,302,608 $(15,458) $(978) $6,557,696 Balance at December 31, 2004 $11,076 $187,738 $98,289 $7,009,482 $(3,509) $(3,166) $7,299,910 Comprehensive income Net income $283, , ,257 Other comprehensive loss, net of tax: Change in net unrealized losses on investment securities, net of reclassification adjustment of ($2) (3,073) (3,073) (3,073) Change in net unrealized losses on cash flow hedges, net of reclassification adjustment of ($7,820) (2,532) (2,532) (2,532) Other comprehensive loss, net of tax (5,605) Total comprehensive income $277,652 Patronage reserve (15,939) (15,939) Surplus allocated under patronage program 109 (109) -- Distribution of allocated surplus (61) (61) Capital stock/participation certificates issued 13,026 13,026 Capital stock/participation certificates retired (1,494) (9,323) (10,817) Balance at June 30, 2005 $9,582 $191,441 $98,337 $7,276,691 $(6,582) $(5,698) $7,563,771 The accompanying notes are an integral part of these combined financial statements. 5

6 COMBINED STATEMENT OF CASH FLOWS (Dollars in thousands) (Unaudited) Six months ended June Cash flows from operating activities Net income $283,257 $245,150 Adjustments to reconcile net income to cash flow from operating activities: Depreciation on premises and equipment 13,045 11,199 Depreciation on assets held for lease 24,947 24,699 Provision for loan losses 204 2,017 (Increase) decrease in accrued interest receivable (44,643) 6,990 Increase in other assets (3,398) (14,943) Increase in accrued interest payable 45,888 13,650 Increase (decrease) in other liabilities 4,684 (43,786) Loss on derivative activities 2, Loss (gain) on sale of premises and equipment 1,403 (510) Gain on sale of other property owned (710) (670) Gain on disposal of assets held for lease (330) (397) Total adjustments 43,375 (956) Net cash provided by operating activities 326, ,194 Cash flows from investing activities Increase in loans, net (1,567,393) (945,073) Proceeds from sale of other property owned 6,183 9,498 Increase in investment securities (477,202) (912,859) Purchases of assets held for lease, net (14,954) (19,654) Purchases of premises and equipment, net (14,303) (15,345) Net cash used in investing activities (2,067,669) (1,883,433) Cash flows from financing activities Consolidated bonds and notes issued, net 1,985,764 1,322,903 Sale of derivatives 1, Cash patronage paid (70,389) (11,636) Capital stock/participation certificates issued (retired), net 2,209 (1,886) Net cash provided by financing activities 1,919,102 1,309,381 Net increase (decrease) in cash and federal funds 178,065 (329,858) Cash and federal funds at beginning of year 330, ,043 Cash and federal funds at end of period $508,512 $168,185 Supplemental schedule of non-cash activities (Increase) decrease in derivative assets $(5,056) $5,385 Increase in derivative liabilities 35,509 43,286 Decrease in bonds and notes related to hedging activities (26,696) (62,002) (Decrease) increase in members' equity from cash flow derivatives (1,039) 14,126 Decrease in members' equity from investments (3,073) (17,384) Decrease in collateral posted by derivative counterparty -- (3,940) Loans transferred to other property owned 1,653 4,162 Patronage distributions payable to members 16,595 6,323 Supplemental information Interest paid $533,198 $395,919 Taxes paid 14,504 20,405 The accompanying notes are an integral part of these combined financial statements. 6

7 NOTES TO COMBINED FINANCIAL STATEMENTS NOTE 1 ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES A description of the organization and operation of the District, significant accounting policies followed, and combined financial condition and results of operations as of and for the year ended December 31, 2004 are contained in the 2004 annual report. These unaudited second quarter 2005 combined financial statements should be read in conjunction with the annual report. The accompanying combined financial statements include the accounts of AgriBank combined with its 18 affiliated associations. All significant transactions and balances between AgriBank and the associations have been eliminated in combination. The accompanying combined financial statements contain all adjustments necessary for a fair presentation of the interim financial condition and results of operations and conform to generally accepted accounting principles and prevailing practices within the banking industry. Certain prior period amounts have been reclassified to conform to current year presentation. NOTE 2 ALLOWANCE FOR LOAN LOSSES A summary of changes in the combined allowance for loan losses is presented in the following table (in thousands): Six months ended June Balance at beginning of period $95,469 $706,044 Provision for loan losses 204 2,017 Charge-offs (5,822) (6,973) Recoveries 2,983 3,468 Balance at end of period $92,834 $704,556 As discussed in our 2004 annual report, the significant reduction in the allowance for loan losses compared to June 30, 2004 is the result of a fourth quarter 2004 refinement to the allowance methodologies. NOTE 3 CAPITAL Farm Credit Administration's capital adequacy regulations require AgriBank and the Associations to maintain permanent capital of at least 7% of risk-adjusted assets. In addition, each System institution is required to maintain a total surplus to risk-adjusted assets ratio of at least 7% and a core surplus to risk-adjusted assets ratio of at least 3.5%. At June 30, 2005, AgriBank exceeded these requirements with a 20.9% permanent capital ratio, 20.8% total surplus ratio, and 14.1% core surplus ratio. All District Associations exceeded the regulatory minimums at June 30, Farm Credit Administration regulations also require AgriBank to maintain a collateral ratio of at least 103%. At June 30, 2005 this requirement was exceeded with a net collateral ratio of 105.2%. NOTE 4 EMPLOYEE BENEFIT PLANS Net periodic benefit costs included the following components (in thousands): Pension Other Six months ended June 30, 2005 Benefits Benefits Components of net periodic benefit cost Service cost $8,042 $257 Interest cost 14,333 1,210 Expected return on plan assets (17,871) (222) Amortization of prior service cost 721 (250) Amortization of loss or (gain) 3,124 (272) Net periodic benefit cost $8,349 $723 The amount of employer contributions expected to be paid during 2005 is $13.0 million for pension benefits and $2.2 million for other postretirement benefits. NOTE 5 CONTINGENT LIABILITIES AND LITIGATION Actions are pending against certain Associations in which claims for money damages are asserted. Based on current information, management and legal counsels are of the opinion that resulting liability, if any, would be immaterial in relation to the combined financial position of AgriBank, FCB and the affiliated Associations. NOTE 6 AGRIBANK ONLY DATA (in thousands) Statement of Condition Loans, net $29,681,929 $28,358,186 Other assets 8,594,139 7,817,063 Total assets $38,276,068 $36,175,249 Liabilities $36,177,547 $34,098,887 Members' equity 2,098,521 2,076,362 Total liabilities and members' equity $38,276,068 $36,175,249 Six months ended June 30 Statement of Income Interest income $650,801 $456,856 Interest expense 579, ,555 Net interest income 71,627 47,301 Reversal of provision for loan losses 1, Other, net (9,370) (8,380) Net income $63,537 $38,921 Patronage $38,780 $36,240 Substantially all patronage is paid to the Associations and is eliminated in combination. 7

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