AgriBank, FCB. Amended Quarterly Report September 30, 2009 MANAGEMENT'S DISCUSSION AND ANALYSIS

Transcription

1 AgriBank, FCB Amended Quarterly Report September 30, 2009 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 This quarterly report is an amendment of the September 30, 2009 quarterly report originally issued November 9, The quarterly report is being amended to correct errors in the calculation of certain risk-adjusted regulatory capital ratios. These regulatory ratios, as originally reported, inaccurately reflected the treatment of certain asset-backed and mortgage-backed liquidity investment securities whose credit ratings had been downgraded below double-b. The Statement of Condition and Results of Operations are not impacted by this correction. This correction is more fully discussed in Note 5 in the Notes to the Financial Statements. MANAGEMENT'S DISCUSSION AND ANALYSIS The following table illustrates changes in the significant components of net income: Increase (decrease) in net income (in millions) 2009 vs Nine months ended September Net interest income $118.0 Prov ision for loan losses (10.5) Non-interest income 7.7 Operating ex penses (12.2) Loan serv icing fees paid to Associations (5.8) Loss on debt ex tinguishment (4.8) Asset impairment (34.6) Total change in net income $57.8 The following discussion is a review of the financial position and results of operations of AgriBank, FCB. This information should be read in conjunction with the accompanying financial statements, the notes to the financial statements and the 2008 annual report. We provide funding and business services to Associations in states across America s heartland. The Associations are chartered to serve 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. AgriBank and its Affiliated Associations are collectively referred to as the District. FINANCIAL MARKET VOLATILITY During the first nine months of 2009, the severe stress in the financial markets began to and has continued to stabilize. While conditions were far from historical norms, certain sectors of the capital markets began to function better. Corporate debt issuance has improved and borrowing rates, particularly short-term rates, have trended lower. More importantly, investor demand for Farm Credit debt securities with short-term maturities remained strong, although demand for longer-term maturities, particularly over five years, remained moderate. Long-term funding costs, while declining, remained slightly elevated relative to benchmarks. Throughout this period of financial market volatility, AgriBank has been able to access the debt capital markets across the yield curve to support the District mission of providing credit to farmers, ranchers and other eligible borrowers. This has enabled AgriBank to maintain appropriate liquidity and a conservative asset/liability risk profile while continuing to offer a full array of loan products to our Associations. We expect to be able to continue to issue debt securities, even though the market for issuing longer-term debt with maturities greater than five years may continue to be challenging. Association partners are responding to these funding challenges with appropriate actions, including adjusting loan structures and payment terms, and in appropriate cases, increased pricing to customers. Net interest income for the nine months ended September 30, 2009 increased by $118.0 million or 50.3% higher than net interest income for the same period in The increase in net interest income was due to the positive effects of changes in volume of $75.0 million, and positive effects of changes in rates of $43.0 million. Average earning assets increased to $62.4 billion for the nine months ended September 30, 2009 compared to $55.8 billion for the same period in This increase in average volume reflects the strong growth experienced throughout However, growth has moderated significantly during 2009, reflective of softening loan demand due to decline in commodity prices, continued adherence to strong credit underwriting standards and to the overall downturn in the U.S. and global economies. The composition of our portfolio has changed with the purchase of retail loans from the Associations under the Asset Pool program, which reduced our wholesale loan volume and increased our retail loan volume. The positive impact of changes in rates was due to declining interest rates on debt, including positive funding results related to exercising options on callable debt and other funding. The following table presents the impact on net interest income due to changes in volume and rates based on the average daily balances for loans, investments and debt: Nine months ended Volume Rates Combined September 30, 2009 (in millions) Loans $201.2 $(436.5) $(235.3) Inv estments 36.7 (140.8) (104.1) Interest income (577.3) (339.4) Debt (162.9) Net change in net interest income $75.0 $43.0 $118.0 RESULTS OF OPERATIONS Our net income for the nine months ended September 30, 2009 totaled $295.1 million compared to $237.3 million for the same period in The return on average assets was 0.62% for the nine months ended September 30, 2009 compared to 0.56% for the same period in

2 Information regarding the year-to-date average daily balances (ADBs) and annualized average rates earned and paid on our portfolio follows: Nine months ended September 30, 2009 ADB Rate (in millions) Earning assets: Wholesale loans $45, % Retail accrual loans 7, % Retail nonaccrual loans % Inv estments and federal funds 9, % Total earning assets 62, % Total interest bearing liabilities 59, % Total interest rate spread 0.65% Impact of equity financing $2, % Net interest margin 0.75% Nine months ended September 30, 2008 ADB Rate (in millions) Earning assets: Wholesale loans $44, % Retail accrual loans 3, % Retail nonaccrual loans % Inv estments and federal funds 7, % Total earning assets 55, % Total interest bearing liabilities 53, % Total interest rate spread 0.40% Impact of equity financing $2, % Net interest margin 0.56% The average interest rate spread was 0.65% during the first nine months of 2009 compared to 0.40% in Interest rate spread is the difference between the rate we earn on interest earning assets and the rate we pay on interest bearing liabilities. Spread income has been positively impacted by our purchase of retail assets under the Asset Pool program. In addition, during 2008 and into 2009, in a period of falling interest rates, we were able to call and reprice a significant amount of debt faster than our assets repriced. The impact of equity financing was negatively impacted by the decline in interest rates, dropping from 16 basis points for the first nine months of 2008 to 10 basis points for the first nine months of Changes in loan volumes are further discussed in the Loan Portfolio section of this report. The change in net income for the first nine months of 2009 was impacted by an increase of $10.5 million in provision for loan losses, reflecting deterioration in our loan credit quality primarily in the pork, dairy and ethanol sectors. The increase in operating expense results primarily from an $8.5 million increase in Farm Credit System Insurance Corporation premiums and a $1.5 million increase in professional purchased services. The increase in the insurance corporation premiums is due to an increase in debt supporting our retail loans, primarily related to Asset Pools, and increases in the premium rate assessed. The increase in professional purchased services is due to our participation in a Systemwide project looking at increasing efficiencies within the System. Loan servicing fees paid to Associations increased due to retail loan participations purchased under the Asset Pool program. The changes in loss on debt extinguishments reflect a $4.8 million loss in September 2009 resulting from transfers of long term debt to another Farm Credit System bank. There were no debt transfers from AgriBank in We evaluated all investments in an unrealized loss position and determined that 20 securities were in other-than-temporary loss positions at September 30, We believe underlying credit issues in the housing related mortgages that support these securities may result in us not collecting all principal and interest contractually due. As a result of this evaluation, we have recognized $43.8 million in impairment losses during the first nine months of 2009 compared to $9.2 million for the same period in See Note 1 for discussions on recent accounting developments related to fair value and other-than-temporary impairment. See also Note 3 for further discussion on investment impairment. LOAN PORTFOLIO The following table presents the components of loan volume: September 30, December 31, (in millions) Accrual loans Wholesale $46,993.3 $44,943.1 Retail 7, ,749.7 Nonaccrual loans Total loan v olume $54,742.3 $52,753.6 Loan volume totaled $54.7 billion at September 30, 2009, an increase of $2.0 billion from December 31, Loan growth has moderated significantly during 2009, reflective of softening loan demand due to decline in commodity prices, continued adherence to strong credit underwriting standards and to the overall downturn in the U.S. and global economies. The increase in loan volume during the first nine months of 2009 resulted primarily from the seasonal impact, although the seasonal impact has been lower this year due to levels of cash income many grain farmers earned in 2008 and early in 2009 from selling crops at high commodity prices. The seasonal impact reflects that loan volume typically increases throughout the year as farmers borrow for operating and capital needs and then declines because of payments after harvest. The change in non-interest income for the first nine months of 2009 results primarily from: $12.5 million increase in fee income due to the volume of loan conversions and prepayment activity, $1.2 million increase in patronage income, $1.2 million increase due to the impact of a write-down in 2008 of a receivable arising from a terminated swap, offset by $6.7 million decrease in minerals income due to declines in oil and gas prices. 2

3 The components of risk asset volume follow: September 30, December 31, (in millions) Nonaccrual $110.0 $60.8 Accruing restructured Past due 90 day s or more still accruing Total risk loans $123.8 $71.0 Other property ow ned Total risk assets $130.1 $71.5 Risk loans as % of total loans 0.23% 0.13% Risk assets as % of total loans plus other property ow ned 0.24% 0.14% Delinquencies as a % of total loans 0.11% 0.05% Our risk assets have increased significantly from December 31, 2008, but remain at acceptable levels. Based on management s analysis, all loans 90 days or more past due and still accruing interest were adequately secured and in the process of collection and, as such, were eligible to remain in accruing status. The increase in nonaccrual loans was due primarily to stress in the pork and dairy industries. Despite the increase in nonaccrual loans, total risk loans as a percentage of total loans remains well within our established risk management guidelines. The volume of nonaccrual loans remained at an acceptable level at September 30, 2009, representing 0.2% of our total portfolio. At September 30, 2009, 69.1% of nonaccrual volume was current as to principal and interest. In April 2009, a portion of our nonaccrual volume related to ethanol was transferred into other property owned, representing our interest in certain ethanol loans. The acquired properties are held in limited liability corporations formed by the lenders for that purpose. The total amount of our share of the acquired properties was $27.3 million, of which $20.7 million was sold by the end of September 2009 and $4.8 million was sold in October We financed the sales of the acquired properties and $4.1 million of the new loans were classified as nonaccrual at September 30, Credit quality on retail loans remains at acceptable levels; however, there has been an increase in special mention and adversely classified retail volume. Special mention volume on retail loans increased to $125.2 million at September 30, 2009, compared to $68.9 million at December 31, Adversely classified volume increased to $258.8 million at September 30, 2009 from $93.3 million at December 31, These increases have been driven primarily by stress in the pork, dairy and ethanol sectors. Credit quality on some wholesale loans has declined. One wholesale loan has moved to special mention classification during the third quarter of This loan represented $4.8 billion of our wholesale portfolio at September 30, The Association underlying this wholesale loan has been impacted by stress in the pork, dairy and ethanol sectors. This Association is approaching certain loan quality covenants in the General Financing Agreement, which, if breached, would trigger an Event of Default under the terms of the agreement. We are actively engaged with this Association to ensure they are taking appropriate actions to address and rectify the credit quality issues within their loan portfolio. All wholesale loans were classified acceptable at December 31, Comparative allowance coverage of various loan categories follows: September 30, December 31, Allow ance as a percentage of: Loans 0.04% 0.03% Nonaccrual loans 21.37% 22.83% Total risk loans 18.98% 19.56% The allowance for loan losses is an estimate of losses on loans in our portfolio as of the financial statement date. We determine the appropriate allowance level based on periodic evaluation of factors such as loan loss history, portfolio quality and current economic and environmental conditions. During the first nine months of 2009 we increased our allowance for loan losses by $9.6 million, which is net of the impact of $4.6 million of charge-offs. These allowance changes are reflective of an increase in adverse volume in the pork, dairy and ethanol sectors of our portfolio. We consider the allowance for loan losses at September 30, 2009 to be reasonable in relation to the risk in our loan portfolio. INVESTMENT PORTFOLIO At September 30, 2009, investments and federal funds totaled $8.9 billion, down $0.5 billion from December 31, We evaluated all investments in an unrealized loss position and determined that 20 securities were in other-than-temporary loss positions at September 30, We believe underlying credit issues in the housing related mortgages that support these securities may result in us not collecting all principal and interest contractually due. As a result of this evaluation, we have recognized $43.8 million in impairment losses during the first nine months of No other securities, including those in the housing related asset and mortgage backed sectors, were determined to be other-than-temporarily impaired. On April 1, 2009, we adopted new guidance on investment fair value measurement, impairment and disclosure. Upon adoption, we increased our unallocated surplus and decreased accumulated other comprehensive income by $31.5 million representing the non-credit portion of previously impaired securities that had reduced prior period net income. We continue to closely monitor our housing related mortgage-backed and assetbacked securities. At September 30, 2009, investment securities included nonagency mortgage-backed securities with a fair value of $399.1 million and housing related asset-backed securities (subprime, insurance wrapped and second liens) with a fair value of $322.8 million. The fair value of the non-agency mortgage backed assets reflected a $158.4 million unrealized loss, and the fair value of the housing related asset-backed securities reflected an unrealized loss of $113.4 million. At September 30, 2009, we had securities that, because the ratings were downgraded below AAA, were no longer eligible under FCA regulations. The fair value of all ineligible investments totaled $397.2 million including $70.8 million on which we have taken impairment charges. Of the securities ineligible under the FCA regulations, securities totaling $163.9 million have been approved by the FCA to hold beyond six months and be included in our net collateral ratio. Securities totaling $233.3 million have not yet received FCA approval. AgriBank has submitted a plan for approval to hold $178.7 million of ineligible investments and to be allowed to include them as collateral. AgriBank will submit to the FCA a plan for approval to hold the remaining $54.6 million of ineligible investments. In addition, we held split-rated mortgage-backed securities with a fair value of $191.9 million that were downgraded below AAA by at least one rating agency. All of these securities were housing related securities. We also held $3.6 million of non-agency mortgage-backed securities on credit watch. If any security doesn t retain an AAA rating by at least one rating agency, the security would become ineligible. 3

4 AGRICULTURAL CONDITIONS The Food, Conservation, and Energy Act of 2008 (FCEA/farm bill) was enacted into law in June FCEA includes significant federal financial support for wheat, feed grains, cotton, rice, oilseeds and dairy, largely continuing the same total level of financial support to agriculture, while changing the distribution and methods of allocating such support. FCEA also contains new, expanded assistance to certain specialty crops, and added price support and trade protection for domestically produced sugar. FCEA continues the direct payment, loan rate and countercyclical payments (CCP) programs from previous farm support legislation, but the levels of support provided by each program have changed. Such support may be unable to cover operating losses due to the dramatic changes in commodity prices for inputs as well as outputs. Also, FCEA provides a new income support program called Average Crop Revenue Election (ACRE), which provides countercyclical support to farmers of many major commodities and it is based on average statewide farm income of recent years rather than more local average incomes. Enrollment in ACRE is low, however, so at an aggregate level ACRE is not a significant source of farm support. Instead, federal farm support revenue has shifted to subsidized crop insurance programs which, with revenue insurance products, now provide more federal support for farm operations than traditional farm support programs. Net farm income reached record levels in 2008, but the forecast for 2009 is significantly lower. Strong agricultural economic conditions in 2008 were the result of the continued positive impact of government programs as well as record high prices for agricultural commodities through early third quarter of However, commodity prices have subsequently reverted back to more normalized levels. The United States Department of Agriculture ( USDA ) now forecasts net farm income to be $54.0 billion in 2009, down $33.2 billion (38%) from the preliminary estimate of $87.2 billion for The 2009 forecast is $9.2 billion below the average of $63.2 billion in net farm income earned in the previous 10 years. Crop income is forecast to drop by $18 billion, the largest drop in crop income in recent history. Net cash income, which is a better measure of farmers ability to service or repay loans is forecast to be $68.2 billion in 2009, down $29.4 billion (30 percent) from 2008, and $3 billion below its 10-year average of $71.2 billion. Net cash income is projected to decline less than net farm income primarily because net cash income reflects the sale of $1.8 billion in carryover stocks from Net farm income reflects only the earnings from production that occurred in the current year. FUNDING, LIQUIDITY AND MEMBERS EQUITY AgriBank is responsible for meeting the District's funding, liquidity and asset/liability management needs. Access to funding remains the primary source of liquidity for AgriBank. We also maintain liquidity through our investment portfolio. Our liquidity policy requires us to maintain a minimum of 90 days of liquidity on a continuous basis, assuming no access to the debt capital markets. As of September 30, 2009, we had sufficient liquidity to fund all debt maturing within 130 days. In July 2009, we issued $500 million of 9.125% unsecured subordinated notes due 2019, generating net proceeds of $496.8 million. The effect of the transaction increased certain regulatory capital ratios pursuant to the Farm Credit Administration regulations. These notes are unsecured and subordinate to all other categories of creditors, including general creditors, and senior to all classes of shareholders. Total members equity at September 30, 2009 was $3.2 billion, a $401.8 million increase from December 31, Members equity was positively impacted through the third quarter of 2009 by net income, changes in other comprehensive income and an increase in stock and participation certificates. These increases were partially offset by earnings reserved for patronage distributions. The undersigned have reviewed the September 30, 2009 quarterly report of AgriBank, FCB which has been prepared under the oversight of the audit committee 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. Thomas Klahn Chairman of the Board November 18, 2009 LAND VALUES Farmland value survey information compiled by the USDA National Agricultural Statistics Service as of January 1, 2009 indicated farm real estate values averaging 3.2% lower than one year earlier. According to the survey, average cropland value changes in regions within the AgriBank District were -4.0% in the Corn Belt, -3.5% in the Appalachian states, -1.9% in the Lake states, +0.6% in the Delta states, and +1.6% in the Northern Plains. Based upon the District s most recent real estate market survey as of June 2009, regional agricultural land value changes since July 1, 2008, ranged from -6.6% to +10.3%, averaging +2.3%. Further erosion of commodity prices could adversely affect agricultural land values. However, land value changes have not had a material impact on our financial results because of the underlying financial strength of agricultural producers. L. William York Chief Executive Officer November 18, 2009 Brian J. O Keane Senior Vice President and Chief Financial Officer November 18,

5 STATEMENT OF CONDITION AgriBank, FCB (Dollars in thousands) (Unaudited) September 30, December 31, Assets Loans $54,742,323 $52,753,649 Allow ance for loan losses 23,503 13,883 Net loans 54,718,820 52,739,766 Investment securities 8,420,600 8,733,089 Cash 12,490 68,793 Federal funds 469, ,030 Accrued interest receivable 563, ,312 Derivative assets 271, ,832 Other property ow ned 6, Other assets 137, ,493 Total assets $64,600,072 $63,285,845 Liabilities Bonds and notes $60,197,822 $59,705,155 Subordinated notes 500, Accrued interest payable 386, ,788 Derivative liabilities 11,639 1,290 Collateral pledged by counterparties 204, ,760 Other liabilities 130, ,640 Total liabilities 61,431,013 60,518,633 Contingent liabilities Members' equity Capital stock and participation certificates 1,696,397 1,624,616 Unallocated surplus 1,711,261 1,537,850 Accumulated other comprehensive loss (238,599) (395,254) Total members' equity 3,169,059 2,767,212 Total liabilities and members' equity $64,600,072 $63,285,845 The accompanying notes are an integral part of these financial statements. 5

6 STATEMENT OF INCOME AgriBank, FCB (Dollars in thousands) (Unaudited) Three months Nine months Period ended September Interest income Loans $431,546 $531,279 $1,313,273 $1,548,510 Investment securities and federal funds 30,333 64, , ,937 Total interest income 461, ,741 1,420,072 1,759,447 Interest expense 336, ,532 1,067,787 1,525,119 Net interest income 125,225 97, , ,328 Provision for loan losses 8,498 1,564 14,132 3,574 Net interest income after provision for loan losses 116,727 95, , ,754 Non-interest income Business services income 4,825 4,852 14,443 14,424 Loan prepayment and fee income 7,580 3,938 35,103 22,631 Miscellaneous income and other gains, net 4,972 7,016 14,650 19,413 Total non-interest income 17,377 15,806 64,196 56,468 Non-interest expense Salaries and employee benefits 6,651 6,101 19,970 18,940 Other operating 9,341 6,963 28,839 17,686 Loan servicing fees paid to Associations 3,309 2,605 9,850 4,032 Loss on debt extinguishment 4,762-4,762 - Impairment losses recognized in earnings: Total other-than-temporary impairment losses (recoveries) (321) 9,234 55,107 9,234 Portion of loss recognized in other comprehensive income 5,971 - (11,322) - Net impairment losses recognized in earnings 5,650 9,234 43,785 9,234 Total non-interest expense 29,713 24, ,206 49,892 Net income $104,391 $86,548 $295,143 $237,330 The accompanying notes are an integral part of these financial statements. 6

7 STATEMENT OF CHANGES IN MEMBERS' EQUITY AgriBank, FCB (Dollars in thousands) (Unaudited) Accumulated Other Comprehensive Capital Stock and Non-other-than- Income (Loss) Other-than-temporarily- Comprehensive Participation Unallocated temporarily-impaired impaired Income Certificates Surplus Investments Investments Derivatives Total Balance at December 31, 2007 $1,073,403 $1,388,160 $(64,423) $ -- $(521) $2,396,619 Comprehensive income Net income $237, , ,330 Other comprehensive loss: Change in net unrealized losses on investment securities, net of reclassification adjustment of $9,234 (198,003) (198,003) (198,003) Change in net unrealized losses on cash flow hedges, net of reclassification adjustment of $(643) 3,164 3,164 3,164 Other comprehensive loss (194,839) Total comprehensive income $42,491 Patronage (120,271) (120,271) Cumulative effect of adoption of fair value option Capital stock/participation certificates issued 522, ,936 Capital stock/participation certificates retired (84,190) (84,190) Balance at September 30, 2008 $1,512,149 $1,505,261 $(262,426) $ -- $2,643 $2,757,627 Balance at December 31, 2008 $1,624,616 $1,537,850 $(354,731) $ -- $(40,523) $2,767,212 Cummulative effect of adoption of new investment guidance 31,520 (31,520) -- Comprehensive income Net income $295, , ,143 Other comprehensive income: Change in unrealized losses on investment securities w ith other-thantemporary impairment recognition, net of reclassification adjustment of $29,977 (4,748) (4,748) (4,748) Change in unrealized losses on investment securities not otherthan-temporarily impaired, net of reclassification adjustment of $13, , , ,033 Change in net unrealized losses on cash flow hedges, net of reclassification adjustment of $(4,207) 44,890 44,890 44,890 Other comprehensive income 188,175 Total comprehensive income $483,318 Patronage (153,252) (153,252) Capital stock/participation certificates issued 91,963 91,963 Capital stock/participation certificates retired (20,182) (20,182) Balance at September 30, 2009 $1,696,397 $1,711,261 $(206,698) $(36,268) $4,367 $3,169,059 The accompanying notes are an integral part of these financial statements. 7

8 STATEMENT OF CASH FLOWS AgriBank, FCB (Dollars in thousands) (Unaudited) Nine months ended September Cash flows from operating activities Net income $295,143 $237,330 Adjustments to reconcile net income to cash flow from operating activities: Depreciation on premises and equipment 2,114 1,727 Provision for loan losses 14,132 3,574 Increase in accrued interest receivable (1,054,392) (1,505,437) Increase in other assets (4,696) (45,279) Decrease in accrued interest payable (67,022) (43,628) Increase in other liabilities 7,901 78,151 Loss on derivative activities 943 2,282 Impairment of investments 43,785 9,234 (Gain) loss on sale of premises and equipment (2) 10 Gain on bonds held at fair value under fair value option (4,477) (1,419) Loss on debt extinguishment 4, Gain on sale of other property ow ned (4) (70) Total adjustments (1,056,956) (1,500,855) Net cash used in operating activities (761,813) (1,263,525) Cash flow s from investing activities Increase in loans, net (905,398) (6,335,772) Proceeds from sale of other property ow ned 4 70 Decrease (increase) in investment securities, net 411,990 (584,179) Purchases of premises and equipment, net (1,892) (3,585) Increase in restricted cash - (17,500) Net cash used in investing activities (495,296) (6,940,966) Cash flow s from financing activities Consolidated bonds and notes issued, net 610,933 8,191,983 Issuance of subordinated notes 500, Sale of derivatives 11,973 1,998 Cash patronage paid (153,458) (120,386) Decrease in cash collateral pledged by counterparties, net (31,310) -- Capital stock/participation certificates issued, net 71, ,746 Net cash provided by financing activities 1,009,919 8,512,341 Net (decrease) increase in cash and federal funds (247,190) 307,850 Cash and federal funds at beginning of year 728, ,082 Cash and federal funds at end of period $481,633 $1,006,932 Supplemental schedule of non-cash activities Decrease in derivative assets $64,255 $3,946 Increase in derivative liabilities 10,349 7,042 Decrease in bonds and notes related to hedging activities (118,551) (11,870) Increase in members' equity from cash flow derivatives 44,890 3,164 Increase (decrease) in members' equity from investments 143,285 (198,003) Loans transferred to other property ow ned 28, Interest capitalized to loan principal 1,093,552 1,490,838 Patronage distributions payable to members Cumulative effect of the adoption of fair value option Write-dow n of receivable -- 1,492 Investment in Farmer Mac not yet settled -- (17,500) Financed sales of other property ow ned (22,381) -- Supplemental information Interest paid $1,134,809 $1,568,747 The accompanying notes are an integral part of these financial statements. 8

9 NOTES TO FINANCIAL STATEMENTS AgriBank, FCB NOTE 1 ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES A description of our organization and operation, significant accounting policies followed, financial condition, and results of operations as of and for the year ended December 31, 2008 are contained in the 2008 annual report. These unaudited third quarter 2009 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 and conform to accounting principles generally accepted in the United States of America and prevailing practices within the financial services industry. Recent Accounting Developments Effective January 1, 2009, we adopted the Financial Accounting Standards Board (FASB) guidance on, Disclosures about Derivative Instruments and Hedging Activities, which amends and expands the disclosure requirements for derivative instruments and for hedging activities previously required. The guidance requires that an entity with derivative instruments shall disclose information to enable users of the financial statements to understand: How and why an entity uses derivative instruments How derivative instruments and related hedged items are accounted for under this Statement and related interpretations How derivative instruments and related hedged items affect an entity s financial position, financial performance, and cash flows. The adoption of this Standard did not have an impact on the financial statements; however, the derivative instruments disclosures have been expanded. Effective January 1, 2009, we adopted accounting guidance for fair value measurements of nonfinancial assets and nonfinancial liabilities. The impact of adoption resulted in additional fair value disclosures, but did not have an impact on our financial condition or results of operations. In April 2009, the FASB issued new guidance on investment fair value measurements and impairments. The new guidance was effective for interim periods ending after June 15, 2009, with early application permitted for periods ending after March 15, We adopted the new guidance during the second quarter of 2009 as described below: The FASB issued guidance, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly, which provides guidance on determining fair value when there is no active market or where the price inputs being used represent distressed sales. It reaffirms the objective of previous fair value measurement guidance, which is that fair value should reflect how much an asset would be sold for in an orderly transaction, as opposed to a distressed or forced transaction, at the date of the financial statements under current conditions. The FASB issued guidance, Recognition and Presentation of Other-Than-Temporary Impairments, which amends the other-than-temporary impairment guidance for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt securities in the financial statements, which amends existing impairment guidance by eliminating the ability and intent to hold provision and replace it with a requirement that management assert it does not have the intent to sell the security and it is more likely than not it will not have to sell the security before recovery of its cost basis. The guidance requires credit losses on other-than-temporary impairment of a debt security, measured on the basis of an entity s estimate of the decrease in expected cash flows, be recognized in earnings with the non credit portion of impairment being recognized in other comprehensive income. The guidance requires separate presentation on the income statement and accumulated other comprehensive income as well as provides for expanded disclosures for impaired securities. A cumulative-effect adjustment to reclassify the noncredit component of a previously recognized impairment was made to the opening balance of retained earnings upon adoption of this guidance. Upon implementation on April 1, 2009, we made an adjustment to increase surplus and decrease accumulated other comprehensive losses for the non-credit component of losses recognized on impaired investments totaling $31.5 million. The FASB issued guidance, Interim Disclosures about Fair Value of Financial Instruments. This guidance expands the disclosure requirements for publicly traded companies to require disclosures about fair value of financial instruments for interim reporting periods, in addition to the previously required annual disclosures. In May 2009, the FASB issued guidance, "Subsequent Events," which sets forth general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. Under this guidance, subsequent events that arise from conditions that existed at the date of the balance sheet are recognized in the financial statements, while subsequent events that arise from conditions that did not exist as of the balance sheet date are not recognized in the financial statements. This guidance, which includes a required disclosure of the date through which an entity has evaluated subsequent events, was effective for interim or annual periods ending after June 15,

10 In June 2009, the FASB issued guidance, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles. This Codification became the source of authoritative U.S. generally accepted accounting principles recognized by the FASB. This guidance is effective for financial statements issued for interim and annual periods ending after September 15, This guidance impacted how we refer to guidance in our disclosures but did not have an impact on our financial condition or results of operations. NOTE 2 LOANS AND ALLOWANCE FOR LOAN LOSSES A summary of changes in the allowance for loan losses is presented in the following table: Nine months ended September (in thousands) Balance at beginning of period $13,883 $3,162 Prov ision for loan losses 14,132 3,574 Charge-offs (4,607) (20) Recoveries Balance at end of period $23,503 $6,739 These allowance changes are reflective of increased adverse volume in the pork, dairy and ethanol sectors of the portfolio. We consider the allowance for loan losses at September 30, 2009 to be reasonable in relation to the risk in our loan portfolio. The following table presents information concerning risk loans (risk loans include nonaccrual loans, accruing restructured loans, and loans past due 90 days or more and still accruing interest): As of September (in thousands) Volume w ith specific reserv es $57,069 $196 Volume w ithout specific reserv es 66,764 17,040 Total risk loans $123,833 $17,236 Total specific reserv es $11,332 $196 For the nine months ended September (in thousands) Income on accrual risk loans $527 $135 Income on nonaccrual loans 2, Total income on risk loans $2,529 $686 Av erage recorded inv estment $71,845 $7,798 The increase in risk loans reflects stress in the pork, dairy and ethanol sectors of the portfolio. NOTE 3 INVESTMENT SECURITIES AND FEDERAL FUNDS A summary of the amortized cost and fair value of investment securities and federal funds follows. Commercial paper and other is primarily corporate and municipal obligations and term federal funds. All securities are classified as available for sale. As of September 30, 2009 Weighted Amortized Unrealized Unrealized Fair Average (in thousands) Cost Gains Losses Value Yield Federal funds $469,143 $ -- $ -- $469, % U.S. Agencies 651,334 23, , % Asset-backed securities 517,803 5, , , % Mortgage-backed securities 3,596,017 23, ,478 3,440, % Commercial paper and other 3,898,412 2, ,900, % Total $9,132,709 $55,210 $298,176 $8,889, % 10

11 As of December 31, 2008 Weighted Amortized Unrealized Unrealized Fair Av erage (in thousands) Cost Gains Losses Value Yield Federal funds $660,030 $ -- $ -- $660, % U.S. Agencies 970,084 21, , % Asset-backed securities 754, , , % Mortgage-backed securities 3,370,132 8, ,173 3,121, % Commercial paper and other 3,992,821 2, ,994, % Total $9,747,850 $32,506 $387,237 $9,393, % A summary of the investments in an unrealized loss position presented by the length of time that the investments have been in a continuous unrealized loss position at follows: As of September 30, 2009 Less than 12 months More than 12 months Fair Unrealized Fair Unrealized (in thousands) Value Losses Value Losses U.S. Agencies $ -- $ -- $ -- $ -- Asset-backed securities 58, , ,211 Mortgage-backed securities 2,129,774 6,989 1,310, ,489 Commercial paper and other 3,194, Total $5,382,195 $7,476 $1,656,856 $290,700 A summary of the contractual maturity at fair value and weighted average yield by maturity of investment securities and federal funds follows: As of September 30, 2009 Year of Maturity One Year One to Five to More Than (in thousands) or Less Five Years Ten Years Ten Years Total Federal funds $469,143 $ -- $ -- $ -- $469,143 U.S. Agencies 305, , , ,932 Asset-backed securities -- 58,709 2, , ,554 Mortgage-backed securities -- 10, ,275 3,150,519 3,440,800 Commercial paper and other 3,133, , ,900,314 Total $3,908,247 $1,095,159 $392,325 $3,494,012 $8,889,743 Weighted Av erage Yield 1.0% 1.7% 1.7% 1.8% 1.5% We evaluate our investment securities for other-than-temporary impairment on a quarterly basis. Factors considered in determining whether an impairment is other-thantemporary include: 1) the length of time and the extent to which the fair value is less than cost, 2) the financial condition and near-term prospects of the issuer and, if applicable, the financial condition of any financial guarantor, 3) the estimated cash flow projections compared to contractual cash flows, and 4) our intent to sell the impaired security and whether we are more likely than not to be required to sell the security before recovery. In addition, we qualitatively consider all available information when assessing whether impairment is other-than-temporary. Based on the results of these evaluations, if it is determined that the impairment is other-than-temporary, the loss is separated into credit-related and noncredit-related components. The credit-related portion is recognized through earnings and the non-credit related portion is recognized in other comprehensive income. The credit-related components of the other-than-temporary impairment losses were determined by projecting cash flows using cash flow models which require certain market assumptions. The significant inputs into the models include assumptions with regard to interest rates, prepayment speeds, default rates, and loss severities. The assumptions are applied at the individual security and associated collateral pool level. The unrealized losses primarily reflect concerns about the creditworthiness and liquidity of home mortgage related asset-backed and mortgage-backed securities. We determined that securities with a fair value of $107.1 million at September 30, 2009 were in an other-than-temporary loss position compared to securities with a fair value of $22.3 million at December 31, As a result of our evaluations, we have recognized $43.8 million in net impairment losses during the first nine months of 2009, reflecting a gross impairment charge in 2009 of $55.1 million, net of $11.3 million which was recognized in other comprehensive income. We have determined no other securities were in an other-than-temporary loss position at September 30,

12 The following is a roll forward of the activity during the period related to cumulative credit losses for which a portion of other-than-temporary-impairment was recognized in other comprehensive income (in thousands): Total life to date losses on impairment of inv estments at March 31, 2009 $67,870 Cumulativ e effect adjustment to income for adoption of new guidance on April 1, 2009 (31,520) Initial credit impairments at April 1, ,350 Additions for credit loss on new ly impaired securities 13,912 Additional credit losses related to prev iously impaired securities 13,808 Cummulativ e credit impairments at September 30, 2009 $64,070 NOTE 4 SUBORDINATED NOTES In July 2009, AgriBank issued $500 million of 9.125% unsecured subordinated notes due 2019, generating net proceeds of $496.8 million. The effect of the transaction increased certain regulatory capital ratios. These notes are unsecured and subordinate to all other categories of creditors, including general creditors, and senior to all classes of shareholders. Interest is payable semi-annually on January 15 and July 15 beginning on January 15, Interest is deferred if, as of the fifth business day prior to an interest payment date of the notes, any applicable minimum regulatory capital ratios are not satisfied. A deferral period may not last for more than five consecutive years or beyond the maturity date of the subordinated notes. During such a period, we may not declare or pay any dividends or patronage refunds, among certain other restrictions, until interest payments are resumed and all deferred interest has been paid. The subordinated notes are not Systemwide debt and are not obligations of any of the other Banks of the Farm Credit System. Payments on the subordinated notes are not insured by the Farm Credit Insurance Fund. AMENDED NOTE 5 CAPITAL Farm Credit Administration's capital adequacy regulations require us to maintain a permanent capital to risk-adjusted assets ratio of at least 7.0%, a total surplus to riskadjusted assets ratio of at least 7.0% and a core surplus to risk-adjusted assets ratio of at least 3.5%. In November 2009, we determined we had not accurately calculated our risk-adjusted permanent capital, total surplus and core surplus ratios with respect to the treatment of asset-backed and mortgage-backed investment securities which had credit ratings downgraded below double-b. Our amended regulatory capital ratios for the quarters ending September 30, 2009, June 30, 2009, March 31, 2009 and December 31, 2008 are presented in the following table: September 30, 2009 June 30, 2009 March 31, 2009 December 31, 2008 Amended Original Amended Original Amended Original Amended Original Permanent capital ratio 16.1% 17.7% 14.4% 15.6% 14.9% 15.3% 15.4% 15.5% Total surplus ratio 12.0% 13.8% 10.5% 11.8% 10.9% 11.3% 11.5% 11.6% Core surplus ratio 6.1% 8.1% 6.7% 8.0% 7.2% 7.7% 7.6% 7.7% These corrections do not impact the Statement of Condition or Results of Operations for any of the periods presented. After the correction of the originally reported ratios, we remained well above the regulatory minimums for all periods presented. Farm Credit Administration regulations also require us to maintain a net collateral ratio of at least 103.0%. However, we are required by our regulator to maintain a higher minimum of 104.0% during the period in which we have subordinated notes outstanding. At September 30, 2009, our net collateral ratio was 105.4%. NOTE 6 EMPLOYEE BENEFITS We participate in District-wide employee benefit plans. Our allocated portion of the benefit costs for the first nine months of 2009 was $1.7 million for pension benefits and a credit of $101.0 thousand for other postretirement benefits. NOTE 7 FAIR VALUE MEASUREMENTS Authoritative guidance on Fair Value Measurements and Disclosures defines fair value as the exchange price that would be received for an asset or paid to transfer a liability in an orderly transaction between market participants in the principal or most advantageous market for the asset or liability. The guidance also establishes a fair value hierarchy, with three levels of inputs that may be used to measure fair value. See Note 2 and Note 14 to the 2008 Annual Report to Stockholders for a more complete description. 12

13 Assets and liabilities measured at fair value on a recurring basis are summarized below: As of September 30, 2009 Fair Value Measurement Using Total Fair (in thousands) Level 1 Level 2 Level 3 Value Assets: Federal funds sold and securities purchased under resale agreements $ -- $469,143 $ -- $469,143 Inv estments av ailable for sale -- 7,616, ,612 8,420,600 Derivative assets , ,604 Total assets $ -- $8,356,955 $804,392 $9,161,347 Liabilities: Sy stemw ide debt securities $ -- $177,077 $ -- $177,077 Cash collateral pledged by counterparties 204, ,450 Deriv ativ e liabilities -- 11, ,639 Total liabilities $204,450 $188,716 $ -- $393,166 As of December 31, 2008 Fair Value Measurement Using Total Fair (in thousands) Lev el 1 Lev el 2 Lev el 3 Value Assets: Federal funds sold and securities purchased under resale agreements $ -- $660,030 $ -- $660,030 Inv estments av ailable for sale -- 7,562,897 1,170,192 8,733,089 Derivative assets ,632 1, ,832 Total assets $ -- $8,569,559 $1,171,392 $9,740,951 Liabilities: Sy stemw ide debt securities $ -- $181,553 $ -- $181,553 Cash collateral pledged by counterparties 235, ,760 Deriv ativ e liabilities -- 1, ,290 Total liabilities $235,760 $182,843 $ -- $418,603 The table below represents a reconciliation of all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3): Lev el 3 Instruments Only Total Fair Value Measurement (in thousands) Investment Securities Derivative Assets Systemwide Debt Derivative Liabilities Balance at December 31, 2008 $1,170,192 $1,200 $ -- $ -- Total gains or losses realized/unrealized: Included in earnings (43,785) (420) Included in other comprehensiv e income (208,694) Purchases, issuances and settlements (114,101) Transfers in and/or out of Lev el Balance at September 30, 2009 $803,612 $780 $ -- $ -- 13

14 Lev el 3 Instruments Only Total Fair Value Measurement (in thousands) Inv estment Securities Derivative Assets Sy stemw ide Debt Derivative Liabilities Balance at December 31, 2007 $2,170,028 $ -- $ -- $483 Impact of adoption of fair v alue guidance Balance at January 1, ,170, Total gains or losses realized/unrealized: Included in earnings (9,234) (483) Included in other comprehensiv e income (173,648) Purchases, issuances and settlements (537,375) Transfers in and/or out of Level Balance at September 30, 2008 $1,449,771 $215 $ -- $ -- Assets and liabilities measured at fair value on a non-recurring basis for each of the fair value hierarchy values are summarized below: As of September 30, 2009 Fair Value Measurement Using Total Fair Total (in thousands) Level 1 Level 2 Level 3 Value (Gains) Losses Assets: Loans $ -- $ -- $48,023 $48,023 $4,217 Other property ow ned ,546 6,546 (4) As of December 31, 2008 Fair Value Measurement Using Total Fair Total (in thousands) Lev el 1 Lev el 2 Lev el 3 Value Losses Assets: Loans $ -- $ -- $34,500 $34,500 $7,022 Loans: Represents the carrying amount and related write-downs of loans which were evaluated for individual impairment based on the appraised value of the underlying collateral. The fair value measurement would fall under level 2 of the hierarchy if the process uses independent appraisals and other market-based information. The fair value measurement would fall under level 3 of the hierarchy if the process requires significant input based on management s knowledge of and judgment about current market conditions, specific issues relating to the collateral, and other matters. When the value of the real estate, less estimated costs to sell, is less than the principal balance of the loan, a specific reserve is established. Other Property Owned: Represents the fair value and related losses of foreclosed assets that were measured at fair value based on the collateral value. Costs to sell represent transaction costs and are not included as a component of the asset s fair value. Systemwide Debt Securities Under Fair Value Option We selected certain bonds to elect fair value option under authoritative guidance. Bonds elected under the fair value option are measured at fair value. Management made this decision to increase operational efficiency related to hedge effectiveness required under derivative guidance. The book value of these bonds is $175.0 million and the fair value of these bonds is $177.1 million at September 30, NOTE 8 DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES Use of Derivatives We maintain an overall interest rate risk management strategy that incorporates the use of derivative products to minimize significant unplanned fluctuations in earnings that are caused by interest rate volatility. Our goals are to manage interest rate sensitivity by modifying the repricing or maturity characteristics of certain balance sheet assets and liabilities so that movements in interest rates do not adversely affect the net interest margin. As a result of interest rate fluctuations, hedged fixed-rate liabilities will appreciate or depreciate in market value. The effect of this unrealized appreciation or depreciation is expected to be substantially offset by our gains or losses on the derivative instruments that are linked to these hedged assets and liabilities. Another result of interest rate fluctuations is that the interest income and interest expense of hedged floating-rate liabilities will increase or decrease. The effect of this variability in earnings is expected to be substantially offset by our gains and losses on the derivative instruments that are linked to these hedged assets and liabilities. We consider the use of derivatives to be a prudent method of managing interest rate sensitivity, as it prevents earnings from being exposed to undue risk posed by changes in interest rates. 14