AgriBank, FCB. Quarterly Report September 30, 2007 MANAGEMENT'S DISCUSSION AND ANALYSIS

Transcription

1 Quarterly Report September 30, 2007 Copies of quarterly and annual reports are available upon request by contacting, 375 Jackson Street, St. Paul, Minnesota or by calling (651) Reports are also available at MANAGEMENT'S DISCUSSION AND ANALYSIS The following discussion is a review of the financial position and results of operations of. This information should be read in conjunction with the accompanying financial statements, the notes to the financial statements and the 2006 annual report. We provide funding and services to Associations in states across America s heartland. 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. AgriBank and its affiliated Associations are collectively referred to as the District. RESULTS OF OPERATIONS Our net income for the nine months ended September 30, 2007 totaled $132.5 million compared to $119.7 million for the same period in The return on average assets was 0.36% for the nine months ended September 30, 2007 compared to 0.37% for the comparable period in The following table illustrates changes in the significant components of net income (in millions): Increase (decrease) in net income 2007 vs Nine months ended September Net interest income $19.6 Provision for loan losses (0.2) Non-interest income (9.5) Operating expenses 3.0 Compensation expense (0.1) Total change in net income $12.8 Net interest income for the nine months ended September 30, 2007 increased $19.6 million or 15.6% compared to the nine months ended September 30, The increase in net interest income was due to the effects of changes in volume of $11.3 million, the effect of changes in rates of $8.1 million and a $0.2 million increase in nonaccrual income. The positive impacts on net interest income from the increase in the average daily balance of wholesale and retail loans as well as investments and federal funds was partially offset by the impact of increased debt. Information regarding the year-to-date average daily balances (ADBs) and annualized average rates earned and paid on our portfolio follows (dollars in millions): Nine months ended September 30, 2007 ADB Rate Earning assets: Wholesale loans $38, % Retail accrual loans % Retail nonaccrual loans % Investments and federal funds 9, % Total earning assets 48, % Total interest bearing liabilities 46, % Total interest rate spread 0.15% Impact of equity financing $2, % Net interest margin 0.40% Nine months ended September 30, 2006 ADB Rate Earning assets: Wholesale loans $32, % Retail accrual loans % Retail nonaccrual loans % Investments and federal funds 9, % Total earning assets 42, % Total interest bearing liabilities 40, % Total interest rate spread 0.15% Impact of equity financing $2, % Net interest margin 0.40% Net interest margin was 40 basis points for the nine months ended September 30, 2007 and The average interest rate spread was 0.15% during the first nine months of 2007 and The largest component of earning assets is wholesale loans. Our wholesale loans earned 11 basis points on average in the first nine months of Net interest income has been positively impacted by the increased volume of our wholesale loans and investments. Changes in loan volumes of this discussion. are discussed in the Loan Portfolio section Other significant changes in net income are as follows: The decrease in non-interest income results primarily from: i) a $4.7 million loss related to the first quarter 2007 purchases of Farm Credit System Financial Assistance Corporation stock held by certain District Associations, ii) a loss of $2.0 million recorded in September for our portion of the adjustment to the gain on sale of building rights and land from the FCA building association. We originally recorded a $4.3 million gain in December And iii) business services income was reduced as certain technology services transitioned to associations. The decrease in operating expense is primarily due to a decrease in salaries and employee benefits expense from a reduction in head count, which resulted from the reorganization of our Information Services Group in

2 LOAN PORTFOLIO The following table presents the components of loan volume at September 30, 2007 and December 31, 2006 (in millions): September 30, December 31, Accrual loans Wholesale $40,831.5 $36,089.4 Retail 1, Nonaccrual loans Total loan volume $41,902.7 $37,090.1 Loan volume totaled $41.9 billion at September 30, 2007, an increase of $4.8 billion from December 31, The increase in loan volume is due to our Associations retail loan volume growth as a result of strong marketing activities, competitive rates and products, and participation activity. The components of risk asset volume follow (in millions): September 30, December 31, Nonaccrual $3.9 $5.0 Accruing restructured Past due 90 days or more still accruing Total risk loans $7.3 $8.4 Other property owned Total risk assets $7.4 $8.4 Risk loans as % of total loans 0.02% 0.02% Delinquencies as a % of total loans 0.01% 0.00% Total risk assets at September 30, 2007 are slightly lower than risk assets at December 31, 2006, and are at acceptable levels. At September 30, 2007, 98.2% of nonaccrual volume was current in payment. Comparative allowance coverage of various loan categories follows: September 30, December 31, Allowance as a percentage of: Loans 0.01% 0.01% Nonaccrual loans 80.08% 60.29% Total risk loans 43.06% 36.10% 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. We consider the allowance for loan losses at September 30, 2007 to be reasonable in relation to the risk in our loan portfolio. INVESTMENT PORTFOLIO At September 30, 2007, our investment portfolio included $1.0 billion of asset-backed securities backed by home equity and subprime mortgage loans. All of these securities have various credit enhancements, which include insurance wraps, overcollateralization and priority of payments. These securities include 2nd lien positions with borrowers with FICO scores that would traditionally be considered prime borrowers and first lien positions with borrowers with FICO scores that would traditionally be considered subprime borrowers. At September 30 the fair value of this sector included a $19.9 million unrealized loss. The Bank determined that this impairment is temporary and primarily driven by a decrease in market liquidity. The Bank intends and has the ability to hold these securities to maturity. The Bank s portfolio includes three securities totaling $20 million, that have been downgraded by one or more ratings agencies, but continue to be rated AAA by S&P. S&P downgraded a number of securities in mid-october. No investments held by AgriBank were downgraded nor were on watch for downgrade. 2 AGRICULTURAL CONDITIONS The six year Farm Security and Rural Investment Act of 2002 (Farm Bill) is in its final year. The Act includes 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 a high degree of income support for major crops, which helps support credit quality and decreases the volatility of overall farm income over the term of the program. The level of government support for agriculture may change under the next Farm Bill. USDA s net farm income forecast for 2007 is $87.1 billion, a significant increase over previous forecasts and The value of agricultural production is expected to increase by $47.7 billion while expenses are expected to increase by $19.6 billion, resulting in an increase in net farm income of $28.1 billion. Ethanol prices have deteriorated relative to gasoline prices as a result of excess production capacity which may persist for two to three years. As a result, combined with increased corn prices, we anticipate producers may experience reduced profitability and in some cases, operating losses. The District s ethanol portfolio at September 30, 2007 consisted of 356 loans with $1.2 billion of outstanding principal and $1.0 billion of unfunded commitments. Of these amounts, $0.1 billion of principal and $.2 billion of unfunded commitments have been guaranteed by Farmer Mac. AgriBank s direct exposure consists of $46 million of outstanding principal and $36 million of unfunded commitments. FUNDING, LIQUIDITY AND MEMBERS EQUITY AgriBank is responsible for meeting the District's funding, liquidity and asset/liability management needs. Total members equity at September 30, 2007 was $2.4 billion, up slightly from December 31, Members equity was positively impacted during the first nine months of 2007 by net income and increased stock and participation certificates. These increases were partially offset by earnings reserved for patronage distributions and changes in other comprehensive income. At September 30, 2007, we exceeded the regulatory minimum capital ratios which are further discussed in Note 3 to the financial statements. DISCUSSIONS WITH COBANK, ACB We have engaged in discussions with CoBank, ACB, to evaluate the benefits and feasibility of combining the business operations of the two institutions. These discussions are consistent with our belief that there are further opportunities to enhance the value of the Farm Credit System and AgriBank for the benefit of our customer/owners and rural America. The focus of our discussions is on ensuring we have common business philosophies and on identifying whether and how a combination would enhance our ability to serve rural America. Management does not expect that a merger proposal, if any, would be submitted to AgriBank s Board of Directors prior to the first quarter of Any merger would be subject to a variety of conditions, including approval by each institution s Board of Directors, the FCA and each institution s voting shareholders. CoBank, ACB, one of the five Banks in the Farm Credit System, has assets in excess of $43.0 billion and capital in excess of $3.0 billion at June 30, The undersigned certify that the September 30, 2007 quarterly report of 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. Roy Tiarks L. William York Chairperson of the Board Chief Executive Officer October 31, 2007 October 31, 2007

3 STATEMENT OF CONDITION (Dollars in thousands) (Unaudited) September 30, December 31, Assets Loans $41,902,706 $37,090,083 Allowance for loan losses 3,128 3,029 Net loans 41,899,578 37,087,054 Investment securities 7,820,256 8,624,856 Cash 3,745 56,436 Federal funds 1,114, ,200 Accrued interest receivable 555, ,100 Derivative assets 14,071 4,449 Other assets 97,710 89,276 Total assets $51,505,025 $47,007,371 Liabilities Bonds and notes $48,403,413 $44,152,111 Accrued interest payable 489, ,086 Derivative liabilities 22,733 84,129 Other liabilities 192,677 99,067 Total liabilities 49,108,761 44,754,393 Contingent liabilities Members' equity Capital stock and participation certificates 1,029, ,287 Unallocated surplus 1,393,908 1,340,535 Accumulated other comprehensive loss (26,908) (19,844) Total members' equity 2,396,264 2,252,978 Total liabilities and members' equity $51,505,025 $47,007,371 The accompanying notes are an integral part of these financial statements. 3

4 STATEMENT OF INCOME (Dollars in thousands) (Unaudited) Three months Nine months Period ended September Interest income Loans $541,426 $448,160 $1,529,931 $1,209,478 Investment securities and federal funds 125, , , ,565 Total interest income 667, ,471 1,917,646 1,545,043 Interest expense 612, ,540 1,772,142 1,419,117 Net interest income 54,261 46, , ,926 Reversal of provision for loan losses - (216) - (216) Net interest income after provision for loan losses 54,261 47, , ,142 Non-interest income Business services income 4,653 6,340 14,491 19,595 Loan prepayment and fee income 1,332 1,088 3,958 3,681 Miscellaneous income and other gains, net 1,160 1,254 1,708 6,336 Total non-interest income 7,145 8,682 20,157 29,612 Non-interest expense Salaries and employee benefits 6,085 7,168 18,311 21,734 Other operating 4,985 4,608 14,357 13,955 Compensation expense Total non-interest expense 11,219 11,901 33,119 36,090 Net income $50,187 $43,928 $132,542 $119,664 The accompanying notes are an integral part of these financial statements. 4

5 STATEMENT OF CHANGES IN MEMBERS' EQUITY (Dollars in thousands) (Unaudited) Capital Stock and Accumulated Other Comprehensive Comprehensive Participation Unallocated Income (Loss) Income Certificates Surplus Investments Derivatives Total Balance at December 31, 2005 $842,505 $1,288,681 $(28,147) $10,803 $2,113,842 Comprehensive income Net income $119, , ,664 Other comprehensive loss: Change in net unrealized losses on investment securities, net of reclassification adjustment of $0 2,398 2,398 2,398 Change in net unrealized gains on cash flow hedges, net of reclassification adjustment of $3,387 2,020 2,020 2,020 Other comprehensive loss 4,418 Total comprehensive income $124,082 Patronage (64,547) (64,547) Capital stock/participation certificates issued 144, ,705 Capital stock/participation certificates retired (86,666) (86,666) Balance at September 30, 2006 $900,544 $1,343,798 $(25,749) $12,823 $2,231,416 Balance at December 31, 2006 $932,287 $1,340,535 $(30,059) $10,215 $2,252,978 Comprehensive income Net income $132, , ,542 Other comprehensive income: Change in net unrealized losses on investment securities, net of reclassification adjustment of $0 (2,561) (2,561) (2,561) Change in net unrealized gains on cash flow hedges, net of reclassification adjustment of $(3,687) (4,503) (4,503) (4,503) Other comprehensive income (7,064) Total comprehensive income $125,478 Patronage (79,169) (79,169) Capital stock/participation certificates issued 119, ,749 Capital stock/participation certificates retired (22,772) (22,772) Balance at September 30, 2007 $1,029,264 $1,393,908 $(32,620) $5,712 $2,396,264 The accompanying notes are an integral part of these financial statements. 5

6 STATEMENT OF CASH FLOWS (Dollars in thousands) (Unaudited) Nine months ended September Cash flows from operating activities Net income $132,542 $119,664 Adjustments to reconcile net income to cash flow from operating activities: Depreciation on premises and equipment 1,879 1,906 Reversal of provision for loan losses -- (216) Increase in accrued interest receivable (1,488,622) (1,171,553) Increase in other assets (8,589) (19,607) Increase in accrued interest payable 70, ,647 Increase in other liabilities 93,776 7,929 Gain on derivative activities (3,192) (1,003) Loss (gain) on sale of premises and equipment 23 (4) Loss on Farm Credit System Financial Assistance Corporation stock 4, Loss on sale of other property owned Total adjustments (1,329,206) (1,080,901) Net cash used in by operating activities (1,196,664) (961,237) Cash flows from investing activities Increase in loans, net (3,395,030) (3,184,896) Purchases of other property owned (10) -- Decrease (Increase) in investment securities 802,039 (1,827,654) Purchases of premises and equipment, net (1,684) (1,263) Purchases of Farm Credit System Financial Assistance Corporation stock (4,657) -- Net cash used in investing activities (2,599,342) (5,013,813) Cash flows from financing activities Consolidated bonds and notes issued, net 4,178,971 5,779,097 Cash patronage paid (79,333) (64,670) Capital stock/participation certificates issued, net 96,977 58,039 Net cash provided by financing activities 4,196,615 5,772,466 Net increase (decrease) in cash and federal funds 400,609 (202,584) Cash and federal funds at beginning of year 717, ,484 Cash and federal funds at end of period $1,118,245 $752,900 Supplemental schedule of non-cash activities Increase in derivative assets $(9,622) $(1,409) Decrease in derivative liabilities (61,396) (52,188) Increase in bonds and notes related to hedging activities 72,331 50,574 (Decrease) increase in members' equity from cash flow derivatives (4,503) 2,020 (Decrease) increase in members' equity from investments (2,561) 2,398 Loans transferred to other property owned Interest capitalized to loan principal 1,417,557 1,062,996 Patronage distributions payable to members Supplemental information Interest paid $1,701,290 $1,317,470 The accompanying notes are an integral part of these financial statements. 6

7 NOTES TO FINANCIAL STATEMENTS NOTE 1 ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES A description of our organization and operation, significant accounting policies followed, and financial condition and results of operations as of and for the year ended December 31, 2006 are contained in the 2006 annual report. These unaudited third quarter 2007 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 generally accepted accounting principles and prevailing practices within the banking industry. NOTE 2 ALLOWANCE FOR LOAN LOSSES A summary of changes in the allowance for loan losses is presented in the following table (in thousands): Nine months ended September Balance at beginning of period $3,029 $3,141 Reversal of provision for loan losses -- (216) Charge-offs (22) (179) Recoveries Balance at end of period $3,128 $3,001 NOTE 3 CAPITAL Farm Credit Administration's capital adequacy regulations require us to maintain permanent capital of at least 7% of risk-adjusted assets, 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 September 30, 2007, we exceeded these requirements with a 19.9% permanent capital ratio, 19.8% total surplus ratio, and 11.8% core surplus ratio. Farm Credit Administration regulations also require us to maintain a net collateral ratio of at least 103.0%. At September 30, 2007 this requirement was exceeded with a net collateral ratio of 104.7%. NOTE 4 EMPLOYEE BENEFIT PLANS We participate in District-wide employee benefit plans. Our allocated portion of the benefit costs for the first nine months of 2007 was $2.0 million for pension benefits and $47.4 thousand for other postretirement benefits. Total District net periodic benefit costs for the District plans in which we participate included the following components (in thousands): Pension Other Nine months ended September 30, 2007 Benefits Benefits Components of net periodic benefit cost Service cost $14,688 $413 Interest cost 25,876 1,583 Expected return on plan assets (31,035) (311) Amortization of prior service cost 475 (507) Amortization of loss or (gain) 7,686 (48) Net periodic benefit cost $17,690 $1,130 The amount of total employer contributions to be paid during 2007 for the benefit plans of the District that we participate in are expected to be $13.6 million for pension benefits and $1.5 million for other postretirement benefits. On September 30, 2006, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 158 Employers Accounting for Defined Benefit Pension and Other Postretirement Plans. The Standard requires an employer to recognize the overfunded or underfunded status of a defined benefit pension or other postretirement plan as an asset or liability in its statement of financial position and recognize changes in that funded status in the year in which the changes occur through other comprehensive income. The Standard is effective for employers with publicly traded securities for the fiscal year ending after December 15, 2006 and for employers without publicly traded securities for the fiscal year ending after June 15, In addition, this Standard requires that the funded status of a plan be measured as of the date of the year-end financial statements. Currently, we use a measurement date of September 30th. The requirement to measure the funded status as of the fiscal year-end is effective for fiscal years ending after December 15, It is anticipated that the implementation of this Standard will have no impact on the Consolidated Statement of Income. Our defined benefit plan and other post-employer benefit plans are multi-employer plans. Accordingly, the underfunded status of the plans will be recorded at the District level only. 7

8 NOTE 5 FARM CREDIT SYSTEM FINANCIAL ASSISTANCE CORPORATION STOCK TRANSACTIONS In October 2006, the Board of Directors authorized to offer to purchase all Farm Credit System Financial Assistance Corporation (FAC) stock held by certain District associations at a purchase price equal to approximately 71% of the face value of that stock. Legislation in 1987 had required certain associations to purchase stock to capitalize the Farm Credit System Financial Assistance Corporation. We incurred $5.3 million of expense in December 2006 and $4.7 million in January and February of 2007 to purchase all outstanding FAC stock. The Farm Credit Act sets out a formula for retirement of this stock at full face value; however, due to uncertainty regarding the timing of the stock retirement this stock has been and will continue to be recorded at zero book value. As a result, we recorded a loss of $4.7 million in the first quarter of 2007, which has been included in Miscellaneous income and other gains, net on the Statement of Income. 375 Jackson Street St. Paul, Minnesota (651) Visit us at