AgCarolina Farm Credit, ACA THIRD QUARTER 2018

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1 AgCarolina Farm Credit, ACA THIRD QUARTER 2018 TABLE OF CONTENTS Report on Internal Control Over Financial Reporting... 2 Management s Discussion and Analysis of Financial Condition and Results of Operations... 3 Consolidated Financial Statements Consolidated Balance Sheets... 7 Consolidated Statements of Comprehensive Income... 8 Consolidated Statements of Changes in Members Equity... 9 Notes to the Consolidated Financial Statements CERTIFICATION The undersigned certify that we have reviewed the September 30, 2018 quarterly report of AgCarolina Farm Credit, ACA, that the report has been prepared under the oversight of the Audit Committee of the Board of Directors and in accordance with all applicable statutory or regulatory requirements, and that the information contained herein is true, accurate, and complete to the best of our knowledge and belief. Paul A. Drake Chairman of the Board David W. Corum President Chief Executive Officer Matthew J. Currin Senior Vice President Chief Financial Officer November 8, 2018 AgCarolina Farm Credit, ACA 1

2 AgCarolina Farm Credit, ACA Report on Internal Control Over Financial Reporting The Association s principal executives and principal financial officers, or persons performing similar functions, are responsible for establishing and maintaining adequate internal control over financial reporting for the Association s Consolidated Financial Statements. For purposes of this report, internal control over financial reporting is defined as a process designed by, or under the supervision of the Association s principal executives and principal financial officers, or persons performing similar functions, and effected by its Board of Directors, management and other personnel. This process provides reasonable assurance regarding the reliability of financial reporting information and the preparation of the Consolidated Financial Statements for external purposes in accordance with accounting principles generally accepted in the United States of America. The Association s management has completed an assessment of the effectiveness of internal control over financial reporting as of September 30, In making the assessment, management used the framework in Internal Control Integrated Framework (2013), promulgated by the Committee of Sponsoring Organizations of the Treadway Commission, commonly referred to as the COSO criteria. Based on the assessment performed, the Association s management concluded that as of September 30, 2018, the internal control over financial reporting was effective based upon the COSO criteria. Additionally, based on this assessment, the Association s management determined that there were no material weaknesses in the internal control over financial reporting as of September 30, Internal control over financial reporting includes those policies and procedures that: (1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Association, (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial information in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures are being made only in accordance with authorizations of management and directors of the Association, and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Association s assets that could have a material effect on its Consolidated Financial Statements. David W. Corum President Chief Executive Officer Matthew J. Currin Senior Vice President Chief Financial Officer November 8, 2018 AgCarolina Farm Credit, ACA 2

3 AgCarolina Farm Credit, ACA Management s Discussion and Analysis of Financial Condition and Results of Operations (dollars in thousands) The following commentary reviews the financial condition and results of operations of AgCarolina Farm Credit, ACA (Association) for the nine months ended September 30, These comments should be read in conjunction with the accompanying financial statements, notes to the financial statements and the 2017 annual report of the Association. LOAN PORTFOLIO The Association provides funds to farmers, rural homeowners, and farm-related businesses for financing of short and intermediate-term loans and long-term real estate mortgage loans. The five predominant commodities in the portfolio are tobacco, forestry, poultry, soybeans and corn, which constitute $676,300 or percent, of the loan portfolio as of September 30, Other major farm commodities include swine, cotton, and sweet potatoes. Farm size varies and many of the borrowers in the region have diversified farming operations. This factor, along with the numerous opportunities for non-farm income in the area, somewhat reduces the level of dependency on a given commodity. The net loan volume of the Association as of September 30, 2018 was $1,194,210, an increase of $73,710 or 6.58 percent as compared to $1,120,500 at December 31, Net loans accounted for percent of total assets at September 30, 2018 as compared to percent of total assets at December 31, The increase in net loan volume during the reporting period is primarily attributed to seasonal lending. The short-term portfolio, which is heavily influenced by operating-type loans, normally reaches a peak in August and declines in the fall and winter months as farm commodities are marketed and proceeds are applied to the operating loans. There is an inherent risk in the extension of any type of credit. Portfolio credit quality continues to be maintained at an acceptable level, however, and credit administration remains satisfactory. Nonaccrual loans remained flat at $26,927 from December 31, 2017 to September 30, The balance has fluctuated during this time but has remained flat due to offsetting transfers of loans in to nonaccrual and transfers out of nonaccrual, including one large liquidation. Association management maintains an allowance for loan losses at a level considered sufficient to absorb possible losses in the loan portfolio based on current and expected future conditions. The allowance for loan losses at September 30, 2018 was $13,528, as compared to $12,271 at December 31, 2017, an increase of $1,257. The main reason for this increase was an allowance provision of $779 and net recoveries of $478. The ratio of the allowance for loan losses to total loans at September 30, 2018 was 1.12 percent, which was slightly higher than the prior year end. The allowance was considered by management to be adequate to cover possible losses. Other property owned was $20 as of September 30, 2018, which was down $88 from the outstanding balance of $108 at December 31, The decrease was the result of the sale of one property and the write down of another. RESULTS OF OPERATIONS For the three months ended September 30, 2018 Net income for the three months ended September 30, 2018 totaled $5,471, an increase of $107 or 1.99 percent, as compared to the same period of The primary reasons for the increase in net income as compared to the previous period is due to an increase in net interest income which was related to the collection of a large nonaccrual loan and a decrease in the provision for loan losses. For the three months ended September 30, 2018, total interest income increased by $1,699 compared to the same period of The increase in interest income is mainly due to increased nonaccrual loan interest income related to the income from a nonaccrual loan liquidation as well as increased market rates. Interest income from nonaccrual loans was $173 for the three months ended September 30, 2018, an increase of $153 from the same period of Interest expense increased $1,095 for the three months ended September 30, 2018, as compared to the same period of The increase in interest expense is mainly attributed to the increase in the direct note due to loan volume growth as well as increased interest rates. Noninterest income for the three months ended September 30, 2018 totaled $2,551 as compared to $2,542 for the same period of 2017, an increase of $9. The overall increase is primarily due to gains on other transactions and an increase in patronage refunds, which was offset by a decrease in loan fees and fees for financially related services. Loan fees and fees for financially related services decreased a combined $47 for the period as compared to the prior year. AgCarolina Farm Credit, ACA 3

4 Noninterest expense for the three months ended September 30, 2018 was $5,022, an increase of $269, or 5.65 percent as compared to the same period of This increase is due to increases in Salaries and employee benefits of $331 and other operating expenses of $101. These were offset by decreases in Insurance Fund premiums of $135 and a decrease of $13 in losses on other property owned. For the nine months ended September 30, 2018 Net income for the nine months ended September 30, 2018 totaled $17,523, an increase of $3,145, or percent, as compared to the same period of The primary reasons for the increase in net income were increases in net interest income of $2,861, an increase in noninterest income of $442, and a decrease in provision for loan losses of $489. At September 30, 2018, total interest income increased by $5,431 compared to the same period in The increase in interest income is mainly due to an increase in nonaccrual interest income and an increase in interest rates. Interest income from nonaccrual loans was $2,382 as of September 30, 2018, an increase of $1,764 from the same period of Interest expense increased $2,570 for the first nine months in 2018, as compared to the same period of The increase in interest expense is attributed to the increase in the direct note as a result of loan growth as well as increased interest rates. Noninterest income for the nine months ended September 30, 2018 totaled $8,816 as compared to $8,374 for the same period of 2017, an increase of $442. The increase is primarily due to an increase in the Insurance Fund refund and gains on sales of premises and equipment related to the sale of a vacant branch building, which were offset by a $283 reduction in loan fees and fees for financially related services. Noninterest expense for the nine months ended September 30, 2018 was $15,493, an increase of $644 as compared to the same period of Salaries and employee benefits totaled $11,144 for the nine months ended September 30, 2018, for an increase of $947 or 9.29 percent, as compared to the same period of The increase is primarily due to increased salaries for additional hiring in the third quarter. Funding Sources The principal source of funds for the Association is the borrowing relationship established with the Bank through a General Financing Agreement. The General Financing Agreement utilizes the Association's credit and fiscal performance as criteria for establishing a line of credit on which the Association may draw funds. The funds are advanced by the Bank to the Association in the form of notes payable. The notes payable are segmented into variable rate and fixed rate sections. The variable rate note is utilized by the Association to fund variable rate loan advances and operating funds requirements. The fixed rate note is used specifically to fund fixed rate loan advances made by the Association. The total notes payable to the Bank at September 30, 2018 was $959,775 as compared to $885,588 at December 31, The 8.38 percent increase during the period was a result of an increase in loan volume since December 31, The Association has no lines of credit outstanding with third parties as of September 30, CAPITAL RESOURCES Total members' equity at September 30, 2018, increased 6.95 percent to $280,790 from the December 31, 2017, total of $262,549. The increase is attributed to the net of an increase in retained earnings related to net income and a slight increase in preferred stock. Preferred stock was $33,028 as of September 30, 2018, as compared to $32,020 on December 31, 2017, for an increase of 3.15 percent. Farm Credit Administration (FCA) regulations require all Farm Credit institutions to maintain minimum capital ratios, which are shown in the table below. As of September 30, 2018, all capital ratios were well above the minimum regulatory requirements. If the capital ratios fall below the minimum regulatory requirements, including the buffer amounts, capital distributions (equity redemptions, dividends, and patronage) and discretionary senior executive bonuses are restricted or prohibited without prior FCA approval. LIQUIDITY AND FUNDING SOURCES Liquidity Liquidity management is the process whereby funds are made available to meet all financial commitments including the extension of credit, payment of operating expenses and payment of debt obligations. The Association receives access to funds through its borrowing relationship with AgFirst Farm Credit Bank (Bank) and from income generated by operations. Sufficient liquid funds have been available to meet all financial obligations. AgCarolina Farm Credit, ACA 4

5 The following sets forth the regulatory capital ratios, which were effective January 1, 2017: Minimum Requirement Capital Conservation Buffer* Minimum Requirement with Capital Conservation Buffer Capital Ratios as of September 30, 2018 Ratio Risk-adjusted ratios: CET1 Capital 4.5% 0.625% 5.125% 18.69% Tier 1 Capital 6.0% 0.625% 6.625% 18.69% Total Capital 8.0% 0.625% 8.625% 19.76% Permanent Capital Ratio 7.0% 0.0% 7.0% 21.66% Non-risk-adjusted: Tier 1 Leverage Ratio 4.0% 1.0% 5.0% 18.83% UREE Leverage Ratio 1.5% 0.0% 1.5% 18.98% * - The capital conservation buffers have a 3 year phase-in period and will become fully effective January 1, Riskadjusted ratio minimums will increase 0.625% each year until fully phased in. There is no phase-in period for the tier 1 leverage ratio. REGULATORY MATTERS On May 10, 2018, the Farm Credit Administration adopted a final rule that amends the regulations governing investments of System banks and associations. The final rule strengthens eligibility criteria for the investments the banks may purchase and hold. It also implements Section 939A of the Dodd-Frank Act by removing references to and requirements for credit ratings and substitutes the eligibility requirement with other appropriate standards of credit worthiness. In addition, it grants associations greater flexibility regarding the risk management purposes for investments and limits the type and amount of investments that an association may hold. Only securities that are issued by, or are unconditionally guaranteed or insured as to the timely payment of principal and interest by, the U.S. government or its agencies are eligible for association risk management purposes. An association may purchase and hold investments not to exceed 10 percent of its 90-day average daily balance of outstanding loans on the last business day of the quarter. The final rule will become effective January 1, RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS Please refer to Note 1, Organization, Significant Accounting Policies, and Recently Issued Accounting Pronouncements, in the Notes to the Financial Statements, and the 2017 Annual Report to Shareholders for recently issued accounting pronouncements. Additional information is provided in the table below. The following ASUs were issued by the Financial Accounting Standards Board (FASB) but have not yet been adopted: Summary of Guidance Adoption and Potential Financial Statement Impact ASU Financial Instruments Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments Replaces multiple existing impairment standards by establishing a single The Association has begun implementation efforts by establishing a framework for financial assets to reflect management s estimate of current expected credit losses (CECL) over the complete remaining life of the financial assets. Changes the present incurred loss impairment guidance for loans to a cross-discipline governance structure. The Association is currently identifying key interpretive issues, and assessing existing credit loss forecasting models and processes against the new guidance to determine what modifications may be required. CECL model. The Association expects that the new guidance will result in an increase The Update also modifies the other-than-temporary impairment model for in its allowance for credit losses due to several factors, including: debt securities to require an allowance for credit impairment instead of a direct write-down, which allows for reversal of credit impairments in future periods based on improvements in credit. Eliminates existing guidance for purchased credit impaired (PCI) loans, 1. The allowance related to loans and commitments will most likely increase to cover credit losses over the full remaining expected life of the portfolio, and will consider expected future changes in macroeconomic conditions, and requires recognition of an allowance for expected credit losses on these financial assets. 2. An allowance will be established for estimated credit losses on any debt securities, Requires a cumulative-effect adjustment to retained earnings as of the beginning of the reporting period of adoption. Effective for fiscal years beginning after December 15, 2020, and interim 3. The nonaccretable difference on any PCI loans will be recognized as an allowance, offset by an increase in the carrying value of the related loans. periods within those fiscal years. Early application will be permitted for The extent of the increase is under evaluation, but will depend upon the fiscal years, and interim periods within those fiscal years, beginning after December 15, nature and characteristics of the Association s portfolio at the adoption date, and the macroeconomic conditions and forecasts at that date. The Association expects to adopt the guidance in first quarter AgCarolina Farm Credit, ACA 5

6 ASU Leases (Topic 842) Requires lessees to recognize leases on the balance sheet with lease The practical expedients allow entities to largely account for existing liabilities and corresponding right-of-use assets based on the present value leases consistent with current guidance, except for the incremental of lease payments. balance sheet recognition for lessees. Lessor accounting activities are largely unchanged from existing lease The Association has started its implementation of the Update which has accounting. included an initial evaluation of leasing contracts and activities. The Update also eliminates leveraged lease accounting but allows existing As a lessee the Association is developing its methodology to estimate the leveraged leases to continue their current accounting until maturity, right-of-use assets and lease liabilities, which is based on the present termination or modification. value of lease payments but does not expect a material change to the Also, expands qualitative and quantitative disclosures of leasing timing of expense recognition. arrangements. Given the limited changes to lessor accounting, the Association does not Requires adoption using a modified cumulative effect approach wherein expect material changes to recognition or measurement, but the the guidance is applied to all periods presented. A recent amendment implementation process and the impact will continue to be evaluated. provides an additional (and optional) transition method to adopt the new The Association is evaluating existing disclosures and may need to leases standard. Under this new transition method, an entity initially provide additional information as a result of adopting the Update. applies the new leases standard at the adoption date and recognizes a The Association expects to adopt the guidance in first quarter 2019 using cumulative-effect adjustment to the opening balance of retained earnings the optional modified retrospective method and practical expedients for in the period of adoption. transition. Effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. NOTE: Shareholder investment in the Association is materially affected by the financial condition and results of operations of AgFirst Farm Credit Bank. Copies of AgFirst s annual and quarterly reports are available upon request free of charge by calling , ext. 2764, or writing Matthew Miller, AgFirst Farm Credit Bank, P.O. Box 1499, Columbia, SC Information concerning AgFirst Farm Credit Bank can also be obtained at their website, Copies of the Association s annual and quarterly reports are also available upon request free of charge by calling , writing Matthew J. Currin, AgCarolina Farm Credit, ACA, P. O. Box 14789, Raleigh, NC 27620, or accessing the website, The Association prepares a quarterly report within 40 days after the end of each fiscal quarter, except that no report need be prepared for the fiscal quarter that coincides with the end of the fiscal year of the institution. AgCarolina Farm Credit, ACA 6

7 AgCarolina Farm Credit, ACA Consolidated Balance Sheets September 30, December 31, (dollars in thousands) (unaudited) (audited) Assets Cash $ 1,073 $ 5,853 Loans 1,207,738 1,132,771 Allowance for loan losses (13,528) (12,271) Net loans 1,194,210 1,120,500 Accrued interest receivable 21,595 15,808 Equity investments in other Farm Credit institutions 12,940 12,950 Premises and equipment, net 10,522 10,158 Other property owned Accounts receivable 5,587 15,919 Other assets 4,730 4,316 Total assets $ 1,250,677 $ 1,185,612 Liabilities Notes payable to AgFirst Farm Credit Bank $ 959,775 $ 885,588 Accrued interest payable 2,479 2,061 Patronage refunds payable ,435 Accounts payable 816 2,084 Other liabilities 6,710 12,895 Total liabilities 969, ,063 Commitments and contingencies (Note 7) Members' Equity Capital stock and participation certificates 36,525 35,474 Retained earnings Allocated 159, ,279 Unallocated 84,834 67,796 Total members' equity 280, ,549 Total liabilities and members' equity $ 1,250,677 $ 1,185,612 The accompanying notes are an integral part of these consolidated financial statements. AgCarolina Farm Credit, ACA 7

8 AgCarolina Farm Credit, ACA Consolidated Statements of Comprehensive Income (unaudited) For the three months For the nine months ended September 30, ended September 30, (dollars in thousands) Interest Income Loans $ 15,552 $ 13,853 $ 44,559 $ 39,128 Interest Expense Notes payable to AgFirst Farm Credit Bank 7,372 6,277 19,577 17,007 Net interest income 8,180 7,576 24,982 22,121 Provision for loan losses ,268 Net interest income after provision for loan losses 7,946 7,576 24,203 20,853 Noninterest Income Loan fees ,033 2,187 Fees for financially related services Patronage refunds from other Farm Credit institutions 1,981 1,950 5,562 5,573 Gains (losses) on sales of premises and equipment, net Gains (losses) on other transactions Insurance Fund refund 736 Total noninterest income 2,551 2,542 8,816 8,374 Noninterest Expense Salaries and employee benefits 3,579 3,248 11,144 10,197 Occupancy and equipment Insurance Fund premiums (Gains) losses on other property owned, net 13 (24) 13 Other operating expenses ,037 2,856 Total noninterest expense 5,022 4,753 15,492 14,848 Income before income taxes 5,475 5,365 17,527 14,379 Provision for income taxes Net income 5,471 5,364 17,523 14,378 Other comprehensive income Comprehensive income $ 5,471 $ 5,364 $ 17,523 $ 14,378 The accompanying notes are an integral part of these consolidated financial statements. AgCarolina Farm Credit, ACA 8

9 AgCarolina Farm Credit, ACA Consolidated Statements of Changes in Members Equity (unaudited) Capital Stock and Retained Earnings Total Participation Members' (dollars in thousands) Certificates Allocated Unallocated Equity Balance at December 31, 2016 $ 46,646 $ 150,444 $ 67,062 $ 264,152 Comprehensive income 14,378 14,378 Capital stock/participation certificates issued/(retired), net (9,906) (9,906) Dividends declared/paid 333 (333) Patronage distribution adjustment 109 (216) (107) Balance at September 30, 2017 $ 37,073 $ 150,553 $ 80,891 $ 268,517 Balance at December 31, 2017 $ 35,474 $ 159,279 $ 67,796 $ 262,549 Comprehensive income 17,523 17,523 Capital stock/participation certificates issued/(retired), net Dividends declared/paid 333 (333) Patronage distribution adjustment 152 (152) Balance at September 30, 2018 $ 36,525 $ 159,431 $ 84,834 $ 280,790 The accompanying notes are an integral part of these consolidated financial statements. AgCarolina Farm Credit, ACA 9

10 AgCarolina Farm Credit, ACA Notes to the Consolidated Financial Statements (dollars in thousands, except as noted) (unaudited) Note 1 Organization, Significant Accounting Policies, and Recently Issued Accounting Pronouncements Organization The accompanying financial statements include the accounts of AgCarolina Farm Credit, ACA and its Production Credit Association (PCA) and Federal Land Credit Association (FLCA) subsidiaries (collectively, the Association). A full description of the organization and operations, the significant accounting policies followed, and the financial condition and results of operations for the Association as of and for the year ended December 31, 2017, are contained in the 2017 Annual Report to Shareholders. These unaudited interim consolidated financial statements should be read in conjunction with the latest Annual Report to Shareholders. Basis of Presentation In the opinion of management, the accompanying consolidated financial statements contain all adjustments necessary for a fair statement of results for the periods presented. These adjustments are of a normal recurring nature, unless otherwise disclosed. Certain amounts in the prior period s consolidated financial statements may have been reclassified to conform to the current period presentation. Such reclassifications had no effect on the prior period net income or total capital as previously reported. The results of any interim period are not necessarily indicative of those to be expected for a full year. Significant Accounting Policies The Association s accounting and reporting policies conform with U.S. generally accepted accounting principles (GAAP) and practices in the financial services industry. To prepare the financial statements in conformity with GAAP, management must make estimates based on assumptions about future economic and market conditions (for example, unemployment, market liquidity, real estate prices, etc.) that affect the reported amounts of assets and liabilities at the date of the financial statements, income and expenses during the reporting period, and the related disclosures. Although these estimates contemplate current conditions and expectations of change in the future, it is reasonably possible that actual conditions may be different than anticipated, which could materially affect results of operations and financial condition. Management has made significant estimates in several areas, including loans and allowance for loan losses (Note 2, Loans and Allowance for Loan Losses), investment securities and other-than-temporary impairment (Note 3, Investments), and financial instruments (Note 5, Fair Value Measurement). Actual results could differ from those estimates. For further details of significant accounting policies, see Note 2, Summary of Significant Accounting Policies, from the latest Annual Report. Accounting Standards Updates (ASUs) Issued During the Period The following ASUs were issued by the Financial Accounting Standards Board (FASB) since the most recent year end: In August 2018, the FASB issued ASU Intangibles Goodwill and Other Internal-Use Software (Subtopic ): Customer s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. The amendments align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). The accounting for the service element of a hosting arrangement that is a service contract is not affected by the amendments in this Update. The guidance is effective for public business entities for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted, including adoption in any interim period, for all entities. The amendments should be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption. In August 2018, the FASB issued ASU Disclosure Framework Changes to the Disclosure Requirements for Fair Value Measurement. The amendments are part of the FASB s disclosure framework project. The project s objective and primary focus are to improve the effectiveness of disclosures in the notes to financial statements by facilitating clear communication of the information required by GAAP that is most important to users of each entity s financial statements. The amendments remove, modify or add certain disclosures contained in the financial statement footnotes related to fair value. Additionally, the guidance is intended to promote the appropriate exercise of discretion by entities when considering fair value measurement disclosures and to clarify that materiality is an appropriate consideration of entities and their auditors when evaluating disclosure AgCarolina Farm Credit, ACA 10

11 requirements. The amendments are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, Certain amendments should be applied prospectively for only the most recent interim or annual period presented in the initial fiscal year of adoption. All other amendments should be applied retrospectively to all periods presented upon their effective date. Entities may early adopt the provisions in whole upon issuance or may early adopt any removed or modified disclosures upon issuance and delay adoption of the additional disclosures until their effective date. In July 2018, the FASB issued ASU Leases (Topic 842): Targeted Improvements. The amendments are intended to reduce costs and ease implementation of the leases standard for financial statement preparers. It addresses certain areas identified as possible sources of unnecessary cost or complexity in the standard. Specifically, the amendments provide an option to apply the transition provisions of the new standard at its adoption date instead of at the earliest comparative period presented in its financial statements and a practical expedient that permits lessors to not separate nonlease components from the associated lease component if certain conditions are met. For entities that have not adopted Topic 842 before the issuance of this Update, the effective date and transition requirements for the amendments related to separating components of a contract are the same as the effective date and transition requirements in ASU In July 2018, the FASB issued ASU Codification Improvements to Topic 842, Leases. The amendments affect narrow aspects of the guidance issued in ASU Specifically, the Update corrects, clarifies or changes inconsistent language to improve application of the guidance in ASU For entities that have not adopted Topic 842, the effective date and transition requirements will be the same as the effective date and transition requirements in ASU In July 2018, the FASB issued ASU Codification Improvements. The amendments affect a wide variety of Topics in the Codification. They apply to all reporting entities within the scope of the affected accounting guidance. The Board has an ongoing project on its agenda about improvements to clarify the Codification or to correct unintended application of guidance. Those items generally are not expected to have a significant effect on current accounting practice. The transition and effective date guidance is based on the facts and circumstances of each amendment. In February 2018, the FASB issued ASU Technical Corrections and Improvements to Financial Instruments Overall (Subtopic ): Recognition and Measurement of Financial Assets and Financial Liabilities. The amendments in this Update include items brought to the Board s attention by stakeholders. The amendments clarify certain aspects of the guidance issued in Update The amendments are effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years beginning after June 15, All entities may early adopt these amendments for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years, as long as they have adopted Update In February 2018, the FASB issued ASU Income Statement Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. The guidance allows a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act. The amendments eliminate the stranded tax effects resulting from the Tax Cuts and Jobs Act and are intended to improve the usefulness of information reported to financial statement users. However, because the amendments only relate to the reclassification of the income tax effects of the Tax Cuts and Jobs Act, the underlying guidance that requires that the effect of a change in tax laws or rates be included in income from continuing operations is not affected. The Update also requires certain disclosures about stranded tax effects. The guidance is effective for all entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted. ASUs Pending Effective Date For a detailed description of the ASUs below, see the latest Annual Report. Potential effects of ASUs issued in previous periods: In March 2017, the FASB issued ASU Receivables Nonrefundable Fees and Other Costs (Subtopic ): Premium Amortization on Purchased Callable Debt Securities. The guidance relates to certain callable debt securities and shortens the amortization period for any premium to the earliest call date. The Update will be effective for interim and annual periods beginning after December 15, 2018 for public business entities. Early adoption is permitted. The Association is in the process of evaluating what effects the guidance may have on the statements of financial condition and results of operations. In June 2016, the FASB issued ASU Financial Instruments Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. This Update is intended to improve financial reporting by requiring timelier recording of credit losses on financial instruments. It requires an organization to measure all expected credit losses for financial assets held at the reporting date. Financial institutions and other organizations will use forward-looking information to AgCarolina Farm Credit, ACA 11

12 better estimate their credit losses. Additionally, the ASU amends the accounting for credit losses on available-forsale debt securities and purchased financial assets with credit deterioration. For public companies that are not SEC filers, it will take effect for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. Early application will be permitted for all organizations for fiscal years, and interim periods within those fiscal years, beginning after December 15, The Association is in the process of evaluating what effects the guidance may have on the statements of financial condition and results of operations. In February 2016, the FASB issued ASU Leases (Topic 842). This Update, and subsequent clarifying guidance issued, requires organizations that lease assets to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases. Leases will be classified as either finance leases or operating leases. This distinction will be relevant for the pattern of expense recognition in the income statement. The amendments will be effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years for public business entities. Early adoption is permitted. The Association is in the process of evaluating what effects the guidance may have on the statements of financial condition and results of operations. Accounting Standards Effective During the Period There were no changes in the accounting principles applied from the latest Annual Report, other than any discussed below. No recently adopted accounting guidance issued by the FASB had a significant effect on the current period reporting. See the most recent Annual Report for a detailed description of each of the standards below: In February 2017, the FASB issued ASU Other Income Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic ): Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets. The Update clarifies whether certain transactions are within the scope of the guidance on derecognition and the accounting for partial sales of nonfinancial assets, and defines the term in substance nonfinancial asset. The amendments conform the derecognition guidance on nonfinancial assets with the model for transactions in the new revenue standard. The amendments were effective January 1, 2018 for the Association. Adoption in 2018 had no impact on the statements of financial condition and results of operations of the Association. In January 2017, the FASB issued ASU Business Combinations (Topic 805): Clarifying the Definition of a Business. The amendments provide a more robust framework to use in determining when a set of assets and activities is a business. They also support more consistency in applying the guidance, reduce the costs of application, and make the definition of a business more operable. The ASU was effective January 1, 2018 for the Association. The amendments were applied prospectively. Adoption of the guidance in 2018 had no impact on the statements of financial condition and results of operations. In January 2016, the FASB issued ASU Financial Instruments Overall (Subtopic ): Recognition and Measurement of Financial Assets and Financial Liabilities. The Update was intended to improve the recognition and measurement of financial instruments. The new guidance makes targeted improvements to existing GAAP. Transition Information The Association identified investment securities affected by this Update and adopted the guidance on January 1, The amendments related to equity securities without readily determinable fair values were applied prospectively to equity investments that existed as of the date of adoption. Application of the amendments did not require a cumulative effect adjustment. Adoption did not have an impact on the Association's financial condition or results of operations. The new standard did result in changes to certain disclosures. In May 2014, the FASB issued ASU Revenue from Contracts with Customers (Topic 606). This guidance changed the recognition of revenue from contracts with customers. The core principle of the guidance is that an entity should recognize revenue to reflect the transfer of goods and services to customers in an amount equal to the consideration the entity receives or expects to receive. The guidance also included expanded disclosure requirements that result in an entity providing users of financial statements with comprehensive information about the nature, amount, timing, and uncertainty of revenue and cash flows arising from the entity s contracts with customers. Based on input received from stakeholders, the FASB issued several additional Updates that generally provided clarifying guidance where there was the potential for diversity in practice, or address the cost and complexity of applying Topic 606. Transition Information The Association identified ancillary revenues affected by this Update and adopted the guidance on January 1, The amendments were applied using the modified retrospective approach. The Association elected to only apply the guidance to contracts that were not completed at the date of initial application. AgCarolina Farm Credit, ACA 12

13 Subtopics on gains and losses from the derecognition of nonfinancial assets, and on other assets and deferred costs-contracts with customers were adopted using the same transition options. Adoption did not have an impact on the Association's financial condition or results of operations. The new standard did result in enhanced disclosures about revenue (see Note 8, Revenue from Contracts with Customers). Note 2 Loans and Allowance for Loan Losses The Association maintains an allowance for loan losses at a level considered adequate by management to provide for probable and estimable losses inherent in the loan portfolio as of the report date. The allowance for loan losses is increased through provisions for loan losses and loan recoveries and is decreased through loan charge-offs and allowance reversals. A review of individual loans in each respective portfolio is performed periodically to determine the appropriateness of risk ratings and to ensure loss exposure to the Association has been identified. See Note 3, Loans and Allowance for Loan Losses, from the latest Annual Report for further discussion. Credit risk arises from the potential inability of an obligor to meet its repayment obligation. The Association manages credit risk associated with lending activities through an assessment of the credit risk profile of an individual obligor. The Association sets its own underwriting standards and lending policies that provide direction to loan officers and are approved by the board of directors. A summary of loans outstanding at period end follows: September 30, 2018 December 31, 2017 Real estate mortgage $ 640,793 $ 634,025 Production and intermediate-term 474, ,378 Loans to cooperatives 2,033 2,659 Processing and marketing 42,110 37,056 Farm-related business 12,455 8,796 Communication 1,849 1,946 Power and water/waste disposal Rural residential real estate 34,027 33,845 Total loans $ 1,207,738 $ 1,132,771 A substantial portion of the Association s lending activities is collateralized, and exposure to credit loss associated with lending activities is reduced accordingly. The Association may purchase or sell participation interests with other parties in order to diversify risk, manage loan volume, and comply with Farm Credit Administration (FCA) regulations. The following tables present the principal balance of participation loans at periods ended: September 30, 2018 Within AgFirst District Within Farm Credit System Outside Farm Credit System Total Purchased Sold Purchased Sold Purchased Sold Purchased Sold Real estate mortgage $ 11,594 $ 51,457 $ $ 879 $ $ $ 11,594 $ 52,336 Production and intermediate-term 12,414 58,669 3, ,670 15, ,339 Loans to cooperatives 2,033 2,033 Processing and marketing 14,979 15, ,446 15,668 Farm-related business Communication 1,853 1,853 Power and water/waste disposal Total $ 43,578 $ 125,794 $ 4,199 $ 198,549 $ $ $ 47,777 $ 324,343 December 31, 2017 Within AgFirst District Within Farm Credit System Outside Farm Credit System Total Purchased Sold Purchased Sold Purchased Sold Purchased Sold Real estate mortgage $ 6,722 $ 45,545 $ $ 1,041 $ $ $ 6,722 $ 46,586 Production and intermediate-term 17,838 61,315 3, ,569 21, ,884 Loans to cooperatives 2,661 2,661 Processing and marketing 12,686 13, ,113 13,967 Farm-related business Communication 1,951 1,951 Power and water/waste disposal Total $ 42,494 $ 120,931 $ 3,890 $ 184,610 $ $ $ 46,384 $ 305,541 AgCarolina Farm Credit, ACA 13

14 A significant source of liquidity for the Association is the repayments of loans. The following table presents the contractual maturity distribution of loans by loan type at the latest period end: Due less than 1 year September 30, 2018 Due 1 Through 5 years Due after 5 years Total Real estate mortgage $ 16,281 $ 96,168 $ 528,344 $ 640,793 Production and intermediate-term 238, ,306 49, ,373 Loans to cooperatives 1, ,033 Processing and marketing 6,490 26,134 9,486 42,110 Farm-related business 3,876 5,692 2,887 12,455 Communication 1,849 1,849 Power and water/waste disposal Rural residential real estate 828 2,175 31,024 34,027 Total loans $ 266,419 $ 320,055 $ 621,264 $ 1,207,738 Percentage 22.06% 26.50% 51.44% % The recorded investment in a receivable is the face amount increased or decreased by applicable accrued interest, unamortized premium, discount, finance charges, or acquisition costs and may also reflect a previous direct write-down of the investment. The following table shows the recorded investment of loans, classified under the FCA Uniform Loan Classification System, as a percentage of the recorded investment of total loans by loan type as of: September 30, 2018 December 31, 2017 Real estate mortgage: Acceptable 87.41% 85.88% OAEM Substandard/doubtful/loss % % Production and intermediate-term: Acceptable 86.54% 84.64% OAEM Substandard/doubtful/loss % % Loans to cooperatives: Acceptable % % OAEM Substandard/doubtful/loss % % Processing and marketing: Acceptable 97.32% 96.17% OAEM 1.77 Substandard/doubtful/loss % % September 30, 2018 December 31, 2017 Farm-related business: Acceptable 97.09% 97.96% OAEM Substandard/doubtful/loss % % Communication: Acceptable % % OAEM Substandard/doubtful/loss % % Power and water/waste disposal Acceptable % % OAEM Substandard/doubtful/loss % % Rural residential real estate: Acceptable 97.59% 97.46% OAEM Substandard/doubtful/loss % % Total loans: Acceptable 87.83% 86.25% OAEM Substandard/doubtful/loss % % The following tables provide an aging analysis of the recorded investment of past due loans as of: 30 Through 89 Days Past Due September 30, 2018 Not Past Due or Less Than 30 Days Past Due 90 Days or More Past Due Total Past Due Total Loans Real estate mortgage $ 4,280 $ 6,089 $ 10,369 $ 642,551 $ 652,920 Production and intermediate-term 900 8,009 8, , ,368 Loans to cooperatives 2,041 2,041 Processing and marketing ,562 42,271 Farm-related business ,567 12,627 Communication 1,850 1,850 Power and water/waste disposal Rural residential real estate ,865 34,158 Total $ 5,435 $ 14,905 $ 20,340 $ 1,208,993 $ 1,229,333 AgCarolina Farm Credit, ACA 14

15 30 Through 89 Days Past Due December 31, 2017 Not Past Due or Less Than 30 Days Past Due 90 Days or More Past Due Total Past Due Total Loans Real estate mortgage $ 1,700 $ 4,332 $ 6,032 $ 636,850 $ 642,882 Production and intermediate-term 1,763 6,118 7, , ,023 Loans to cooperatives 2,662 2,662 Processing and marketing ,417 37,184 Farm-related business 8,863 8,863 Communication 1,947 1,947 Power and water/waste disposal Rural residential real estate ,844 33,952 Total $ 3,533 $ 11,255 $ 14,788 $ 1,133,791 $ 1,148,579 Nonperforming assets (including related accrued interest as applicable) and related credit quality statistics at period end were as follows: September 30, 2018 December 31, 2017 Nonaccrual loans: Real estate mortgage $ 14,718 $ 16,500 Production and intermediate-term 11,279 9,854 Processing and marketing Farm-related business 60 Rural residential real estate Total $ 26,927 $ 27,300 Accruing restructured loans: Real estate mortgage $ 2,304 $ 2,087 Production and intermediate-term Total $ 2,650 $ 2,102 Accruing loans 90 days or more past due: Production and intermediate-term $ 3,381 $ Total $ 3,381 $ Total nonperforming loans $ 32,958 $ 29,402 Other property owned Nonperforming assets $ 32,978 $ 29,510 Nonaccrual loans as a percentage of total loans 2.23% 2.41% Nonperforming assets as a percentage of total loans and other property owned 2.73% 2.60% Nonperforming assets as a percentage of capital 11.74% 11.24% The following table presents information related to the recorded investment of impaired loans at period end. Impaired loans are loans for which it is probable that all principal and interest will not be collected according to the contractual terms of the loan. September 30, 2018 December 31, 2017 Impaired nonaccrual loans: Current as to principal and interest $ 15,072 $ 14,628 Past due 11,855 12,672 Total $ 26,927 $ 27,300 Impaired accrual loans: Restructured $ 2,650 $ 2, days or more past due 3,381 Total $ 6,031 $ 2,102 Total impaired loans $ 32,958 $ 29,402 Additional commitments to lend $ 139 $ AgCarolina Farm Credit, ACA 15