Report to Stockholders 2nd Quarter 2015

Transcription

1 Report to Stockholders 2nd Quarter 2015 Frontier Farm Credit, ACA Administrative Office 2009 Vanesta Place Manhattan, Kansas

2 Administrative Office 2009 Vanesta Place Manhattan, KS fax customercare@frontierfarmcredit.com Parsons Office 2005 Harding Drive P.O. Box 937 Parsons, KS fax parsons@frontierfarmcredit.com Baldwin Office 1270 N. 300 Road P.O. Box 858 Baldwin City, KS fax baldwin@frontierfarmcredit.com Frontier Farm Credit, ACA Office Locations Emporia Office 1221 E. 12th Avenue P.O. Box L Emporia, KS fax emporia@frontierfarmcredit.com Hiawatha Office 2219 Natchez P.O. Box 297 Hiawatha, KS fax hiawatha@frontierfarmcredit.com Manhattan Office 9370 E. U.S. Hwy 24 P.O. Box 188 Manhattan, KS fax manhattan@frontierfarmcredit.com Marysville Office 835 Pony Express Highway P.O. Box 349 Marysville, KS fax marysville@frontierfarmcredit.com Board of Directors Term Expires Bill Miller, Chair, Council Grove, KS 2017 Mark Wulfkuhle, Vice Chair, Berryton, KS 2017 Kathy Brick, Appointed Director, Overland Park, KS 2018 Mike Collinge, Hamilton, KS 2018 Ronald E. Dunbar, Richmond, KS 2016 James F. Feldkamp, Centralia, KS 2016 Bill Fleming, Appointed Director, Lawrence, KS 2019 Jennifer Gehrt, Alma, KS 2016 Alan J. Hess, Alma, KS 2018 Larry Hoobler, Manhattan, KS 2019 Lee Mueller, Hiawatha, KS 2019 Steve Powers, Chanute, KS 2017 The shareholders investment in Frontier Farm Credit, ACA is materially affected by the financial condition and results of operations of CoBank, ACB, (CoBank). The 2014 CoBank Annual Report to Shareholders and the CoBank quarterly shareholders reports are available on CoBank s website, or may be obtained at no charge by contacting any of the offices listed above.

3 MANAGEMENT S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Dollars in Thousands, Except as Noted) (Unaudited) The following discussion summarizes the financial position and results of operations of Frontier Farm Credit, ACA for the six months ended June 30, 2015, with comparisons to prior periods. You should read these comments along with the accompanying financial statements and footnotes and the 2014 Annual Report to Shareholders. The accompanying financial statements were prepared under the oversight of our Audit Committee. NOTICE OF SIGNIFICANT OR MATERIAL EVENT On May 20, 2014, the Boards of Directors of Farm Credit Services of America and Frontier Farm Credit signed a letter of intent to form a strategic alliance. The alliance is designed to benefit the farmers and ranchers who own and support the two financial services cooperatives by ensuring that both associations have the strength and capacity to serve agricultural customers needs for years to come. As part of the new alliance, Farm Credit Services of America and Frontier Farm Credit continue to exist as separate associations while integrating their day-to-day business operations, technology systems and leadership teams. Each association continues to have its own Board, with representatives participating in a coordinating committee to facilitate Board governance between the two organizations. By aligning with Farm Credit Services of America, Frontier Farm Credit gains access to state-of-theart technology and business processes to serve its customers, lowers its cost of operations and strengthens its risk management capabilities. Farm Credit Services of America benefits from economies of scale with access to larger capital pools and the ability to spread technology investments across a larger customer base. In October 2014, Frontier Farm Credit stockholders voted to approve the alliance. Farm Credit Services of America provided information concerning the alliance to its stockholders. The alliance was implemented January 1, Under the alliance agreement, Farm Credit Services of America and Frontier Farm Credit have agreed to share current year income and expenses based on the average total assets of each entity for the prior calendar year. Due to the transition period required to fully implement the alliance, the agreement specifies generally that pre-tax net income will be shared on fixed percentages of 94.0 percent Farm Credit Services of America and 6.0 percent Frontier Farm Credit for 2015 and 93.0 percent Farm Credit Services of America 7.0 percent Frontier Farm Credit for For the first half of 2015, Frontier Farm Credit recorded $5.9 million of expense under the income and expense sharing provisions of the alliance agreement primarily due to the payment of salary and related expenses incurred by Farm Credit Services of America for former Frontier Farm Credit employees added to the Farm Credit Services of America payroll. Frontier Farm Credit has $1.9 billion in assets and serves multiple counties in eastern Kansas. Farm Credit Services of America has $23.3 billion in assets and serves the states of Iowa, Nebraska, South Dakota and Wyoming. ECONOMIC CONDITIONS The economic conditions in our region consist of, generally, lower commodity prices, historically low interest rate environment and stable to rising land prices. Commodity prices at June 30, 2015 are lower than December 31, 2014; and June 30, 2014, with the exception of feeder cattle. The low interest rate environment supports the trading of agricultural land and land values. Land prices have remained stable in the agricultural sector of our lending area. Agricultural commodity input costs have remained at elevated levels and these levels are expected to trend with commodity prices. The weather conditions in eastern Kansas have been a combination of milder temperatures, wetter than normal spring with isolated flood damage in some areas. LOAN PORTFOLIO Loans outstanding at June 30, 2015 totaled $1.75 billion, an increase of $41.7 million, or 2.4%, from loans of $1.71 billion at December 31, The overall increase was primarily due to increases in real estate mortgage loans, processing and marketing loans, farm related business loans and energy loans; however, these increases were partially offset by decreases in communication loans, rural residential real estate loans and agricultural export finance. The increase in real estate mortgage loans is due to the low interest rate environment, increases in land prices, strong demand for agricultural financing and the expansion of farming operations. The increases in processing and marketing loans, farm related business loans and energy loans are due to the purchase of additional loan participations. The purchase of loan participations allows the association to generate additional earnings and diversify risk in the loan portfolio. The slight increase in production and intermediate-term loans reflects the cyclical nature and financing needs associated with agricultural operating loans. The decrease in communication and agricultural export finance loans is the payoff of participations purchased. Rural residential real estate loans have decreased because of normal payment activity. 1

4 OTHER PROPERTY OWNED Other property owned is real or personal property that has been acquired through foreclosure, deed in lieu of foreclosure or other means. We had no other property owned at June 30, 2015 or December 31, RESULTS OF OPERATIONS Net income for the six months ended June 30, 2015 was $14.6 million, a decrease of $2.2 million, or 13.11%, from the same period ended one year ago primarily due to a decrease of gains in other property owned. The decrease is partially offset by an increase in net interest income and reversal of loan loss provisions. Net interest income for the six months ended March 31, 2015 was $22.8 million, an increase of $1.7 million, or 8.12%, compared with June 30, Net interest income increased as a result of a growing loan portfolio and improvement in net interest spread. The loan loss reversal for the six months ended June 30, 2015 was $725 thousand, compared to a $66 thousand loan loss reversal for the same period ended one year ago. The loan loss reversal is the result of strong credit quality, effective loan servicing and strong collateral positions. Noninterest income decreased $226 thousand during the first six months of 2015 compared with the first six months in 2014 primarily due to decreases in mineral income, loan fees, and fees for financially related services. Mineral income varies based on the rate of production and the underlying commodity prices. Financial related services income decreased primarily due to the decrease in crop insurance revenue and decreases in our business services income. Patronage from our funding bank increased due to a growing loan portfolio. During the first six months of 2015, noninterest expense increased $4.3 million to $14.6 million, primarily due to the increases in operating expenses and Farm Credit Insurance Fund premiums. An increase in purchased services from AgVantis is due to additional work related to our moving to Farm Credit Services of America s (FCSAmerica) systems, as part of the strategic alliance that began January 1, The increase in Farm Credit Insurance Fund premium is due to growth in our loan portfolio. The primary increase in other noninterest expense was due to the monthly settlement of operating expenses as part of the strategic alliance. Salaries and employee benefits decreased due to employees being transferred to FCSAmerica, as part of the strategic alliance. Occupancy and equipment decreased due to a portion of these expenses now being assumed by FCSA as part of the strategic alliance. CAPITAL RESOURCES Our shareholders equity at June 30, 2015 was $348.1 million, an increase from $333.5 million at December 31, This increase is due to net income and amortization of pension costs included in net periodic benefit cost, offset by net stock retirements. REGULATORY MATTERS On May 8, 2014, the Farm Credit Administration approved a proposed rule to modify the regulatory capital requirements for System Associations. The stated objectives of the proposed rule are as follows: To modernize capital requirements while ensuring that institutions continue to hold sufficient regulatory capital to fulfill their mission as government-sponsored enterprises; To ensure that the System s capital requirements are comparable to the Basel III framework and the standardized approach that the federal banking regulatory agencies have adopted, but also to ensure that the rules recognize the cooperative structure and the organization of the System; To make System regulatory capital requirements more transparent; and To meet certain requirements of the Dodd-Frank Act. As currently drafted, the proposed rule would, among other things, eliminate the core surplus and total surplus requirements and introduce common equity tier 1, tier 1 and total capital (tier 1 + tier 2) risk-based capital ratio requirements. The proposal would add a minimum tier 1 leverage ratio for all System institutions. In addition, the proposal would establish a capital conservation buffer, and modify and expand risk weightings. The revisions to the risk weightings of exposures would include alternatives to the use of credit ratings, as required by the Dodd-Frank Act. The proposed effective date is January 1,

5 The public comment period ended on February 16, While uncertainty exists as to the final form of the proposed rule, based on our preliminary assessment, we do not believe the new rule will impose any significant constraints on our business strategies or growth prospects. 3

6 Frontier Farm Credit, ACA Consolidated Statement of Condition (Dollars in Thousands) June 30 December UNAUDITED AUDITED ASSETS Loans $ 1,746,778 $ 1,705,111 Less allowance for loan losses 3,836 4,943 Net loans 1,742,942 1,700,168 Cash 8,632 18,908 Accrued interest receivable 21,584 19,433 Investment in CoBank 56,583 56,533 Investment in AgDirect 4,695 4,551 Premises and equipment, net 21,499 21,944 Other assets 7,080 10,075 Total assets $ 1,863,015 $ 1,831,612 LIABILITIES Note payable to CoBank $ 1,478,149 $ 1,444,956 Advance conditional payments 22,797 26,674 Accrued interest payable 2,112 6,764 Patronage distributions payable - 7,000 Accrued benefits liability 1,356 1,044 Reserve for unfunded commitments Other liabilities 9,913 11,712 Total liabilities 1,514,927 1,498,150 Commitments and Contingencies SHAREHOLDERS' EQUITY Capital stock 5,164 5,197 Unallocated retained earnings 343, ,416 Accumulated other comprehensive (loss)/income (139) (151) Total shareholders' equity 348, ,462 Total liabilities and shareholders' equity $ 1,863,015 $ 1,831,612 The accompanying notes are an integral part of these consolidated financial statements.

7 Frontier Farm Credit, ACA Consolidated Statement of Comprehensive Income (Dollars in Thousands) For the three months For the six months ended June 30 ended June 30 UNAUDITED INTEREST INCOME Loans $ 18,130 $ 17,361 $ 36,040 $ 34,484 Total interest income 18,130 17,361 36,040 34,484 INTEREST EXPENSE Note payable to CoBank 6,644 6,667 13,135 13,265 Other Total interest expense 6,668 6,708 13,191 13,351 Net interest income 11,462 10,653 22,849 21,133 Provision for credit loss/(credit loss reversal) - 73 (725) (66) Net interest income after provision for credit loss/credit loss reversal 11,462 10,580 23,574 21,199 NONINTEREST INCOME Financially related services income Loan fees Patronage refund from Farm Credit Institutions 1,884 1,768 3,775 3,467 Mineral income ,147 Gain on equity investment - 2,416-2,416 Other noninterest income Total noninterest income 2,718 5,584 5,762 8,404 NONINTEREST EXPENSE Salaries and employee benefits 3,366 3,781 6,415 7,774 Occupancy and equipment ,081 Purchased services from AgVantis, Inc ,357 1,205 Gains on other property owned, net Farm Credit Insurance Fund premium Supervisory and examination costs Other noninterest expense 1, ,958 1,637 Total noninterest expense 6,941 6,186 14,622 12,718 Income before income taxes 7,239 9,978 14,714 16,885 Provision for income taxes Net income 7,190 9,964 14,647 16,856 OTHER COMPREHENSIVE INCOME Net change in unrealized gain on cash flow hedges - (1) - (1) Amortization of retirement costs Comprehensive income $ 7,196 $ 9,967 $ 14,659 $ 16,863 The accompanying notes are an integral part of these consolidated financial statements.

8 Frontier Farm Credit, ACA Consolidated Statement of Changes in Shareholders' Equity (Dollars in Thousands) Accumulated Protected Unallocated Other Total Borrower Capital Retained Comprehensive Shareholders' UNAUDITED Stock Stock Earnings Income/(Loss) Equity Balance at December 31, 2013 $ 2 $ 5,179 $ 306,958 $ (104) $ 312,035 Comprehensive income 16, ,863 Stock issued Stock retired - (174) (174) Balance at June 30, 2014 $ 2 $ 5,183 $ 323,814 $ (97) $ 328,902 Balance at December 31, 2014 $ - $ 5,197 $ 328,416 $ (151) $ 333,462 Comprehensive income 14, ,659 Stock issued Stock retired - (210) (210) Balance at June 30, 2015 $ - $ 5,164 $ 343,063 $ (139) $ 348,088 The accompanying notes are an integral part of these consolidated financial statements.

9 NOTES TO FINANCIAL STATEMENTS (Dollars in Thousands, Except as Noted) (Unaudited) NOTE 1 - ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES A description of the organization and operations of Frontier Farm Credit, ACA (the Association), the significant accounting policies followed, and the financial condition and results of operations as of and for the year ended December 31, 2014, are contained in the 2014 Annual Report to Shareholders. These unaudited second quarter 2015 financial statements should be read in conjunction with the 2014 Annual Report to Shareholders. In the opinion of management, the unaudited financial information is complete and reflects all adjustments, consisting of normal recurring adjustments, necessary for a fair statement of results for the interim periods. The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. The results of operations for interim periods are not necessarily indicative of the results to be expected for the full year ending December 31, Descriptions of the significant accounting policies are included in the 2014 Annual Report to Stockholders. In the opinion of management, these policies and the presentation of the interim financial condition and results of operations conform to GAAP and prevailing practices within the banking industry. In August 2014, the Financial Accounting Standards Board (FASB) issued guidance entitled Presentation of Financial Statements Going Concern. The guidance governs management s responsibility to evaluate whether there is substantial doubt about an entity s ability to continue as a going concern and to provide related footnote disclosures. This guidance requires management to perform interim and annual assessments of an entity s ability to continue as a going concern within one year after the date the financial statements are issued or within one year after the financial statements are available to be issued, when applicable. Substantial doubt exists if it is probable that the entity will be unable to meet its obligations for the assessed period. This guidance becomes effective for interim and annual periods ending after December 15, 2016, and early application is permitted. Management will be required to make its initial assessment as of December 31, In May 2014, the FASB issued guidance entitled, Revenue from Contracts with Customers. The guidance governs revenue recognition from contracts with customers and requires an entity to recognize revenue to depict the transfer of promised good or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those good or services. Financial instruments and other contractual rights within the scope of other guidance issued by the FASB are excluded from the scope of this new revenue recognition guidance. In this regard, a majority of our contracts would be excluded from the scope of this new guidance. In April 2015, this guidance was deferred by one year and results in the new revenue standard becoming effective for interim and annual reporting periods ending after December 15, The guidance becomes effective for the first interim reporting period within the annual reporting periods after December 15, The Association is in the process of reviewing contracts to determine the effect, if any, on its financial condition or results of operations. NOTE 2 - LOANS AND ALLOWANCE FOR LOAN LOSSES A summary of loans follows. June 30, 2015 December 31, 2014 Real estate mortgage $ 1,094,947 $ 1,062,841 Production and intermediate-term 463, ,218 Agribusiness: Loans to cooperatives 20,175 26,012 Processing and marketing 101,821 83,798 Farm-related business 13,703 5,789 Communication 19,022 20,157 Energy 16,980 28,089 Rural residential real estate 5,710 7,846 Agricultural export finance 11,278 13,361 Total loans $ 1,746,778 $ 1,705,111

10 The Association purchases or sells participation interests with other parties in order to diversify risk, manage loan volume and comply with Farm Credit Administration regulations. The following table presents information regarding the balances of participations purchased and sold during the quarter ended June 30, 2015: Other Farm Credit Institutions Non-Farm Credit Institutions Total Purchased Sold Purchased Sold Purchased Sold Real estate mortgage $ 35,616 $ 27,824 $ $ $ 35,616 $ 27,824 Production and intermediate-term 56,702 19,495 2,677 59,379 19,495 Agribusiness Loans to cooperatives 17,880 6,386 8,595 26,475 6,386 Processing and marketing 136,137 60,806 3, ,202 60,806 Farm-related business 12,187 1,192 2,212 14,399 1,192 Communication 41,760 22,738 41,760 22,738 Energy 24,151 9,620 2,450 26,601 9,620 Agricultural export finance 20,201 8,918 20,201 8,918 Lease Receivables 15,264 15,264 Total $ 359,898 $156,979 $ 18,999 $ $ 378,897 $ 156,979 The following table shows loans and related accrued interest classified under the Farm Credit Administration Uniform Loan Classification System as a percentage of total loans and related accrued interest receivable by loan type as of: June 30, 2015 December 31, 2014 Real estate mortgage Acceptable 98.07% 97.92% OAEM Substandard Total % % Production and intermediate-term Acceptable 96.97% 97.63% OAEM Substandard Total % % Agribusiness Acceptable 99.89% 99.71% OAEM Total % % Communication Acceptable % % Total % % Energy Acceptable 75.25% % OAEM Total % % Rural residential real estate Acceptable 96.34% 96.40% OAEM Substandard Total % % Agricultural export finance Acceptable % % Total % % Total Loans Acceptable 97.73% 98.03% OAEM Substandard Total % %

11 High risk assets consist of impaired loans and other property owned. These nonperforming assets (including related accrued interest) and related credit quality are as follows: (dollars in thousands) June 30, 2015 December 31, 2014 Nonaccrual loans Real estate mortgage $ 4,499 $ 4,038 Production and intermediate-term Rural residential real estate Total nonaccrual loans 5,107 4,318 Accruing restructured loans Real estate mortgage Agribusiness Total accruing restructured loans Accruing loans 90 days past due Production and intermediate-term 797 Total accruing loans 90 days past due 797 Total impaired loans 6,201 4,620 Other property owned Total high risk assets $ 6,201 $ 4,620 Additional impaired loan information is as follows: Recorded Investment June 30, 2015 December 31, 2014 Unpaid Unpaid Principal Related Recorded Principal Related Balance Allowance Investment Balance Allowance Impaired loans with no related allowance for credit losses: Real estate mortgage $ 4,795 $ 5,328 $ $ 4,340 $ 4,778 $ Production and intermediate-term 1,281 3, ,384 Rural residential real estate Total $ 6,201 $ 8,906 $ $ 4,620 $ 7,295 $ Total impaired loans: Real estate mortgage $ 4,795 $ 5,328 $ $ 4,340 $ 4,778 $ Production and intermediate-term 1,281 3, ,384 Rural residential real estate Total $ 6,201 $ 8,906 $ $ 4,620 $ 7,295 $ Note: The recorded investment in the receivable is the face amount increased or decreased by applicable accrued interest and unamortized premium, discount, finance charges, or acquisition costs and may also reflect a previous direct write-down of the investment.

12 For the Three Months Ended June 30, 2015 Average Interest Income Impaired Loans Recognized For the Three Months Ended June 30, 2014 Average Impaired Loans Interest Income Recognized Impaired loans with a related allowance for credit losses: $ 15 $ $ $ Total $ 15 $ $ $ Impaired loans no related allowance for credit losses: $ 5,112 $ 15 $ 4,562 $ 8 Production and intermediate-term 1, Agribusiness: Processing and marketing 559 Rural residential real estate 126 Total $ 6,507 $ 30 $ 5,360 $ 10 For the Six Months Ended June 30, 2015 Average Impaired Loans Interest Income Recognized For the Six Months Ended June 30, 2014 Average Impaired Loans Interest Income Recognized Impaired loans with a related allowance for credit losses: Production and intermediate-term $ 7 $ $ $ Total $ 7 $ $ $ Impaired loans with no related allowance for credit losses: Real estate mortgage $ 4,701 $ 18 $ 4,216 $ 18 Production and intermediate-term Agribusiness: Processing and marketing Rural residential real estate 128 Total $ 5,528 $ 52 $ 5,483 $ 70 Impaired loans with no related allowance for credit losses: Real estate mortgage $ 4,701 $ 18 $ 4,216 $ 18 Production and intermediate-term Agribusiness: Processing and marketing Rural residential real estate 128 Total $ 5,535 $ 52 $ 5,483 $ 70

13 The following tables provide an age analysis of past due loans (including accrued interest). June 30, Days Past Due 90 Days or More Past Due Total Past Due Not Past Due or less than 30 Days Past Due Total Loans Recorded Investment Accruing Loans 90 Days or More Past Due Real estate mortgage $ 2,079 $ 412 $ 2,491 $1,107,266 $1,109,757 $ Production and intermediateterm 2, , , , Agribusiness 136, ,099 Communication 19,024 19,024 Energy 16,994 16,994 Rural residential real estate 5,728 5,728 Agricultural export finance 11,355 11,355 Total $ 4,694 $ 1,374 $ 6,068 $1,762,294 $1,768,362 $ 797 December 31, 2014 Real estate mortgage $ 365 $ 413 $ 778 $1,075,417 $1,076,195 $ Production and intermediateterm , ,820 Agribusiness 115, ,942 Communication 20,161 20,161 Energy 28,120 28,120 Rural residential real estate 7,872 7,872 Agricultural export finance 13,434 13,434 Total $ 594 $ 482 $ 1,076 $1,723,468 $1,724,544 $ Note: The recorded investment in the receivable is the face amount increased or decreased by applicable accrued interest and unamortized premium, discount, finance charges, or acquisition costs and may also reflect a previous direct write-down of the investment. In 2015, the Association revised its methodology for disclosing the allowance for credit losses. The new methodology splits the allowance for credit losses between the amount calculated on outstanding loans and the amount calculated on unfunded loan commitments. The amount calculated on outstanding loan balances is reported in the assets section of the statement of condition in the allowance for loan loss and the amount calculated on unfunded loan commitments is reported in the liability section of the statement of condition in the reserve for unfunded commitments. The related provision for the reserve for unfunded commitments is included as part of the provision for credit losses on the income statement, along with the provision for loan losses. Previously, both amounts were reported in the asset section of the statement of condition in the allowance for loan losses. A summary of changes in the allowance for loan losses and period end recorded investment in loans is as follows: Balance at December 31, 2014 Charge-offs Recoveries Provision for Loan Losses/ (Loan Loss Reversals) Balance at June 30, 2015 Real estate mortgage $ 2,186 $ $ $ (233) $ 1,953 Production and intermediate-term 2, (1,213) 1,228 Agribusiness Communication Energy Rural residential real estate Agricultural export finance Total $ 4,943 $ 39 $ 257 $ (1,325) $ 3,836

14 A summary of changes in the reserve for unfunded commitments follows: 2015 Balance at December 31, 2014 $ Provision of unfunded commitments 600 Total $ 600 Balance at December 31, 2013 Charge-offs Recoveries Provision for Loan Losses/ (Loan Loss Reversals) Balance at June 30, 2014 Real estate mortgage $ 1,968 $ $ $ 205 $ 2,173 Production and intermediate-term 2, (40) 2,344 Agribusiness 622 (232) 390 Communication 34 (4) 30 Energy Rural residential real estate Agricultural export finance 6 (1) 5 Total $ 5,004 $ $ 68 $ (66) $ 5,006 Recorded Investments in Allowance for Credit Losses Loans Outstanding Ending Balance at June 30, 2015 Ending Balance at June 30, 2015 Individually evaluated for impairment Collectively evaluated for impairment Individually evaluated for impairment Collectively evaluated for impairment Real estate mortgage $ $ 1,953 $ 4,795 $ 1,104,962 Production and intermediate-term 1,228 1, ,124 Agribusiness ,099 Communication ,024 Energy 89 16,994 Rural residential real estate ,603 Agricultural export finance 14 11,355 Total $ $ 3,836 $ 6,201 $ 1,762,161 Recorded Investments in Allowance for Credit Losses Loans Outstanding Ending Balance at December 31, 2014 Ending Balance at December 31, 2014 Individually evaluated for impairment Collectively evaluated for impairment Individually evaluated for impairment Collectively evaluated for impairment Real estate mortgage $ $ 2,186 $ 4,340 $ 1,071,855 Production and intermediate-term 2, ,671 Agribusiness ,942 Communication 51 20,161 Energy 68 28,120 Rural residential real estate ,741 Agricultural export finance 7 13,434 Total $ $ 4,943 $ 4,620 $ 1,719,924 A restructuring of a debt constitutes a troubled debt restructuring (TDR) if the creditor, for economic or legal reasons related to the debtor s financial difficulties, grants a concession to the debtor that it would not otherwise consider. The Association recorded no TDRs during the six months ended June 30, The Association had no TDRs within the previous 12 months for which there were payment defaults during the period. There were no additional commitments to lend to borrowers whose loans have been modified in troubled debt restructurings at period end.

15 The following table provides information on outstanding loans restructured in troubled debt restructurings at period end. These loans are included as impaired loans in the impaired loan table. Loans modified as TDRs June 30, 2015 December 31, 2014 TDRs in Nonaccrual Status* June 30, December 31, Real estate mortgage $ 2,917 $ 2,995 $ 2,622 $ 2,694 Production and intermediate-term Total $ 2,980 $ 3,057 $ 2,622 $ 2,756 * Represents the portion of loans modified as TDRs that are in nonaccrual status. NOTE 3 CAPITAL The following tables present the activity in the accumulated other comprehensive loss, net of tax by component: Unrealized losses on cash flow hedges, net Quarter Ended June Pension and other benefit plans Unrealized losses on cash flow hedges, net Pension and other benefit plans Beginning Balance $ $ (151) $ 2 $ (106) Other comprehensive income before reclassifications (1) Amounts reclassified from accumulated other comprehensive loss 12 8 Net current period other comprehensive income 12 (1) 8 Ending Balance $ $ (139) $ 1 $ (98) The following table represents reclassifications out of accumulated other comprehensive income (loss). Pension and other benefit plans: Amount Reclassified from Accumulated Other Comprehensive (Income) Loss June Net actuarial gain 12 8 Total reclassifications $ 12 $ 8 Location of Gain/Loss Recognized in Statement of Income Salaries and employee benefits NOTE 4 - FAIR VALUE MEASUREMENTS Accounting guidance defines fair value as the exchange price that would be received for an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability. See Note 2 to the 2014 Annual Report to Shareholders for a more complete description.

16 Assets measured at fair value on a recurring basis are summarized below: Fair Value Measurement Using Total Fair Level 1 Level 2 Level 3 Value June 30, 2015 Assets held in nonqualified benefits trusts $ 1,669 $ $ $ 1,669 December 31, 2014 Assets held in nonqualified benefits trusts $ 1,619 $ $ $ 1,619 During the first six months of 2015, the Association recorded no transfers in or out of Levels 1, 2, or 3. The Association had no liabilities measured at fair value on a recurring basis at June 30, 2015 or December 31, Assets measured at fair value on a non-recurring basis for each of the fair value hierarchy values are summarized below: Fair Value Measurement Using Total Fair Total Level 1 Level 2 Level 3 Value Gains/(Losses) June 30, 2015 Loans $ $ $ $ $ 50 December 31, 2014 Loans $ $ $ 60 $ 60 $ 87 There were no liabilities measured at fair value on a non-recurring basis at June 30, 2015 or December 31, With regard to impaired loans and other property owned, it is not practicable to provide specific information on inputs as each collateral property is unique. System institutions utilize appraisals to value these loans and other property owned and take into account unobservable inputs such as income and expense, comparable sales, replacement cost and comparability adjustments. Valuation Techniques As more fully discussed in Note 2 to the 2014 Annual Report to Shareholders, accounting guidance establishes a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The following presents a brief summary of the valuation techniques used by the Association for assets and liabilities, subject to fair value measurement. Loans For certain loans evaluated for impairment under accounting guidance, the fair value is based upon the underlying collateral since the loans were collateral dependent loans for which real estate is the collateral. The fair value measurement process uses independent appraisals and other market-based information, but in many cases it also requires significant input based on management s knowledge of and judgment about current market conditions, specific issues relating to the collateral and other matters. As a result, these fair value measurements fall within Level 3 of the hierarchy. 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.

17 Derivatives Exchange-traded derivatives valued using quoted prices are classified within Level 1 of the valuation hierarchy. However, few classes of derivative contracts are listed on an exchange; thus, the Association s derivative positions are valued using internally developed models that use as their basis readily observable market parameters and are classified within Level 2 of the valuation hierarchy. Such derivatives include basic interest rate swaps. Derivatives that are valued based upon models with significant unobservable market parameters and that are normally traded less actively or have trade activity that is one way are classified within Level 3 of the valuation hierarchy. The Association does not have any derivatives classified within Level 3. The models used to determine the fair value of derivative assets and liabilities use an income approach based on observable market inputs, primarily the LIBOR swap curve and volatility assumptions about future interest rate movements. Assets Held in Non-Qualified Benefits Trusts Assets held in trust funds related to deferred compensation and supplemental retirement plans are classified within Level 1. The trust funds include investments that are actively traded and have quoted net asset values that are observable in the marketplace. NOTE 5 DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES The Association maintains an overall interest rate risk management strategy that incorporates the use of derivative instruments to minimize significant unplanned fluctuations in earnings that are caused by interest rate volatility. The Association s goal is to manage interest rate sensitivity by modifying the repricing or maturity characteristics of certain balance sheet assets or liabilities so that movements in interest rates do not adversely affect the net interest margin. As a result of interest rate fluctuation, the Association s interest income and interest expense related to hedged variable-rate assets and liabilities, respectively, will increase or decrease. The effect of this variability in earnings is expected to be substantially offset by the Association s gains and losses on the derivative instruments that are linked to these hedged assets and liabilities. The Association considers its strategic use of derivatives to be a prudent method of managing interest rate sensitivity, because it prevents earnings from being exposed to certain volatility posed by changes in interest rates. The Association s interest-earning assets, to the extent they are funded with debt, are matched with similarly priced and termed liabilities. Volatility in net interest income comes from equity funded, variable priced assets. To the extent that variable priced assets are funded with equity, interest rate swaps in which the Association pays the floating rate and receives the fixed rate (receive fixed swaps) are used to reduce the impact of market fluctuations on the Association s net interest income. Under interest rate swap arrangements, the Association agrees with a third party (CoBank) to exchange, at specified intervals, payment streams calculated on a specified notional principal amount, with at least one stream based on a specified floating rate index. By using derivative instruments, the Association exposes itself to credit and market risk. If a counterparty fails to fulfill its performance obligations under a derivative contract, the Association s credit risk will equal the fair value of a derivative. Generally, when the fair value of a derivative contract is positive, this indicates that the counterparty owes the Association, thus creating a repayment risk for the Association. When the fair value of the derivative contract is negative, the Association owes the counterparty and, therefore, assumes no repayment risk. The Association minimizes the credit (or repayment) risk by entering into transactions only with CoBank, its funding bank. The Association s derivative activities are monitored by senior management. The Association has elected not to offset derivative fair value, accrued interest receivable and accrued interest payable by master netting agreement for reporting derivatives in the statement of condition. Cash Flow Hedges The Association uses receive fixed/pay variable interest rate swaps to hedge its equity funded, variable rate assets. These swaps, which qualify for hedge accounting, have a 2-year term, with a pay rate indexed to 1-month LIBOR. The Association does not expect to reclassify any of the derivative gain out of accumulated other comprehensive income within the next 12 months. No derivative gain or loss was reclassified into earnings as a result of the discontinuance of cash flow hedges because it is probable that the original forecasted transactions will not occur by the end of the originally specified time period. The Association had no derivatives outstanding at June 30, NOTE 6 - SUBSEQUENT EVENTS

18 The Association has evaluated subsequent events through August 10, 2015, which is the date the financial statements were issued, and no material subsequent events were identified.