AgChoice Farm Credit, ACA THIRD QUARTER 2017

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1 AgChoice Farm Credit, ACA THIRD QUARTER 2017 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... 9 Consolidated Statements of Income Consolidated Statements of Comprehensive Income Consolidated Statements of Changes in Members Equity Notes to the Consolidated Financial Statements CERTIFICATION The undersigned certify that we have reviewed the September 30, 2017 quarterly report of AgChoice 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. Darrell L. Curtis Chief Executive Officer Mark F. Kerstetter Chief Financial Officer Donald G. Cotner Jr. Chairman of the Board November 8, 2017 AgChoice Farm Credit, ACA 1

2 AgChoice 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, 2017, 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. Darrell L. Curtis Chief Executive Officer Mark F. Kerstetter Chief Financial Officer November 8, 2017 AgChoice Farm Credit, ACA 2

3 AgChoice 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 AgChoice Farm Credit ACA, (Association) for the period ended September 30, These comments should be read in conjunction with the accompanying financial statements, notes to the financial statements, and the 2016 Annual Report of the Association. The accompanying consolidated financial statements were prepared under the oversight of the Audit Committee of the Board of Directors. Information in any part of this Quarterly Report may be incorporated by reference in answer or partial answer to any other item of the Quarterly Report. 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 Association s loan portfolio is diversified over a range of agricultural commodities, including dairy, livestock, poultry, forest products, and various crops, and also includes part-time farm and rural home loans. 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, impacts the level of dependency on a given commodity. Loans as of September 30, 2017 totaled $1,831,597, an increase of $29,306 as compared to $1,802,291 at December 31, Net loans outstanding at September 30, 2017, were $1,818,922 as compared to $1,790,489 at December 31, Net loans accounted for 97.0 percent of total assets at September 30, 2017, as compared to 96.3 percent of total assets at December 31, The increase in both loans and net loans primarily resulted from increased local servicing area 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, and credit administration remains satisfactory. Nonaccrual volume decreased from $22,687 at December 31, 2016 to $21,040 at September 30, 2017, mainly due to several large paydowns, offset by additional transfers to nonaccrual. The Association continues efforts to work out of nonaccrual accounts or to assist such operations to return to accrual status. Association management maintains an allowance for loan losses in an amount considered sufficient to absorb possible losses in the loan portfolio based on current and expected future conditions. The allowance for loan losses was $12,675 and $11,802 at September 30, 2017 and December 31, 2016, respectively. As a further means to reduce credit risk, the Association had $506 and $461 in a reserve for unfunded loan commitments at September 30, 2017 and December 31, 2016, respectively, which is classified as a liability on the Consolidated Balance Sheets. These reserves were considered by management to be adequate to cover possible losses. RESULTS OF OPERATIONS For the three months ended September 30, 2017 Net income for the three months ended September 30, 2017, totaled $9,435 an increase of $1,385 compared to $8,050 for the same period in This increase resulted primarily from higher net interest income, higher noninterest income and lower noninterest expense offset by higher provisions for income taxes. Net interest income increased by $751 for the three months ended September 30, 2017 compared to the same period in This increase resulted from an increase of $2,335 in interest income on accruing loans and investment securities and an increase of $74 in interest income on nonaccruing loans offset by an increase of $1,658 in interest expense. The provision for loan losses was $172 in the third quarter of 2017 as compared to $246 in the same period for Greater increases in volume and slight changes in credit quality resulted in a larger increase to the general allowance during the third quarter of 2017 compared to the same period in 2016, but that was offset by larger decreases in specific reserves in 2017 compared to the same period in Noninterest income for the three months ended September 30, 2017 increased by $575 to $4,170, compared to $3,595 for the same period of This increase resulted primarily from higher general patronage, higher gains on the sale of premises and equipment and gains on other transactions. Noninterest expense for the three months ended September 30, 2017, decreased $152, compared to the same period of This decrease is due to lower personnel, FCSIC and other AgChoice Farm Credit, ACA 3

4 operating costs, offset by higher occupancy and equipment costs and lower gains on other property owned in 2017 compared to The provision for income taxes was $89 for the third quarter of 2017 compared to a benefit for income taxes of $78 for the third quarter of For the nine months ended September 30, 2017 Net income for the nine months ended September 30, 2017, totaled $26,730, as compared to $23,641 for the same period in Net interest income increased $1,623 for the nine months ended September 30, 2017, as compared to the same period one year ago. Interest income on accruing loans and investment securities increased $5,408, interest income on nonaccruing loans increased by $102 and interest expense increased $3,887 as compared to the same period in The increase in interest income on accruing loans and interest expense is primarily related to an increase in loan volume. Increased general reserves due to loan volume growth, offset by decreases in specific reserves during 2017 resulted in a provision for loan losses of $897, compared to a provision for loan losses of $1,423 in Noninterest income for the nine months ended September 30, 2017, totaled $11,904, as compared to $11,313 for the same period of 2016, an increase of $591. This increase resulted primarily from the following factors: an increase of $363 in general patronage due to loan volume growth, an increase of $214 in Business Management Services revenue, an increase in servicing fee income of $133 and an increase in other gains of $113, offset by a decrease of $126 in patronage on participations sold due to a decline in volume sold and a decrease of $91 in fee income on participations purchased. Noninterest expense for the nine months ended September 30, 2017, decreased $524, compared to the same period of This decrease was primarily due to lower personnel costs, training, data processing, FCSIC and public and member relations expenses offset by higher directors expense, cost of space and furniture and equipment expense. The provision for income taxes was $167 for the nine months ended September 30, 2017 as compared to a benefit for income taxes of $8 for the same period last year. 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 Bank advances funds 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, 2017, was $1,475,384 as compared to $1,464,915 at December 31, This increase resulted from increased loan volume, offset by the receipt of the 2016 patronage refunds from other Farm Credit institutions and cash generated from Association 2017 earnings. CAPITAL RESOURCES Total members equity at September 30, 2017 increased by $26,662 to $380,680 from the December 31, 2016 total of $354,018. The increase is primarily attributed to year-to-date 2017 net income. Total capital stock and participation certificates were $10,997 on September 30, 2017, compared to $11,049 on December 31, Farm Credit Administration (FCA) regulations require all Farm Credit institutions to maintain certain minimum regulatory capital ratios. As of September 30, 2017, the Association was well above the minimum regulatory ratios for all capital adequacy ratios. Please refer to the Regulatory Matters section for additional disclosures related to the regulatory capital ratios. REGULATORY MATTERS Capital Effective January 1, 2017, the regulatory capital requirements for System Banks and Associations were modified. The new regulations 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. New regulations replaced existing core surplus and total surplus ratios with common equity tier 1 (CET1), tier 1 capital, and total capital risk-based capital ratios. The new regulations also replaced the existing net collateral ratio with a tier 1 leverage ratio and an unallocated retained earnings equivalents (UREE) leverage ratio. The current permanent capital ratio (PCR) remains in effect. Risk-adjusted assets have been defined by FCA Regulations as the Balance Sheet assets and off-balance-sheet commitments adjusted AgChoice Farm Credit, ACA 4

5 by various percentages, depending on the level of risk inherent in the various types of assets. The primary changes which generally have the effect of increasing risk-adjusted assets (decreasing riskbased regulatory capital ratios) were as follows: Inclusion of off-balance-sheet commitments less than 14 months Increased risk-weighting of most loans 90 days past due or in nonaccrual status Calculation of PCR risk-adjusted assets includes the allowance for loan losses as a deduction from risk-adjusted assets. This differs from the other risk-based capital calculations. The ratios are calculated using three-month average daily balances, in accordance with FCA regulations, as follows: The CET1 ratio is the sum of statutory minimum purchased borrower stock, other required borrower stock held for a minimum of 7 years, allocated equities held for a minimum of 7 years or not subject to revolvement, unallocated retained earnings, paid-in capital, less certain regulatory required deductions including the amount of investments in other System institutions, divided by average risk-adjusted assets. The tier 1 capital ratio is CET1 capital plus non-cumulative perpetual preferred stock, divided by average risk-adjusted assets. Total capital is tier 1 capital plus other required borrower stock held for a minimum of 5 years, subordinated debt and limited-life preferred stock greater than 5 years to maturity at issuance subject to certain limitations, allowance for loan losses and reserve for unfunded commitments under certain limitations less certain investments in other System institutions under the corresponding deduction approach, divided by average risk-adjusted assets. The permanent capital ratio is all at-risk borrower stock, any allocated excess stock, unallocated retained earnings, paid-in capital, subordinated debt and preferred stock subject to certain limitations, less certain investments in other System institutions, divided by PCR risk-adjusted assets. The tier 1 leverage ratio is tier 1 capital, divided by average assets less regulatory deductions to tier 1 capital. The UREE leverage ratio is unallocated retained earnings, paid-in capital, and allocated surplus not subject to revolvement less certain regulatory required deductions including the amount of allocated investments in other System institutions divided by average assets less regulatory deductions to tier 1 capital. 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, 2017 Ratio Risk-adjusted ratios: CET1 Capital 4.5% 0.625% 5.125% 17.30% Tier 1 Capital 6.0% 0.625% 6.625% 17.30% Total Capital 8.0% 0.625% 8.625% 17.96% Permanent Capital Ratio 7.0% 0.0% 7.0% 17.57% Non-risk-adjusted: Tier 1 Leverage Ratio 4.0% 1.0% 5.0% 18.68% UREE Leverage Ratio 1.5% 0.0% 1.5% 18.78% * - The capital conservation buffers have a 3 year phase-in period and will become fully effective January 1, Risk-adjusted ratio minimums will increase 0.625% each year until fully phased in. There is no phase-in period for the tier 1 leverage ratio. 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. Other Regulatory Matters On July 25, 2014, the FCA published a proposed rule in the Federal Register to revise the requirements governing the eligibility of investments for System banks and associations. The public comment period ended on October 23, The FCA expects to issue a final regulation in The stated objectives of the proposed rule are as follows: To strengthen the safety and soundness of System banks and associations, To ensure that System banks hold sufficient liquidity to continue operations and pay maturing obligations in the event of market disruption, To enhance the ability of the System banks to supply credit to agricultural and aquatic producers, To comply with the requirements of Section 939A of the Dodd-Frank Act, To modernize the investment eligibility criteria for System banks, and To revise the investment regulation for System associations to improve their investment management practices so they are more resilient to risk AgChoice Farm Credit, ACA 5

6 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 2016 Annual Report to Shareholders for recently issued accounting pronouncements. Additional information is provided in the table below. The following Accounting Standards Updates (ASUs) were issued by the Financial Accounting Standards Board (FASB) but have not yet been adopted: Standard Summary of Guidance Effective Date and Potential Financial Statement Impact ASU Receivables Nonrefundable Fees and Other Costs (Subtopic ): Premium Amortization on Purchased Callable Debt Securities ASU Financial Instruments Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments Requires amortization of premiums to the earliest call date on debt securities with call features that are explicit, noncontingent and callable at fixed prices and on preset dates. Does not impact securities held at a discount; the discount continues to be amortized to the contractual maturity. Requires adoption on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. Replaces multiple existing impairment standards by establishing a single 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 current expected credit loss (CECL) model. The Update also modifies the other-thantemporary impairment model for 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, and requires recognition of an allowance for expected credit losses on financial assets purchased with more than insignificant credit deterioration since origination. Requires a cumulative-effect adjustment to retained earnings as of the beginning of the reporting period of adoption. The investment securities portfolio may include holdings of callable debt securities. The Association is currently evaluating the impact of the Update on the financial statements, which will be affected by any investments in callable debt securities carried at a premium at the time of adoption. The Association expects to adopt the guidance in first quarter 2019 using the modified retrospective method with a cumulative-effect adjustment to retained earnings as of the beginning of the year of adoption. The Association has begun implementation efforts by establishing 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. The Association expects that the new guidance will result in an increase in its allowance for credit losses due to several factors, including: 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, 2. An allowance will be established for estimated credit losses on debt securities, 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. The extent of the increase is under evaluation, but will depend upon the 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 2021 using the modified retrospective method with a cumulative-effect adjustment to retained earnings as of the beginning of the year of adoption. AgChoice Farm Credit, ACA 6

7 ASU Leases (Topic 842) Requires lessees to recognize leases on the balance sheet with lease liabilities and corresponding right-of-use assets based on the present value of lease payments. Lessor accounting activities are largely unchanged from existing lease accounting. The Update also eliminates leveraged lease accounting but allows existing leveraged leases to continue their current accounting until maturity, termination or modification. Expands qualitative and quantitative disclosures of leasing arrangements. Requires adoption using a modified cumulativeeffect approach wherein the guidance is applied to all periods presented. The practical expedients allow entities to largely account for existing leases consistent with current guidance, except for the incremental balance sheet recognition for lessees. The Association has started its implementation of the Update which has included an initial evaluation of leasing contracts and activities. As a lessee the Association is developing its methodology to estimate the right-of use assets and lease liabilities, which is based on the present value of lease payments but does not expect a material change to the timing of expense recognition. Given the limited changes to lessor accounting, the Association does not expect material changes to recognition or measurement, but it is early in the implementation process and the impact will continue to be evaluated. The Association is evaluating existing disclosures and may need to provide additional information as a result of adoption of the Update. The Association expects to adopt the guidance in first quarter 2019 using the modified retrospective method and practical expedients for transition. ASU Financial Instruments Overall (Subtopic ): Recognition and Measurement of Financial Assets and Financial Liabilities The Update amends the presentation and accounting for certain financial instruments, including liabilities measured at fair value under the fair value option and equity investments. Requires certain equity instruments be measured at fair value, with changes in fair value recognized in earnings. The guidance also updates fair value presentation and disclosure requirements for financial instruments measured at amortized cost. The Association is currently evaluating any impacts to the financial statements. The Association s implementation efforts include the identification of securities within the scope of the guidance, the evaluation of the measurement alternative available for equity securities without a readily determinable fair value, and the related impact to accounting policies, presentation, and disclosures. Any investments in nonmarketable equity investments accounted for under the cost method of accounting (except for other Farm Credit Institution stock) will be accounted for either at fair value with unrealized gains and losses reflected in earnings or, if elected, using an alternative method. The alternative method is similar to the cost method of accounting, except that the carrying value is adjusted (through earnings) for subsequent observable transactions in the same or similar investment. The Association is evaluating which method will be applied to these nonmarketable equity investments. Additionally, for purposes of disclosing the fair value of loans carried at amortized cost, the Association is evaluating valuation methods to determine the necessary changes to conform to an exit price notion as required by the Standard. Accordingly, the fair value amounts disclosed for such loans may change upon adoption. The Association expects to adopt the guidance in first quarter 2018 with a cumulative-effect adjustment to retained earnings as of the beginning of the year of adoption, except for changes related to nonmarketable equity investments, which is applied prospectively. The Association expects the primary accounting changes will relate to equity investments. AgChoice Farm Credit, ACA 7

8 ASU Revenue from Contracts With Customers (Topic 606) and subsequent related Updates Requires that revenue from contracts with customers be recognized upon transfer of control of a good or service, and transfers of nonfinancial assets, in an amount equaling the consideration expected to be received. Changes the accounting for certain contract costs, including whether they may be offset against revenue in the Statements of Income, and requires additional disclosures about revenue and contract costs. May be adopted using a full retrospective approach or a modified, cumulative-effect approach wherein the guidance is applied only to existing contracts as of the date of initial application, and to new contracts transacted after that date. The Association s revenue is the sum of net interest income and noninterest income. The scope of the guidance explicitly excludes net interest income as well as many other revenues for financial assets and liabilities including loans, leases, securities, and derivatives. Accordingly, the majority of the Association s revenues will not be affected. The Association is performing an assessment of revenue contracts as well as working with industry participants on matters of interpretation and application. Accounting policies will not change materially since the principles of revenue recognition from the Update are largely consistent with existing guidance and current practices. The Association has not identified material changes to the timing or amount of revenue recognition. The Association expects a minor change to the presentation of costs for certain underwriting activities which will be presented in expenses rather than the current presentation against the related revenues. The Association will provide qualitative disclosures of performance obligations related to revenue recognition and will continue to evaluate disaggregation for significant categories of revenue in the scope of the guidance. The Association expects to adopt the guidance in first quarter 2018 using the modified retrospective method with a cumulative-effect adjustment to opening retained earnings. 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 or writing AgChoice Farm Credit, ACA, 900 Bent Creek Blvd., Mechanicsburg, PA, 17050, 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. AgChoice Farm Credit, ACA 8

9 AgChoice Farm Credit, ACA Consolidated Balance Sheets September 30, December 31, (dollars in thousands) (unaudited) (audited) Assets Cash $ 55 $ 43 Investment securities: Held to maturity (fair value of $2,381 and $2,336, respectively) 2,205 2,243 Loans 1,831,597 1,802,291 Allowance for loan losses (12,675) (11,802) Net loans 1,818,922 1,790,489 Accrued interest receivable 8,438 6,402 Investments in other Farm Credit institutions 23,320 23,295 Premises and equipment, net 11,452 11,527 Other property owned Accounts receivable 9,623 21,595 Other assets 1,356 2,670 Total assets $ 1,875,408 $ 1,858,343 Liabilities Notes payable to AgFirst Farm Credit Bank $ 1,475,384 $ 1,464,915 Accrued interest payable 3,351 2,935 Patronage refunds payable ,663 Accounts payable 3,772 4,502 Other liabilities 11,847 12,310 Total liabilities 1,494,728 1,504,325 Commitments and contingencies (Note 8) Members' Equity Capital stock and participation certificates 10,997 11,049 Retained earnings Allocated 161, ,489 Unallocated 208, ,537 Accumulated other comprehensive income (loss) (56) (57) Total members' equity 380, ,018 Total liabilities and members' equity $ 1,875,408 $ 1,858,343 The accompanying notes are an integral part of these consolidated financial statements. Ag Choice Farm Credit, ACA 9

10 AgChoice Farm Credit, ACA Consolidated Statements of Income (unaudited) For the three months For the nine months ended September 30, ended September 30, (dollars in thousands) Interest Income Loans $ 22,483 $ 20,073 $ 65,165 $ 59,653 Investments Total interest income 22,517 20,108 65,269 59,759 Interest Expense Notes payable to AgFirst Farm Credit Bank 10,147 8,489 28,796 24,909 Net interest income 12,370 11,619 36,473 34,850 Provision for loan losses ,423 Net interest income after provision for loan losses 12,198 11,373 35,576 33,427 Noninterest Income Loan fees Fees for financially related services ,448 1,259 Patronage refunds from other Farm Credit institutions 3,152 3,013 9,293 9,056 Gains (losses) on sales of rural home loans, net Gains (losses) on sales of premises and equipment, net 318 (4) Gains (losses) on other transactions 4 (100) 40 (163) Other noninterest income Total noninterest income 4,170 3,595 11,904 11,313 Noninterest Expense Salaries and employee benefits 4,209 4,337 12,961 13,243 Occupancy and equipment , Insurance Fund premiums ,610 1,692 (Gains) losses on other property owned, net 2 (21) Other operating expenses 1,676 1,710 4,920 4,955 Total noninterest expense 6,844 6,996 20,583 21,107 Income before income taxes 9,524 7,972 26,897 23,633 Provision (benefit) for income taxes 89 (78) 167 (8) Net income $ 9,435 $ 8,050 $ 26,730 $ 23,641 The accompanying notes are an integral part of these consolidated financial statements. Ag Choice Farm Credit, ACA 10

11 AgChoice 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) Net income $ 9,435 $ 8,050 $ 26,730 $ 23,641 Other comprehensive income net of tax Employee benefit plans adjustments 1 1 Comprehensive income $ 9,435 $ 8,050 $ 26,731 $ 23,642 The accompanying notes are an integral part of these consolidated financial statements. Ag Choice Farm Credit, ACA 11

12 AgChoice Farm Credit, ACA Consolidated Statements of Changes in Members Equity (unaudited) Capital Accumulated Stock and Retained Earnings Other Total Participation Comprehensive Members' (dollars in thousands) Certificates Allocated Unallocated Income (Loss) Equity Balance at December 31, 2015 $ 11,054 $ 161,489 $ 159,895 $ (52) $ 332,386 Comprehensive income 23, ,642 Capital stock/participation certificates issued/(retired), net (67) (67) Dividends declared/paid 9 (9) Patronage distribution adjustment 2 2 Balance at September 30, 2016 $ 10,996 $ 161,489 $ 183,529 $ (51) $ 355,963 Balance at December 31, 2016 $ 11,049 $ 161,489 $ 181,537 $ (57) $ 354,018 Comprehensive income 26, ,731 Capital stock/participation certificates issued/(retired), net (75) (75) Dividends declared/paid 23 (23) Patronage distribution adjustment 6 6 Balance at September 30, 2017 $ 10,997 $ 161,489 $ 208,250 $ (56) $ 380,680 The accompanying notes are an integral part of these consolidated financial statements. Ag Choice Farm Credit, ACA 12

13 AgChoice 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 AgChoice Farm Credit, ACA and its Production Credit Association (PCA) and Federal Land Credit Association (FLCA) subsidiaries (collectively, the Association). A 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, 2016, are contained in the 2016 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 6, 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 Annual Report: 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 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 recognition standard. The amendments will be effective for reporting periods beginning after December 15, 2017 for public business entities. 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 January 2017, the FASB issued ASU Intangibles Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. The Update simplifies the accounting for goodwill impairment for public business entities and other entities that have AgChoice Farm Credit, ACA 13

14 goodwill reported in their financial statements and have not elected the private company alternative for the subsequent measurement of goodwill. The amendment removes Step 2 of the goodwill impairment test. Goodwill impairment will now be the amount by which a reporting unit s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. The effective date and transition requirements for the technical corrections will be effective for reporting periods beginning after December 15, 2020 for public business entities that are not SEC filers. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 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 January 2017, the FASB issued ASU Accounting Changes and Error Corrections (Topic 250) and Investments Equity Method and Joint Ventures (Topic 323): Amendments to SEC Paragraphs Pursuant to Staff Announcements at the September 22, 2016 and November 17, 2016 EITF Meetings (SEC Update). The ASU incorporates recent SEC guidance about disclosing, under SEC SAB Topic 11.M, the effect on financial statements of adopting the revenue, leases, and credit losses standards. The Update was effective upon issuance. Application of this guidance is not expected to have a material impact on the Association s financial condition or results of operations. 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: Business Combinations (Topic 805): Clarifying the Definition of a Business. In January, 2017, the FASB issued this update to provide a more robust framework to use in determining when a set of assets and activities is a business. It supports more consistency in applying the guidance, reduces the costs of application, and makes the definition of a business more operable. For public business entities, the ASU is effective for annual periods beginning after December 15, 2017, including interim periods within those periods. The amendments should be applied prospectively. The Association is in the process of evaluating what effects the guidance may have on the statements of financial condition and results of operations Income Taxes (Topic 740) - Intra-Entity Transfers of Assets Other Than Inventory: In October, 2016, the FASB issued this Update that requires an entity to recognize the income tax consequences of an intraentity transfer of an asset other than inventory when the transfer occurs. For public business entities, the amendments are effective, on a modified retrospective basis, for annual reporting periods beginning after December 15, 2017, including interim reporting periods within those annual reporting periods. The Association is in the process of evaluating what effects the guidance may have on the statements of financial condition and results of operations Financial Instruments Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments: In June, 2016, the FASB issued this Update 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 better estimate their credit losses. Additionally, the ASU amends the accounting for credit losses on available-for-sale 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 Leases (Topic 842): In February, 2016, the FASB issued this Update which 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 Financial Instruments Overall (Subtopic ) Recognition and Measurement of Financial Assets and Financial Liabilities: In January, 2016, the FASB issued this Update which is intended to improve the recognition and measurement of financial instruments. The new guidance makes targeted improvements to existing GAAP. The ASU will be effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years for public business entities. The Association is in the process of evaluating what effects the guidance may have on the statements of financial condition and results of operations. AgChoice Farm Credit, ACA 14

15 Revenue from Contracts with Customers (Topic 606): In May 2014, the FASB issued this guidance to change the recognition of revenue from contracts with customers. The core principle of the new 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. This guidance also includes 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 has issued several additional Updates that generally provide clarifying guidance where there was the potential for diversity in practice, or address the cost and complexity of applying Topic 606. The guidance and all related updates will be effective for reporting periods beginning after December 15, 2017 for public business entities. Early application is not permitted. The amendments are to be applied retrospectively. The Association has identified ancillary revenues that will be affected by this Update. However, because financial instruments are not within the scope of the guidance, it is expected that adoption will not have a material impact on the Association s financial condition or results of operations, but may result in additional disclosures. 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: the consolidation guidance on how a reporting entity that is the single decision maker of a variable interest entity (VIE) should treat indirect interests in the entity held through related parties that are under common control with the reporting entity when determining whether it is the primary beneficiary of that VIE. The amendments are effective for public business entities for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. Application of the guidance had no impact on the Association s financial statements Statement of Cash Flows (Topic 230) - Classification of Certain Cash Receipts and Cash Payments (a consensus of the Emerging Issues Task Force): In August, 2016, the FASB issued this Update to eliminate diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The Update addresses eight specific cash flow issues with the objective of reducing existing diversity in practice. The amendments are effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. An entity that elects early adoption must adopt all of the amendments in the same period. The amendments are to be applied using a retrospective transition method to each period presented. The Association elected retrospective early adoption of this guidance. The criteria of the standard were not significantly different from the Association s policy in place at adoption. Application of the guidance had no impact on the Association s Statements of Cash Flows. Note 2 Loans and Allowance for Loan Losses Statement of Cash Flows (Topic 230): Restricted Cash. In November, 2016, the FASB issued this Update to clarify that amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginningof-period and end-of-period total amounts shown on the statement of cash flows. The amendments are effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted using a retrospective transition method to each period presented. The Association elected retrospective early adoption of this guidance. The criteria of the standard were not significantly different from the Association s policy in place at adoption. Application of the guidance had no impact on the Association s Statements of Cash Flows Consolidation (Topic 810) - Interests Held through Related Parties That Are under Common Control: In October, 2016, the FASB issued this Update to amend 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. AgChoice Farm Credit, ACA 15

16 A summary of loans outstanding at period end follows: September 30, 2017 December 31, 2016 Real estate mortgage $ 846,492 $ 811,807 Production and intermediate-term 629, ,005 Loans to cooperatives 45,467 53,928 Processing and marketing 136, ,574 Farm-related business 34,798 39,173 Communication 88,491 78,626 Power and water/waste disposal 17,378 22,391 Rural residential real estate 19,507 19,804 International 12,624 11,969 Lease receivables Other (including Mission Related) Total loans $ 1,831,597 $ 1,802,291 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, 2017 Within AgFirst District Within Farm Credit System Outside Farm Credit System Total Purchased Sold Purchased Sold Purchased Sold Purchased Sold Real estate mortgage $ 9,644 $ 28,380 $ 6,921 $ $ $ $ 16,565 $ 28,380 Production and intermediate-term 34,284 16,627 65,759 7, ,043 24,026 Loans to cooperatives 45,507 45,507 Processing and marketing 36,766 47,731 84,497 Farm-related business Communication 8,609 80,114 88,723 Power and water/waste disposal 2,663 14,788 17,451 Rural residential real estate International ,000 12,661 Lease receivables Total $ 92,627 $ 45,529 $ 273,647 $ 7,399 $ $ $ 366,274 $ 52,928 December 31, 2016 Within AgFirst District Within Farm Credit System Outside Farm Credit System Total Purchased Sold Purchased Sold Purchased Sold Purchased Sold Real estate mortgage $ 15,509 $ 34,989 $ 9,692 $ $ $ $ 25,201 $ 34,989 Production and intermediate-term 37,016 19,438 70,814 7, ,830 27,428 Loans to cooperatives 53,971 53,971 Processing and marketing 24, ,640 76, Farm-related business Communication 8,304 70,533 78,837 Power and water/waste disposal 3,693 18,784 22,477 Rural residential real estate International 12,000 12,000 Lease receivables Total $ 89,408 $ 55,341 $ 288,210 $ 7,990 $ $ $ 377,618 $ 63,331 AgChoice Farm Credit, ACA 16