10-K 1 f10k_031504.txt As filed with the Securities and Exchange Commission on March 15, 2004 -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 -------------------------------------------------------------------------------- FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2003. OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____ to _____. Commission File Number 0-17440 ----------------------------------------------------------------------- FEDERAL AGRICULTURAL MORTGAGE CORPORATION ---------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Federally chartered instrumentality of the United States 52-1578738 ---------------------------------- --------------------------------------- (State or other jurisdiction of (I.R.S. employer identification number) incorporation or organization) 1133 21st Street, N.W., Suite 600, Washington, D.C. 20036 ---------------------------------------- --------------------------------- (Address of principal executive offices) (Zip code) (202) 872-7700 --------------------------------------------------- (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: Title of Each Class Exchange on Which Registered ------------------- ---------------------------- Class A voting common stock New York Stock Exchange Class C non-voting common stock New York Stock Exchange Securities registered pursuant to Section 12(g) of the Act: Class B voting common stock Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (or such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (17 C.F.R. ss.229.405) is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes [X] No [ ] The aggregate market values of the Class A voting common stock and Class C non-voting common stock held by non-affiliates of the registrant were $17,214,026 and $229,287,264 respectively as of the last business day of the registrant's most recently completed second fiscal quarter, based upon the closing prices for the respective classes on June 30, 2003 reported by the New York Stock Exchange. The aggregate market value of the Class B voting common stock is not ascertainable due to the absence of publicly available quotations or prices for the Class B voting common stock as a result of the limited market for, and infrequency of trades in, Class B voting common stock and the fact that any such trades are privately negotiated transactions. As of March 1, 2004, the registrant had outstanding 1,030,780 shares of Class A voting common stock, 500,301 shares of Class B voting common stock and 10,539,131 shares of Class C non-voting common stock. DOCUMENTS INCORPORATED BY REFERENCE Proxy Statement to be filed on or about April 19, 2004 in connection with the Annual Meeting of Stockholders to be held on June 3, 2004 (portions of which are incorporated by reference into Part II and Part III of this Annual Report on Form 10-K). -------------------------------------------------------------------------- Table of Contents PART I.......................................................................5 Item 1. Business.........................................................5 General..........................................................5 FARMER MAC PROGRAMS..............................................7 Farmer Mac I.....................................................7 Loan Eligibility..............................................7 Purchases.....................................................8 Off-Balance Sheet Guarantees and Commitments..................9 Underwriting and Appraisal Standards.........................10 Sellers......................................................13 Servicing....................................................13 Farmer Mac I Guaranteed Securities...........................13 Farmer Mac I Transactions....................................15 Funding of Guarantee and Purchase Commitment Obligations.....16 Portfolio Diversification....................................16 Farmer Mac II...................................................17 General......................................................17 United States Department of Agriculture Guaranteed Loan Programs............................................17 Farmer Mac II Guaranteed Securities..........................18 Farmer Mac II Transactions...................................18 Financing.......................................................19 Debt Issuance................................................19 Equity Issuance..............................................20 Farmer Mac's Authority to Borrow from the U.S. Treasury.........21 Government Regulation of Farmer Mac.............................21 Item 2. Properties.....................................................24 Item 3. Legal Proceedings...............................................25 Item 4. Submission of Matters to a Vote of Security Holders.............25 PART II.....................................................................26 Item 5. Market for Registrant's Common Equity and Related Stockholder Matters..................................................26 Item 6. Selected Financial Data.........................................27 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.......................................28 Forward-Looking Statements......................................28 Critical Accounting Policy and Estimates........................29 Results of Operations...........................................31 Balance Sheet Review............................................45 Risk Management.................................................47 Liquidity and Capital Resources.................................63 Other Matters...................................................70 Item 7A. Quantitative and Qualitative Disclosures About Market Risk......70 Item 8. Financial Statements............................................71 Reports of Independent Auditors.................................71. Consolidated Balance Sheets.....................................73 Consolidated Statements OF Operations...........................74 Consolidated Statements OF Changes in Stockholders' Equity......75 Consolidated Statements OF Cash Flows...........................76 Notes in Consolidated Financial Statements......................77 Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.......................................117 Item 9A. Controls and Procedures........................................117 PART III...................................................................119 Item 10. Directors and Executive Officers of the Registrant.............119 Item 11. Executive Compensation.........................................119 Item 12. Security Ownership of Certain Beneficial Owners and Management.119 Item 13. Certain Relationships and Related Transactions.................119 Item 14. Principal Accounting Fees and Services.........................119 PART IV....................................................................120 Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K................................................120 PART I Item 1. Business General The Federal Agricultural Mortgage Corporation ("Farmer Mac" or the "Corporation") was chartered by the U.S. Congress in the Agricultural Credit Act of 1987 (12 U.S.C. ss.ss. 2279aa et seq.), which amended the Farm Credit Act of 1971 (collectively, as amended, the "Act"). Farmer Mac is a stockholder-owned instrumentality of the United States that was created to establish a secondary market for agricultural real estate and rural housing mortgage loans and to increase the availability of long-term credit at stable interest rates to American farmers, ranchers and rural homeowners. The Farmer Mac secondary market for agricultural mortgage loans accomplishes that mission by providing liquidity and lending capacity to agricultural mortgage lenders by: o purchasing newly originated and pre-existing ("seasoned") eligible mortgage loans directly from lenders through its "cash window" and seasoned eligible mortgage loans from lenders and other third parties in negotiated transactions; o exchanging newly issued agricultural mortgage-backed securities guaranteed by Farmer Mac ("Farmer Mac Guaranteed Securities") for newly originated and seasoned eligible mortgage loans that back those securities in "swap" transactions; o issuing long-term standby purchase commitments ("LTSPCs") for newly originated and seasoned eligible mortgage loans; and o purchasing and guaranteeing mortgage-backed bonds secured by eligible mortgage loans, which are referred to as AgVantage bonds. Farmer Mac conducts these activities through two programs--Farmer Mac I and Farmer Mac II. Under the Farmer Mac I program, Farmer Mac: o purchases eligible mortgage loans; o securitizes eligible mortgage loans purchased and guarantees the timely payment of principal and interest on the agricultural mortgage-backed securities backed by such loans; and o commits to purchase eligible mortgage loans under LTSPCs for such loans. To be eligible for the Farmer Mac I program, loans must meet Farmer Mac's underwriting, appraisal, documentation and other specified standards that are discussed in "Business--Farmer Mac Programs--Farmer Mac I." Under the Farmer Mac II program, Farmer Mac purchases the guaranteed portions of loans guaranteed by the United States Department of Agriculture (the "USDA-guaranteed portions") pursuant to the Consolidated Farm and Rural Development Act (7 U.S.C. ss.ss. 1921 et seq.) and guarantees securities backed by those USDA-guaranteed portions purchased by Farmer Mac. Farmer Mac may retain Farmer Mac Guaranteed Securities in its portfolio or sell them to third parties. As of December 31, 2003, outstanding loans held by Farmer Mac and loans that either back Farmer Mac Guaranteed Securities or are subject to LTSPCs totaled $5.8 billion. For more information about Farmer Mac's securities and its financial performance, see "Management's Discussion and Analysis of Financial Condition and Results of Operations." Farmer Mac's two principal sources of revenue are: o fees received in connection with outstanding Farmer Mac Guaranteed Securities and LTSPCs; and o net interest income earned on its portfolio of Farmer Mac Guaranteed Securities, mortgage loans, AgVantage bonds and investments. Farmer Mac funds its program purchases primarily by issuing debt obligations of various maturities. As of December 31, 2003, Farmer Mac had outstanding $2.6 billion of discount notes and $1.3 billion of medium-term notes. During 2003, the Corporation continued its strategy of regularly issuing debt to increase its presence in the capital markets in order to reduce the rates it pays on its debt, which allows Farmer Mac to accept lower rates on mortgages it purchases from lenders to farmers, ranchers and rural homeowners. To the extent the proceeds of the debt issuances exceed Farmer Mac's need to fund program assets, those proceeds are invested in high quality non-program assets. Farmer Mac is an institution of the Farm Credit System, but is not liable for any debt or obligation of any other institution of the Farm Credit System. Likewise, neither the Farm Credit System nor any other individual institution of the Farm Credit System is liable for any debt or obligation of Farmer Mac. The Farm Credit Administration ("FCA"), acting through its Office of Secondary Market Oversight, has general regulatory and enforcement authority over Farmer Mac, including the authority to promulgate rules and regulations governing the activities of Farmer Mac and to apply FCA's general enforcement powers to Farmer Mac and its activities. For a discussion of Farmer Mac's statutory capital requirements and its capital levels, see "Business--Government Regulation of Farmer Mac--Regulation--Capital Standards" and "Management's Discussion and Analysis of Financial Condition and Results of Operations--Balance Sheet Review--Capital" and "--Liquidity and Capital Resources--Capital Requirements." Farmer Mac has three classes of common stock outstanding--Class A voting, Class B voting and Class C non-voting. See "Market for Registrant's Common Equity and Related Stockholder Matters" for information regarding Farmer Mac's common stock. Farmer Mac has one class of preferred stock. See "Farmer Mac Programs--Financing--Equity Issuance." As of December 31, 2003, Farmer Mac employed 36 persons, located primarily at its principal executive offices at 1133 Twenty-First Street, N.W., Suite 600, Washington, D.C. 20036. Farmer Mac's main telephone number is (202) 872-7700. Farmer Mac makes available free of charge on its Internet website at www.farmermac.com (in the "Investors" section) copies of materials it files with, or furnishes to, the U.S. Securities and Exchange Commission ("SEC"), including Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports, as soon as reasonably practicable after electronically filing of such materials with, or furnishing to, the SEC. Please note that all references to www.farmermac.com in this report are inactive textual references only and that the information contained on Farmer Mac's website is not incorporated by reference into this report. FARMER MAC PROGRAMS Farmer Mac I Loan Eligibility Under the Farmer Mac I program, Farmer Mac purchases, or commits to purchase, eligible mortgage loans and guarantees the timely payment of principal and interest on securities backed by, or representing interests in, eligible mortgage loans. A loan is eligible for the Farmer Mac I program if it is: o secured by a fee simple mortgage or a long-term leasehold mortgage, with status as a first lien on agricultural real estate or rural housing (as defined below) located within the United States; o an obligation of a citizen or national of the United States, an alien lawfully admitted for permanent residence in the United States or a private corporation or partnership that is majority-owned by U.S. citizens, nationals or legal resident aliens; o an obligation of a person, corporation or partnership having training or farming experience that is sufficient to ensure a reasonable likelihood that the loan will be repaid according to its terms; and o in conformance with Farmer Mac's underwriting, appraisal, documentation and other specified standards to be eligible for participation in the Farmer Mac I program. See "--Underwriting and Appraisal Standards" and "--Sellers" for a description of these standards. For purposes of the Farmer Mac I program, agricultural real estate is one or more parcels of land, which may be improved by permanently affixed buildings or other structures, that: o is used for the production of one or more agricultural commodities or products; and o consists of a minimum of five acres or generates minimum annual receipts of $5,000. Currently, the maximum principal amount of an eligible loan secured by agricultural real estate is $5.0 million, as adjusted annually for inflation, for loans secured by more than 1,000 acres of land and $12.0 million for loans secured by 1,000 acres or less. For purposes of the Farmer Mac I program, rural housing is a one- to four-family, owner-occupied, moderately priced principal residence located in a community with a population of 2,500 or less. Since October 2003, the maximum purchase price or current appraised value for a dwelling, excluding the land to which the dwelling is affixed, that secures a rural housing loan has been $197,807, as adjusted for inflation. In addition to the dwelling itself, an eligible rural housing loan can be secured by land associated with the dwelling having an appraised value of no more than 50 percent of the total appraised value of the combined property. To date, loans meeting the eligibility criteria under the rural housing segment of Farmer Mac's requirements have not represented a significant part of Farmer Mac's business. Purchases Loan Purchases. Farmer Mac offers credit products that are intended to increase the secondary market liquidity of agricultural mortgage loans and the lending capacity of financial institutions that originate agricultural mortgage loans, while permitting Farmer Mac to efficiently securitize eligible mortgage loans acquired through its secondary market activities. Farmer Mac enters into mandatory and optional delivery commitments to purchase loans and prices such commitments daily through its cash window. Because the securitization process requires the grouping of loans into uniform pools, Farmer Mac emphasizes the importance of conformity to its program requirements, including the interest rate, amortization, maturity and payment frequency specifications. Farmer Mac also purchases portfolios of newly originated and seasoned loans on a negotiated basis through its cash window. Farmer Mac purchases fixed- and adjustable-rate loans primarily, but also may purchase other types of loans, including convertible mortgage loans. Loans purchased by Farmer Mac have a variety of maturities and often include balloon payments. Loans purchased or subject to purchase commitments also may include provisions that require a yield maintenance payment or some other form of prepayment penalty in the event a borrower prepays a loan (depending upon the level of interest rates at the time of prepayment). During 2003, Farmer Mac purchased $192.6 million of loans through its cash window. Of the loans purchased during 2003, 74 percent included balloon payments and 11 percent included yield maintenance prepayment protection. By comparison, during 2002, Farmer Mac purchased $747.9 million of loans through its cash window, including a $489.5 million loan portfolio in second quarter 2002. Of the loans purchased during 2002, 76 percent included balloon payments and 54 percent included yield maintenance prepayment protection. During 2003, Farmer Mac's top ten sellers generated 80.8 percent of the total Farmer Mac I cash window loan purchase volume, of which Zions First National Bank, Farmer Mac's largest combined Class A and Class C stockholder, accounted for 38.7 percent. Including the second quarter loan portfolio purchase transaction, the top ten sellers in 2002 generated 90.0 percent of the total Farmer Mac I cash window loan purchase volume, of which Zions First National Bank accounted for 10.3 percent. For more information regarding loan volume, see "Management's Discussion and Analysis of Financial Condition and Results of Operations--Results of Operations--Business Volume." Mortgage-Backed Bond Purchases. Farmer Mac purchases and guarantees timely payment of principal and interest on mortgage-backed bonds, referred to as AgVantage bonds, issued by institutions approved by Farmer Mac. Farmer Mac assesses an institution's agricultural loan underwriting and servicing capabilities as well as its creditworthiness in approving an institution for AgVantage bond sales to Farmer Mac. Each AgVantage bond is a general obligation of the issuing institution and is secured by eligible collateral in an amount ranging from 120 percent to 150 percent of the bond's outstanding principal amount. Eligible collateral consists of loans that meet the same loan eligibility criteria applied by Farmer Mac in its loan purchases and commitments and have an outstanding aggregate principal balance equal to at least 100 percent of the bond's outstanding principal amount plus cash or securities issued by the U.S. Treasury or guaranteed by an agency or instrumentality of the United States that make up any remaining required collateral. During 2003, Farmer Mac purchased six AgVantage bonds with maturities ranging from one month to five years from five institutions resulting in Farmer Mac guarantees of $13.1 million. As of December 31, 2003, the outstanding principal amount of AgVantage bonds was $25.2 million. To date, Farmer Mac has experienced no losses, nor has it been called upon to make a guarantee payment, on any of its AgVantage bonds. Off-Balance Sheet Guarantees and Commitments Farmer Mac offers two Farmer Mac I credit enhancement alternatives that allow approved agricultural and rural residential mortgage lenders both to retain the cash flow benefits of their loans and increase their liquidity and lending capacity. These alternatives are: o a swap transaction, in which Farmer Mac acquires eligible loans from sellers in exchange for Farmer Mac Guaranteed Securities backed by those loans. As consideration for its assumption of the credit risk on loans underlying the Farmer Mac Guaranteed Securities, Farmer Mac receives guarantee fees payable in arrears out of the periodic loan interest payments and based on the outstanding balance of the Farmer Mac Guaranteed Securities. o an LTSPC, which is not a guarantee of loans or securities, but a Farmer Mac commitment to purchase loans from a segregated pool of loans on one or more undetermined future dates. As consideration for its assumption of the credit risk on loans underlying an LTSPC, Farmer Mac receives commitment fees payable monthly in arrears, in an amount approximating what would have been the guarantee fees if the transaction were structured as a swap transaction. A swap transaction or an LTSPC may involve loans with payment, maturity and interest rate characteristics that differ from those purchased through the cash window. A swap transaction or an LTSPC permits a seller to nominate from its portfolio a segregated pool of loans, subject to review by Farmer Mac for conformance with its underwriting and appraisal standards. Upon Farmer Mac's acceptance of the eligible loans, whether under a swap transaction or an LTSPC, the seller effectively transfers the credit risk on those loans to Farmer Mac, thereby reducing the seller's credit and concentration risk exposures and, consequently, its regulatory capital and its loss reserve requirements. Only the LTSPC structure permits the seller to retain the segregated loan pool in its portfolio until such time, if ever, as the seller delivers some or all of the segregated loans to Farmer Mac for purchase under the LTSPC. An LTSPC commits Farmer Mac to a future purchase of loans that met Farmer Mac's underwriting standards at the time the loans first became subject to the LTSPC and Farmer Mac assumed the credit risk on loans. Farmer Mac generally purchases loans subject to an LTSPC: o At par plus accrued interest, if the loans become four months delinquent; o At a mark-to-market price, if the loans are not delinquent and are standard Farmer Mac cash window loan products; or in exchange for Farmer Mac I Guaranteed Securities. o If the loans are not four months delinquent, either at a mark-to-market negotiated price for all (but not some) loans in the pool, based on the sale of Farmer Mac I Guaranteed Securities in the capital markets or the funding obtained by Farmer Mac through the issuance of matching debt in the capital markets; or in exchange for Farmer Mac I Guaranteed Securities. In 2003, Farmer Mac entered into $763.3 million of LTSPCs, compared to $1.2 billion in 2002. During 2003, LTSPCs continued as the preferred credit enhancement alternative for new non-cash transactions and were a significant portion of the Farmer Mac I program. However, during third quarter 2003, Farm Credit West, ACA, a related party program participant, exercised the conversion feature incorporated in all existing LTSPCs and Farmer Mac converted that participant's $722.3 million LTSPC into a Farmer Mac I Guaranteed Security in a swap transaction. No similar transactions took place in 2002. Net of this transaction, as of December 31, 2003, Farmer Mac had committed to purchase under LTSPCs a cumulative total of 12,771 eligible mortgage loans with an aggregate principal balance of $2.3 billion. As of December 31, 2003, off-balance sheet Farmer Mac I Guaranteed Securities included 1,623 mortgage loans and totaled $952.1 million. For more information regarding guarantee and LTSPC volume, see "Management's Discussion and Analysis of Financial Condition and Results of Operations--Results of Operations--Business Volume." Underwriting and Appraisal Standards Farmer Mac has established underwriting and appraisal standards for agricultural mortgage loans to mitigate the risk of loss from borrower defaults and to provide guidance concerning the management, administration and conduct of underwriting and appraisals to all participating sellers and potential sellers in its programs. These standards were developed on the basis of industry norms for agricultural mortgage loans and are designed to assess the creditworthiness of the borrower, as well as the value of the mortgaged property relative to the amount of the mortgage loan. Farmer Mac requires sellers to make representations and warranties regarding the conformity of eligible mortgage loans to these standards and other requirements it may impose from time to time. Farmer Mac I credit underwriting standards require that the loan-to-value ratio ("LTV") for any loan not exceed 70 percent, except that a loan secured by a livestock facility and supported by a contract with an integrator may have an LTV of up to 75 percent, a part-time farm loan supported by private mortgage insurance may have an LTV of up to 85 percent and a rural housing loan supported by private mortgage insurance may have an LTV of up to 97 percent. Farmer Mac also has a loan product for borrowers with high credit scores whose loans are secured by collateral with low LTVs. For those borrowers, loan processing has been simplified and documentation of the credit ratios described above is not necessary. In the case of newly originated loans that are not part-time farm, facility, low-documentation, or rural housing loans, borrowers on the loans must, among other criteria set forth in Farmer Mac's underwriting standards, also meet the following standard underwriting ratios on a pro forma basis (i.e., giving effect to the new loan): o debt-to-asset ratio of 50 percent or less; o cash flow debt service coverage ratio on the mortgaged property of not less than 1:1; o total debt service coverage ratio, including farm and non-farm income, of not less than 1.25:1; and o ratio of current assets to current liabilities of not less than 1:1. Farmer Mac's underwriting standards provide for acceptance of loans that do not conform to one or more of the standard underwriting ratios, other than LTV, when those loans: o exceed minimum requirements for one or more of the underwriting standards to a degree that compensates for noncompliance with one or more other standards, referred to as compensating strengths; and o are made to producers of particular agricultural commodities in a segment of agriculture in which such compensating strengths are typical of the financial condition of sound borrowers in that segment. Farmer Mac's use of compensating strengths is not intended to provide a basis for waiving or lessening the requirement that eligible mortgage loans under the Farmer Mac I program be of consistently high quality. In fact, loans approved on the basis of compensating strengths have not demonstrated a significantly different rate of default than that of loans that were approved on the basis of conformance with all of the standard credit ratios. As of December 31, 2003, a total of $1.8 billion (36 percent) of the outstanding balance of loans held and loans underlying LTSPCs and Farmer Mac I Guaranteed Securities issued after the enactment of the Farm Credit System Reform Act of 1996 (the "1996 Act") were approved based upon compensating strengths ($63.4 million of which had original loan-to-value ratios of greater than 70 percent). The original loan-to-value ratio is calculated by dividing the loan principal balance at the time of guarantee, purchase or commitment by the appraised value at the date of loan origination or, when available, updated appraised value at the time of guarantee, purchase or commitment. During 2003, $351.0 million (37 percent) of the loans purchased or added under LTSPCs were approved based upon compensating strengths ($14.9 million of which had original loan-to-value ratios of greater than 70 percent). In the case of a seasoned loan, Farmer Mac considers sustained performance to be a reliable alternative indicator of a borrower's ability to pay the loan according to its terms. A seasoned loan generally will be deemed an eligible loan if: o it has been outstanding for at least five years and has a loan-to-value ratio of 60 percent or less; o there have been no payments more than 30 days past due during the previous three years; and o there have been no material restructurings or modifications for credit reasons during the previous five years. A seasoned loan that has been outstanding for more than one year but less than five years must substantially comply with the underwriting standards for newly originated loans as of the date the loan was originated by the lender. The loan must also have a payment history that shows no payment more than 30 days past due during the three-year period immediately prior to the date the loan is either purchased by Farmer Mac or made subject to an LTSPC. As with the secondary market for residential mortgages, there is no requirement that each loan's compliance with the underwriting standards be re-evaluated after Farmer Mac accepts the loan into its program. The due diligence Farmer Mac performs before purchasing, guaranteeing securities backed by, or committing to purchase seasoned loans includes: o evaluation of loan database information to determine conformity to the criteria set forth in the preceding paragraphs; o confirmation that loan file data conform to database information; validation of supporting credit information in the loan files; and o review of loan collateral appraisals. All of the foregoing are performed through methods that give due regard to the size, age, leverage and nature of the collateral for the loans. In the case of rural housing and part-time farm loans, the borrower may finance up to 97 percent and 85 percent, respectively, of the appraised value of the property if the amount above 80 percent is covered by private mortgage insurance. For newly originated part-time farm loans, the borrower must generate sufficient income from all sources to repay all creditors. A borrower's capacity to repay debt obligations is determined by two tests: o the borrower's monthly mortgage payment-to-income ratio should be 28 percent or less; and o the borrower's monthly debt payment-to-income ratio should be 36 percent or less. Farmer Mac's appraisal standards for newly originated loans require, among other things, that the appraisal function be performed independently of the credit decision-making process and conform to the Uniform Standards of Professional Appraisal Practice promulgated by the Appraisal Standards Board. Farmer Mac's appraisal standards require the appraisal function to be conducted or administered by an individual meeting specific qualification and competence criteria and who: o is not associated, except by the engagement for the appraisal, with the credit underwriters making the loan decision, though both the appraiser and the credit underwriter may be directly or indirectly employed by a common employer; o receives no financial or professional benefit of any kind by virtue of the report content, valuation or credit decision made or based on the appraisal product; and o has no present or contemplated future direct or indirect interest in the appraised property. The appraisal standards also require uniform reporting of reliable and credible opinions of the market value, market rent and property net income characteristics of the mortgaged property and the relative market forces. Farmer Mac requires current collateral valuations in conformance with the Uniform Standards of Professional Appraisal Practice for newly originated loans purchased or placed under a Farmer Mac I Guaranteed Security or LTSPC. For seasoned loans, Farmer Mac obtains appraisal updates as considered necessary by its assessment of collateral risk determined in the due diligence process. Farmer Mac personnel include experienced agricultural credit underwriters, appraisers and servicers who perform those functions with respect to many loans that come into the Farmer Mac I program. In addition, those personnel oversee the activities of several servicing centers to which Farmer Mac outsources a significant amount of its underwriting function in order to access the expertise and specialized knowledge of several industry-recognized third-party service providers throughout the country. The outsourcing agreements afford Farmer Mac the benefits of those servicing centers at fees based upon marginal costs, which allows Farmer Mac to avoid the fixed costs associated with such operations. Farmer Mac supervises and monitors the performance of the outsourced functions. Farmer Mac believes that the combined expertise of those third-party service providers and its own internal staff provides the Corporation with access to adequate resources for performing the necessary underwriting, appraisal and servicing functions. Sellers As of December 31, 2003, there were 142 approved loan sellers in the Farmer Mac I program ranging from single-office to multi-branch institutions, spanning community banks, Farm Credit System associations, mortgage companies, large multi-state Farm Credit System banks, commercial banks and insurance companies, of which 81 were active participants in the program. As of December 31, 2002, there were 219 approved sellers in the Farmer Mac I program, of which 79 were active participants in the program. In addition to participating directly in the Farmer Mac I program, some of the approved loan sellers enable other lenders to participate indirectly in the Farmer Mac I program by managing correspondent networks of lenders from which they purchase loans to sell to Farmer Mac. As of December 31, 2003, more than 75 lenders were participating in those networks, bringing the total Farmer Mac I program participants to more than 200 as of December 31, 2003. To be considered for approval as a Farmer Mac I seller, a financial institution must meet the criteria that Farmer Mac establishes, including: o owning a requisite amount of Farmer Mac Class A or Class B voting common stock according to a schedule prescribed for the size and type of institution; o having the ability and experience to make or purchase and sell agricultural mortgage loans of the type that will qualify for purchase by Farmer Mac and service such mortgage loans in accordance with the Farmer Mac requirements either through its own staff or through contractors and originators; o maintaining a minimum adjusted net worth of $1.0 million; o maintaining a fidelity bond and errors and omissions insurance coverage (or acceptable substitute insurance coverage) in a prescribed amount according to the size of the institution; and o entering into a Seller/Servicer agreement to comply with the terms of the Farmer Mac Seller/Servicer Guide, including representations and warranties regarding the eligibility of the loans and accuracy of loan data provided to Farmer Mac. Servicing Farmer Mac generally does not directly service loans held in its portfolio, although it does act as "master servicer" for pools of loans and loans underlying Farmer Mac Guaranteed Securities and may assume direct servicing for certain impaired loans. Farmer Mac's loans and the loans underlying its Farmer Mac Guaranteed Securities are serviced only by Farmer Mac-approved entities designated as "central servicers" that have entered into central servicing contracts with Farmer Mac. Sellers of eligible mortgage loans sold into the Farmer Mac I program have a right to retain certain "field servicing" functions (typically direct borrower contacts) and may enter into contracts with Farmer Mac's central servicers that specify such servicing functions. Farmer Mac I Guaranteed Securities Farmer Mac guarantees the timely payment of principal and interest on Farmer Mac Guaranteed Securities. Farmer Mac Guaranteed Securities backed by mortgage loans eligible for the Farmer Mac I program are referred to as "Farmer Mac I Guaranteed Securities." By statute, public offerings of Farmer Mac Guaranteed Securities are required to be registered with the SEC under the federal securities laws. Accordingly, Farmer Mac, through its subsidiary Farmer Mac Mortgage Securities Corporation, maintains a shelf registration statement with the SEC through which Farmer Mac Guaranteed Securities may be publicly offered from time to time. Farmer Mac also may offer Farmer Mac Guaranteed Securities in private, unregistered offerings. U.S. Bank National Association, a national banking association based in Minneapolis, Minnesota, or Farmer Mac serves as trustee for the trusts that acquire eligible loans and issue Farmer Mac Guaranteed Securities. Farmer Mac I Guaranteed Securities are agricultural mortgage pass-through certificates guaranteed by Farmer Mac that represent beneficial interests in pools of loans or in obligations backed by pools of loans. All Farmer Mac I Guaranteed Securities issued during and since 1996 have been single class or multiclass "grantor trust" pass-through certificates. These securities entitle each investor in a class of securities to receive a portion of the payments of principal and interest on the related underlying pool of loans equal to the investor's proportionate interest in the pool. These securities also may support other Farmer Mac I Guaranteed Securities, including real estate mortgage investment conduit securities, commonly referred to as REMICs, and other agricultural mortgage-backed securities. Farmer Mac I Guaranteed Securities issued prior to the enactment of changes to Farmer Mac's statutory charter in 1996 are supported by unguaranteed first-loss subordinated interests that represented ten percent of the balance of the loans underlying the securities at issuance. Farmer Mac I Guaranteed Securities are not assets of Farmer Mac, except when acquired for investment purposes, nor are Farmer Mac I Guaranteed Securities recorded as liabilities on Farmer Mac's consolidated financial statements. Farmer Mac, however, is liable under its guarantee on the securities to make timely payments to investors of principal (including balloon payments) and interest based on the scheduled payments on the underlying loans, regardless of whether the grantor trust has actually received such scheduled payments. Because it guarantees timely payments on Farmer Mac I Guaranteed Securities, Farmer Mac assumes the ultimate credit risk of borrower defaults on the underlying loans, which are subject to Farmer Mac's Underwriting Standards described above in "--Underwriting and Appraisal Standards." See also "Management's Discussion and Analysis of Financial Condition and Results of Operations--Risk Management--Credit Risk - Loans." Farmer Mac receives guarantee fees in return for its guarantee obligations on Farmer Mac I Guaranteed Securities. These fees are collected as installment payments are made on the underlying loans until those loans have been repaid or otherwise liquidated (generally as a result of default). The aggregate amount of guarantee fees received on Farmer Mac I Guaranteed Securities depends upon the amount of such securities outstanding and on the guarantee fee rate, which is capped by statute at 50 basis points (0.50 percent) per annum. The Farmer Mac I guarantee fee rate typically ranges from 40 to 50 basis points (0.40 to 0.50 percent) per annum, depending on the credit quality of and other criteria regarding the loans. The amount of Farmer Mac I Guaranteed Securities outstanding is influenced by the repayment rates on the underlying loans and by the rate at which Farmer Mac issues new Farmer Mac I Guaranteed Securities. In general, when the level of interest rates declines significantly below the interest rates on loans underlying Farmer Mac I Guaranteed Securities, the rate of prepayments is likely to increase; conversely, when interest rates rise above the interest rates on the loans underlying Farmer Mac I Guaranteed Securities, the rate of prepayments is likely to decrease. In addition to changes in interest rates, the rate of principal payments on Farmer Mac I Guaranteed Securities is also influenced by a variety of economic, demographic and other considerations, including yield maintenance provisions that are associated with many of the loans underlying Farmer Mac I Guaranteed Securities. For more information regarding yield maintenance provisions, see "Management's Discussion and Analysis of Financial Condition and Results of Operations--Risk Management--Interest Rate Risk." For each of the years ended December 31, 2003 and 2002, Farmer Mac sold SEC-registered Farmer Mac Guaranteed Securities at no gain or loss in the amount of $78.3 million and $47.7 million, respectively, principally to a related party. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Results of Operations--Business Volume." Farmer Mac I Transactions During the year ended December 31, 2003, Farmer Mac purchased or placed under guarantee or LTSPC $1.0 billion of loans under the Farmer Mac I program. As of December 31, 2003, loans held and loans underlying Farmer Mac I Guaranteed Securities and LTSPCs totaled $5.0 billion. The 1996 Act revised Farmer Mac's statutory charter to eliminate the requirement of a first-loss subordinated interest in Farmer Mac I Guaranteed Securities. As of December 31, 2003, $24.7 million of Farmer Mac I Guaranteed Securities issued prior to the 1996 Act remained outstanding. The following table summarizes loans purchased or newly placed under guarantees or LTSPCs under the Farmer Mac I program for each of the years ended December 31, 2003, 2002 and 2001.
For the Year Ended December 31, ---------------------------------------------- 2003 2002 2001 --------------- -------------- --------------- (in thousands) Loans and Guaranteed Securities $ 192,577 $ 747,881 $ 272,127 LTSPCs 763,342 1,155,479 1,032,967 --------------- -------------- --------------- Total $ 955,919 $1,903,360 $1,305,094 --------------- -------------- ---------------
The following table presents the outstanding balances of Farmer Mac I loans and loans underlying Farmer Mac I Guaranteed Securities and LTSPCs as of the dates indicated:
Outstanding Balances as of December 31, --------------------------------------- 2003 2002 ------------------- ------------------ (in thousands) Post-1996 Act: Loans and Guaranteed Securities $ 2,696,530 $ 2,168,994 LTSPCs 2,348,702 2,681,240 Pre-1996 Act 24,734 31,960 ------------------- ------------------ Total Farmer Mac I program $ 5,069,966 $ 4,882,194 ------------------- ------------------
Funding of Guarantee and Purchase Commitment Obligations The principal sources of funding for the payment of Farmer Mac's obligations under its guarantees and LTSPCs are the fees for its guarantees and commitments, net interest income and the proceeds of debt issuance. Farmer Mac satisfies its guarantee and purchase commitment obligations by purchasing defaulted loans out of LTSPCs and from the related trusts for Farmer Mac Guaranteed Securities. Farmer Mac typically recovers a significant portion of the value of defaulted loans purchased either through borrower payments, loan payoffs, payments by third parties or foreclosure and sale. Ultimate losses arising from Farmer Mac's guarantees and commitments are reflected in the Corporation's charge-offs against its allowance for losses and gains and losses on the sale of real estate owned. During 2003, Farmer Mac's net charge-offs were $5.2 million, compared to $4.1 million in net charge-offs during 2002. Gains on the sale of real estate owned were $0.2 million and $0.1 million for each of the years ended December 31, 2003 and 2002, respectively. The Act requires Farmer Mac to set aside, as an allowance for losses in a reserve account, a portion of the guarantee fees it receives from its guarantee activities. Among other things, that reserve account must be exhausted before Farmer Mac may issue obligations to the Secretary of the Treasury against the $1.5 billion Farmer Mac is statutorily authorized to borrow from the Secretary of the Treasury to fulfill its guarantee obligations. That borrowing authority is not intended to be a routine funding source and has never been used. Although total outstanding guarantees exceed the amount held as an allowance for losses and the amount it may borrow from the U.S. Treasury, Farmer Mac does not expect its obligations under the guarantees to exceed amounts available to satisfy those obligations. For information regarding the allowance for losses, see "Management's Discussion and Analysis of Financial Condition and Results of Operations--Risk Management--Credit Risk - Loans," Note 2(j) and Note 8 to the consolidated financial statements. For a more detailed discussion of Farmer Mac's borrowing authority from the Treasury, see "Farmer Mac's Authority to Borrow from the U.S. Treasury." Portfolio Diversification It is Farmer Mac's policy to diversify its portfolio of loans held and loans underlying Farmer Mac Guaranteed Securities and LTSPCs, both geographically and by commodity. Farmer Mac directs its marketing efforts toward agricultural lenders throughout the nation to achieve commodity and geographic diversification in its exposure to credit risk. Farmer Mac measures its credit exposure in particular geographic regions and commodities as a percentage of the total principal amount of all loans outstanding, adjusted for the credit quality of the loans in that particular geographic region or commodity group based on the loan-to-value, debt service coverage, equity-to-asset and working capital-to-current asset ratios of the loans. Farmer Mac is not obligated to buy every loan submitted to it by eligible sellers that meets its underwriting and appraisal standards. Farmer Mac considers other factors such as its overall portfolio diversification, commodity and farming forecasts and risk management objectives in deciding whether to accept the loans into the Farmer Mac I program. For example, if industry forecasts indicate possible weakness in a geographic area or commodity, Farmer Mac may decide not to purchase or commit to purchase an affected loan as part of managing its overall portfolio exposure to areas of possible heightened risk exposure. Because Farmer Mac effectively assumes the credit risk on all loans under an LTSPC, Farmer Mac's commodity and geographic diversification disclosures reflect all loans under LTSPCs and any loans that have been purchased out of LTSPC pools. For information regarding the diversification of Farmer Mac's existing portfolio, see "Management's Discussion and Analysis of Financial Condition and Results of Operations--Risk Management--Credit Risk - Loans" and Note 8 to the consolidated financial statements. Farmer Mac II General The Farmer Mac II program was initiated in 1992 and is authorized under sections 8.0(3) and 8.0(9)(B) of Farmer Mac's statutory charter (12 U.S.C. ss.ss. 2279aa(3) and 2279aa(9)(B)), which provide that: o USDA-guaranteed portions are statutorily included in the definition of loans eligible for Farmer Mac's secondary market programs; o USDA-guaranteed portions are exempted from the underwriting, appraisal and repayment standards that all other loans must meet to be eligible for Farmer Mac programs, and are exempted from any diversification and internal credit enhancement that may be required of pools of other loans eligible for Farmer Mac programs; and o Farmer Mac is authorized to pool and issue Farmer Mac Guaranteed Securities backed by USDA-guaranteed portions. United States Department of Agriculture Guaranteed Loan Programs The USDA, acting through its various agencies, currently administers the federal rural credit programs first developed in the mid-1930s. The USDA makes direct loans and guarantees portions of loans made and serviced by USDA-qualified lenders for various purposes. The USDA's guarantee is supported by the full faith and credit of the United States. USDA-guaranteed portions represent up to 95 percent of the principal amount of guaranteed loans. Through its Farmer Mac II program, Farmer Mac is one of several competing purchasers of USDA-guaranteed portions of farm ownership loans, farm operating loans, business and industry loans and other loans that are fully guaranteed as to principal and interest by the USDA (collectively, the "guaranteed loans"). USDA Guarantees. Each USDA guarantee is a full faith and credit obligation of the United States and becomes enforceable if a lender fails to repurchase the USDA-guaranteed portion from its owner within 30 days after written demand from the owner when: o the borrower under the guaranteed loan is in default not less than 60 days in the payment of any principal or interest due on the USDA-guaranteed portion; or o the lender has failed to remit to the owner the payment made by the borrower on the USDA-guaranteed portion or any related loan subsidy within 30 days after the lender's receipt of the payment. If the lender does not repurchase the USDA-guaranteed portion as provided above, the USDA is required to purchase the unpaid principal balance of the USDA-guaranteed portion together with accrued interest (including any loan subsidy) to the date of purchase, less the servicing fee, within 30 days after written demand upon the USDA by the owner. While the USDA guarantee will not cover the note interest to the owner on USDA-guaranteed portions accruing after 90 days from the date of the original demand letter of the owner to the lender requesting repurchase, Farmer Mac has established procedures to require prompt tendering of USDA-guaranteed portions. If, in the opinion of the lender (with the concurrence of the USDA) or in the opinion of the USDA, repurchase of the USDA-guaranteed portion is necessary to service the related guaranteed loan adequately, the owner will sell the USDA-guaranteed portion to the lender or USDA for an amount equal to the unpaid principal balance and accrued interest (including any loan subsidy) on such USDA-guaranteed portion less the lender's servicing fee. Federal regulations prohibit the lender from repurchasing USDA-guaranteed portions for arbitrage purposes. Lenders. Any lender authorized by the USDA to obtain a USDA guarantee on a loan may sell loans to Farmer Mac through the Farmer Mac II program. As of December 31, 2003, there were 150 active lenders in the Farmer Mac II program, consisting mostly of community and regional banks, an increase of 7 active lenders from December 31, 2002. Loan Servicing. The lender on each guaranteed loan is required by regulation to retain the unguaranteed portion of the guaranteed loan, to service the entire underlying guaranteed loan, including the USDA-guaranteed portion, and to remain mortgagee and/or secured party of record. The USDA-guaranteed portion and the unguaranteed portion of the underlying guaranteed loan are to be secured by the same security with equal lien priority. The USDA-guaranteed portion cannot be paid later than or in any way be subordinated to the related unguaranteed portion. Farmer Mac II Guaranteed Securities Farmer Mac guarantees the timely payment of principal and interest on Farmer Mac II Guaranteed Securities backed by USDA-guaranteed portions. Farmer Mac does not guarantee the repayment of the USDA-guaranteed portions, only the Farmer Mac II Guaranteed Securities that are backed by USDA-guaranteed portions. In addition to purchasing USDA-guaranteed portions for retention in its portfolio, Farmer Mac offers Farmer Mac II Guaranteed Securities to lenders in swap transactions or to other investors for cash. Farmer Mac II Transactions During the years ended December 31, 2003 and 2002, Farmer Mac issued $271.2 million and $173.0 million of Farmer Mac II Guaranteed Securities, respectively. As of December 31, 2003, $729.5 million Farmer Mac II Guaranteed Securities were outstanding. See Note 5 and Note 12 to the consolidated financial statements. The following table presents Farmer Mac II Guaranteed Securities issued for each of the years indicated:
For the Year Ended December 31, ---------------------------------------------- 2003 2002 2001 --------------- -------------- --------------- (in thousands) Purchased and retained $ 270,727 $ 173,011 $ 186,679 Swaps (issued to third parties) 502 - 11,492 --------------- -------------- --------------- Total $ 271,229 $ 173,011 $ 198,171 --------------- -------------- ---------------
The following table presents the outstanding balance of Farmer Mac II Guaranteed Securities as of the dates indicated:
Outstanding Balance of Farmer Mac II Guaranteed Securites as of December 31, ----------------------------------------- 2003 2002 ------------------ ------------------- (in thousands) On-balance sheet $ 678,229 $ 578,681 Off-balance sheet 51,241 67,109 ------------------ ------------------- Total $ 729,470 $ 645,790 ------------------ -------------------
To date, Farmer Mac has experienced no credit losses on any of its Farmer Mac II transactions. As of December 31, 2003 and 2002, Farmer Mac had outstanding $1.2 million of principal and interest advances, respectively, on Farmer Mac II Guaranteed Securities. Financing Debt Issuance Section 8.6(e) of Farmer Mac's statutory charter (12 U.S.C. ss. 2279aa-6(e)) authorizes Farmer Mac to issue debt obligations to purchase eligible mortgage loans and Farmer Mac Guaranteed Securities and to maintain reasonable amounts for business operations, including adequate liquidity. Farmer Mac funds its program purchases primarily by issuing debt obligations, consisting of discount notes and medium-term notes of various maturities, in the public capital markets. Farmer Mac also issues discount notes and medium-term notes to obtain monies to finance its investments, transaction costs and guarantee and LTSPC payments. The Corporation's discount notes and medium-term notes are obligations of Farmer Mac only, are not rated by a nationally recognized statistical rating organization and the interest and principal thereon are not guaranteed by and do not constitute debts or obligations of the Farm Credit Administration or the United States or any agency or instrumentality of the United States other than Farmer Mac. Farmer Mac is an institution of the Farm Credit System, but is not liable for any debt or obligation of any other institution of the Farm Credit System. Likewise, neither the Farm Credit System nor any other individual institution of the Farm Credit System is liable for any debt or obligation of Farmer Mac. Income to the purchaser of a Farmer Mac discount note or medium-term note is not exempt under federal law from federal, state or local taxation. Farmer Mac's board of directors has authorized the issuance of up to $5.0 billion outstanding of discount notes and medium-term notes, subject to periodic review of the adequacy of that level relative to Farmer Mac's borrowing requirements. Farmer Mac invests in loans, Farmer Mac Guaranteed Securities and non-program investment assets in accordance with policies established by its board of directors. The current policies authorize non-program investments in: o U.S. Treasury obligations; o agency and instrumentality obligations; o repurchase agreements; o commercial paper; o guaranteed investment contracts; o certificates of deposit; o federal funds and bankers acceptances; o securities and debt obligations of corporate and municipal issuers; o asset-backed securities; o corporate money market funds; and o preferred stock of government-sponsored enterprises. For more information about Farmer Mac's outstanding investments and indebtedness, see Note 4 and Note 7 to the consolidated financial statements. Equity Issuance The Act authorizes Farmer Mac to issue voting common stock, non-voting common stock and non-voting preferred stock. Only banks, other financial entities, insurance companies and institutions of the Farm Credit System eligible to participate in one or more of the Farmer Mac programs may hold voting common stock. No holder of Class A voting common stock may directly or indirectly be a beneficial owner of more than 33 percent of the outstanding shares of Class A voting common stock. There are no ownership restrictions applicable to Class C non-voting common stock or preferred stock. The Class C non-voting common stock and the preferred stock are freely transferable. Upon liquidation, dissolution or winding up of the business of Farmer Mac, after payment and provision for payment of outstanding debt of the Corporation, the holders of preferred stock would be paid in full at par value, plus all accrued dividends, before the holders of shares of common stock received any payment. To date, Farmer Mac has not paid any dividends on its common stock, nor does it expect to pay such dividends in the foreseeable future. Farmer Mac's ability to declare and pay common stock dividends could be restricted if it were to fail to comply with its regulatory capital requirements. See Note 9 to the consolidated financial statements and "Business--Government Regulation of Farmer Mac--Regulation--Capital Standards--Enforcement levels." As of December 31, 2003, 1,030,780 shares of Class A common stock, 500,301 shares of Class B common stock, 10,522,513 shares of Class C non-voting common stock and 700,000 shares of 6.40 percent non-voting Cumulative Preferred Stock, Series A were outstanding. Farmer Mac may obtain additional capital from future issuances of voting and non-voting common stock and non-voting preferred stock. Farmer Mac has no present intention to issue any additional shares of common stock, except pursuant to programs in which employees, members of management or the board of directors may be granted or may purchase Class C non-voting common stock, or exercise options to purchase Class C non-voting common stock granted as part of their compensation arrangements. The Cumulative Preferred Stock, Series A has a redemption price and liquidation preference of $50.00 per share, plus accrued and unpaid dividends. The preferred stock does not have a maturity date. Beginning on June 30, 2012, Farmer Mac has the option to redeem the preferred stock at any time, in whole or in part, at the redemption price of $50.00 per share, plus accrued and unpaid dividends through and including the redemption date. The costs of issuing the preferred stock were charged to additional paid-in capital. Farmer Mac pays cumulative dividends on the preferred stock quarterly in arrears, when and if declared by the board of directors. Farmer Mac's ability to declare and pay a dividend could be restricted if it failed to comply with regulatory capital requirements. The following table presents the dividends declared on the preferred stock during and subsequent to 2003:
Date Per For For Dividend Share Period Period Date Declared Amount Beginning Ending Paid ------------------------ ------------ ---------------------- ----------------------- ---------------------- February 6, 2003 $ 0.80 January 1, 2003 March 31, 2003 March 31, 2003 June 5, 2003 0.80 April 1, 2003 June 30, 2003 June 30, 2003 August 7, 2003 0.80 July 1, 2003 September 30, 2003 September 30, 2003 December 4, 2003 0.80 October 1, 2003 December 31, 2003 December 31, 2003 February 5, 2004 0.80 January 1, 2004 March 31, 2004 * * The dividend declared on February 5, 2004 is scheduled to be paid on March 31, 2004.
FARMER MAC'S AUTHORITY TO BORROW FROM THE U.S. TREASURY Farmer Mac may, in extreme circumstances, issue obligations to the U.S. Treasury in a cumulative amount not to exceed $1.5 billion. The proceeds of such obligations may be used solely for the purpose of fulfilling Farmer Mac's guarantee commitments under the Farmer Mac I and Farmer Mac II programs. The Act provides that the U.S. Treasury is required to purchase such obligations of Farmer Mac if Farmer Mac certifies that: o a portion of the guarantee fees assessed by Farmer Mac has been set aside as a reserve against losses arising out of Farmer Mac's guarantee activities in an amount determined by Farmer Mac's board of directors to be necessary and such reserve has been exhausted; and o the proceeds of such obligations are needed to fulfill Farmer Mac's guarantee obligations. Such obligations would bear interest at a rate determined by the U.S. Treasury, taking into consideration the average rate on outstanding marketable obligations of the United States as of the last day of the last calendar month ending before the date of the purchase of the obligations from Farmer Mac, and would be required to be repurchased from the U.S. Treasury by Farmer Mac within a "reasonable time." The United States government does not guarantee payments due on Farmer Mac Guaranteed Securities, funds invested in the equity or debt securities of Farmer Mac, any dividend payments on shares of Farmer Mac stock or the profitability of Farmer Mac. GOVERNMENT REGULATION OF FARMER MAC General Public offerings of Farmer Mac Guaranteed Securities must be registered with the SEC under the federal securities laws. Farmer Mac also is required to file reports with the SEC pursuant to the SEC's periodic reporting requirements. Regulation Office of Secondary Market Oversight As an institution of the Farm Credit System, Farmer Mac is subject to the regulatory authority of FCA. FCA, acting through its Office of Secondary Market Oversight, has general regulatory and enforcement authority over Farmer Mac, including the authority to promulgate rules and regulations governing the activities of Farmer Mac and to apply its general enforcement powers to Farmer Mac and its activities. The Director of the Office of Secondary Market Oversight, who is selected by and reports to the FCA board, is responsible for the examination of Farmer Mac and the general supervision of the safe and sound performance by Farmer Mac of the powers and duties vested in it by the Act. The Act requires an annual examination of the financial transactions of Farmer Mac and authorizes FCA to assess Farmer Mac for the cost of its regulatory activities, including the cost of any examination. Farmer Mac is required to file quarterly reports of condition with FCA. Department of the Treasury In connection with the passage of the 1996 Act, the Chairmen of the House and Senate Agriculture Committees requested FCA, in a cooperative effort with the Department of the Treasury, to "monitor and review the operations and financial condition of Farmer Mac and to report in writing to the appropriate subcommittees of the House Agriculture Committee, the House Financial Services Committee and the Senate Agriculture, Nutrition and Forestry Committee at six-month intervals during the capital deferral period and beyond, if necessary." Although the "capital deferral period" expired on January 1, 1999 and the risk-based capital rule went into effect on May 23, 2002, it appears that the FCA reports are ongoing. Comptroller General/General Accounting Office The Act permits the Comptroller General of the United States, head of the General Accounting Office (GAO), to perform reviews of the actuarial soundness and reasonableness of the guarantee fees established by Farmer Mac. A review of Farmer Mac was performed by GAO at the request of the Senate Committee on Committee on Agriculture, Nutrition, and Forestry and GAO's findings were published in a report dated October 16, 2003 (the "Report"). The Report made recommendations to Farmer Mac for enhancement of its risk management and corporate governance practices, many of which were already being implemented, or have since been implemented, by Farmer Mac as part of its commitment to ensure that best practices are being applied in its risk management operations. The Report, No. GAO-04-116, may be obtained directly from GAO. Capital Standards General. The Act, as amended by the 1996 Act, establishes three capital standards for Farmer Mac: o Minimum capital - Farmer Mac's minimum capital level is an amount of core capital equal to the sum of 2.75 percent of Farmer Mac's aggregate on-balance sheet assets, as calculated for regulatory purposes, plus 0.75 percent of the aggregate off-balance sheet obligations of Farmer Mac, specifically including: o the unpaid principal balance of outstanding Farmer Mac Guaranteed Securities; o instruments issued or guaranteed by Farmer Mac that are substantially equivalent to Farmer Mac Guaranteed Securities, including LTSPCs; and o other off-balance sheet obligations of Farmer Mac. o Critical capital - Farmer Mac's critical capital level is an amount of core capital equal to 50 percent of the total minimum capital requirement at that time. o Risk-based capital - The Act directs FCA to establish a risk-based capital stress test for Farmer Mac, using specified stress-test parameters. While the Act does not specify the required level of risk-based capital, that level is permitted to exceed the statutory minimum capital requirement applicable to Farmer Mac, if so indicated by the risk-based capital stress test. Farmer Mac is required to comply with the higher of the minimum capital requirement or the risk-based capital requirement. FCA issued its final risk-based capital regulation for Farmer Mac on April 12, 2001 and the Corporation was required to meet the risk-based capital standards beginning on May 23, 2002. The risk-based capital stress test promulgated by FCA is intended to determine the amount of regulatory capital (core capital plus allowance for losses) that Farmer Mac would need to maintain positive capital during a ten-year period in which: o annual losses occur at a rate of default and severity "reasonably related" to the rates of the highest sequential two-years in a limited U.S. geographic area; and o there is an initial interest rate shock at the lesser of 600 basis points or 50 percent of the ten-year U.S. Treasury rate, and interest rates remain at such level for the remainder of the period. The risk-based capital stress test then adds an additional 30 percent to the resulting capital requirement for management and operational risk. As of December 31, 2003, Farmer Mac's minimum and critical capital requirements were $142.0 million and $71.0 million, respectively, and its actual core capital level was $215.5 million, $73.5 million above the minimum capital requirement and $144.5 million above the critical capital requirement. Based on the risk-based capital stress test, Farmer Mac's risk-based capital requirement as of December 31, 2003 was $38.8 million and Farmer Mac's regulatory capital of $237.6 million exceeded that amount by approximately $198.8 million. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources--Capital Requirements" for a presentation of Farmer Mac's current regulatory capital position. Enforcement levels. The Act directs FCA to classify Farmer Mac within one of four enforcement levels for purposes of determining compliance with capital standards. At December 31, 2003, Farmer Mac was classified as within level I--the highest compliance level. Failure to comply with the applicable required capital level in the Act would result in Farmer Mac being classified as within level II (below the applicable risk-based capital level, but above the minimum capital level), level III (below the minimum, but above the critical capital level) or level IV (below the critical capital level). In the event that Farmer Mac were classified as within level II, III or IV, the Act requires the Director of the Office of Secondary Market Oversight to take a number of mandatory supervisory measures and provides the Director with discretionary authority to take various optional supervisory measures depending on the level in which Farmer Mac is classified. The mandatory measures applicable to level II include: o requiring Farmer Mac to submit and comply with a capital restoration plan; o prohibiting the payment of dividends if such payment would result in Farmer Mac being reclassified as within level III or IV, and requiring the pre-approval of any dividend payment even if such payment would not result in reclassification as within level IV; and o reclassifying Farmer Mac as within level III if it does not submit a capital restoration plan that is approved by the Director, or the Director determines that Farmer Mac has failed to make, in good faith, reasonable efforts to comply with such a plan and fulfill the schedule for the plan approved by the Director. The mandatory measures applicable to level III include: o requiring Farmer Mac to submit (and comply with) a capital restoration plan; o prohibiting the payment of dividends if such payment would result in Farmer Mac being reclassified as within level IV and requiring the pre-approval of any dividend payment even if such payment would not result in reclassification as within level IV; and o reclassifying Farmer Mac as within a lower level if it does not submit a capital restoration plan that is approved by the Director or the Director determines that Farmer Mac has failed to make, in good faith, reasonable efforts to comply with such a plan and fulfill the schedule for the plan approved by the Director. If Farmer Mac were classified as within level III, then, in addition to the foregoing mandatory supervisory measures, the Director of the Office of Secondary Market Oversight could take any of the following discretionary supervisory measures: o imposing limits on any increase in, or ordering the reduction of, any obligations of Farmer Mac, including off-balance sheet obligations; o limiting or prohibiting asset growth or requiring the reduction of assets; o requiring the acquisition of new capital in an amount sufficient to provide for reclassification as within a higher level; o terminating, reducing or modifying any activity the Director determines creates excessive risk to Farmer Mac; or o appointing a conservator or a receiver for Farmer Mac. The Act does not specify any supervisory measures, either mandatory or discretionary, to be taken by the Director in the event Farmer Mac were classified as within level IV. The Director of the Office of Secondary Market Oversight has the discretionary authority to reclassify Farmer Mac to a level that is one level below its then current level (for example, from level I to level II) if the Director determines that Farmer Mac is engaging in any action not approved by the Director that could result in a rapid depletion of core capital or if the value of property subject to mortgages backing Farmer Mac Guaranteed Securities has decreased significantly. Item 2. Properties Farmer Mac currently occupies its principal offices, which are located at 1133 Twenty-First Street, N.W., Suite 600, Washington, D.C. 20036, under the terms of a lease that expires on November 30, 2011 and covers approximately 13,500 square feet of office space. Farmer Mac's offices are suitable and adequate for its needs. Item 3. Legal Proceedings Farmer Mac is not a party to any material pending legal proceedings. Item 4. Submission of Matters to a Vote of Security Holders Not applicable. PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters Farmer Mac has three classes of common stock outstanding. Ownership of Class A voting common stock is restricted to banks, insurance companies and other financial institutions or similar entities that are not institutions of the Farm Credit System. Ownership of Class B voting common stock is restricted to institutions of the Farm Credit System. There are no ownership restrictions on the Class C non-voting common stock. Under the terms of the original public offering of the Class A and Class B voting common stock, the Corporation reserved the right to redeem at book value any shares of either class held by an ineligible holder. The Class A and Class C common stocks trade on the New York Stock Exchange under the symbols AGMA and AGM, respectively. The Class B voting common stock, which has a limited market and trades infrequently, is not listed or quoted on any exchange or other medium, and Farmer Mac is unaware of any publicly available quotations or prices for that class. The information below represents the high and low closing sale prices for the Class A and Class C common stocks for the periods indicated as reported by the New York Stock Exchange.
Sales Price --------------------------------------------------- Class A Stock Class C Stock ------------------------- ------------------------- High Low High Low ------------ ------------ ------------ ------------ (dollars per share) 2004 First quarter (through March 1, 2004) $ 22.85 $ 20.30 $ 31.19 $ 26.01 2003 Fourth quarter 22.90 20.01 32.00 26.68 Third quarter 22.00 16.75 30.49 23.11 Second quarter 17.92 16.70 25.14 21.86 First quarter 22.65 15.50 34.50 20.25 2002 Fourth quarter 26.00 19.90 33.37 25.06 Third quarter 24.30 20.30 30.47 20.80 Second quarter 35.00 22.00 47.20 25.60 First quarter 34.55 28.60 47.80 38.95
As of March 1, 2004, it was estimated that there were 1,406 registered owners of the Class A voting common stock, 103 registered owners of the Class B voting common stock and 1,345 registered owners of the Class C non-voting common stock. Although the dividend rights of all three classes of its common stock are the same, to date, Farmer Mac has not paid any dividends on its common stock, nor does it expect to pay dividends in the foreseeable future. Farmer Mac's ability to declare and pay dividends could be restricted if it were to fail to comply with regulatory capital requirements. Information about securities authorized for issuance under Farmer Mac's equity compensation plans appears under "Equity Compensation Plans" in Farmer Mac's Proxy Statement to be filed on or about April 19, 2004. That portion of the Proxy Statement is incorporated by reference into this report. Item 6. Selected Financial Data
As of December 31, ----------------------------------------------------------------------- Summary of Financial Condition: 2003 2002 2001 2000 1999 -------------- -------------- ------------ ------------- ------------ (dollars in thousands) Cash and cash equivalents $ 623,674 $ 723,800 $437,831 $537,871 $336,282 Investment securities 1,064,782 830,409 1,007,954 836,757 847,220 Farmer Mac Guaranteed Securities 1,508,134 1,608,507 1,690,376 1,679,993 1,306,223 Loans, net 983,624 963,461 198,003 30,279 38,509 Total assets 4,299,650 4,222,915 3,415,856 3,160,899 2,590,410 Notes payable Due within one year 2,799,384 2,895,746 2,233,267 2,141,548 1,722,061 Due after one year 1,136,110 985,318 968,463 827,635 750,337 Total liabilities 4,086,396 4,039,344 3,281,419 3,028,238 2,503,267 Stockholders' equity 213,254 183,571 134,437 132,661 87,143 Selected Financial Ratios: Return on average assets 0.59% 0.56% 0.50% 0.36% 0.31% Return on average common equity 15.32% 15.00% 12.19% 9.50% 8.24% Average equity to assets 4.66% 4.16% 4.06% 3.82% 3.71% For the Year Ended December 31, ----------------------------------------------------------------------- Summary of Operations: 2003 2002 2001 2000 1999 -------------- -------------- ------------ ------------- ------------ (dollars in thousands, except per share amounts) Net interest income after provision for loan losses $ 30,728 $ 37,759 $ 28,666 $ 17,398 $ 14,838 Guarantee and commitment fees 20,685 19,277 15,807 11,677 7,396 Gains/(Losses) on financial derivatives and trading assets 2,357 (8,433) (3,053) - - Gains on the repurchase of debt - 1,368 - - - Gains on the sale of real estate owned 178 24 61 - - Miscellaneous 812 1,332 560 399 220 -------------- -------------- ------------ ------------- ------------ Total revenues 54,760 51,327 42,041 29,474 22,454 Total operating expenses 15,182 18,767 16,616 13,288 11,863 -------------- -------------- ------------ ------------- ------------ Income before income taxes and cumulative effect of change in accounting principles 39,578 32,560 25,425 16,186 10,591 Income tax expense 12,308 9,809 8,419 5,749 3,670 Cumulative effect of change in accounting principles, net of taxes - - (726) - - -------------- -------------- ------------ ------------- ------------ Net income 27,270 22,751 16,280 10,437 6,921 Preferred stock dividends (2,240) (1,456) - - - -------------- -------------- ------------ ------------- ------------ Net income available to common stockholders $ 25,030 $ 21,295 $ 16,280 $ 10,437 $ 6,921 -------------- -------------- ------------ ------------- ------------ Earnings Per Share: Basic earnings per share $ 2.13 $ 1.83 $ 1.44 $ 0.94 $ 0.64 Diluted earnings per share $ 2.08 $ 1.77 $ 1.38 $ 0.92 $ 0.62 Earnings per share before cumulative effect of change in accounting principles Basic earnings per share $ 2.13 $ 1.83 $ 1.50 $ 0.94 $ 0.64 Diluted earnings per share $ 2.08 $ 1.77 $ 1.45 $ 0.92 $ 0.62
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Financial information as of and for each of the years ended December 31, 2003, 2002 and 2001 is consolidated to include the accounts of Farmer Mac and its wholly-owned subsidiary, Farmer Mac Mortgage Securities Corporation. The following discussion should be read together with Farmer Mac's consolidated financial statements and is not necessarily indicative of future results. Forward-Looking Statements Certain statements made in this Form 10-K are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 pertaining to management's current expectations as to Farmer Mac's future financial results, business prospects and business developments. Forward-looking statements include, without limitation, any statement that may predict, forecast, indicate or imply future results, performance or achievements, and typically are accompanied by, and identified with, such terms as "anticipates," "believes," "expects," "intends," "should" and similar phrases. The following management's discussion and analysis includes forward-looking statements addressing Farmer Mac's: o prospects for earnings; o growth in loan purchase, guarantee, securitization and LTSPC volume; o trends in net interest income; o trends in provisions for losses; o changes in capital position; and o other business and financial matters. Management's expectations for Farmer Mac's future necessarily involve a number of assumptions and estimates and the evaluation of risks and uncertainties. Various factors could cause Farmer Mac's actual results or events to differ materially from the expectations as expressed or implied by the forward-looking statements, including uncertainties regarding: o the rate and direction of development of the secondary market for agricultural mortgage loans; o the possible establishment of additional statutory or regulatory restrictions or constraints on Farmer Mac that could hamper its growth or diminish its profitability; o legislative or regulatory developments or interpretations of Farmer Mac's statutory charter that could adversely affect Farmer Mac or the ability or motivation of certain lenders to participate in its programs or the terms of any such participation, or increase the cost of regulation and related corporate activities; o possible reaction in the financial markets to events involving government-sponsored enterprises other than Farmer Mac; o Farmer Mac's access to the debt markets at favorable rates and terms; o the possible effect of the risk-based capital requirement, which could, under certain circumstances, be in excess of the statutory minimum capital requirement; o the rate of growth in agricultural mortgage indebtedness; o lender interest in Farmer Mac credit products and the Farmer Mac secondary market; o borrower preferences for fixed-rate agricultural mortgage indebtedness; o competitive pressures in the purchase of agricultural mortgage loans and the sale of agricultural mortgage-backed and debt securities; o substantial changes in interest rates, agricultural land values, commodity prices, export demand for U.S. agricultural products and the general economy; o protracted adverse weather, market or other conditions affecting particular geographic regions or particular commodities related to agricultural mortgage loans backing Farmer Mac I Guaranteed Securities or under LTSPCs; o the willingness of investors to invest in agricultural mortgage-backed securities; or o the effects on the agricultural economy or the value of agricultural real estate of any changes in federal assistance for agriculture. The foregoing factors are not exhaustive. Other sections of this report may include additional factors that could adversely impact Farmer Mac's business and its financial performance. Furthermore, new risk factors emerge from time to time and it is not possible for management to predict all such risk factors, nor assess the effects of such factors on Farmer Mac's business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from the expectations expressed or implied by the forward-looking statements. In light of these potential risks and uncertainties, no undue reliance should be placed on any forward-looking statements expressed in this report. Furthermore, Farmer Mac undertakes no obligation to release publicly the results of revisions to any forward-looking statements that may be made to reflect any future events or circumstances, except as otherwise mandated by the Securities and Exchange Commission. Critical Accounting Policy and Estimates The preparation of the consolidated financial statements in conformity with accounting principals generally accepted in the United States requires the use of estimates and assumptions that affect the amounts reported in the consolidated financial statements and related notes for the periods presented. Actual results could differ from those estimates. The critical accounting policy that is both important to the portrayal of Farmer Mac's financial condition and results of operations and requires complex, subjective judgments is the accounting policy for the allowance for losses. Farmer Mac's allowance for losses is presented in four components on its consolidated balance sheet: o an "Allowance for loan losses" on loans held for investment; o a valuation allowance on real estate owned, which is included in the balance sheet under "Real estate owned, net of valuation allowance"; o an allowance for losses on loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs entered into or modified after January 1, 2003, which is included in the balance sheet as a portion of the amount reported as "Guarantee and commitment obligation"; and o an allowance for losses on loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs entered into prior to January 1, 2003, which is included in the balance sheet under "Reserve for losses." The provision for losses is presented in two components on the consolidated statement of operations: o a "Provision for loan losses," which represents losses on Farmer Mac's loans held for investment; and o a "Provision for losses," which represents losses on loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs and real estate owned. The purpose of the allowance for losses is to provide for estimated losses that are probable to have occurred as of the balance sheet date, and not to predict or account for future potential losses. The determination of the allowance for losses requires management to make significant estimates based on information available as of the balance sheet date, including the amounts and timing of losses and current market and economic conditions. These estimates are subject to change in future reporting periods if such conditions and information change. For example, a continued decline in the national or agricultural economy could result in an increase in delinquencies or foreclosures, which may require additional allowances for losses in future periods. Farmer Mac maintains an allowance for losses to cover estimated probable losses on loans held for investment, real estate owned and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs. Farmer Mac estimates probable losses using a systematic process that begins with management's evaluation of the results of its proprietary loan pool simulation and guarantee fee model (the "Model"). The Model draws upon historical information from a data set of agricultural mortgage loans recorded over a longer period of time than Farmer Mac's own experience to date, screened to include only those loans with credit characteristics similar to those on which Farmer Mac has assumed credit risk. The results generated by the Model are modified by the application of management's judgment as required to take key factors into account, including: o economic conditions; o geographic and agricultural commodity concentrations in Farmer Mac's portfolio; o the credit profile of Farmer Mac's portfolio; o delinquency trends of Farmer Mac's portfolio; o Farmer Mac's experience in the management and sale of real estate owned; and o historical charge-off and recovery activities of Farmer Mac's portfolio. The allowance for losses is increased through periodic provisions for loan losses that are charged against net interest income and provisions for losses charged to operating expense and reduced by charge-offs for actual losses, net of recoveries. Charge-offs represent losses on the outstanding principal balance, any interest payments previously accrued or advanced and expected costs of liquidation. The establishment of and periodic adjustments to the valuation allowance for real estate owned are charged against income as a portion of the provision for losses charged to operating expense. Gains and losses on the sale of real estate owned are recorded in income based on the difference between the recorded investment at the time of sale and liquidation proceeds. No allowance for losses has been made for loans underlying Farmer Mac I Guaranteed Securities issued prior to the 1996 Act or Farmer Mac II Guaranteed Securities. Farmer Mac I Guaranteed Securities issued prior to the 1996 Act are supported by unguaranteed first loss subordinated interests, which are expected to exceed the estimated credit losses on those loans. USDA-guaranteed portions collateralizing Farmer Mac II Guaranteed Securities are obligations backed by the full faith and credit of the United States. To date, Farmer Mac has experienced no credit losses on any pre-1996 Act Farmer Mac I Guaranteed Securities or on any Farmer Mac II Guaranteed Securities and does not expect to incur any such losses in the future. Further information regarding the allowance for losses is included in "--Risk Management--Credit Risk - Loans." Results of Operations Overview. Net income available to common stockholders for 2003 rose to $25.0 million or $2.08 per diluted common share, compared to $21.3 million or $1.77 per diluted common share in 2002 and $16.3 million or $1.38 per diluted common share in 2001. Farmer Mac's growth continued in 2003, with outstanding guarantee and LTSPC volume as of December 31, 2003 that was $271.5 million higher than at December 31, 2002. During 2003, Farmer Mac: o added $763.3 million of Farmer Mac I eligible loans under LTSPCs; o purchased $192.6 million of newly originated Farmer Mac I eligible loans; and o purchased $271.2 million of Farmer Mac II USDA-guaranteed portions of loans. As of December 31, 2003, the percentage of Farmer Mac I loans purchased or placed under Farmer Mac I Guaranteed Securities or LTSPCs after changes to Farmer Mac's statutory charter in 1996 that were 90 days or more past due, in foreclosure, restructured after delinquency, in bankruptcy or classified as real estate owned, decreased to 1.39 percent, compared to 1.56 percent at the end of 2002. As Farmer Mac's portfolio of loans held and loans underlying LTSPCs and post-1996 Act Farmer Mac I Guaranteed Securities has had certain cohort years of loan originations enter, and now start exiting, their peak default years, segments of the portfolio are beginning to exhibit characteristics of a mature portfolio, which includes loans cycling through foreclosure and into the asset category real estate owned, which completes the involuntary loan liquidation process. As of December 31, 2003, Farmer Mac had $15.5 million of real estate owned, net of valuation allowance, compared to $5.0 million as of December 31, 2002 and $2.5 million as of December 31, 2001. During the foreclosure process Farmer Mac devises a liquidation strategy, based upon economics and local law, that results in either an immediate sale of the property or retention pending later sale. The increase in real estate owned is the result of historical delinquencies in Farmer Mac's portfolio. With the recent downward trend in delinquencies, management expects real estate owned to trend downward as well in future years. Farmer Mac's portfolio also has developed a core of loans that, though the borrowers on those loans have filed for bankruptcy protection, are current under the original terms of the loans or as modified under a court-approved bankruptcy plan. Non-performing assets are loans 90 days or more past due, in foreclosure, restructured after delinquency, in bankruptcy, or real estate owned. 90-day delinquencies are loans 90 days or more past due, in foreclosure, restructured after delinquency, or in bankruptcy, excluding loans performing under either their original loan terms or a court-approved bankruptcy plan. The difference between the non-performing asset and 90-day delinquencies measures is the exclusion of real estate owned and loans performing in bankruptcy from 90-day delinquencies.
As of December 31, --------------------------- 2003 2002 ------------- ------------ (in thousands) 90-day delinquencies (including loans in $30,056 $ 58,214 foreclosure and loans restructured after delinquency) Loans performing in bankruptcy 24,192 11,471 Real estate owned 15,716 5,623 ------------- ------------ Non-performing assets $69,964 $ 75,308 ------------- ------------
The table below presents non-performing assets and 90-day delinquency data as of the dates indicated:
Outstanding Post-1996 Act Less: Loans, Non- REO and Guarantees and Performing Performing 90-day LTSPCs Assets Percentage Bankruptcies Delinquencies Percentage ------------------ ----------------- -------------- ---------------- ----------------- ---------------- (dollars in thousands) December 31, 2003 $ 5,020,032 $ 69,964 1.39% $ 39,908 $ 30,056 0.60% September 30, 2003 4,871,756 84,583 1.74% 37,442 47,141 0.98% June 30, 2003 4,875,059 80,169 1.64% 28,883 51,286 1.06% March 31, 2003 4,820,887 94,822 1.97% 18,662 76,160 1.58% December 31, 2002 4,821,634 75,308 1.56% 17,094 58,214 1.21% September 30, 2002 4,506,330 91,286 2.03% 11,460 79,826 1.77% June 30, 2002 4,489,735 65,196 1.45% 14,931 50,265 1.12% March 31, 2002 3,754,171 87,097 2.32% 7,903 79,194 2.11% December 31, 2001 3,428,176 58,279 1.70% 3,743 54,536 1.59% September 30, 2001 3,318,796 71,686 2.16% 5,183 66,503 2.00% June 30, 2001 3,089,460 53,139 1.72% 4,274 48,865 1.58% March 31, 2001 2,562,374 67,134 2.62% 2,154 64,980 2.54%
Farmer Mac experienced $5.2 million in net losses charged against the allowance for losses in 2003, compared with $4.1 million in net losses for 2002 and $2.2 million in 2001. Through direct charges to earnings, Farmer Mac provided for $7.3 million in total losses during 2003, compared to $8.2 million during 2002 and $6.8 million in 2001. Farmer Mac recorded gains on the sale of real estate owned of $0.2 million, $0.1 million and $0.1 million in 2003, 2002 and 2001, respectively. Farmer Mac's total allowance for losses as of December 31, 2003 was $22.1 million, compared to $20.0 million as of December 31, 2002 and $15.9 million as of December 31, 2001. For further discussion of the increase in the allowance for losses and provision for losses, see "--Risk Management--Credit Risk - Loans." As of December 31, 2003, a significant portion of Farmer Mac's portfolio of post-1996 Act Farmer Mac I loans and loans underlying LTSPCs and Farmer Mac Guaranteed Securities were in their peak default years. Accordingly, during 2004 the dollar level of 90-day delinquencies could increase slightly and higher charge-offs could follow, notwithstanding positive trends in the agricultural economy. Outlook for 2004. USDA is currently forecasting: ---------------- o 2004 net cash farm income to be $55.9 billion, $7.1 billion lower than 2003, but only slightly below the 1994-2003 average of $57.0 billion; o Total direct government payments to be $10.3 billion in 2004, a decrease from the 2003 estimate of $17.4 billion. Market prices for crops affect direct government payment rates for government programs, and USDA anticipates program crop prices to be higher in 2004, with prices for some crops at levels not seen in years; o Demand for crop exports to be high, due to tight global supplies and the decline in the value of the dollar, which lowers the effective price of U.S. commodities; o The value of U.S. farm real estate to increase 3.5 percent in 2004 to $1.13 trillion, up from the 2003 forecast of $1.09 trillion. USDA is anticipating improvement in the general economy to support further growth in farmland values, though at a rate slower than the annual average gain since 1999, which exceeded 4 percent; and o The value of farm real estate debt to increase by 4.7 percent in 2004 to $116.5 billion, up from $111.3 billion in 2003. The USDA forecast components referenced above relate to U.S. agriculture generally, but should be favorable for Farmer Mac's business plans, as they indicate strong borrower cash flows, greater global demand for U.S. commodities, and generally increased value of U.S. farm real estate. The last item in particular increases the mortgageable farm real estate base, the ability of borrowers to repay real estate debt and Farmer Mac's ability to recover in foreclosures. As management evaluates Farmer Mac's business prospects for 2004 and beyond, certain factors and conditions remain that are likely to constrain Farmer Mac's progress. As a matter of historical practice, and particularly in the current low interest rate and steep yield curve environment, many institutions still prefer to retain agricultural mortgage loans in portfolio rather than sell them into the secondary market, notwithstanding the corporate finance and capital planning benefits they might realize through participation in Farmer Mac's programs, such as greater liquidity, greater lending capacity, increased return on equity and decreased capital requirements. Some lending institutions subsidize their agricultural mortgage loan rates out of higher rates on non-mortgage loans, or by low-return use of equity, both of which generate uneconomic competition with Farmer Mac's programs. The rate of growth of Farmer Mac's business with many traditional portfolio lenders has been slowed by reduced growth rates in the agricultural mortgage market. (See "--Business Volume" for a description of factors affecting growth rates in the agricultural mortgage market.) With particular regard to Farm Credit System institutions, some business prospects have been constrained by increased insurance premiums assessed on loans held by those institutions, including loans under LTSPCs, by the Farm Credit System Insurance Corporation ("FCSIC"), an independent U.S. Government controlled corporation managed by a three-member board of directors composed of the members of the Farm Credit Administration (FCA) Board with a different member serving as chairman. In addition, FCSIC has recently indicated to those institutions that they should be cautious about the risk of doing business with government-sponsored enterprises, including Farmer Mac, as counterparties. Moreover, FCSIC has raised objections to Farm Credit institutions' use of Farmer Mac swaps, which generate Farmer Mac I Guaranteed Securities that are not subject to the previously mentioned insurance premiums. Notwithstanding slower growth in 2003 than in 2002, Farmer Mac launched marketing initiatives in the fourth quarter of 2003 that are generating promising business opportunities for 2004 and beyond. New and expanded business relationships (including a strategic alliance with a related party Farm Credit System institution that will serve community banks), product enhancements, such as new open prepayment loan structures, and new loan securitization structures, are all underway. While the continued growth in Farmer Mac's guarantees and LTSPCs evidences significant progress in developing the secondary market for agricultural mortgages, Farmer Mac continues to face the challenges of establishing a new market where none previously existed. Acceptance of Farmer Mac's programs among lenders is based upon the competitive rates, terms and products offered, and the advantages Farmer Mac believes its programs provide. As of December 31, 2003, Farmer Mac's outstanding program volume was $5.8 billion, which represented 13 percent of management's estimate of a $44.5 billion market of eligible agricultural mortgage loans. For Farmer Mac to succeed in realizing its business development and profitability goals over the longer term, the use of Farmer Mac's programs and products by agricultural mortgage lenders, whether traditional or non-traditional, must continue to expand. Farmer Mac believes that prospects for larger portfolio transactions similar to those that have accounted for a significant portion of growth in prior years continue to exist, but no assurance can be given at this time as to the certainty or timing of such transactions. During 2003 and continuing in 2004, Farmer Mac began several initiatives to validate and enhance its risk management practices, internal controls, and accounting and financial reporting. These initiatives are the result of ongoing corporate diligence and a number of regulatory considerations, including the Sarbanes-Oxley Act of 2002 and FCA requirements, as well as the general regulatory environment for government-sponsored enterprises. A detailed presentation of Farmer Mac's financial results for the years ended December 31, 2003, 2002 and 2001 follows. Net Interest Income. Net interest income was $37.3 million for 2003, $39.1 million for 2002 and $29.3 million for 2001. The net interest yield, which does not include guarantee fees for loans purchased prior to April 1, 2001 (the effective date of Statement of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities ("SFAS 140")), was 93 basis points for the year ended December 31, 2003, compared to 104 basis points for the year ended December 31, 2002 and 91 basis points for the year ended December 31, 2001. The effect of the adoption of SFAS 140 was a reclassification of approximately $4.4 million (11 basis points) of guarantee fee income as interest income for the year ended December 31, 2003, compared to $2.7 million (7 basis points) for the year ended December 31, 2002 and $0.4 million (one basis point) for the year ended December 31, 2001. During third quarter 2003, the Chief Accountant at the U.S. Securities and Exchange Commission provided additional guidance to all registrants regarding the classification on the statement of operations of realized gains and losses resulting from financial derivatives that are not in fair value or cash flow hedge relationships. All registrants were requested to comply with this guidance in future filings and to reclassify this activity for all prior periods presented. As a result of the application of this additional guidance, the net interest income and expense realized on financial derivatives that are not in fair value or cash flow hedge relationships have been reclassified from net interest income into gains and losses on financial derivatives and trading assets. For the years ended December 31, 2003 and 2002, this reclassification resulted in a decrease of the net interest yield of one basis point and a decrease of 11 basis points, respectively. The net interest yields for the years ended December 31, 2003, 2002 and 2001 included the benefits of yield maintenance payments received of 12 basis points, 8 basis points and 3 basis points, respectively. Yield maintenance payments represent the present value of expected future interest income streams and accelerate the recognition of interest income from the related loans. Because the timing and size of these payments vary greatly, variations should not be considered indicative of positive or negative trends to gauge future financial results. For the years ended December 31, 2003, 2002 and 2001, the after-tax effects of yield maintenance payments on net income and diluted earnings per share were $3.0 million or $0.25 per diluted share, $2.1 million or $0.17 per diluted share and $0.7 million or $0.06 per diluted share, respectively. The $1.8 million decrease in net interest income from 2002 to 2003 was due principally to lower average spreads on cash and cash equivalents and investments. The following table provides information regarding interest-earning assets and funding for the years ended December 31, 2003, 2002 and 2001. The balance of non-accruing loans is included in the average balance of interest earning loans presented, though no related income is included in the income figures presented. Therefore, as the balance of non-accruing loans increases or decreases, the net interest yield will increase or decrease, accordingly. Net interest income and the yield will also fluctuate due to the uncertainty of the timing and size of yield maintenance payments.
2003 2002 2001 ---------------------------------- ---------------------------------- -------------------------------- Average Income/ Average Average Income/ Average Average Income/ Average Balance Expense Rate Balance Expense Rate Balance Expense Rate ------------- ---------- --------- ----------- ----------- ---------- ------------ ---------- -------- (dollars in thousands) Interest-earning assets: Cash and cash equivalents $ 677,075 $ 8,171 1.21% $ 564,614 $ 10,237 1.81% $ 522,227 $21,464 4.11% Investments 932,738 27,115 2.91% 902,740 32,392 3.59% 922,856 45,070 4.88% Loans and Farmer Mac Guaranteed Securities 2,415,466 126,273 5.24% 2,291,887 129,241 5.64% 1,778,601 115,879 6.52% ------------- ---------- --------- ----------- ---------- ---------- ------------ ----------- ------- Total interest-earning assets $ 4,025,279 161,559 4.02% $ 3,759,241 171,870 4.57% $ 3,223,684 182,413 5.66% ------------- ------------- ------------- Funding: Notes payable due within one year $ 2,702,188 60,756 2.26% $ 2,533,762 67,896 2.68% $ 2,175,087 94,274 4.33% Notes payable due after one year 1,200,219 63,551 5.29% 1,102,485 64,875 5.88% 926,878 58,873 6.35% ------------- ---------- --------- ------------ ---------- ---------- ------------ ----------- ------ Total interest-bearing liabilities 3,902,407 124,307 3.19% 3,636,247 132,771 3.65% 3,101,965 153,147 4.94% Net non-interest-bearing funding 122,872 - 0.00% 122,994 - 0.00% 121,719 - 0.00% ------------- ---------- --------- ------------- ---------- ---------- ------------ ----------- ------- Total funding $ 4,025,279 124,307 3.10% $ 3,759,241 132,771 3.53% $ 3,223,684 153,147 4.94% ------------- ---------- --------- ------------- ---------- ---------- ------------ ----------- ------- Net interest income/ yield $ 37,252 0.93% $ 39,099 1.04% $29,266 0.91% ----------- ---------- ---------- ----------- ------------ ------
For 2003, the decreases in all of the rates presented above tracked the general decline in interest rates relative to the prior year. The average rates for cash and cash equivalents and discount notes reflect that decline in short-term interest rates during 2003, while the average rates for investments and loans and Farmer Mac Guaranteed Securities reflect the decline in interest rates for investments of similar term to the rate reset or maturity date. The following table sets forth information regarding the changes in the components of Farmer Mac's net interest income for the periods indicated. For each category, information is provided on changes attributable to changes in volume (change in volume multiplied by old rate) and changes in rate (change in rate multiplied by old volume). Combined rate/volume variances, the third element of the calculation, are allocated based on their relative size. The decreases due to rate reflect the short-term or adjustable-rate nature of the assets or liabilities and the general decreases in market rates described above.
2003 vs. 2002 2002 vs. 2001 ------------------------------------- ------------------------------------ Increase (Decrease) Due to Increase (Decrease) Due to ------------------------------------- ------------------------------------ Rate Volume Total Rate Volume Total ------------ ----------- ------------ ------------ ---------- ----------- (in thousands) Income from interest-earning assets: Cash and cash equivalents $ (2,572) $ 506 $ (2,066) $ (13,134) $ 1,907 $ (11,227) Investments (6,323) 1,046 (5,277) (11,716) (962) (12,678) Loans and Farmer Mac Guaranteed Securities (9,719) 6,751 (2,968) (11,659) 25,021 13,362 ------------ ----------- ------------ ------------ ---------- ----------- Total (18,614) 8,303 (10,311) (36,509) 25,966 (10,543) Expense from interest-bearing liabilities (17,593) 9,129 (8,464) (50,247) 29,871 (20,376) ------------ ----------- ------------ ------------ ---------- ----------- Change in net interest income $ (1,021) $ (826) $ (1,847) $13,738 $ (3,905) $ 9,833 ------------ ----------- ------------ ------------ ---------- -----------
Guarantee and Commitment Fees. Guarantee and commitment fee income, which compensate Farmer Mac for assuming the credit risk on loans underlying Farmer Mac Guaranteed Securities and LTSPCs, was $20.7 million for 2003, compared to $19.3 million for 2002 and $15.8 million for 2001. The increase in guarantee and commitment fee income reflects an increase in the average balance of outstanding guarantees and LTSPCs. For 2003, the effect of SFAS 140 reclassified $4.4 million of guarantee fee income as interest income, although management considers that amount to have been earned in consideration for the assumption of credit risk. That portion of the difference or "spread" between the cost of Farmer Mac's debt funding for loans and the yield on post-1996 Act Farmer Mac I Guaranteed Securities held on its books compensates for credit and interest rate risk. If a post-1996 Act Farmer Mac I Guaranteed Security is sold to a third party, Farmer Mac continues to receive the guarantee fee component of that spread, which continues to compensate Farmer Mac for its assumption of credit risk. The portion of the spread that compensates for interest rate risk would not typically continue to be received by Farmer Mac, except to the extent attributable to any retained interest-only strip, if the asset were sold. Gains and Losses on Financial Derivatives and Trading Assets. Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS 133") requires the change in the fair values of financial derivatives to be reflected in a company's net income or accumulated other comprehensive income. SFAS 133 became effective as of January 1, 2001. The cumulative effect of the change in accounting principles recognized during 2001 was a charge of $0.7 million, net of taxes. The net effect of financial derivatives that do not qualify for hedge accounting under SFAS 133 and trading assets recorded in Farmer Mac's consolidated statements of operations was a net gain of $2.4 million for 2003, a net loss of $8.4 million for 2002 and a net loss of $3.1 million for 2001. On a net after-tax basis, those gains and losses, combined with the cumulative effect of the change in accounting principles and benefits received from the elimination of the amortization of certain premium payments that resulted from SFAS 133, increased net income available to common stockholders by $2.0 million for 2003 and reduced net income available to common stockholders by $1.6 million for 2002. Gains on the Sale of Real Estate Owned. Farmer Mac has reclassified items on its consolidated statements of operations to present more clearly the costs related to carrying its real estate owned and the gains or losses incurred upon it's the ultimate disposition of real estate owned. Previously, gains and losses on the sale of real estate owned were reflected as adjustments to the allowance for losses as either a charge-off or recovery. Those amounts have been reclassified and are reported separately as gains or losses on the sale of real estate owned. Prior period amounts have been reclassified to conform to the current period classification. Gains on the sale of real estate owned were $0.2 million, $0.1 million and $0.1 million for each of the years ended December 2003, 2002 and 2001, respectively. Miscellaneous Income. Miscellaneous income was $0.8 million for 2003, compared to $1.3 million for 2002 and $0.6 million for 2001. Both the decrease in miscellaneous income from 2002 to 2003 and the increase from 2001 to 2002 were primarily a result of the receipt of the high level of late fee income and processing fees on Farmer Mac II refinance transactions received during 2002. Expenses. During 2003 and into 2004, Farmer Mac began several initiatives to validate and enhance its risk management practices, internal controls, and accounting and financial reporting. These initiatives are the result of ongoing corporate diligence and a number of regulatory considerations, including compliance with the Sarbanes-Oxley Act of 2002 and FCA requirements, as well as the general regulatory environment for government-sponsored enterprises. The general increases in both compensation and employee benefits and general and administrative expenses from 2001 to 2003 reflect the costs of those initiatives. Compensation and employee benefits were $6.1 million, $5.1 million and $5.6 million for 2003, 2002 and 2001, respectively. General and administrative expenses were $6.0 million, $5.5 million and $4.1 million for 2003, 2002 and 2001, respectively. For 2002, increased general and administrative expenses reflected higher legal and consulting fees associated with external events and publicity; these expenses dissipated somewhat in 2003. During 2003, the reduction in legal and consulting fees was more than offset by higher costs of regulatory compliance and the costs of servicing loans nearing or in foreclosure or bankruptcy. Prospectively, the loan servicing costs are expected to fluctuate with the level of these categories of non-performing assets, while the regulatory costs are expected to be ongoing. Regulatory fees were $2.0 million, $1.2 million and $0.7 million for 2003, 2002 and 2001, respectively. FCA has advised Farmer Mac that its estimated assessment for 2004 is $1.7 million. The regulatory assessments from the FCA for each of the examination periods corresponding approximately with each of the years ended December 31, 2003, 2002 and 2001 include both their originally estimated assessments and revisions to those estimates that reflect actual costs incurred. These revisions have resulted in both additional assessments and refunds in the past. Real estate owned operating expenses were $0.7 million and operating revenues were $0.4 million for 2003. Net real estate owned operating costs were $0.3 million for 2003. These net costs increased from prior years' nominal amounts as the number of properties owned increased. Farmer Mac's provision for losses on loans underlying Farmer Mac I Guaranteed Securities and LTSPCs, which is classified as a component of operating expenses, was $0.8 million for 2003, $6.9 million for 2002 and $6.2 million in 2001. Farmer Mac also provides for losses on the loans on its balance sheet through provisions that are charged against net interest income on the statement of operations and presented as a reduction to the reported loan balances on Farmer Mac's balance sheet. The total amount provided for Farmer Mac's allowance for losses for 2003, 2002 and 2001 were $7.3 million, $8.2 million and $6.8 million, respectively. The amount provided for the allowance for losses in 2003 decreased $0.9 million from the amount provided in 2002 as a result of lower estimated probable losses during 2003. As of December 31, 2003, Farmer Mac's allowance for losses for loans underlying Farmer Mac I Guaranteed Securities and LTSPCs was $15.9 million, compared to $16.8 million as of December 31, 2002. For further discussion and presentation regarding Farmer Mac's provisions for losses and allowances for losses in the aggregate, see "--Risk Management--Credit Risk - Loans" Income Tax Expense. Income tax expense totaled $12.3 million in 2003, compared to $9.8 million in 2002 and $8.4 million in 2001. Farmer Mac's effective tax rates for 2003 and 2002 were approximately 31.1 percent and 30.1 percent, respectively, reflecting the effects of certain tax-advantaged investments, compared to 33.1 percent for 2001. Farmer Mac expects its effective tax rate in 2004 to approximate 30 percent. For more information about income taxes, see Note 10 to the consolidated financial statements. Gains and Losses on the Repurchase of Debt. During 2003, Farmer Mac did not repurchase any of its outstanding debt. During 2002, Farmer Mac recognized $1.4 million of net gains on the repurchase of $103.7 million of its outstanding debt. All of the repurchases were from outstanding Farmer Mac debt that had a maturity date of October 14, 2011 and an interest rate of 5.4 percent. Those debt securities were replaced with new fixed-rate funding to the same maturity dates at more attractive interest rates, which preserves Farmer Mac's asset-liability match and reduced future interest expense. Non-GAAP Performance Measures. Farmer Mac reports its financial results in accordance with GAAP. In addition to GAAP measures, Farmer Mac presents certain non-GAAP performance measures. Farmer Mac uses these non-GAAP performance measures to develop financial plans, to gauge corporate performance and to set incentive compensation. As described below, because the Financial Accounting Standards Board ("FASB") has adopted a mixed attribute accounting model that does not reflect the economics for transactions involving Farmer Mac's callable swaps, in management's view the non-GAAP measures provide a more accurate representation of Farmer Mac's economic performance, transaction economics and business trends. Investors and the investment analyst community have previously relied upon similar measures to evaluate performance and issue projections. These non-GAAP disclosures are not intended to replace GAAP information but, rather, to supplement it. One such non-GAAP measure is core earnings, which Farmer Mac developed to present net income less the after-tax effects of SFAS 133 and less the after-tax net gains and losses on the repurchase of debt that, prior to January 1, 2003, were reported as extraordinary items. Core earnings for the years ended December 31, 2003, 2002 and 2001 were $23.0 million, $22.9 million and $17.1 million, respectively. The reconciliation of GAAP net income available to common stockholders to core earnings is presented in the following table:
Reconciliation of GAAP Net Income Available to Common Stockholders to Core Earnings --------------------------------------------------------------------------------------------- Year Ended ----------------------------------------------------- December 31, December 31, December 31, 2003 2002 2001 ---------------- ------------------ ----------------- (in thousands) GAAP net income available to common stockholders $ 25,030 $ 21,295 $ 16,280 Less the effects of SFAS 133: Unrealized gains/(losses) on financial derivatives and trading assets, net of tax 1,720 (2,834) (469) Benefit from non-amortization of premium payments on financial derivatives, net of tax 317 382 404 Cumulative effect of the adoption of SFAS 133 - - (726) Less gains on the repurchase of debt previously reported as extraordinary items - 889 - ---------------- ------------------ ----------------- Core earnings $ 22,993 $ 22,858 $ 17,071 ---------------- ------------------ -----------------
Effects of SFAS 133 on Accounting for Callable Interest Rate Swaps. Farmer Mac enters into financial derivative transactions to protect against risk from the effects of market price or interest rate movements on the value of assets, future cash flows and debt issuance, not for trading or speculative purposes. Farmer Mac enters into interest rate swap contracts to adjust the characteristics of its short-term debt to match more closely the cash flow and duration characteristics of its longer-term mortgage and other assets, and also to adjust the characteristics of its long-term debt to match more closely the cash flow and duration characteristics of its short-term assets, thereby reducing interest rate risk and also to derive an overall lower effective fixed-rate cost of borrowing than would otherwise be available to Farmer Mac in the conventional debt market. Specifically, interest rate swaps convert economically the variable cash flows related to the forecasted issuance of short-term debt to effectively fixed-rate medium-term and long-term notes that match the anticipated duration, repricing and interest rate characteristics of the corresponding assets. Since this strategy provides Farmer Mac with the same cash flows as those that are inherent in the issuance of medium-term notes, Farmer Mac uses either the bond market or the swap market based upon their relative pricing efficiencies. Farmer Mac uses callable interest rate swaps (in conjunction with the issuance of short-term debt) as an alternative to callable medium-term notes with equivalently structured maturities and call options. The call options on the swaps are designed to match the implicit prepayment options on those mortgage assets without prepayment protection. The blended durations of the swaps are also designed to match the duration of the mortgages over their estimated lives. If the mortgages prepay, the swaps can be called and the short-term debt repaid; if the mortgages do not prepay, the swaps remain outstanding and the short-term debt is rolled over, effectively providing fixed-rate callable funding over the lives of the mortgages. Thus, the economics of the assets are closely matched to the economics of the interest rate swap and funding combination. The callable interest rate swaps are recorded at fair value on Farmer Mac's balance sheet with the related changes in fair value recognized in the consolidated statement of operations. Although Farmer Mac believes that this strategy achieves its economic and risk management objectives, the FASB has adopted a mixed attribute accounting model for callable swaps that does not reflect the economics of the transactions. Pursuant to that model, while the issuance of a callable medium-term note is recorded at historical cost, the economic equivalent (the issuance of short term-debt with the forecasted rollover of that debt and the simultaneous issuance of a callable interest rate swap) is recorded differently (the discount notes are recorded at historical cost and the interest rate swap is recorded at fair value). Despite the closely matched economics and optionality of the assets and the associated interest rate swap and funding combination, the callable swaps do not qualify for hedge accounting under SFAS 133 because the test for hedge effectiveness under SFAS 133 is based on the linkage between the forecasted short-term funding and the callable interest rate swap and ignores the prepayable characteristics of the associated assets being funded. Business Volume. Loans are brought into the Farmer Mac I and Farmer Mac II programs as follows: o Farmer Mac purchases eligible loans and guarantees timely payments of principal and interest of securities backed by those loans as part of the Farmer Mac I program. Farmer Mac may retain some or all of those securities in its portfolio or sell them to third parties in capital markets transactions. o Farmer Mac purchases USDA-guaranteed portions of loans and guarantees timely payments of principal and interest of securities backed by those guaranteed portions as part of the Farmer Mac II program. Farmer Mac may retain some or all of those securities in its portfolio or sell them to third parties in capital markets transactions. o Farmer Mac also enters into LTSPCs for eligible loans. Farmer Mac's commitments through LTSPCs include either newly originated or seasoned eligible loans, and are part of the Farmer Mac I program. o Farmer Mac exchanges Farmer Mac Guaranteed Securities for eligible loans or USDA-guaranteed portions of loans ("swaps"). Farmer Mac's swaps of Farmer Mac Guaranteed Securities for USDA-guaranteed portions of loans are part of the Farmer Mac II program; Farmer Mac's swaps of Farmer Mac Guaranteed Securities for any other eligible loans are part of the Farmer Mac I program. During 2003, the volume of loans purchased or placed under Farmer Mac Guaranteed Securities and LTSPCs totaled $1.2 billion, a decrease from 2002 volume of $2.1 billion. That decrease was largely attributable to the purchase of a $489.5 million loan portfolio in second quarter 2002 and a decrease in LTSPC volume of $392.1 million in 2003, partially offset by an increase in Farmer Mac II volume of $98.2 million in 2003. See "Business--Farmer Mac Programs--Farmer Mac I--Off-Balance Sheet Guarantees and Commitments" and Note 12 to the consolidated financial statements for a description of LTSPCs. The following table sets forth information regarding the volume of loans purchased or placed under Farmer Mac Guaranteed Securities or LTSPCs for the periods indicated:
Farmer Mac Loan Purchases, Guarantees and LTSPCs ---------------------------------------------------------------------------------- For the Year Ended December 31, ---------------------------------------------- 2003 2002 2001 --------------- -------------- -------------- (in thousands) Farmer Mac I: Loans and Guaranteed Securities $ 192,577 $ 747,881 $ 272,127 LTSPCs 763,342 1,155,479 1,032,967 Farmer Mac II 271,229 173,011 198,171 --------------- -------------- -------------- Total $ 1,227,148 $ 2,076,371 $ 1,503,265 --------------- -------------- --------------
The purchase price of newly originated and seasoned eligible loans and portfolios purchased through the cash window, none of which are delinquent at the time of purchase, is the fair value based on current market interest rates and Farmer Mac's target net yield, which includes an amount to compensate Farmer Mac for credit risk that is similar to the guarantee or commitment fee it receives for accepting credit risk on loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs. The purchase price for loans purchased from all related parties is determined in the same manner as for loans acquired from any other third party. See Note 3 to the consolidated financial statements for a description of related party transactions. As part of fulfilling its guarantee obligations for Farmer Mac I Guaranteed Securities and commitments to purchase eligible loans underlying LTSPCs, Farmer Mac purchases defaulted loans, all of which are at least 90 days delinquent at the time of purchase, out of those securities and pools. The purchase price for defaulted loans purchased out of Farmer Mac I Guaranteed Securities is the current outstanding principal balance of the loan plus accrued and unpaid interest. The purchase price for defaulted loans purchased under an LTSPC is the current outstanding principal balance of the loan, with accrued and unpaid interest on the defaulted loans payable out of any future loan payments or liquidation proceeds as received. The purchase price of a defaulted loan is not an indicator of the expected loss on that loan; many other factors affect expected loss, if any, on loans so purchased. See "--Risk Management--Credit Risk - Loans." The following table presents Farmer Mac's purchases of newly originated and current seasoned loans and purchases of defaulted loans underlying Farmer Mac I Guaranteed Securities and LTSPCs.
For the Year Ended December 31, ------------------------------ 2003 2002 -------------- -------------- (in thousands) Farmer Mac I newly originated and current seasoned loan purchases $ 192,577 $ 747,881 Defaulted loans purchased underlying off-balance sheet Farmer Mac I Guaranteed Securities 16,276 17,386 Defaulted loans purchased underlying LTSPCs 4,266 3,386 Defaulted loans underlying on-balance sheet Farmer Mac I Guaranteed Securities transferred to loans 35,100 25,675
The decrease in newly originated and current seasoned loan purchases was attributable to a decrease in program volume that resulted primarily from the purchase of a $489.5 million loan portfolio in second quarter 2002, that was not replicated in 2003. The purchases of defaulted loans from Farmer Mac I Guaranteed Securities and LTSPCs are pursuant to Farmer Mac's obligations as guarantor and under its contractual commitments, respectively. With respect to the transfer of loans from on-balance sheet Farmer Mac I Guaranteed Securities to loans, when particular criteria are met, such as the default of the borrower, Farmer Mac becomes entitled to purchase the defaulted loans underlying Farmer Mac I Guaranteed Securities (commonly referred to as "removal-of-account" provisions). Farmer Mac records these loans in the consolidated financial statements during the period in which Farmer Mac becomes entitled to repurchase the loans and therefore regains effective control over the transferred loans. The weighted-average age of the Farmer Mac I newly originated and current seasoned loans purchased during 2003 and 2002 was less than one year and 3 years, respectively. Of the combined total of Farmer Mac I newly originated and seasoned loans that were purchased (excluding purchases of defaulted loans) during 2003 and 2002, 74 percent and 76 percent, respectively, had principal amortization periods longer than the maturity date, resulting in balloon payments at maturity, with a weighted-average remaining term to maturity of 15.2 years and 11.1 years, respectively. The weighted-average age of delinquent loans purchased out of securitized pools and LTSPCs during 2003 and 2002 was 4.7 years and 4.3 years, respectively. The outstanding principal balance of loans held and loans underlying LTSPCs and on- and off-balance sheet Farmer Mac Guaranteed Securities increased five percent to $5.8 billion as of December 31, 2003 from $5.5 billion as of December 31, 2002. The following table sets forth information regarding those outstanding balances as of the dates indicated:
Outstanding Balance of Farmer Mac Loans and Loans Underlying Farmer Mac Guaranteed Securities and LTSPCs ------------------------------------------------------------------------------------------- As of December 31, -------------------------------------------------- 2003 2002 2001 --------------- --------------- --------------- (in thousands) Farmer Mac I: Post-1996 Act: Loans and Guaranteed Securities $2,696,530 $2,168,994 $1,658,716 LTSPCs 2,348,702 2,681,240 1,884,260 Pre-1996 Act 24,734 31,960 48,979 Farmer Mac II 729,470 645,790 595,156 --------------- --------------- --------------- Total $5,799,436 $5,527,984 $4,187,111 --------------- --------------- ---------------
The following table sets forth information regarding the Farmer Mac I Guaranteed Securities issued during the periods indicated:
Farmer Mac I Guaranteed Securities Issuances -------------------------------------------------------------------------------------------------------- For the Year Ended December 31, ---------------------------------------------- 2003 2002 2001 --------------- -------------- -------------- (in thousands) Retained $ - $ - $ 33,932 Sold 78,254 47,682 77,422 Swap transactions 722,315 - 5,574 --------------- -------------- -------------- Total Farmer Mac Guaranteed Securities Issuances $ 800,569 $ 47,682 $ 116,928 --------------- -------------- --------------
Based on market conditions, Farmer Mac either retains the loans it purchases or securitizes them and issues Farmer Mac I Guaranteed Securities backed by those loans. During 2003 and 2002, Farmer Mac securitized and sold $78.3 million and $47.7 million, respectively ($75.9 million and $47.7 million, respectively, of such securities were sold to a related party, Zions First National Bank) of the loans purchased, and issued $722.3 million in the form of a swap transaction with a related party participant, Farm Credit West, ACA. This transaction resulted from the participant's exercise of a conversion feature incorporated in all existing LTSPCs. Farmer Mac's decision to retain the remainder of the loans it purchased was based on favorable underlying funding costs that resulted in attractive net interest income over the lives of the loans and Farmer Mac Guaranteed Securities it holds. LTSPCs typically involve seasoned loans, while cash purchase transactions usually represent acquisitions of newly originated loans. The decreased LTSPC activity in 2003 was a result of reduced growth rates in the agricultural mortgage market, which have tended to be a function of the interest rate environment and other factors described two paragraphs below. With particular regard to Farm Credit System institutions, some business prospects have been constrained by increased FCSIC insurance premiums assessed on loans held by those institutions, including loans under LTSPCs. In addition, FCSIC has recently indicated to those institutions that they should be cautious about the risk of doing business with government-sponsored enterprises, including Farmer Mac, as counterparties. Moreover, FCSIC has raised objections to Farm Credit institutions' use of Farmer Mac swaps, which generate Farmer Mac I Guaranteed Securities that are not subject to the previously mentioned insurance premiums. Notwithstanding this, management expects that LTSPCs will continue to constitute a significant portion of new Farmer Mac I program activity during 2004. Indicators of future loan purchase and guarantee volume through the cash window (but not future LTSPC, swap or portfolio purchase volume) in the immediately succeeding reporting period include outstanding commitments to purchase loans (other than under LTSPCs) and the total balance of loans submitted for approval or approved but not yet purchased. Many purchase commitments entered into by Farmer Mac are mandatory delivery commitments. If a seller obtains a mandatory commitment and is unable to deliver the loans required, Farmer Mac requires the seller to pay a fee to modify, extend or cancel the commitment. As of December 31, 2003, outstanding commitments to purchase Farmer Mac I and Farmer Mac II loans totaled $11.2 million, compared to $26.2 million as of December 31, 2002. Of the total Farmer Mac I and II commitments outstanding as of December 31, 2003 and 2002, $11.2 million and $21.7 million, respectively, were mandatory commitments. Loans submitted for approval or approved but not yet committed to purchase totaled $26.6 million as of December 31, 2003, compared to $53.4 million as of December 31, 2002. Not all of such loans are purchased, as some are denied for credit reasons or withdrawn by the seller. New business volume was down during 2003 compared to 2002. Farmer Mac believes this trend is traceable to: o general conditions in the agricultural mortgage market affecting agricultural mortgage lenders, including payments received by farmers under the 2002 Farm Bill and lower short-term interest rates, that have resulted in reduced borrower inclination to finance their real estate assets, particularly at long-term fixed rates; o diminished expansion in the capital intensive livestock and permanent crop sectors that have, in the past, been significant sources of new business for Farmer Mac; o adverse publicity about and increased regulatory pressure on government-sponsored enterprises, including Farmer Mac; and o increased FCSIC insurance premiums on loans held by Farm Credit System institutions and FCSIC' indications regarding counterparty risk, as discussed above. Nonetheless, lender interest in Farmer Mac produced a consistent stream of new volume in the form of Farmer Mac I and II individual loan purchases and additions to existing LTSPC arrangements during 2003. In the fourth quarter of 2003, Farmer Mac launched marketing initiatives that are generating promising business opportunities for 2004 and beyond. New and expanded business relationships (including a strategic alliance with a related party Farm Credit System institution that will serve community banks), product enhancements, such as new open prepayment loan structures, and new loan securitization structures, are all underway. Farmer Mac believes that prospects for larger portfolio transactions similar to those that have accounted for a significant portion of growth in prior years continue to exist, but no assurance can be given at this time as to the certainty or timing of such transactions. As of December 31, 2003, there were 142 approved loan sellers in the Farmer Mac I program ranging from single-office to multi-branch institutions, spanning community banks, Farm Credit System associations, mortgage companies, large multi-state Farm Credit System banks, commercial banks and insurance companies, of which 81 were active participants in the program. As of December 31, 2002, there were 219 approved sellers in the Farmer Mac I program, of which 79 were active participants in the program. In addition to participating directly in the Farmer Mac I program, some of the approved loan sellers enable other lenders to participate indirectly in the Farmer Mac I program by managing correspondent networks of lenders from which they purchase loans to sell to Farmer Mac. As of December 31, 2003, more than 75 lenders were participating in those networks, bringing the total Farmer Mac I program participants to more than 200 as of December 31, 2003. To be considered for approval as a Farmer Mac I seller, a financial institution must meet criteria established by Farmer Mac, including: o owning a requisite amount of Farmer Mac Class A or Class B voting common stock according to a schedule prescribed for the size and type of institution; o having the ability and experience to make or purchase and sell agricultural mortgage loans of the type that will qualify for purchase by Farmer Mac and service such mortgage loans in accordance with the Farmer Mac requirements either through its own staff or through contractors and originators; o maintaining a minimum adjusted net worth of $1.0 million; o maintaining a fidelity bond and errors and omissions insurance coverage (or acceptable substitute insurance coverage) in a prescribed amount according to the size of the institution; and o entering into a Seller/Servicer agreement to comply with the terms of the Farmer Mac Seller/Servicer Guide, including representations and warranties regarding the eligibility of the loans and accuracy of loan data provided to Farmer Mac. Any lender authorized by the USDA to obtain a USDA guarantee on a loan may be a seller in the Farmer Mac II program. As of December 31, 2003, there were 150 active sellers in the Farmer Mac II program, compared to 143 as of December 31, 2002. Sellers in the Farmer Mac II program consist mostly of community and regional banks. Thus, in the aggregate, more than 300 lenders were actively participating either directly or indirectly in one or both of the Farmer Mac I or Farmer Mac II programs during 2003. Related Party Transactions. In 2002 and 2003, Farmer Mac conducted business with entities that are related parties as a result of a member of Farmer Mac's board of directors being affiliated with the entity in some capacity. These transactions were conducted in the ordinary course of business, with terms and conditions comparable to those available to any other third party. For more information about related party transactions, see Note 3 to the consolidated financial statements. Balance Sheet Review Assets. As of December 31, 2003, total assets were $4.3 billion compared to $4.2 billion as of December 31, 2002. On-balance sheet program assets (Farmer Mac Guaranteed Securities and loans), decreased $77.5 million during 2003 to a total of $2.5 billion, while non-program assets increased $134.2 million to $1.7 billion as of December 31, 2003. The following table presents Farmer Mac's on-balance sheet program assets based on their repricing frequency.
Outstanding Balance of Loans Held and Loans Underlying On-Balance Sheet Farmer Mac Guaranteed Securities ----------------------------------------------------------------------- As of December 31, ------------------------------------ 2003 2002 ----------------- ---------------- (in thousands) Fixed rate (10-yr. wtd. avg. term) $ 860,874 $ 1,003,434 5-to-10 year ARMs and resets 1,045,217 981,548 1-Month-to-3-Year ARMs 542,024 494,713 ----------------- ---------------- Total held in portfolio $ 2,448,115 $ 2,479,695 ----------------- ----------------
Liabilities. Total liabilities increased to $4.1 billion as of December 31, 2003 from $4.0 billion as of December 31, 2002. The increase in liabilities was primarily due to growth in notes payable, which corresponded to the growth and funding of on-balance sheet program assets. For more information about Farmer Mac's funding and interest rate risk practices and how financial derivatives are used, see "--Risk Management--Interest Rate Risk." For more information about Farmer Mac's reserve for losses, see "--Risk Management--Credit Risk - Loans." Capital. As of December 31, 2003, stockholders' equity totaled $213.3 million, compared to $183.6 million as of December 31, 2002. The increase was primarily due to net income available to common stockholders of $25.0 million earned during 2003. That increase was partially offset by a $1.9 million decrease in accumulated other comprehensive income/(loss) resulting from a net increase of $17.2 million in the market values of financial derivatives classified as cash flow hedges and a decrease of $19.1 million in net unrealized gains on investment securities and Farmer Mac Guaranteed Securities classified as available for sale. Accumulated other comprehensive income is not a component of Farmer Mac's core capital or regulatory capital. Return on average common equity was 15.3 percent for 2003, compared to 15.0 percent for 2002. The effects of SFAS 133 and Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities, increased the average return on common equity by 1.1 percent for 2003 and reduced the average return on common equity by 3.9 percent for 2002. As of December 31, 2003, Farmer Mac's core capital totaled $215.5 million, compared to $184.0 million as of December 31, 2002. As of December 31, 2003, Farmer Mac's core capital exceeded its statutory minimum capital requirement of $142.0 million by $73.5 million. FCA issued its final risk-based capital regulation for Farmer Mac on April 12, 2001 and the Corporation was required to meet the risk-based capital standards beginning on May 23, 2002. As of December 31, 2003 the risk-based capital stress test generated a regulatory capital requirement of $38.8 million. Farmer Mac's regulatory capital of $237.6 million exceeded that amount by approximately $198.8 million. The Corporation is required to hold capital at the higher of the statutory minimum capital requirement or the amount required by the risk-based capital stress test. For further information, see "--Liquidity and Capital Resources--Capital Requirements." Off-Balance Sheet Farmer Mac Guaranteed Securities and LTSPCs. Farmer Mac offers approved agricultural and rural residential mortgage lenders two alternatives to increase their liquidity or lending capacity while retaining the cash flow benefits of their loans: (1) Farmer Mac Guaranteed Securities, which are available through either the Farmer Mac I program or the Farmer Mac II program, and (2) LTSPCs, which are available only through the Farmer Mac I program. Both of these alternatives result in off-balance sheet transactions for Farmer Mac. To be eligible for the Farmer Mac I program, a loan must meet Farmer Mac's credit underwriting, appraisal and documentation standards. Accordingly, Farmer Mac believes the credit risk it assumes for Farmer Mac Guaranteed Securities backed by loans that are eligible for the Farmer Mac I program and for LTSPCs is the same and considers the effects of all on- and off-balance sheet activities on its overall portfolio diversification and credit risk. See Note 12 to Farmer Mac's consolidated financial statements for more detail on the Corporation's off-balance sheet program activities. As of December 31, 2003, outstanding off-balance sheet Farmer Mac Guaranteed Securities and LTSPCs totaled $3.4 billion, compared to $3.0 billion as of December 31, 2002. The following table presents the balance of outstanding LTSPCs and off-balance sheet Farmer Mac Guaranteed Securities as of December 31, 2003 and 2002:
Outstanding Balance of LTSPCs and Off-Balance Sheet Farmer Mac Guaranteed Securities ---------------------------------------------------------------------------------- As of December 31, ---------------------------------- 2003 2002 ----------------- --------------- (in thousands) Farmer Mac I: Post-1996 Act obligations: Farmer Mac I Guaranteed Securities $ 952,134 $ 299,940 LTSPCs 2,348,702 2,681,240 ----------------- --------------- Total Post-1996 Act obligations 3,300,836 2,981,180 Pre-1996 Act Farmer Mac I Guaranteed Securities - - ----------------- --------------- Total Farmer Mac I 3,300,836 2,981,180 Farmer Mac II Guaranteed Securities 51,241 67,109 ----------------- --------------- Total Farmer Mac I and II $ 3,352,077 $ 3,048,289 ----------------- ---------------
For more information about off-balance sheet Farmer Mac Guaranteed Securities, see "--Risk Management--Credit Risk - Loans" and Note 12 to the consolidated financial statements. Risk Management Interest Rate Risk. Farmer Mac is subject to interest rate risk on all assets held for investment because of possible timing differences in the cash flows of the assets and related liabilities. This risk is primarily related to loans held and on-balance sheet Farmer Mac Guaranteed Securities because of the ability of borrowers to prepay their mortgages before the scheduled maturities, thereby increasing the risk of asset and liability cash flow mismatches. Cash flow mismatches in a changing interest rate environment can reduce the earnings of the Corporation if assets repay sooner than expected and the resulting cash flows must be reinvested in lower-yielding investments when Farmer Mac's funding costs cannot be correspondingly reduced, or if assets repay more slowly than expected and the associated debt must be replaced by higher-cost debt. Yield maintenance provisions and other prepayment penalties contained in many agricultural mortgage loans reduce, but do not eliminate, this risk, particularly in the case of a defaulted loan where yield maintenance may not be collected. Those provisions require borrowers to make an additional payment when they prepay their loans, so that, when reinvested with the prepaid principal, yield maintenance payments generate substantially the same cash flows that would have been generated had the loan not prepaid. This provision creates a disincentive to prepayment and compensates the Corporation for its interest rate risks to a large degree. As of December 31, 2003, 58 percent of the outstanding balance of all loans held and loans underlying on-balance sheet Farmer Mac I Guaranteed Securities (including 92 percent of all loans with fixed interest rates) were covered by yield maintenance provisions and other prepayment penalties. As of December 31, 2003, 51 percent of the total outstanding balance of retained Farmer Mac I loans and Guaranteed Securities had yield maintenance provisions and 7 percent had other forms of prepayment protection. Of the Farmer Mac I new and current loans purchased in 2003, 12 percent had yield maintenance or another form of prepayment protection (including 35 percent of all loans with fixed interest rates). None of the USDA-guaranteed portions underlying Farmer Mac II Guaranteed Securities had yield maintenance provisions. Taking into consideration the prepayment provisions and the default probabilities associated with its mortgage assets, Farmer Mac uses prepayment models to project and value cash flows associated with these assets. Because borrowers' behavior in various interest rate environments may change over time, Farmer Mac periodically evaluates the effectiveness of these models compared to actual prepayment experience and adjusts and refines the models as necessary to improve the precision of subsequent prepayment forecasts. In addition, Farmer Mac consults with independent prepayment experts as part of the model evaluation process. The goal of interest rate risk management at Farmer Mac is to create and maintain a portfolio that generates stable earnings and value across a variety of interest rate environments. Farmer Mac's primary strategy for managing interest rate risk is to fund asset purchases with liabilities that have similar durations so that they will perform similarly as interest rates change. To achieve this match, Farmer Mac issues discount notes and both callable and non-callable medium-term notes across a spectrum of maturities. Farmer Mac issues callable debt to offset the prepayment risk associated with some mortgage assets. By using a blend of liabilities that includes callable debt, the interest rate sensitivities of the liabilities tend to increase or decrease as interest rates change in a manner similar to changes in the interest rate sensitivities of the assets. Farmer Mac also uses financial derivatives to alter the duration of its assets and liabilities to better match their durations, thereby reducing overall interest rate sensitivity. Farmer Mac's $623.7 million of cash and cash equivalents as of December 31, 2003 matures within three months and is match-funded with discount notes having similar maturities. Investment securities of $1.065 billion as of December 31, 2003 consist of $710.0 million (67 percent) of floating rate securities that all have rates that adjust within one year. See Note 4 to the consolidated financial statements for more information on investment securities. These floating rate investments are funded using (i) a series of discount note issuances in which each successive discount note is issued and matures on or about the corresponding repricing date of the related investment; (ii) floating-rate notes having similar rate reset provisions as the related investment; or iii) fixed-rate notes swapped to floating rates having similar reset provisions as the related investment. Farmer Mac is also subject to interest rate risk on loans, including loans that Farmer Mac has committed to acquire (other than through LTSPCs) but has not yet purchased. When Farmer Mac commits to purchase such loans, it is exposed to interest rate risk between the time it commits to purchase the loans and the time it either: o sells Farmer Mac Guaranteed Securities backed by the loans; or o issues debt to retain the loans in its portfolio (although issuing debt to fund the loans as investments does not fully eliminate interest rate risk due to the possible timing differences in the cash flows of the assets and related liabilities, as discussed above). Farmer Mac manages the interest rate risk related to such loans, and any related Farmer Mac Guaranteed Securities or debt issuance, through the use of forward sale contracts on the debt and mortgage-backed securities of other government-sponsored enterprises and futures contracts involving U.S. Treasury securities. Farmer Mac uses forward sale contracts on government-sponsored enterprise securities to reduce its interest rate exposure to changes in both Treasury rates and spreads on Farmer Mac debt and Farmer Mac I Guaranteed Securities. Since interest rate sensitivity may change with the passage of time and as interest rates change, Farmer Mac assesses this exposure on a regular basis and rebalances its portfolio of assets and liabilities as necessary through: o the purchase of mortgage assets in the ordinary course of business; o the refunding of existing liabilities; or o the use of derivatives to alter the characteristics of existing assets or liabilities. The most strenuous measure of the long-term interest rate risk of Farmer Mac's current portfolio is the sensitivity of its Market Value of Equity ("MVE") to yield curve shocks. MVE represents the present value of all future cash flows from on- and off-balance sheet assets, liabilities and financial derivatives, discounted at current interest rates and spreads. The following schedule summarizes the results of Farmer Mac's MVE sensitivity analysis as of December 31, 2003 and December 31, 2002 to an immediate and instantaneous parallel shift in the yield curve.
Percentage Change in MVE from Base Case --------------------------------------- Interest Rate December 31, December 31, Scenario 2003 2002 --------------- --------------------------------------- + 300 bp -0.4% 15.6% + 200 bp 0.2% 11.0% + 100 bp 0.4% 5.9% - 100 bp 0.0% -7.1% - 200 bp N/A* N/A* - 300 bp N/A* N/A* * As of December 31, 2003 and 2002, a -200 bp parallel shift of the U. S. Treasury yield curve produced negative interest rates for maturities of 2 years and shorter.
Farmer Mac's long-term interest rate sensitivity decreased during 2003, and remained relatively stable and at relatively low levels despite the volatile interest rate environment during the year. Farmer Mac's effective duration gap was minus 0.1 months as of December 31, 2003, compared to minus 3.6 months as of December 31, 2002. As interest rates declined during 2003, prepayments of mortgages without prepayment penalties increased, thereby shortening the duration of the Corporation's assets relative to the duration of its liabilities. Throughout the year, Farmer Mac shortened the duration of its liabilities through various rebalancing strategies. As a result, Farmer Mac was able to improve its overall risk profile even as interest rates declined to historic lows. As of December 31, 2003, a uniform or "parallel" increase of 100 basis points would have increased NII by 5.6 percent, while a parallel decrease of 100 basis points would have decreased NII by 9.4 percent. Farmer Mac also measures the sensitivity of both MVE and NII to a variety of non-parallel interest rate shocks, including flattening and steepening yield curve scenarios. As of December 31, 2003, both MVE and NII showed similar sensitivity to non-parallel shocks as to the parallel shocks. The sensitivity of Farmer Mac's MVE and NII to both parallel and non-parallel interest rate shocks, and its duration gap, indicate the effectiveness of Farmer Mac's approach to managing its interest rate risk exposures. The economic effects of financial derivatives, including interest rate swaps, are included in the MVE, NII and duration gap analyses. Farmer Mac generally enters into various interest rate swaps to reduce interest rate risk as follows: o "floating-to-fixed interest rate swaps" in which it pays fixed rates of interest to, and receives floating rates of interest from, counterparties; these swaps adjust the characteristics of short-term debt to match more closely the cash flow and duration characteristics of longer-term reset and fixed-rate mortgages and other assets and provide an overall lower effective cost of borrowing than would otherwise be available in the conventional debt market; o "fixed-to-floating interest rate swaps" in which it receives fixed rates of interest from, and pays floating rates of interest to, counterparties; these transactions adjust the characteristics of long-term debt to match more closely the cash flow and duration characteristics of short-term assets; and o "basis swaps" in which it pays variable rates of interest based on one index to, and receives variable rates of interest based on another index from, counterparties; these swaps alter interest rate indices of liabilities to match those of assets, and vice versa. As of December 31, 2003, Farmer Mac had $1.3 billion combined notional amount of interest rate swaps, of which $674.4 million were floating-to-fixed interest rate swaps, $25.0 million were floating-to-floating interest rate swaps, $321.9 million were basis swaps and $245.0 million were fixed-to-floating interest rate swaps, with terms ranging from one to fifteen years. Farmer Mac uses financial derivatives as an end-user for hedging purposes, not for trading or speculative purposes. When financial derivatives meet the specific hedge criteria under SFAS 133, they are accounted for as either fair value hedges or cash flow hedges. Financial derivatives that do not satisfy those hedge criteria are not accounted for as hedges and changes in the fair value of those financial derivatives are reported as a gain or loss on financial derivatives and trading assets in the consolidated statement of operations. All of Farmer Mac's financial derivatives transactions are conducted under standard collateralized agreements that limit Farmer Mac's potential credit exposure to any counterparty. As of December 31, 2003, Farmer Mac had no uncollateralized net exposure to any counterparty. Credit Risk - Loans. Farmer Mac's primary exposure to credit risk is the risk of loss resulting from the inability of borrowers to repay their mortgages in conjunction with a deficiency in the value of the collateral relative to the amount outstanding on the mortgage and the cost of liquidation. Farmer Mac is exposed to credit risk on: o loans it holds; o loans underlying Farmer Mac Guaranteed Securities; and o loans underlying LTSPCs. Loans held or loans underlying Farmer Mac Guaranteed Securities or LTSPCs can be divided into four groups: o loans held for investment; o loans underlying pre-1996 Act Farmer Mac I Guaranteed Securities; o loans underlying post-1996 Act Farmer Mac I Guaranteed Securities or LTSPCs; and o USDA-guaranteed portions underlying Farmer Mac II Guaranteed Securities. For loans underlying pre-1996 Act Farmer Mac I Guaranteed Securities, ten percent first-loss subordinated interests mitigate Farmer Mac's credit risk exposure. Before Farmer Mac incurs a credit loss, full recourse must first be taken against the subordinated interest. The 1996 Act eliminated the subordinated interest requirement. As a result, Farmer Mac generally assumes 100 percent of the credit risk on loans held for investment and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs. Farmer Mac's credit exposure on USDA-guaranteed portions is covered by the full faith and credit of the United States. Farmer Mac believes it has little or no credit risk exposure to loans underlying pre-1996 Act Farmer Mac I Guaranteed Securities because of the subordinated interests, or to USDA-guaranteed portions because of the USDA guarantee. The outstanding principal balance of loans held, real estate owned and loans underlying Farmer Mac Guaranteed Securities (including AgVantage bonds) or LTSPCs is summarized in the table below.
As of December 31, ------------------------------------ 2003 2002 ------------------- --------------- (in thousands) Farmer Mac I: Post-1996 Act $ 5,045,232 $ 4,850,234 Pre-1996 Act 24,734 31,960 Farmer Mac II: USDA-guaranteed portions 729,470 645,790 ---------------- ----------------- $ 5,799,436 $ 5,527,984 ---------------- -----------------
For several years, Farmer Mac has conducted guarantee fee adequacy analyses, using stress-test models developed internally and with the assistance of outside experts. These analyses have taken into account the diverse and dissimilar characteristics of the various asset categories for which Farmer Mac manages its risk exposures, and have evolved as the mix and character of assets under management has shifted with growth in the business and the addition of new asset categories. Based on current information, Farmer Mac believes that its guarantee fee is adequate compensation for the credit risk that it assumes. Farmer Mac has established underwriting, appraisal and documentation standards for agricultural mortgage loans to mitigate the risk of loss from borrower defaults and to provide guidance concerning the management, administration and conduct of underwriting and appraisals to all participating sellers and potential sellers in its programs. These standards were developed on the basis of industry norms for agricultural mortgage loans and are designed to assess the creditworthiness of the borrower, as well as the value of the collateral securing the loan. Farmer Mac requires sellers to make representations and warranties regarding the conformity of eligible mortgage loans to these standards, the accuracy of loan data provided to Farmer Mac and other requirements related to the loans. Sellers are responsible to Farmer Mac for breaches of those representations and warranties that result in economic losses to the Corporation. Pursuant to contracts with Farmer Mac and in consideration for underwriting and servicing fees, Farmer Mac-approved central servicers underwrite mortgage loans for Farmer Mac in accordance with those standards and other requirements, and service those loans in accordance with Farmer Mac requirements. Central servicers are responsible to Farmer Mac for serious errors in the underwriting and servicing of those mortgage loans. Detailed information regarding Farmer Mac's underwriting and appraisal standards and seller eligibility requirements are presented in "Business--Farmer Mac Programs--Farmer Mac I--Underwriting and Appraisal Standards" and "Business--Farmer Mac Programs--Farmer Mac I--Sellers." Farmer Mac maintains an allowance for losses to cover estimated probable losses on loans held for investment, real estate owned and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs in accordance with Statement of Financial Accounting Standard No. 5, Accounting for Contingencies, ("SFAS 5") and Statement of Financial Accounting Standard No. 114, Accounting by Creditors for Impairment of a Loan ("SFAS 114"), as amended. The methodology for determining the allowance for losses is the same for loans held for investment and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs because Farmer Mac believes the ultimate credit risk is substantially the same, i.e., the underlying agricultural mortgage loans all meet the same credit underwriting and appraisal standards. For accepting the credit risk on loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs, Farmer Mac receives guarantee fees and commitment fees, respectively. For loans held, Farmer Mac receives interest income that includes a component that correlates to its guarantee fee, which Farmer Mac views as compensation for accepting credit risk. No allowance for losses has been made for loans underlying Farmer Mac I Guaranteed Securities issued prior to the 1996 Act or Farmer Mac II Guaranteed Securities. Farmer Mac I Guaranteed Securities issued prior to the 1996 Act are supported by unguaranteed first-loss subordinated interests, which are expected to exceed the estimated credit losses on those loans. USDA-guaranteed portions collateralizing Farmer Mac II Guaranteed Securities are obligations backed by the full faith and credit of the United States. To date, Farmer Mac has experienced no credit losses on any pre-1996 Act Farmer Mac I Guaranteed Securities or on any Farmer Mac II Guaranteed Securities and does not expect to incur any such losses in the future. Farmer Mac's allowance for losses is presented in four components on its consolidated balance sheet: o an "Allowance for loan losses" on loans held for investment; o a valuation allowance on real estate owned, which is included in the balance sheet under "Real estate owned, net of valuation allowance"; o an allowance for losses on loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs entered into or modified after January 1, 2003, which is included in the balance sheet as a portion of the amount reported as "Guarantee and commitment obligation"; and o an allowance for losses on loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs entered into prior to January 1, 2003, which is included in the balance sheet under "Reserve for losses." The provision for losses is presented in two components on the consolidated statement of operations: o a "Provision for loan losses," which represents losses on Farmer Mac's loans held for investment; and o a "Provision for losses," which represents losses on loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs and real estate owned. Farmer Mac estimates probable losses using a systematic process that begins with management's evaluation of the results of its proprietary loan pool simulation and guarantee fee model (the "Model"). The Model draws upon historical information from a data set of agricultural mortgage loans recorded over a longer period of time than Farmer Mac's own experience to date, screened to include only those loans with credit characteristics similar to those on which Farmer Mac has assumed credit risk. The results generated by the Model are modified by the application of management's judgment, as required to take key factors into account, including: o economic conditions; o geographic and agricultural commodity concentrations in Farmer Mac's portfolio; o the credit profile of Farmer Mac's portfolio; o delinquency trends of Farmer Mac's portfolio; o Farmer Mac's experience in the management and sale of real estate owned; and o historical charge-off and recovery activities of Farmer Mac's portfolio. Management believes that its use of this methodology produces a reliable estimate of total probable losses, as of the balance sheet date, for all loans included in Farmer Mac's portfolio, including loans held, real estate owned and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs. Farmer Mac's methodology for determining its allowance for losses will migrate over time away from the Model, to become based on Farmer Mac's own historical portfolio loss experience. Until that time, Farmer Mac will continue to use the results from the Model, augmented by the application of management's judgment, to determine its allowance for losses. In addition, Farmer Mac specifically analyzes its portfolio of non-performing assets (loans 90 days or more past due, in foreclosure, restructured, in bankruptcy, including loans performing under either their original loan terms or a court-approved bankruptcy plan, and real estate owned) on a loan-by-loan basis. This analysis measures impairment based on the fair value of the underlying collateral for each individual loan relative to the total amount due, including principal, interest and advances under SFAS 114. In the event that the updated appraisal or management's estimate of discounted collateral value does not support the total amount due, Farmer Mac specifically determines an allowance for the loan for the difference between the recorded investment and its fair value, less estimated costs to liquidate the collateral. For this analysis and the allocation of specific reserves as of December 31, 2003, Farmer Mac expanded the population of loans specifically reviewed to include: o non-performing assets (loans 90 days or more past due, in foreclosure, restructured, in bankruptcy - including loans performing under either their original loan terms or a court-approved bankruptcy plan - and real estate owned); o loans for which Farmer Mac had adjusted the timing of borrowers' payment schedules within the past three years, but still expects to collect all amounts due and has not made economic concessions; and o additional performing loans that have previously been delinquent or are secured by real estate that produces commodities currently under stress. Management believes that the general allowance, which is the difference between the total allowance for losses (generated through use of the Model) and the specific allowances, adequately covers any losses inherent in the portfolio of performing loans under SFAS 5. Farmer Mac believes that the methodology described above produces a reliable estimate of the total probable losses inherent in Farmer Mac's portfolio. The Model: o uses historical agricultural real estate loan origination and servicing data that reflect varied economic conditions and stress levels in the agricultural sector; o contains features that allow variations for changes in loan portfolio characteristics to make the data set more representative of Farmer Mac's portfolio and credit underwriting standards; and o considers the effects of the ageing of the loan portfolio along the expected loss curves associated with individual origination years, including the segments that are entering into or coming out of their peak default years. Farmer Mac analyzes various iterations of the Model data and considers various configurations of loan types, terms, economic conditions and borrower eligibility criteria to generate a distribution of loss exposures over time for all loans in the portfolio, all to evaluate its overall allowance for losses, and back tests the results to validate the Model. Such tests use prior period data to project losses expected in a current period and compare those projections to actual losses incurred during the current period. The allowance for losses is increased through periodic provisions for loan losses that are charged against net interest income and provisions for losses charged to operating expense and reduced by charge-offs for actual losses, net of recoveries that are recognized if liquidation proceeds exceed previous estimates. Charge-offs represent losses on the outstanding principal balance, any interest payments previously accrued or advanced and expected costs of liquidation. The establishment of and periodic adjustments to the valuation allowance for real estate owned are charged against income as a portion of the provision for losses charged to operating expense. Gains and losses on the sale of real estate owned are recorded in income based on the difference between the recorded investment at the time of sale and liquidation proceeds. The following table summarizes the changes in the components of Farmer Mac's allowance for losses for each year in the three-year period ended December 31, 2003:
------------------------------------------------------------------------- Contingent Allowance REO Obligation Total for Loan Valuation Reserve for Probable Allowance Losses Allowance for Losses Losses for Losses -------------- -------------- ------------- -------------- ------------- (in thousands) Balances as of January 1, 2001 $ 420 $ - $ 10,903 $ - $ 11,323 -------------- -------------- ------------- -------------- ------------- Provision for losses 600 - 6,186 - 6,786 Net allocation of allowance (5) - 5 - - Net recoveries/(charge-offs) 337 - (2,562) - (2,225) -------------- -------------- ------------- -------------- ------------- Balances as of December 31, 2001 $ 1,352 $ - $ 14,532 $ - $ 15,884 -------------- -------------- ------------- -------------- ------------- Provision for losses 1,340 - 6,907 - 8,247 Net allocation of allowance 3,221 1,308 (4,529) - - Net charge-offs (3,251) (716) (153) - (4,120) -------------- -------------- ------------- -------------- ------------- Balances as of December 31, 2002 $ 2,662 $ 592 $ 16,757 $ - $ 20,011 -------------- -------------- ------------- -------------- ------------- Provision for losses 6,524 1,230 (3,145) 2,676 7,285 Net charge-offs (3,219) (1,584) (440) - (5,243) -------------- -------------- ------------- -------------- ------------- Balances as of December 31, 2003 $ 5,967 $ 238 $ 13,172 $ 2,676 $ 22,053 -------------- -------------- ------------- -------------- -------------
During third quarter 2003, Farm Credit West, ACA, a related party program participant, exercised the conversion feature incorporated in all existing LTSPCs and Farmer Mac converted that participant's $722.3 million LTSPC into a Farmer Mac I Guaranteed Security in a swap transaction. In accordance with FIN 45, Farmer Mac recorded the fair value of its obligation to stand ready to perform under the new Farmer Mac Guaranteed Security. The fair value of this obligation includes Farmer Mac's estimate of the losses that are anticipated over the life of each contractual obligation. The change in accounting for this obligation, from a probable loss model to a fair value model, has resulted in a reduction in the reserve for losses of approximately $4.9 million. Since Farmer Mac believes that these losses remain probable, they have been included in the determination of the fair value of the contractual obligation and therefore there was no reduction in the total allowance for losses. When certain criteria are met, such as the default of the borrower, Farmer Mac may, in its sole discretion, repurchase the defaulted loans underlying Farmer Mac Guaranteed Securities and is obligated to purchase those underlying an LTSPC. These acquisitions are recorded in the consolidated financial statements at their fair value. Fair value is determined by appraisal or management's estimate of discounted collateral value. In September 2002, Farmer Mac adopted EITF issue 02-9, Accounting for Changes That Result in a Transferor Regaining Control of Financial Assets Sold ("the consensus" or "EITF 02-9"). The consensus requires that Farmer Mac record, at acquisition, the difference between each loan's acquisition cost and its fair value, if any, as a charge to the reserve for losses. Prior to the adoption of the consensus, any specific allowance that had been established for the off-balance sheet obligation would have been transferred from the reserve for losses to the allowance for loan losses (referred to as "net allocation of the allowance" in the table above). Upon the receipt of each loan's updated appraisal or determination of management's estimate of discounted collateral value, the difference between the acquisition cost of the loan and its fair value, if any, was recorded as a charge to the allowance for loan losses. Farmer Mac's total provision for losses was $7.3 million for 2003, compared to $8.2 million for 2002. During 2003, Farmer Mac charged off $5.2 million in losses against the allowance for losses and recovered $0.2 million on the sale of real estate owned. During 2002, Farmer Mac charged off $4.1 million in losses against the allowance for losses and recovered $0.1 million on the sale of real estate owned. The net charge-offs for 2003 included $0.1 million related to previously accrued or advanced interest on loans or Farmer Mac I Guaranteed Securities, compared to $1.3 million for 2002. As of December 31, 2003, Farmer Mac's allowance for losses totaled $22.1 million, or 44 basis points of the outstanding principal balance of loans held and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs, compared to $20.0 million (42 basis points) as of December 31, 2002. The year-to-year increase in this ratio is a result of the provisions for probable losses during 2003 outpacing charge-offs and the growth of the portfolio. As of December 31, 2003, Farmer Mac's 90-day delinquencies totaled $30.1 million and represented 0.60 percent of the principal balance of all loans held and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs, compared to $58.2 million (1.21 percent) as of December 31, 2002. From quarter to quarter, Farmer Mac anticipates the 90-day delinquencies will fluctuate, both in dollars and as a percentage of the outstanding portfolio, with higher levels likely at the end of the first and third quarters of each year corresponding to the semi-annual (January 1st and July 1st) payment characteristics of most Farmer Mac I loans. As of December 31, 2003, loans held and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs that were 90 days or more past due, in foreclosure, restructured after delinquency, in bankruptcy (including loans performing under either their original loan terms or a court-approved bankruptcy plan) and real estate owned ("post-1996 Act non-performing assets") totaled $70.0 million and represented 1.39 percent of the principal balance of all loans held and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs, compared to $75.3 million (1.56 percent) as of December 31, 2002. Loans that have been restructured after delinquency were insignificant and are included within the reported 90-day delinquency and non-performing asset disclosures. The following table presents historical information regarding Farmer Mac's non-performing assets and 90-day delinquencies:
Outstanding Post-1996 Act Less: Loans, Non- REO and Guarantees and Performing Performing 90-day LTSPCs Assets Percentage Bankruptcies Delinquencies Percentage ------------------ ----------------- -------------- ---------------- ----------------- ---------------- (dollars in thousands) December 31, 2003 $ 5,020,032 $ 69,964 1.39% $ 39,908 $ 30,056 0.60% September 30, 2003 4,871,756 84,583 1.74% 37,442 47,141 0.98% June 30, 2003 4,875,059 80,169 1.64% 28,883 51,286 1.06% March 31, 2003 4,820,887 94,822 1.97% 18,662 76,160 1.58% December 31, 2002 4,821,634 75,308 1.56% 17,094 58,214 1.21% September 30, 2002 4,506,330 91,286 2.03% 11,460 79,826 1.77% June 30, 2002 4,489,735 65,196 1.45% 14,931 50,265 1.12% March 31, 2002 3,754,171 87,097 2.32% 7,903 79,194 2.11% December 31, 2001 3,428,176 58,279 1.70% 3,743 54,536 1.59% September 30, 2001 3,318,796 71,686 2.16% 5,183 66,503 2.00% June 30, 2001 3,089,460 53,139 1.72% 4,274 48,865 1.58% March 31, 2001 2,562,374 67,134 2.62% 2,154 64,980 2.54%
The dollar level of 90-day delinquencies and period-over-period charge-offs correlates to the proportion of Farmer Mac's portfolio of loans, guarantees and commitments entering their peak delinquency and default years (approximately years three through five after origination). As of December 31, 2003, approximately $1.7 billion (34 percent) of Farmer Mac's outstanding loans held and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs were in their peak delinquency and default years compared to $1.8 billion (38 percent) of such loans as of December 31, 2002. The Model takes the portfolio age distribution and maturation into consideration. Accordingly, those trends did not cause management to alter the Model's projection for the provisions for losses. As of December 31, 2003, Farmer Mac analyzed the following three categories of assets for impairment, based on the fair value of the underlying collateral: o $70.0 million of non-performing assets; o $37.4 million of loans for which Farmer Mac has adjusted the timing of borrowers' payment schedules within the past three years, but still expects to collect all amounts due and has not made economic concessions; and o $65.3 million of performing loans that have previously been delinquent or are secured by real estate that produces commodities currently under stress. Those individual assessments covered a total of $172.7 million of assets measured for impairment against updated appraised values, other updated collateral valuations or discounted values. Of the $172.7 million of assets analyzed, $154.5 million were adequately collateralized. For the $18.2 million that were not adequately collateralized, individual collateral shortfalls totaled $3.8 million. Accordingly, Farmer Mac allocated specific allowances of $3.8 million to those under-collateralized assets as of December 31, 2003. As of December 31, 2003, after the allocation of specific allowances to under-collateralized loans, Farmer Mac had additional non-specific or general allowances of $18.3 million, bringing the total allowance for losses to $22.1 million. The following table summarizes Farmer Mac's assets specifically reviewed for impairment and its specific allowance for losses:
Farmer Mac I Post-1996 Act Assets Specifically Reviewed for Impairment and the Allowance for Losses --------------------------------------------------------------------------------------------------------------- As of December 31, 2003 As of December 31, 2002 ----------------------------------- ------------------------------------ (in thousands) Assets Specific Assets Specific Specifically Allowance Specifically Allowance Reviewed for Losses Reviewed for Losses ------------------- -------------- -------------------- --------------- Loans in foreclosure $ 11,016 $ 119 $ 16,856 $ 519 Loans in bankruptcy * 38,047 2,769 35,229 687 Loans 90 days or more past due 5,185 100 17,600 238 Other loans specifically reviewed 102,736 536 - - Real estate owned 15,716 238 5,623 592 ------------------- -------------- -------------------- --------------- Total $ 172,700 $ 3,762 $ 75,308 $ 2,036 ------------------- -------------- -------------------- --------------- Allowance Allowance for Losses for Losses -------------- --------------- Specific allowance for losses $ 3,762 $ 2,036 General allowance for losses 18,291 17,975 -------------- --------------- Total allowance for losses $ 22,053 $ 20,011 -------------- --------------- * Includes loans that are performing under either their original loan terms or a court-approved bankruptcy plan.
Based on Farmer Mac's loan-by-loan analyses, loan collection experience and continuing provisions for the allowance for losses, Farmer Mac believes that ongoing losses will be covered adequately by the allowance for losses. Original loan-to-value ratios are one of many factors Farmer Mac considers in evaluating loss severity. Other factors include, but are not limited to, other underwriting standards, commodity and agricultural economic forecasts. Loans in the Farmer Mac I program are all first mortgage agricultural real estate loans. Accordingly, Farmer Mac's exposure on a loan is limited to the difference between the total of the accrued interest, advances and the principal balance of a loan and the value of the property. Measurement of that excess or shortfall is the best predictor and determinant of loss compared to other measures that evaluate the efficiency of a particular farm operator. Loan-to-value ratios depend upon the market value of a property with due regard for its income-producing potential. As required by Farmer Mac's collateral valuation standards, an appraisal of agricultural real estate must include analysis of the income producing capability of the property and address the income estimate in the market analysis. Debt service ratios depend upon farm operator efficiency and leverage, which can vary widely within a geographic region, commodity type, or an operator's business and farming skills. As of December 31, 2003, the weighted-average original loan-to-value ratio for all post-1996 Act loans and loans underlying Farmer Mac Guaranteed Securities and LTSPCs was 49 percent, and the weighted-average original loan-to-value ratio for all post-1996 Act non-performing assets was 56 percent. The following table summarizes the post-1996 Act non-performing assets by original loan-to-value ratio (calculated by dividing the loan principal balance at the time of guarantee, purchase or commitment by the appraised value at the date of loan origination or, when available, updated appraised value at the time of guarantee, purchase or commitment):
Distribution of Post-1996 Act Non-performing Assets by Original LTV Ratio as of December 31, 2003 ----------------------------------------------------- (dollars in thousands) Post-1996 Act Non-performing Original LTV Ratio Assets Percentage -------------------- ---------------- ------------ 0.00% to 40.00% $ 7,207 10% 40.01% to 50.00% 10,237 14% 50.01% to 60.00% 28,183 40% 60.01% to 70.00% 23,111 33% 70.01% to 80.00% 1,050 2% 80.01% + 176 1% -------------- ----------- Total $ 69,964 100% -------------- -----------
The following table presents outstanding loans held and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs, post-1996 Act non-performing assets and specific allowances for losses as of December 31, 2003 by year of origination, geographic region and commodity.
Farmer Mac I Post-1996 Act Non-performing Assets and Specific Allowance for Losses ------------------------------------------------------------------------------------------------------------------- Distribution of Outstanding Outstanding Post-1996 Act Loans, Loans, Non- Non- Specific Guarantees and Guarantees and performing performing Allowance LTSPCs LTSPCs Assets (1) Asset Rate for Losses ------------------- ------------------ ---------------- ---------------- -------------- (dollars in thousands) By year of origination: Before 1994 13% $ 653,746 $ 2,328 0.36% $ - 1994 3% 156,635 863 0.55% - 1995 3% 154,805 4,912 3.17% 677 1996 7% 342,153 9,819 2.87% 395 1997 8% 403,455 13,667 3.39% 360 1998 13% 644,931 14,363 2.23% 541 1999 13% 673,406 9,928 1.47% 221 2000 8% 394,661 7,756 1.97% 908 2001 12% 581,473 5,791 1.00% 660 2002 12% 627,122 537 0.09% - 2003 8% 387,645 - 0.00% - ------------------- ------------------ ---------------- ---------------- -------------- Total 100% $ 5,020,032 $ 69,964 1.39% $ 3,762 ------------------- ------------------ ---------------- ---------------- -------------- By geographic region (2): Northwest 21% $ 1,066,399 $ 40,841 3.83% $ 1,065 Southwest 46% 2,307,812 18,321 0.79% 475 Mid-North 14% 677,755 3,561 0.53% 107 Mid-South 5% 257,664 5,396 2.09% 1,972 Northeast 8% 397,231 1,282 0.32% 48 Southeast 6% 313,171 563 0.18% 95 ------------------- ------------------ ---------------- ---------------- -------------- Total 100% $ 5,020,032 $ 69,964 1.39% $ 3,762 ------------------- ------------------ ---------------- ---------------- -------------- By commodity: Crops 44% $ 2,228,506 $ 26,388 1.18% $ 688 Permanent plantings 27% 1,355,070 27,243 2.01% 1,619 Livestock 21% 1,025,245 13,810 1.35% 1,312 Part-time farm 7% 374,057 2,523 0.67% 143 Other 1% 37,154 - 0.00% - ------------------- ------------------ ---------------- ---------------- -------------- Total 100% $ 5,020,032 $ 69,964 1.39% $ 3,762 ------------------- ------------------ ---------------- ---------------- -------------- (1) Includes loans 90 days or more past due, in foreclosure, restructured after delinquency, in bankruptcy (including loans performing under either their original loan terms or a court-approved bankruptcy plan), and real estate owned. (2) Geographic regions - Northwest (AK, ID, MT, ND, NE, OR, SD, WA, WY); Southwest (AZ, CA, CO, HI, NM, NV, UT); Mid-North (IA, IL, IN, MI, MN, MO, WI); Mid-South (KS, OK, TX); Northeast (CT, DE, KY, MA, MD, ME, NC, NH, NJ, NY, OH, PA, RI, TN, VA, VT, WV); and Southeast (AL, AR, FL, GA, LA, MS, SC).
The following table presents Farmer Mac's cumulative charge-offs and current specific allowances relative to the cumulative original purchased, guaranteed or LTSPC principal balances for all loans purchased and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs. This information is presented by year of origination, geographic region and commodity. The purpose of this information is to present information regarding losses and collateral deficiencies relative to original guarantees and commitments.
Farmer Mac I Post-1996 Act Credit Losses and Specific Allowance for Losses Relative to all Cumulative Original Loans, Guarantees and LTSPCs ------------------------------------------------------------------------------------------------------------------- Cumulative Combined Cumulative Original Loans, Current Credit Loss Net Guarantees Loss Specific and Specific Credit Losses and LTSPCs Rate Allowances Allowance Rate ---------------- ---------------- ----------------- ----------------- ----------------- (dollars in thousands) By year of origination: Before 1994 $ - $ 1,963,835 0.00% $ - 0.00% 1994 - 357,510 0.00% - 0.00% 1995 488 320,056 0.15% 677 0.36% 1996 2,168 620,108 0.35% 395 0.41% 1997 3,263 710,891 0.46% 360 0.51% 1998 2,573 1,055,110 0.24% 541 0.30% 1999 1,414 1,050,984 0.13% 221 0.16% 2000 1,489 641,391 0.23% 908 0.37% 2001 10 862,811 0.00% 660 0.08% 2002 - 862,936 0.00% - 0.00% 2003 - 479,049 0.00% - 0.00% ---------------- ---------------- ----------------- ----------------- --------------- Total $ 11,405 $ 8,924,681 0.13% $ 3,762 0.17% ---------------- ---------------- ----------------- By geographic region (1): Northwest $ 5,919 $ 1,983,957 0.30% $ 1,065 0.35% Southwest 5,381 3,886,015 0.14% 475 0.15% Mid-North - 1,127,594 0.00% 107 0.01% Mid-South 5 417,517 0.00% 1,972 0.47% Northeast - 753,769 0.00% 48 0.01% Southeast 100 755,829 0.01% 95 0.03% ---------------- ---------------- ----------------- ----------------- --------------- Total $ 11,405 $ 8,924,681 0.13% $ 3,762 0.17% ---------------- ---------------- ----------------- By commodity: Crops $ 1,552 $ 3,912,921 0.04% $ 688 0.06% Permanent plantings 8,020 2,300,118 0.35% 1,619 0.42% Livestock 1,458 1,962,189 0.07% 1,312 0.14% Part-time farm 375 653,879 0.06% 143 0.08% Other - 95,574 0.00% - 0.00% ---------------- --------------- ----------------- ----------------- ---------------- Total $ 11,405 $ 8,924,681 0.13% $ 3,762 0.17% ---------------- ---------------- ----------------- (1) Geographic regions - Northwest (AK, ID, MT, ND, NE, OR, SD, WA, WY); Southwest (AZ, CA, CO, HI, NM, NV, UT); Mid-North (IA, IL, IN, MI, MN, MO, WI); Mid-South (KS, OK, TX); Northeast (CT, DE, KY, MA, MD, ME, NC, NH, NJ, NY, OH, PA, RI, TN, VA, VT, WV); and Southeast (AL, AR, FL, GA, LA, MS, SC).
An analysis of Farmer Mac's historical losses and identified specific collateral deficiencies within the portfolio (by origination year) indicates that Farmer Mac has experienced peak loss years as loans have aged between approximately their third and fifth years subsequent to origination, regardless of the year the loans were added to Farmer Mac's portfolio. As a consequence of the combination of principal amortization and collateral value appreciation, there are few loans in the portfolio originated prior to 1996 with known collateral deficiencies. While Farmer Mac expects that there will be loans that have aged past their fifth year that will become delinquent and possibly default, Farmer Mac does not anticipate significant losses on such loans. Analysis of portfolio performance by commodity distribution indicates that losses and collateral deficiencies have been and are expected to remain less prevalent in the loans secured by real estate producing agricultural commodities that receive significant government support (such as cotton, soybeans, wheat and corn) and more prevalent in those that do not receive such support. This analysis is consistent with corresponding commodity analysis, which indicates that Farmer Mac has experienced higher loss and collateral deficiency rates in its loans classified as permanent plantings. The loans classified as permanent plantings do not receive significant government support and are therefore more susceptible to adverse commodity-specific economic trends. Further, as adverse economic conditions persist for a particular commodity that requires a long-term improvement on the land, such as permanent plantings, the prospective sale value of the land is likely to decrease and the related loans may become under-collateralized. Farmer Mac anticipates that one or more particular commodity groups will be under economic pressure at any one time and actively manages its portfolio to mitigate concentration risks while preserving Farmer Mac's ability to meet the financing needs of all commodity groups. Analysis of portfolio performance by geographic distribution indicates that, while commodities are the primary determinant of exposure to loss, within most commodity groups certain geographic areas allow greater economies of scale or proximity to markets than others and, consequently, result in more successful farms within the commodity group. Likewise, certain geographic areas offer better growing conditions than others and, consequently, result in more versatile and more successful farms within a given commodity group - and the ability to switch crops among commodity groups. Farmer Mac's methodologies for pricing its guarantee and commitment fees, managing credit risks and providing adequate allowances for losses consider all of the foregoing factors and information. Credit Risk - Institutional. Farmer Mac is also exposed to credit risk arising from its business relationships with other institutions including: o issuers of AgVantage bonds and other investments held by Farmer Mac; o sellers and servicers; and o interest rate contract counterparties. AgVantage bonds are general obligations of the AgVantage Issuers and are secured by collateral in an amount ranging from 120 percent to 150 percent of the bond amount. In addition to requiring collateral, Farmer Mac mitigates credit risk related to AgVantage bonds by evaluating and monitoring the financial condition of the issuers of the AgVantage bonds. Outstanding AgVantage bonds totaled $25.2 million as of December 31, 2003, and $28.6 million as of December 31, 2002. Farmer Mac manages institutional credit risk related to sellers and servicers by requiring those institutions to meet Farmer Mac's standards for creditworthiness. Farmer Mac monitors the financial condition of those institutions by evaluating financial statements and bank credit rating agency reports and confirms that they maintain adequate fidelity bonds and errors and omissions insurance. For more information on Farmer Mac's approval of sellers, see "Business--Farmer Mac Programs--Farmer Mac I--Sellers." Credit risk related to interest rate contracts is discussed in "--Risk Management--Interest Rate Risk" and Note 6 to the consolidated financial statements. Credit Risk - Other Investments. The credit risk inherent in other investments held by Farmer Mac is mitigated by Farmer Mac's policies of investing in highly-rated instruments and establishing concentration limits, which reduce exposure to any one counterparty. Farmer Mac's policies limit the Corporation's total credit exposure, including uncollateralized credit exposure resulting from financial derivatives, to a single entity by limiting the dollar amount of investments with each individual entity to the greater of 25 percent of Farmer Mac's regulatory core capital or $25 million. That limitation excludes exposure to agencies of the U.S. government, government-sponsored enterprises and money market funds. Farmer Mac policy also requires each individual entity to be rated in one of the three highest rating categories of at least one nationally recognized statistical rating organization for investments with terms greater than 270 days and in one of the two highest rating categories for investments with terms of 270 days or less. As of December 31, 2003, Farmer Mac had investments in commercial paper, corporate debt securities, asset-backed securities, municipal bonds, and preferred stock issued by forty-five entities totaling $887.4 million. Farmer Mac's investments in eighteen of these entities each exceeded 10 percent of Farmer Mac's core capital (the cumulative balance of investments in such entities totaled $439.6 million), and investments in two of these entities each exceeded 15 percent of core capital. In addition, as of December 31, 2002, Farmer Mac held $282.3 million of securities issued by government-sponsored enterprises or agencies of the U.S. government and $516.7 million in three money market investment accounts. The maximum amount held in any one money market fund investment fund at any time during 2003 was approximately $480.1 million. As of December 31, 2003, 53 percent of the investment portfolio, excluding government-sponsored enterprise and agency investments, consisted of short-term highly liquid investments. Liquidity and Capital Resources Farmer Mac has sufficient liquidity and capital resources to support its operations for the next twelve months and has a contingency funding plan to handle unanticipated disruptions in its access to the capital markets. Debt Issuance. Section 8.6(e) of Farmer Mac's statutory charter (12 U.S.C. ss. 2279aa-6(e)) authorizes Farmer Mac to issue debt obligations to purchase eligible mortgage loans and Farmer Mac Guaranteed Securities and to maintain reasonable amounts for business operations, including adequate liquidity. Farmer Mac funds its program purchases primarily by issuing debt obligations of various maturities in the public capital markets. Farmer Mac's debt obligations consist of discount notes and medium-term notes issued to obtain funds principally to cover the costs of purchasing and holding loans and securities (including Farmer Mac Guaranteed Securities). Farmer Mac also issues discount notes and medium-term notes to obtain funds for investments, transaction costs and guarantee payments. The Corporation's discount notes and medium-term notes are obligations of Farmer Mac only, are not rated by any rating agency and the interest and principal thereon are not guaranteed by and do not constitute debts or obligations of the Farm Credit Administration or the United States or any agency or instrumentality of the United States other than Farmer Mac. Farmer Mac is an institution of the Farm Credit System, but is not liable for any debt or obligation of any other institution of the Farm Credit System. Likewise, neither the Farm Credit System nor any other individual institution of the Farm Credit System is liable for any debt or obligation of Farmer Mac. Income on Farmer Mac's discount notes and medium-term notes has no exemption under federal law from federal, state or local taxation. Farmer Mac's board of directors has authorized the issuance of up to $5.0 billion of discount notes and medium-term notes (of which $3.9 billion was outstanding as of December 31, 2003), subject to periodic review of the adequacy of that level relative to Farmer Mac's borrowing requirements. Farmer Mac invests the proceeds of such issuances in loans, Farmer Mac Guaranteed Securities and non-program investment assets in accordance with guidelines established by its board of directors. Liquidity. The funding and liquidity needs of Farmer Mac's business programs are driven by the purchase and retention of loans and Farmer Mac Guaranteed Securities, the maturities of Farmer Mac's discount notes and medium-term notes and payment of principal and interest on Farmer Mac Guaranteed Securities. Farmer Mac's primary sources of funds to meet these needs are: o principal and interest payments and ongoing guarantee and commitment fees received on loans, Farmer Mac Guaranteed Securities and LTSPCs; o principal and interest payments received from investment securities; and o the issuance of new discount notes and medium-term notes. Farmer Mac projects its expected cash flows from loans and securities, other earnings and the sale of assets and matches those with its obligations to retire debt and pay other liabilities as they come due. Farmer Mac issues discount notes and medium-term notes to meet the needs associated with its business operaions, including liquidity, and also to increase its presence in the capital markets in order to enhance the liquidity and pricing efficiency of its discount notes and medium-term notes and Farmer Mac Guaranteed Securities transactions and so improve the mortgage rates available to farmers, ranchers and rural homeowners. Though Farmer Mac's mortgage purchases do not currently necessitate daily debt issuance, the Corporation continued its strategy of using its non-program investment portfolio (referred to as Farmer Mac's liquidity portfolio) to facilitate increasing its ongoing presence in the capital markets during 2003. To meet investor demand for daily presence in the capital markets, Farmer Mac issues discount notes in maturities principally ranging from one day to approximately 90 days and invests the proceeds not needed for program asset purchases in highly-rated securities. Investments are predominantly short-term money market securities with maturities closely matched to the discount note maturities and floating-rate securities with reset terms of less than one year and closely matched to the maturity of the discount notes. The positive spread earned from these investments enhances the net interest income Farmer Mac earns, thereby improving the net yields at which Farmer Mac can purchase mortgages from lenders who may pass that benefit to farmers, ranchers and rural homeowners through the Farmer Mac programs. Subject to dollar amount, issuer concentration and credit quality limitations, the Corporation's board of directors has authorized non-program investments in: o U.S. Treasury obligations; o agency and instrumentality obligations; o repurchase agreements; o commercial paper; o guaranteed investment contracts; o certificates of deposit; o federal funds and bankers acceptances; o securities and debt obligations of corporate and municipal issuers; o asset-backed securities; o corporate money market funds; and o preferred stock of government-sponsored enterprises. As of December 31, 2003, Farmer Mac was in compliance with the investment authorizations set forth in its investment guidelines. The following table presents Farmer Mac's five largest investments as of December 31, 2003:
Security Credit Recorded Percent of Investment Issuer Rating Investment Core Capital ------------------------------- ----------------------------- --------------- --------------- -------------- (dollars in thousands) Merrill Lynch Premier Merrill Lynch & Co., Inc. N/A * $ 255,554 118.5% Institutional Fund Federated Prime Value Federated Group Inc. N/A * 160,740 74.6% Obligations Fund Dreyfus Cash Management Dreyfus Corp. N/A * 100,379 46.6% and Institutional Shares Preferred Stock CoBank, ACB not rated ** 88,500 41.1% Preferred Stock AgFirst Farm Credit Bank not rated ** 88,035 40.8% * These money market funds are not rated, but invest in short-term, high quality money market securities and conform to Rule 2a-7 of the Investment Company Act of 1940. ** CoBank, ACB and AgFirst Farm Credit Bank are institutions of the Farm Credit System, a government-sponsored enterprise.
As a result of Farmer Mac's regular issuance of discount notes and medium-term notes and its status as a federally chartered instrumentality of the United States, Farmer Mac has been able to access the capital markets at favorable rates. Farmer Mac has also used floating-to-fixed interest rate swaps, combined with discount note issuances, as a source of fixed-rate funding. While the swap market may provide favorable fixed rates, swap transactions expose Farmer Mac to the risk of future widening of its own issuance spreads versus corresponding LIBOR rates. If the spreads on the Farmer Mac discount notes were to increase relative to LIBOR, Farmer Mac would be exposed to a commensurate reduction on its net interest yield on the notional amount of its floating-to-fixed interest rate swaps and other LIBOR-based floating rate assets. Farmer Mac compensates for this risk by pricing the required net yield on program asset purchases to reflect the cost of medium-term notes without regard to the savings that may be achievable in the interest rate swap market. Farmer Mac maintains a liquidity investment portfolio of cash and cash equivalents (including commercial paper and other short-term money market instruments) and investment securities consisting mostly of floating rate securities that reprice within one year, which can be drawn upon for liquidity needs. As of December 31, 2003, Farmer Mac's cash and cash equivalents and investment securities totaled $623.7 million and $1,064.8 million, respectively, a combined 39.3 percent of total assets and 42.9 percent of total notes payable. In addition, as of December 31, 2003, Farmer Mac held a $678.2 million portfolio of Farmer Mac II Guaranteed Securities backed by USDA Guaranteed Portions that carry the full faith and credit of the U.S. Government. As of December 31, 2003, the aggregate of the Farmer Mac II Guaranteed Securities and the liquidity investment portfolio represented 55.1 percent of total assets and 60.1 percent of total notes payable. During 2003, exclusive of daily overnight discount note issuances the proceeds of which were invested overnight, the average discount note issuance term and re-funding frequency was approximately 65.8 days. The principal sources of funding for Farmer Mac's obligations under its guarantees and LTSPCs are: o the ongoing fees received on its guarantees and commitments: o net interest income received on loans and Guaranteed Securities; and o the proceeds of debt issuance. Farmer Mac satisfies its guarantee and purchase commitment obligations by purchasing defaulted loans out of LTSPCs and from the related trusts for Farmer Mac Guaranteed Securities. Farmer Mac typically recovers a significant portion of the value of defaulted loans purchased either through borrower payments, loan payoffs, payments by third parties or foreclosure and sale. Farmer Mac's liquidity position and ready access to the debt markets also provide additional flexibility to meet liquidity needs that result from the uncertainty regarding the timing and amount of required purchases of loans underlying either Farmer Mac Guaranteed Securities or LTSPCs, should significantly more loans be required to be purchased than in prior periods. Capital Requirements. The Act, as amended by the 1996 Act, establishes three capital standards for Farmer Mac--minimum, critical and risk-based. The minimum capital requirement is expressed as a percentage of on-balance sheet assets and off-balance sheet obligations, with the critical capital requirement equal to one-half of the minimum capital amount. Higher minimum and critical capital requirements were phased in over a transition period, which ended on January 1, 1999, when the highest level of minimum capital became applicable. The Act does not specify the required level of risk-based capital. It directs FCA to establish a risk-based capital test for Farmer Mac, using specified stress-test parameters. For a discussion of risk-based capital, see "Business--Government Regulation of Farmer Mac--Regulation--Capital Standards--General." Certain enforcement powers are given to FCA depending upon Farmer Mac's compliance with the capital standards. See "Business--Government Regulation of Farmer Mac--Regulation--Capital Standards--Enforcement levels." As of December 31, 2003 and 2002, Farmer Mac was classified as within "level I" (the highest compliance level). The following table sets forth Farmer Mac's minimum capital requirement as of December 31, 2003 and 2002 based on the fully phased-in requirements.
December 31, 2003 December 31, 2002 ----------------------------------------- ---------------------------------------- Capital Capital Amount Ratio Required Amount Ratio Required ------------- ------------ ------------- --------------- ----------- ------------ (dollars in thousands) On-balance sheet assets as defined for determining statutory minimum capital $4,231,931 2.75% $116,378 $4,126,719 2.75% $113,485 Outstanding balance of Farmer Mac Guaranteed Securities held by others and LTSPCs 3,352,078 0.75% 25,141 3,048,289 0.75% 22,862 Derivative and hedging obligations 67,670 0.75% 508 93,997 0.75% 705 ------------- ------------ Minimum capital level 142,026 137,052 Actual core capital 215,550 183,978 ------------- ------------ Capital surplus $ 73,524 $46,926 ------------- ------------
Based on the statutory minimum capital requirements, Farmer Mac's current capital surplus of $73.5 million would support additional guarantee growth in amounts ranging from $2.7 billion of on-balance sheet guarantees to more than $9.8 billion of off-balance sheet guarantees and commitments. Furthermore, Farmer Mac could sell $1.7 billion of on-balance sheet non-program assets (cash and cash equivalents and investment securities) and $2.5 billion of on-balance sheet program assets in order to support further increases of on- and off-balance sheet program guarantees and commitments. Any of these transactions would be evaluated for compliance with risk-based capital requirements and to optimize Farmer Mac's return on equity and capital flexibility. Accordingly, in the opinion of management, Farmer Mac has sufficient capital and liquidity for the next twelve months. Contractual Obligations, Contingent Liabilities and Off-Balance Sheet Arrangements. The following table presents the amount and timing of Farmer Mac's known fixed and determinable contractual obligations by payment date as of December 31, 2003. The payment amounts represent those amounts contractually due to the recipient and do not include any unamortized premiums or discounts or other similar carrying value adjustments.
One Year One to Three to Over Five or Less Three Years Five Years Years Total --------------- ---------------- ------------- ------------ --------------- (in thousands) Discount notes* $2,648,760 $ - $ - $ - $2,648,760 Medium-term notes* 381,375 510,969 307,798 367,239 1,567,381 Operating lease obligations** 545 1,131 1,187 1,897 4,760 Purchase obligations*** 479 13 492 * Future events, including additional issuance of discount notes and medium-term notes and refinancing of those notes, could cause actual payments to differ significantly from these amounts. For more information regarding discount notes and medium-term notes, see Note 7 to the consolidated financial statements. ** Includes amounts due under non-cancelable operating leases for office space and office equipment. See Note 12 to the consolidated financial statements for more information regarding Farmer Mac's minimum lease payments for office space. *** Includes minimum amounts due under non-cancelable agreements to purchase goods or services that are enforceable and legally binding and specify all significant terms. These agreements include agreements for the provision of internal audit services, consulting services, information technology support, equipment maintenance, and financial analysis software and services. The amounts actually paid under these agreements will likely be higher due to the variable components of some of these agreements under which the ultimate obligation owed is determined by reference to actual usage or hours worked. The table does not include amounts due under agreements that are cancelable without penalty or further payment as of December 31, 2003 and therefore do not represent enforceable and legally binding obligations. The table also does not include amounts due under the terms of employment agreements with members of senior management.
See the tables below in this section for information about Farmer Mac's commitments to purchase loans and Farmer Mac's contingent obligations under outstanding Farmer Mac I Guaranteed Securities and LTSPCs. Farmer Mac enters into financial derivative contracts under which it either receives cash from counterparties, or is required to pay cash to them, depending on changes in interest rates. Financial derivatives are carried on the consolidated balance sheet at fair value, representing the net present value of expected future cash payments or receipts based on market interest rates as of the balance sheet date. The fair values of the contracts change daily as market interest rates change. Because the financial derivative liabilities recorded on the consolidated balance sheet as of December 31, 2003 do not represent the amounts that may ultimately be paid under the financial derivative contracts, those liabilities are not included in the table of contractual obligations presented above. Further information regarding financial derivatives is included in Note 2(h) and Note 6 to the consolidated financial statements. In conducting its loan purchase activities, Farmer Mac enters into mandatory and optional delivery commitments to purchase agricultural mortgages and corresponding optional commitments to deliver Farmer Mac Guaranteed Securities. In conducting its LTSPC activities, Farmer Mac enters into arrangements whereby it commits to buy agricultural mortgages at an undetermined future date. The following table presents these significant commitments.
As of As of December 31, December 31, 2003 2002 ---------------- --------------- (in thousands) Mandatory commitments to purchase loans and USDA-guaranteed portions $ 11,226 $ 21,700 Optional commitments to purchase loans - 4,478 Optional commitments to deliver Farmer Mac Guaranteed Securities - 4,478 LTSPCs 2,348,702 2,681,240
Further information regarding commitments to purchase and sell loans is included in Note 12 to the consolidated financial statements. Farmer Mac also may have liabilities that arise from its Farmer Mac Guaranteed Securities. Farmer Mac Guaranteed Securities are issued through trusts and, when sold to third-party investors, accordingly, are not included in the consolidated balance sheets. In performing its obligations related to LTSPCs and Farmer Mac Guaranteed Securities, Farmer Mac would have the right to enforce the underlying agricultural mortgage loans, and in the event of the default under the terms of those loans, would have access to the underlying collateral. The following table presents the balance of outstanding LTSPCs and off-balance sheet Farmer Mac Guaranteed Securities as of December 31, 2003 and 2002:
Outstanding Balance of LTSPCs and Off-Balance Sheet Farmer Mac Guaranteed Securities -------------------------------------------------------------------------------------- As of December 31, ---------------------------------- 2003 2002 ----------------- --------------- (in thousands) Farmer Mac I Post-1996 Act obligations: Farmer Mac I Guaranteed Securities $ 952,134 $ 299,940 LTSPCs 2,348,702 2,681,240 ----------------- --------------- Total Farmer Mac I Post-1996 Act obligations 3,300,836 2,981,180 Farmer Mac II Guaranteed Securities 51,241 67,109 ----------------- --------------- Total Farmer Mac I and II $ 3,352,077 $ 3,048,289 ----------------- ---------------
See Note 2(c), Note 2(e) and Note 5 to the consolidated financial statements for more information on Farmer Mac Guaranteed Securities and Note 2(o) and Note 12 to the consolidated financial statements for more information on LTSPCs. Other Matters New Accounting Standards. For all LTSPCs or guarantees issued or modified on or after January 1, 2003, Farmer Mac recognizes, at inception of the guarantee or commitment, an asset that is equal to the fair value for the fees that will be received over the life of each guarantee or commitment and a liability for the fair value of its obligation to stand ready to perform. Both the asset and liability were subsequently measured and recorded at fair value. In December of 2003, the SEC provided additional guidance on the "day two" accounting for these financial instruments. In accordance with this guidance, Farmer Mac has adopted the amortized cost model for day two accounting. This guidance will be applied prospectively for guarantees and commitments recorded at December 31, 2003 and all guarantees and commitments issued or modified on or after January 1, 2004. In December 2003, the American Institute of Certified Public Accountants issued Statement of Position 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer ("SOP 03-3"). SOP 03-3, addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor's initial investment in loans or debt securities acquired in a transfer if those differences are attributable, at least in part, to credit quality. Specifically, SOP 03-3 limits the yield that may be accreted and prohibits the "carry-over" of a valuation allowance for all impaired loans that are within the scope of SOP 03-3. SOP 03-3 is effective for loans acquired in fiscal years beginning after December 15, 2004. On January 1, 2003, Farmer Mac adopted Statement of Financial Accounting Standards No. 145, Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical Corrections ("SFAS 145"), which requires gains and losses from the extinguishment or repurchase of debt to be classified as extraordinary items only if they meet the criteria for such classification in Accounting Principles Board Opinion No. 30, Reporting the Results of Operations, Reporting the Effects of Disposal of a Segment of a Business and Extraordinary, Unusual and Infrequently Occurring Events and Transactions ("APB 30"). Prior to the adoption of this standard, gains and losses from the extinguishment or repurchase of debt were classified as extraordinary items. This standard effectively eliminated the classification of most debt extinguishments or repurchases as extraordinary items, as reflected in Farmer Mac's consolidated financial statements. All prior period repurchases of debt have been reclassified to conform to the new classification. Item 7A. Quantitative and Qualitative Disclosures About Market Risk Farmer Mac is exposed to market risk from changes in interest rates. Farmer Mac manages this market risk by entering into various financial transactions, including financial derivatives, and by monitoring its exposure to changes in interest rates. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Risk Management--Interest Rate Risk" for more information about Farmer Mac's exposure to interest rate risk and strategies to manage such risk. For information regarding Farmer Mac's use of and accounting policies for financial derivatives, see Note 2(h) and Note 6 to the consolidated financial statements. Item 8. Financial Statements REPORTS OF INDEPENDENT AUDITORS To the Board of Directors and Stockholders of Federal Agricultural Mortgage Corporation: We have audited the accompanying consolidated balance sheets of the Federal Agricultural Mortgage Corporation and subsidiary ("Farmer Mac") as of December 31, 2003 and 2002, and the related consolidated statements of operations, changes in stockholders' equity, and cash flows for the years then ended. These financial statements are the responsibility of Farmer Mac's management. Our responsibility is to express an opinion on these financial statements based on our audits. The consolidated financial statements for the year ended December 31, 2001, before the reclassifications discussed in Note 2 to the consolidated financial statements, were audited by other auditors who have ceased operations. Those auditors expressed an unqualified opinion, dated January 23, 2002, which included an explanatory paragraph regarding Farmer Mac's change in its method of accounting for financial derivatives on January 1, 2001 on those financial statements. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such 2003 and 2002 consolidated financial statements present fairly, in all material respects, the financial position of the Federal Agricultural Mortgage Corporation and subsidiary at December 31, 2003 and 2002, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. As discussed above, the consolidated financial statements of the Federal Agricultural Mortgage Corporation and subsidiary for the year ended December 31, 2001, were audited by other auditors who have ceased operations. As described in Note 2 to the consolidated financial statements, certain reclassifications of the 2001 consolidated financial statements were made to conform to the current period presentation. We audited the reclassifications described in Note 2 to the consolidated financial statements that were made to conform the 2001 financial statements to the current period presentation. Our audit procedures with respect to the 2001 reclassifications described in Note 2 included (1) comparing the amounts shown as the provision for loan losses and the provision for losses in Farmer Mac's consolidated statement of operations to Farmer Mac's underlying accounting analysis obtained from management, (2) on a test basis, comparing the amounts comprising the provision for loan losses and the provision for losses obtained from management to supporting documentation, and (3) testing the mathematical accuracy of the underlying analyses. In our opinion, such reclassifications are appropriate and have been properly applied. However, we were not engaged to audit, review, or apply any procedures to the 2001 financial statements of Farmer Mac other than with respect to such reclassifications and, accordingly, we do not express an opinion or any form of assurance on the 2001 financial statements taken as a whole. DELOITTE & TOUCHE LLP McLean, Virginia March 15, 2004 The report of Arthur Andersen LLP below is a copy of their previously issued report contained in Farmer Mac's Annual Report on Form 10-K for the year ended December 31, 2001. Arthur Andersen LLP has ceased operations and has not reissued its report in connection with this Form 10-K. * * * * * The Board of Directors and Stockholders of Federal Agricultural Mortgage Corporation: We have audited the accompanying consolidated balance sheets of the Federal Agricultural Mortgage Corporation ("Farmer Mac") and subsidiaries as of December 31, 2001 and 2000, and the related consolidated statements of operations, changes in stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2001. These financial statements are the responsibility of Farmer Mac's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Farmer Mac and subsidiaries as of December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States. As discussed in Note 2 to the consolidated financial statements, effective January 1, 2001, Farmer Mac changed its method of accounting for financial derivatives. Arthur Andersen LLP Vienna, VA January 23, 2002 FEDERAL AGRICULTURAL MORTGAGE CORPORATION AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS
December 31, ------------------------------------ 2003 2002 ----------------- ----------------- (in thousands) Assets: Cash and cash equivalents $ 623,674 $ 723,800 Investment securities 1,064,782 830,409 Farmer Mac Guaranteed Securities 1,508,134 1,608,507 Loans held for sale 46,662 37,015 Loans held for investment 942,929 929,108 Allowance for loan losses (5,967) (2,662) ----------------- ----------------- Loans, net 983,624 963,461 Real estate owned, net of valuation allowance 15,478 5,031 of $0.2 million and $0.6 million Financial derivatives 961 317 Interest receivable 58,423 65,276 Guarantee and commitment fees receivable 16,885 5,938 Deferred tax asset, net 10,891 9,666 Prepaid expenses and other assets 16,798 10,510 ----------------- ----------------- Total Assets $ 4,299,650 $ 4,222,915 ----------------- ----------------- Liabilities and Stockholders' Equity: Liabilities: Notes payable: Due within one year $ 2,799,384 $ 2,895,746 Due after one year 1,136,110 985,318 ----------------- ----------------- Total notes payable 3,935,494 3,881,064 Financial derivatives 67,670 94,314 Accrued interest payable 26,342 29,756 Guarantee and commitment obligation 14,144 - Accounts payable and accrued expenses 29,574 17,453 Reserve for losses 13,172 16,757 ----------------- ----------------- Total Liabilities 4,086,396 4,039,344 ----------------- ----------------- Commitments and Contingencies (Note 12) Stockholders' Equity: Preferred stock: Series A, stated at redemption/liquidation value, $50 per share, 700,000 shares authorized, issued and outstanding 35,000 35,000 Common stock: Class A Voting, $1 par value, no maximum authorization, 1,030,780 shares issued and outstanding 1,031 1,031 Class B Voting, $1 par value, no maximum authorization, 500,301 shares issued and outstanding 500 500 Class C Non-Voting, $1 par value, no maximum authorization, 10,522,513 and 10,106,903 shares issued and outstanding as of December 31, 2003 and 2002, respectively 10,523 10,107 Additional paid-in capital 88,652 82,527 Accumulated other comprehensive income/(loss) (2,295) (407) Retained earnings 79,843 54,813 ----------------- ----------------- Total Stockholders' Equity 213,254 183,571 ----------------- ----------------- Total Liabilities and Stockholders' Equity $ 4,299,650 $ 4,222,915 ----------------- ----------------- See accompanying notes to consolidated financial statements.
FEDERAL AGRICULTURAL MORTGAGE CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS
For Year Ended December 31, ------------------------------------------------ 2003 2002 2001 --------------- --------------- -------------- (in thousands, except per share amounts) Interest income: Investments and cash equivalents $ 35,287 $ 42,629 $ 66,534 Farmer Mac Guaranteed Securities 73,692 89,736 110,169 Loans 52,580 39,505 5,710 --------------- --------------- -------------- Total interest income 161,559 171,870 182,413 Interest expense 124,307 132,771 153,147 --------------- --------------- -------------- Net interest income 37,252 39,099 29,266 Provision for loan losses (6,524) (1,340) (600) --------------- --------------- -------------- Net interest income after provision for loan losses 30,728 37,759 28,666 Guarantee and commitment fees 20,685 19,277 15,807 Gains/(Losses) on financial derivatives and trading assets 2,357 (8,433) (3,053) Gains on the repurchase of debt - 1,368 - Gains on the sale of real estate owned 178 24 61 Miscellaneous income 812 1,332 560 --------------- --------------- -------------- Total revenues 54,760 51,327 42,041 --------------- --------------- -------------- Expenses: Compensation and employee benefits 6,121 5,142 5,601 General and administrative 6,031 5,521 4,093 Regulatory fees 2,005 1,172 735 REO operating costs, net 264 25 1 Provision for losses 761 6,907 6,186 --------------- --------------- -------------- Total operating expenses 15,182 18,767 16,616 --------------- --------------- -------------- Income before income taxes 39,578 32,560 25,425 Income tax expense 12,308 9,809 8,419 ------------------------------------------------ Net income before cumulative effect of change in accounting principles 27,270 22,751 17,006 Cumulative effect of change in accounting principles, net of taxes - - (726) --------------- --------------- -------------- Net income 27,270 22,751 16,280 Preferred stock dividends (2,240) (1,456) - --------------- --------------- -------------- Net income available to common stockholders $ 25,030 $ 21,295 $ 16,280 --------------- --------------- -------------- Earnings per common share: Basic earnings per common share $ 2.13 $ 1.83 $ 1.44 Diluted earnings per common share $ 2.08 $ 1.77 $ 1.38 Earnings per common share before cumulative effect of change in accounting principles Basic earnings per common share $ 2.13 $ 1.83 $ 1.50 Diluted earnings per common share $ 2.08 $ 1.77 $ 1.45 See accompanying notes to consolidated financial statements.
FEDERAL AGRICULTURAL MORTGAGE CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (in thousands)
Common Preferred Accumulated Stock Stock Additional Other ------------------ ------------------ Paid-in Comprehensive Retained Shares Amount Shares Amount Capital Income/(Loss) Earnings Total -------- --------- -------- --------- ---------- -------------- ---------- ---------- Balance, January 1, 2001 11,152 $11,152 - $ - $ 72,773 $ 31,498 $17,238 $132,661 -------- --------- -------- --------- ---------- -------------- ---------- ---------- Net income 16,280 16,280 Change in unrealized gain/loss on securities available-for-sale, net of taxes of $4.2 million (7,601) (7,601) Cumulative effect of change in accounting principles, net of taxes of $4.8 million (8,632) (8,632) Change in unrealized gain/loss on financial derivatives, net of taxes of $3.7 million (6,870) (6,870) ---------- Total comprehensive loss (6,823) Issuance of class C common stock 412 412 8,187 8,599 -------- --------- -------- --------- ---------- -------------- -------- ---------- Balance, December 31, 2001 11,564 $11,564 - $ - $ 80,960 $ 8,395 $33,518 $134,437 -------- --------- -------- --------- ---------- -------------- -------- ---------- Net Income 22,751 22,751 Change in unrealized gain/loss on securities available-for-sale, net of taxes of $20.7 million 38,423 38,423 Change in unrealized gain/loss on financial derivatives, net of taxes of $25.4 million (47,225) (47,225) ---------- Total comprehensive income 13,949 Issuance of class C common stock 74 74 1,900 1,974 Issuance of preferred stock 700 35,000 (333) 34,667 Preferred stock dividends (1,456) (1,456) -------- --------- -------- --------- ---------- -------------- -------- ---------- Balance, December 31, 2002 11,638 $11,638 700 $35,000 $ 82,527 $ (407) $54,813 $183,571 -------- --------- -------- --------- ---------- -------------- -------- ---------- Net Income 27,270 27,270 Change in unrealized gain/loss on securities available-for-sale, net of taxes of $10.3 million (19,063) (19,063) Change in unrealized gain/loss on financial derivatives, net of taxes of $9.2 million 17,175 17,175 ---------- Total comprehensive income 25,382 Issuance of class C common stock 416 416 6,125 6,541 Preferred stock dividends (2,240) (2,240) -------- --------- -------- --------- ---------- -------------- -------- ---------- Balance, December 31, 2003 12,054 $12,054 700 $35,000 $ 88,652 $ (2,295) $79,843 $213,254 -------- --------- -------- --------- ---------- -------------- -------- ---------- See accompanying notes to consolidated financial statements.
FEDERAL AGRICULTURAL MORTGAGE CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS
For Year Ended December 31, ------------------------------------------------------ 2003 2002 2001 ----------------- ---------------- ----------------- (in thousands) Cash flows from operating activities: Net income $ 27,270 $ 22,751 $ 16,280 Adjustments to reconcile net income to net cash provided by operating activities: Net amortization of investment premiums and discounts (834) 743 (7,885) Amortization of debt premiums, discounts and issuance costs 34,844 46,859 89,131 Proceeds from repayment of trading investment securities 7,184 34,029 21,717 Net change in fair value of trading securities and derivatives (2,479) 4,359 (202) Amortization of settled financial derivatives contracts 1,596 1,111 461 Gain on the repurchase of debt - 889 - Total provision for losses 7,285 8,247 6,786 Deferred income tax benefit (221) (2,959) (2,250) Decrease/(increase) in interest receivable 6,853 (9,023) (572) (Increase)/decrease in guarantee and commitment fees receivable (10,947) 66 (510) (Increase)/decrease in other assets (21,965) (6,089) 494 (Decrease)/increase in accrued interest payable (3,414) 3,398 5,506 Increase in other liabilities 23,436 6,756 3,762 ----------------- ---------------- ----------------- Net cash provided by operating activities 68,608 111,137 132,718 ----------------- ---------------- ----------------- Cash flows from investing activities: Purchases of available-for-sale investment securities (959,081) (179,146) (592,747) Purchases of Farmer Mac II Guaranteed Securities and AgVantage bonds (299,079) (200,583) (273,061) Purchases of loans (248,219) (794,328) (278,989) Proceeds from repayment of investment securities 719,262 331,880 412,310 Proceeds from repayment Farmer Mac Guaranteed Securities 363,718 242,748 268,351 Proceeds from repayment of loans 151,824 67,168 2,021 Proceeds from sale of loans and Farmer Mac Guaranteed Securities 78,254 47,682 82,995 Purchases of office equipment (126) (161) (71) ----------------- ---------------- ----------------- Net cash used in investing activities (193,447) (484,740) (379,191) ----------------- ---------------- ----------------- Cash flows from financing activities: Proceeds from issuance of discount notes 73,025,686 58,967,290 105,736,192 Proceeds from issuance of medium-term notes 354,027 303,017 295,186 Payments to redeem discount notes (73,235,160) (58,433,613) (105,641,354) Payments to redeem medium-term notes (122,140) (207,254) (246,960) Settlement of financial derivatives (2,001) (5,053) (5,230) Net proceeds from preferred stock issuance - 34,667 - Proceeds from common stock issuance 6,541 1,974 8,599 Preferred stock dividends (2,240) (1,456) - ----------------- ---------------- ----------------- Net cash provided by financing activities 24,713 659,572 146,433 ----------------- ---------------- ----------------- Net (decrease)/increase in cash and cash equivalents (100,126) 285,969 (100,040) Cash and cash equivalents at beginning of period 723,800 437,831 537,871 ----------------- ---------------- ----------------- Cash and cash equivalents at end of period $ 623,674 $ 723,800 $ 437,831 ----------------- ---------------- ----------------- See accompanying notes to consolidated financial statements.
FEDERAL AGRICULTURAL MORTGAGE CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2003, 2002 and 2001 1. ORGANIZATION The Federal Agricultural Mortgage Corporation ("Farmer Mac" or the "Corporation") was chartered by the U.S. Congress in the Agricultural Credit Act of 1987 (12 U.S.C. ss.ss. 2279aa et seq.), which amended the Farm Credit Act of 1971 (collectively, as amended, the "Act"). Farmer Mac is a stockholder-owned instrumentality of the United States that was created to establish a secondary market for agricultural real estate and rural housing mortgage loans and to increase the availability of long-term credit at stable interest rates to American farmers, ranchers and rural homeowners. The Farmer Mac secondary market for agricultural mortgage loans accomplishes that mission by providing liquidity and lending capacity to agricultural mortgage lenders by: o purchasing newly originated and pre-existing ("seasoned") eligible mortgage loans directly from lenders through its "cash window" and seasoned eligible mortgage loans from lenders and other third parties in negotiated transactions; o exchanging newly issued agricultural mortgage-backed securities guaranteed by Farmer Mac ("Farmer Mac Guaranteed Securities") for newly originated and seasoned eligible mortgage loans that back those securities in "swap" transactions; o issuing long-term standby purchase commitments ("LTSPCs") for newly originated and seasoned eligible mortgage loans; and o purchasing and guaranteeing mortgage-backed bonds secured by eligible mortgage loans, which are referred to as AgVantage bonds. Farmer Mac conducts these activities through two programs--Farmer Mac I and Farmer Mac II. Under the Farmer Mac I program, Farmer Mac o purchases eligible mortgage loans; o securitizes eligible mortgage loans purchased and guarantees the timely payment of principal and interest on the agricultural mortgage-backed securities backed by such loans; and o commits to purchase eligible mortgage loans under LTSPCs for such loans. To be eligible for the Farmer Mac I program, loans must meet Farmer Mac's underwriting, appraisal and documentation standards. Under the Farmer Mac II program, Farmer Mac purchases the guaranteed portions of loans guaranteed by the United States Department of Agriculture (the "USDA-guaranteed portions") pursuant to the Consolidated Farm and Rural Development Act (7 U.S.C. ss.ss. 1921 et seq.) and guarantees securities backed by those USDA-guaranteed portions purchased by Farmer Mac. As of December 31, 2003, outstanding loans held by Farmer Mac and loans that either back Farmer Mac Guaranteed Securities or are subject to LTSPCs totaled $5.8 billion. Farmer Mac may retain Farmer Mac Guaranteed Securities in its portfolio or sell them to third parties. Farmer Mac's two principal sources of revenue are: o fees received in connection with outstanding Farmer Mac Guaranteed Securities and LTSPCs; and o net interest income earned on its portfolio of Farmer Mac Guaranteed Securities, loans and investment securities. Farmer Mac funds its program purchases by issuing debt obligations of various maturities. As of December 31, 2003, Farmer Mac had outstanding $2.6 billion of discount notes and $1.3 billion of medium-term notes. During 2003, Farmer Mac continued its strategy of issuing debt obligations and investing a portion of the proceeds in non-program investments to increase its presence in the capital markets and thereby improve the mortgage rates offered by lenders to farmers, ranchers and rural homeowners. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The accounting and reporting policies of Farmer Mac conform with accounting principles generally accepted in the United States of America ("generally accepted accounting principles"). The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities (including, but not limited to, the allowance for loan losses, reserve for losses, valuation allowance for real estate owned and valuation of Farmer Mac Guaranteed Securities) as of the date of the consolidated financial statements and the reported amounts of income and expenses during the reporting period. Actual results could differ from those estimates. The following are the significant accounting policies that Farmer Mac follows in preparing and presenting its consolidated financial statements: (a) Principles of Consolidation The consolidated financial statements include the accounts of Farmer Mac and its wholly-owned subsidiary, Farmer Mac Securities Corporation, whose principal activities are to facilitate the purchase and issuance of Farmer Mac Guaranteed Securities and to act as a registrant under registration statements filed with the Securities and Exchange Commission. All intercompany balances and transactions have been eliminated in consolidation. (b) Cash and Cash Equivalents Farmer Mac considers highly liquid investment securities with remaining maturities of three months or less at the time of purchase to be cash equivalents. Changes in the balance of cash and cash equivalents are reported in the consolidated statements of cash flows. The following table sets forth information regarding certain cash and non-cash transactions for the years ended December 31, 2003, 2002 and 2001.
2003 2002 2001 ------------ ------------- ------------- (in thousands) Cash paid during the year for: Interest $ 60,745 $ 63,750 $ 75,821 Income taxes 11,000 12,600 8,200 Non-cash activity: Real estate owned acquired through foreclosure 19,868 7,632 2,457 Loans securitized as Farmer Mac Guaranteed Securities 78,254 47,682 77,422 Loans under LTSPCs converted to Farmer Mac Guaranteed Securities 722,315 - - Loans acquired from on-balance sheet Farmer Mac Guaranteed Securities 35,100 25,675 526
(c) Investments and Farmer Mac Guaranteed Securities Farmer Mac classifies investments and Farmer Mac Guaranteed Securities that Farmer Mac has the positive intent and ability to hold to maturity as held-to-maturity. Such securities are carried at cost, adjusted for unamortized premiums and unearned discounts. Securities for which Farmer Mac does not have the positive intent to hold to maturity are classified as available-for-sale and are carried at estimated fair value. Unrealized gains and losses on available-for-sale securities are reported as accumulated other comprehensive income/(loss) in stockholders' equity. Securities classified as trading securities are reported at their fair value, with unrealized gains and losses included in earnings. Gains and losses on the sale of available-for-sale and trading securities are determined using the specific identification cost method. Farmer Mac determines the fair value of Farmer Mac Guaranteed Securities based on the present value of the associated expected future cash flows. In estimating the present value of the expected future cash flows, management is required to make estimates and assumptions. The key estimates and assumptions include future discount rates and collateral repayment rates. Premiums, discounts and other deferred costs are amortized to interest income over the estimated life of the security using the effective interest method. Interest income on investments and Farmer Mac Guaranteed Securities is recorded on an accrual basis unless the collection of interest is considered doubtful. Farmer Mac receives yield maintenance payments when certain loans or loans underlying Farmer Mac Guaranteed Securities prepay. These payments mitigate Farmer Mac's exposure to reinvestment risk and are calculated such that, when reinvested with the prepaid principal, they should generate substantially the same cash flows that would have been generated had the loans not prepaid. Yield maintenance payments are recognized as interest income in the consolidated statements of operations upon receipt. (d) Loans Loans for which Farmer Mac has the positive intent and ability to hold for the foreseeable future are classified as held for investment and reported at their unpaid principal balance net of unamortized purchase discounts or premiums. The net unamortized purchase premiums as of December 31, 2003 and 2002 were $13.3 million and $16.7 million, respectively. Loans that Farmer Mac does not intend to hold for the foreseeable future are classified as held for sale and reported at the lower of cost or market using the aggregate method. (e) Securitization of Loans Asset securitization involves the transfer of financial assets to another entity in exchange for cash and/or beneficial interests in the assets transferred. Farmer Mac transfers agricultural mortgage loans into trusts that are used as vehicles for the securitization of the transferred loans. The trusts issue Farmer Mac Guaranteed Securities that are beneficial interests in the assets of the trusts, to either Farmer Mac or third party investors. In most cases, Farmer Mac retains all of the securities issued by the trusts. From time to time, the securities issued by the trusts are sold to third party investors. Farmer Mac guarantees the timely payment of principal and interest on the securities issued by the trusts and receives guarantee fees as compensation for its guarantee. Farmer Mac recognizes guarantee fees on an accrual basis over the terms of the Farmer Mac Guaranteed Securities, which coincide with the terms of the underlying loans. As such, no guarantee fees are unearned at the end of any reporting period. If Farmer Mac purchases a delinquent loan underlying a Farmer Mac Guaranteed Security, Farmer Mac stops accruing the guarantee fee upon the loan purchase. Prior to April 1, 2001, Farmer Mac accounted for the transfer of loans into trusts in accordance with Statement of Financial Accounting Standards No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, ("SFAS 125"). Under that standard, each trust met the requirements of a "qualifying special purpose entity." Therefore, the trusts were not consolidated into Farmer Mac's consolidated financial statements. The Farmer Mac Guaranteed Securities securitized prior to April 1, 2001 that Farmer Mac retained, have been recorded in Farmer Mac's consolidated financial statements as Farmer Mac Guaranteed Securities and are classified and accounted for in accordance with Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities, see Note 2(c). Statement of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities ("SFAS 140"), which became effective for transfers of financial assets after March 31, 2001, expanded the requirements for "qualifying special purposes entities." The trust vehicles used in loan securitization transactions after March 31, 2001, in which Farmer Mac retains all the Farmer Mac Guaranteed Securities issued by the trust, do not meet the "qualifying special purpose entity" requirements of SFAS 140. Accordingly, Farmer Mac accounts for the Farmer Mac Guaranteed Securities it retains in these transactions as loans in its consolidated balance sheets and the guarantee fees earned on those assets are recorded as interest income in the consolidated statements of operations. Transfers of agricultural mortgage loans into trusts in which Farmer Mac surrenders control over the financial assets and receives compensation other than beneficial interests in the underlying loans are recorded as sales under both SFAS 125 and SFAS 140. The carrying amount of the assets that are transferred in these transactions is allocated between the assets sold and the interests retained, if any, based on the relative fair values of each at the date of the transfer. A gain or loss is included in income for the difference between the allocated carrying amount of the asset sold and the net cash proceeds received. In 2003, 2002 and 2001, Farmer Mac did not realize any gains or losses upon the sale of loans accounted for as sales under SFAS 125 or SFAS 140. When particular criteria are met, such as the default of the borrower, Farmer Mac has the option to repurchase the defaulted loans underlying Farmer Mac Guaranteed Securities (these options are commonly referred to as "removal-of-account" provisions). Farmer Mac records these loans in the consolidated financial statements during the period in which Farmer Mac has the option to repurchase the loans and therefore regains effective control over the transferred loans. (f) Non-Performing Loans Non-performing loans are loans for which it is probable that Farmer Mac will be unable to collect all amounts due according to the contractual terms of the loan agreement and include all loans 90 days or more past due. When a loan becomes 90 days past due, interest due on the loan is not recognized as interest income until the payment is received from the borrower. Interest previously accrued on such loans or interest advanced to security holders is charged against the allowance for losses when deemed uncollectible. (g) Real Estate Owned Real estate owned consists of real estate acquired through foreclosure and is recorded at fair value less estimated selling costs at acquisition. Fair value is determined by appraisal or other appropriate valuation method. Losses estimated at the time of acquisition are charged to the allowance for loan losses. Subsequent to the acquisition, management continues to perform periodic valuations and establishes a valuation allowance for real estate owned through a charge to income in the provision for losses if the carrying value of a property exceeds its estimated fair value less estimated selling costs. Farmer Mac contracts with third parties to operate or preserve real estate owned and offered for sale when appropriate to maintain property value. Non-recoverable costs are expensed as incurred and those related to the production of saleable goods or crops are capitalized to the extent they are realizable. As revenues from the sale of goods or crops are received, they are applied first to any capitalized costs and any remaining revenues offset non-recoverable expenses incurred. (h) Financial Derivatives Farmer Mac enters into financial derivative transactions principally to protect against risk from the effects of market price or interest rate movements on the value of certain assets and future cash flows or debt issuance, not for trading or speculative purposes. Farmer Mac enters into interest rate swap contracts principally to adjust the characteristics of its short-term debt to match more closely the cash flow and duration characteristics of its longer-term mortgage and other assets, and also to adjust the characteristics of its long-term debt to match more closely the cash flow and duration characteristics of its short-term assets, thereby reducing interest rate risk. These transactions also may provide an overall lower effective cost of borrowing than would otherwise be available in the conventional debt market. Farmer Mac recognizes contracts and commitments as financial derivatives in accordance with the Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended ("SFAS 133"). Effective January 1, 2001, Farmer Mac adopted SFAS 133, which establishes accounting and reporting standards for financial derivatives including certain financial derivatives embedded in other contracts and for hedging activities. The adoption of SFAS 133 resulted in a $0.7 million charge, net of tax, reported as a cumulative effect of a change in accounting principles (net of taxes) and an $8.6 million decrease, net of tax, in stockholders' equity in Farmer Mac's consolidated financial statements as of and for the year ended December 31, 2001. All financial derivatives are recorded on the balance sheet at fair value as a freestanding asset or liability. Financial derivatives in hedging relationships that mitigate exposure to changes in the fair value of assets are considered fair value hedges. Financial derivatives in hedging relationships that mitigate the exposure to the variability in expected future cash flows or other forecasted transactions are considered cash flow hedges. Financial derivatives that do not satisfy the hedging criteria of SFAS 133 are not accounted for as hedges and changes in the fair values of those financial derivatives are reported as gains or losses on financial derivatives and trading assets in the consolidated statements of operations. Fair value hedges are accounted for by recording the fair value of the financial derivative and the change in fair value of the asset attributable to the risk being hedged on the consolidated balance sheets with the net difference reported as ineffectiveness in the consolidated statements of operations as a gain or loss on financial derivatives. The adjustment to the hedged asset is included in the reported amount of the hedged item. Cash payments or receipts and related amounts accrued during the reporting period on financial derivatives in fair value hedging relationships are recorded as an adjustment to the interest income on the hedged asset. If a financial derivative in a fair value hedging relationship is no longer effective, is de-designated from its hedging relationship, or is terminated, Farmer Mac discontinues fair value hedge accounting for the financial derivative and the hedged item. Accordingly, the hedged item is no longer adjusted for changes in its fair value attributable to the risk being hedged. The accumulated adjustment of the carrying amount of the hedged asset is recognized in earnings as an adjustment to interest income over the expected remaining life of the asset using the effective interest rate method. Cash flow hedges are accounted for by recording the fair value of the financial derivative as either a freestanding asset or a freestanding liability on the consolidated balance sheets, with the effective portion of the change in fair value of the financial derivative recorded in accumulated other comprehensive income/(loss) within stockholders' equity, net of tax. Amounts are reclassified from accumulated other comprehensive income/(loss) to interest income or expense in the consolidated statements of operations in the period the hedged forecasted transaction affects earnings. Any ineffective portion of the change in fair value of the financial derivative is reported as a gain or loss on financial derivatives and trading assets in the consolidated statements of operations. If it becomes probable that a hedged forecasted transaction will not occur, any amounts included in accumulated other comprehensive income related to the specific hedging relationship are reclassified from accumulated other comprehensive income/(loss) to the consolidated statements of operations and reported as gains or losses on financial derivatives and trading assets. Gains and losses on financial derivatives not considered highly effective in hedging the change in fair value or expected cash flows of the related hedged item are recognized in the consolidated statement of operations as a gain or loss on financial derivatives and trading assets, as these derivatives do not qualify for hedge accounting under SFAS 133. If a financial derivative has not been or will not continue to be highly effective as a hedge, hedge accounting is discontinued prospectively and the financial derivative continues to be recorded at fair value with changes in fair value reported as a gain or loss on financial derivatives and trading assets in the consolidated statement of operations. (i) Notes Payable Notes payable are classified as due within one year or due after one year based on their contractual maturities. Debt issuance costs are deferred and amortized to interest income or expense using the effective interest method over the estimated life of the related debt. (j) Allowance for Losses Farmer Mac maintains an allowance and contingent obligation for probable losses ("allowance for losses") to cover estimated probable losses on loans held for investment, real estate owned and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs in accordance with Statement of Financial Accounting Standard No. 5, Accounting for Contingencies ("SFAS 5"), and Statement of Financial Accounting Standard No. 114, Accounting by Creditors for Impairment of a Loan ("SFAS 114"), as amended. The methodology for determining the allowance for losses is the same for loans held for investment and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs because Farmer Mac believes the ultimate credit risk is substantially the same, i.e., the underlying agricultural mortgage loans all meet the same credit underwriting and appraisal standards. The allowance for losses is increased through periodic provisions for loan losses that are charged against net interest income and provisions for losses that are charged to operating expense and is reduced by charge-offs for actual losses, net of recoveries. Charge-offs represent losses on the outstanding principal balance, any interest payments previously accrued or advanced and expected costs of liquidation. Farmer Mac estimates probable losses using a systematic process that begins with management's evaluation of the results of its proprietary loan pool simulation and guarantee fee model (the "Model"). The Model draws upon historical information from a data set of agricultural mortgage loans recorded over a longer period of time than Farmer Mac's own experience to date, screened to include only those loans with credit characteristics similar to those on which Farmer Mac has assumed credit risk. The results generated by the Model are modified by the application of management's judgment, as required to take key factors into account, including: o economic conditions; o geographic and agricultural commodity concentrations in Farmer Mac's portfolio; o the credit profile of Farmer Mac's portfolio; o delinquency trends of Farmer Mac's portfolio; o Farmer Mac's experience in the management and sale of real estate owned; and o historical charge-off and recovery activities of Farmer Mac's portfolio. Management believes that its use of this methodology produces a reliable estimate of total probable losses, as of the balance sheet date, for all loans included in Farmer Mac's portfolio, including loans held, real estate owned and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs. In addition, Farmer Mac specifically analyzes certain assets in its portfolio for impairment. This analysis measures impairment based on the fair value of the underlying collateral for each individual loan relative to the total amount due, including principal, interest and advances under SFAS 114. In the event that the updated appraisal or management's estimate of discounted collateral value does not support the total amount due, Farmer Mac specifically determines an allowance for the loan for the difference between the recorded investment and its fair value, less estimated costs to liquidate the collateral. For this analysis and the allocation of specific reserves as of December 31, 2003, Farmer Mac expanded the population of loans specifically reviewed to include: o non-performing assets (loans 90 days or more past due, in foreclosure, restructured, in bankruptcy - including loans performing under either their original loan terms or a court-approved bankruptcy plan - and real estate owned); o loans for which Farmer Mac had adjusted the timing of borrowers' payment schedules within the past three years, but still expects to collect all amounts due and has not made economic concessions; and o additional performing loans that have previously been delinquent or are secured by real estate that produces commodities currently under stress. Prior to December 31, 2003, the review consisted only of non-performing assets. Management believes that the general allowance, which is the difference between the total allowance for losses (generated through use of the Model) and the specific allowances, adequately covers any losses inherent in the portfolio of performing loans under SFAS 5. Farmer Mac believes that the methodology described above produces a reliable estimate of the total probable losses inherent in Farmer Mac's portfolio. The Model: o uses historical agricultural real estate loan origination and servicing data that reflect varied economic conditions and stress levels in the agricultural sector; o contains features that allow variations for changes in loan portfolio characteristics to make the data set more representative of Farmer Mac's portfolio and credit underwriting standards; and o considers the effects of the ageing of the loan portfolio along the expected loss curves associated with individual origination years, including the segments that are entering into or coming out of their peak default years. When certain criteria are met, such as the default of the borrower, Farmer Mac may, in its sole discretion, repurchase the defaulted loans underlying Farmer Mac Guaranteed Securities and is obligated to purchase those underlying an LTSPC. These acquisitions are recorded in the consolidated financial statements at their fair value. Fair value is determined by appraisal or management's estimate of discounted collateral value. No allowance for losses has been made for loans underlying Farmer Mac I Guaranteed Securities issued prior to the 1996 Act or Farmer Mac II Guaranteed Securities. Farmer Mac I Guaranteed Securities issued prior to the 1996 Act are supported by unguaranteed first loss subordinated interests, which are expected to exceed the estimated credit losses on those loans. USDA-guaranteed portions collateralizing Farmer Mac II Guaranteed Securities are obligations backed by the full faith and credit of the United States. To date, Farmer Mac has experienced no credit losses on any pre-1996 Act Farmer Mac I Guaranteed Securities or on any Farmer Mac II Guaranteed Securities and does not expect to incur any such losses in the future. (k) Earnings Per Common Share Basic earnings per common share are based on the weighted-average number of common shares outstanding. Diluted earnings per share is based on the weighted-average number of common shares outstanding adjusted to include all potentially dilutive common stock options. The following schedule reconciles basic and diluted earnings per common share ("EPS") for the years ended December 31, 2003, 2002 and 2001.
2003 2002 2001 -------------------------------- ------------------------------- ------------------------------- Dilutive Dilutive Dilutive Basic stock Diluted Basic stock Diluted Basic stock Diluted EPS options EPS EPS options EPS EPS options EPS ---------- ----------- --------- --------- ---------- ---------- --------- ---------- ---------- (in thousands, except per share amounts) Net income available to $ 25,030 $ 25,030 $ 21,295 $ 21,295 $ 16,280 $ 16,280 common stockholders Weighted-average 11,742 307 12,049 11,613 437 12,050 11,329 440 11,769 shares Earnings per common share $ 2.13 $ 2.08 $ 1.83 $ 1.77 $ 1.44 $ 1.38 Effects of: Cumulative effect of change in accounting principles - - - - $ (0.06) $ (0.07)
(l) Income Taxes Deferred federal income tax assets and liabilities are established for temporary differences between financial and taxable income and are measured using the current enacted statutory tax rate. Income tax expense is equal to the income taxes payable in the current year plus the net change in the deferred tax asset or liability balance. (m) Stock-Based Compensation Farmer Mac accounts for its stock-based employee compensation plans, which are described more fully in Note 9, using the intrinsic value method of accounting for employee stock options pursuant to Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation ("SFAS 123"), as amended. Accordingly, no compensation expense was recognized in 2003, 2002 and 2001 for employee stock option plans. Had Farmer Mac elected to use the fair value method of accounting for employee stock options, net income available to common stockholders and earnings per share for the years ended December 31, 2003, 2002 and 2001 would have been reduced to the pro forma amounts indicated in the following table:
For the Years Ended December 31, ---------------------------------------- 2003 2002 2001 ------------ ------------- ------------- (in thousands, except per share amounts) Net income available to common stockholders, as reported $ 25,030 $ 21,295 $ 16,280 Add back: Restricted stock compensation expense included in reported net income, net of taxes 304 617 577 Deduct: Total stock-based employee compensation expense determined under fair value-based method for all awards, net of tax (2,833) (2,990) (2,662) ------------ ------------- ------------- Pro forma net income available to common stockholders $ 22,501 $ 18,922 $ 14,195 ------------ ------------- ------------- Earnings per share: Basic - as reported $ 2.13 $ 1.83 $ 1.44 Basic - pro forma 1.92 $ 1.63 $ 1.25 Diluted - as reported $ 2.08 $ 1.77 $ 1.38 Diluted - pro forma 1.87 $ 1.57 $ 1.21
The underlying assumptions to these fair value calculations are presented in Note 9. (n) Comprehensive Income/(Loss) Comprehensive income/(loss) represents all changes in stockholders' equity except those resulting from investments by or distributions to stockholders, and is comprised of net income available to common stockholders, unrealized gains and losses on securities available-for-sale and the effective portion of the unrealized gains and losses on financial derivatives in cash flow hedge relationships, net of reclassification adjustments and related taxes. Comprehensive income is reported in the consolidated statements of changes in stockholders' equity. The following table presents Farmer Mac's accumulated other comprehensive income/(loss) as of December 31, 2003, 2002 and 2001.
As of December 31, 2003 2002 2001 ------------- ------------ ------------- (in thousands) Net unrealized gains on securities available-for-sale, net of taxes $ 43,258 $ 62,321 $ 23,898 Net unrealized losses on financial derivatives in cash flow hedge relationships, net of taxes (45,553) (62,728) (15,503) ------------- ------------ ------------- Accumulated other comprehensive income/(loss), net of tax $ (2,295) $ (407) $ 8,395 ------------- ------------ -------------
(o) Long-Term Standby Purchase Commitments ("LTSPCs") Farmer Mac accounts for its LTSPCs in accordance with the consensus reached in EITF 85-20, Recognition of Fees for Guaranteeing a Loan. As is specified in this consensus, Farmer Mac recognizes LTSPC commitment fees over the life of the underlying loans. As such, no guarantee fees or commitment fees are unearned at the end of any reporting period. If Farmer Mac purchases a defaulted loan underlying an LTSPC, Farmer Mac stops accruing the commitment fee upon the loan purchase. If the loan becomes current and is repurchased from Farmer Mac under the terms of an LTSPC, Farmer Mac resumes accrual of the commitment fee. See Note 2(j) for Farmer Mac's policy for estimating probable losses for LTSPCs. (p) New Accounting Standards On January 1, 2003, Farmer Mac adopted the liability recognition provisions of the Financial Accounting Standards Board Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others ("FIN 45") which requires Farmer Mac to recognize, at the inception of a guarantee, a liability for the fair value of its obligation to stand ready to perform under the terms of each guarantee agreement and an asset that is equal to the fair value of the fees that will be received over the life of each guarantee. Subsequently, both the asset and the liability are measured and recorded at their fair value. In December of 2003, the SEC provided additional guidance on the "day two" accounting for these financial instruments. In accordance with this guidance, Farmer Mac has adopted the amortized cost model for day two accounting. This guidance will be applied prospectively for guarantees and commitments recorded at December 31, 2003 and all guarantees and commitments issued or modified on or after January 1, 2004. In December 2003, the American Institute of Certified Public Accountants issued Statement of Position 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer ("SOP 03-3"). SOP 03-3 addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor's initial investment in loans or debt securities acquired in a transfer if those differences are attributable, at least in part, to credit quality. Specifically, SOP 03-3 limits the yield that may be accreted and prohibits the "carry-over" of a valuation allowance for all impaired loans that are within the scope of SOP 03-3. SOP 03-3 is effective for loans acquired in fiscal years beginning after December 15, 2004. On January 1, 2003, Farmer Mac adopted Statement of Financial Accounting Standards No. 145, Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical Corrections ("SFAS 145"), which requires gains and losses from the extinguishment or repurchase of debt to be classified as extraordinary items only if they meet the criteria for such classification in Accounting Principles Board Opinion No. 30, Reporting the Results of Operations, Reporting the Effects of Disposal of a Segment of a Business and Extraordinary, Unusual and Infrequently Occurring Events and Transactions ("APB 30"). Prior to the adoption of this standard, gains and losses from the extinguishment or repurchase of debt were classified as extraordinary items. This standard effectively eliminated the classification of most debt extinguishments or repurchases as extraordinary items, as reflected in Farmer Mac's consolidated financial statements. All prior period repurchases of debt have been reclassified to conform to the new classification. (q) Reclassifications Certain reclassifications of prior year information were made to conform to the 2003 presentation. Farmer Mac has reclassified items on its consolidated statements of operations to present more clearly the costs related to carrying its real estate owned and the gains or losses incurred upon the ultimate disposition of real estate owned. Previously, gains and losses on the sale of real estate owned were reflected as adjustments to the allowance for losses as either a charge-off or recovery. Those amounts have been reclassified and are reported separately as gains or losses on the sale of real estate owned. Gains on the sale of real estate owned were $0.2 million, $0.1 million and $0.1 million for each of the years ended December 2003, 2002 and 2001, respectively. During third quarter 2003, the Chief Accountant at the U.S. Securities and Exchange Commission provided additional guidance to all registrants regarding the classification on the statement of operations of realized gains and losses resulting from financial derivatives that are not in fair value or cash flow hedge relationships. All registrants were requested to comply with this guidance in future filings and to reclassify this activity for all prior periods presented. As a result of the application of this additional guidance, the net interest income and expense realized on financial derivatives that are not in fair value or cash flow hedge relationships have been reclassified from net interest income into gains and losses on financial derivatives and trading assets. For the years ended December 31, 2003, 2002 and 2001, this reclassification resulted in increases of net interest income and offsetting decreases in gains and losses on financial derivatives and trading assets of $0.2 million, $4.1 million and $2.3 million, respectively. Farmer Mac reclassified its presentation of the allowance for losses and the provisions for losses as of and for the year ended December 31, 2001 to conform to the current year presentation. The following table summarizes the reclassifications on the 2001 consolidated financial statements to conform to the current presentation.
2001 Reclass- 2003 Presentation ifications Presentation --------------- ----------- --------------- (in thousands) Balance sheet reclassifications: Allowance for loan losses $ - $ 1,352 $ 1,352 Reserve for losses 15,884 (1,352) 14,532 --------------- ----------- --------------- Total $ 15,884 $ - $ 15,884 --------------- ----------- --------------- Statement of operations reclassifications: Provision for loan losses $ - $ 600 $ 600 (Gain)/loss on sale of real estate owned - (61) (61) Provision for losses 6,725 (539) 6,186 --------------- ----------- --------------- Total $ 6,725 $ - $ 6,725 --------------- ----------- ---------------
3. RELATED PARTY TRANSACTIONS As provided by Farmer Mac's statutory charter, only banks, insurance companies and other financial institutions or similar entities may hold Farmer Mac's Class A voting common stock and only institutions of the Farm Credit System may hold Farmer Mac's Class B voting common stock. Farmer Mac's statutory charter also provides that Class A stockholders elect five members of Farmer Mac's 15-member board of directors and that Class B stockholders elect five members of the board of directors. Additionally, in order to participate in the Farmer Mac I program, a financial institution must own a requisite amount of Farmer Mac Class A or Class B voting common stock, based on the size and type of institution. As a result of these requirements, Farmer Mac conducts business with related parties in the normal course of Farmer Mac's business. Farmer Mac considers that all such transactions were "arm's length" and has neither made to nor received concessions from these institutions that were outside the range of those made and received in other, similar transactions with non-related parties. During 2003, Farmer Mac purchased newly originated and current seasoned eligible loans from 81 entities, placed loans under LTSPCs with 11 entities and conducted Farmer Mac II transactions with 150 entities operating throughout the United States. During 2003, the top ten institutions generated 80.8 percent of the total Farmer Mac I cash window loan volume. During 2002, Farmer Mac purchased newly originated and current seasoned eligible loans from 79 entities, placed loans under LTSPCs with 16 entities and conducted Farmer Mac II transactions with 143 entities operating throughout the United States. During 2002, the top 10 institutions generated 90.0 percent of the total Farmer Mac I cash window loan volume. For all of the transactions discussed below, Farmer Mac has a related party relationship with each entity resulting from a member of Farmer Mac's board of directors being affiliated with the entity in some capacity. These transactions were conducted in the ordinary course of business, with terms and conditions comparable to those availible to any other third party. The following is a summary of the related party activity for the year ended December 31, 2003: o The following transactions occurred between Zions First National Bank or its affiliates ("Zions"), which is Farmer Mac's largest holder of Class A voting common stock and a major holder of Class C non-voting common stock, and Farmer Mac during 2003: o Farmer Mac purchased 148 loans having an aggregate principal amount of approximately $74.5 million from Zions under the Farmer Mac I program, representing approximately 38.7 percent of that program's volume for the year; o Farmer Mac purchased six USDA-guaranteed portions having an aggregate principal amount of approximately $1.7 million from Zions under the Farmer Mac II program, representing approximately 0.6 percent of that program's volume for the year; o Farmer Mac sold approximately $75.8 million of Farmer Mac Guaranteed Securities to Zions at no gain or loss; o Farmer Mac and Zions entered into interest rate swap transactions having an aggregate notional principal amount of approximately $28.6 million (the aggregate outstanding notional principal amount all interest rate swap transactions between Farmer Mac and Zions was $307.6 million as of December 31, 2003); o Farmer Mac received approximately $1.4 million in guarantee fees on Farmer Mac Guaranteed Securities whose underlying loans were swapped or sold to Farmer Mac by Zions; o Farmer Mac paid Zions approximately $48,000 in underwriting and loan file review fees; o Zions received approximately $1.3 million in servicing fees for acting as a central servicer in the Farmer Mac I program; o Zions received approximately $225,500 in fees for acting as agent with respect to approximately $154.7 million of Farmer Mac medium-term notes; and o Zions received approximately $18,400 in commissions for acting as dealer with respect to approximately $189.0 million par value of Farmer Mac discount notes; o The following transactions occurred between AgFirst Farm Credit Bank ("AgFirst"), which is a major holder of Class B voting common stock, and Farmer Mac during 2003: o Farmer Mac purchased four loans having an aggregate principal amount of approximately $0.9 million from AgFirst under the Farmer Mac I program, representing approximately 0.5 percent of that program's volume for the year; o Farmer Mac extended LTSPCs on 1,016 loans having an aggregate principal balance of approximately $172.5 million to AgFirst (the aggregate outstanding principal balance of the 3,843 total loans underlying LTSPCs with AgFirst was $545.9 million as of December 31, 2003); o For the year ended December 31, 2003, Farmer Mac guaranteed approximately $393.0 million of Farmer Mac Guaranteed Securities backed by rural housing loans under which Farmer Mac is second-loss guarantor for the last 10 percent of the securities; the total guaranteed amount outstanding as of December 31, 2003 was $741.5 million; o Farmer Mac received approximately $0.4 million in guarantee fees and approximately $2.1 million in commitment fees attributable to transactions with AgFirst; o AgFirst received approximately $107,000 in servicing fees for acting as a central servicer in the Farmer Mac I program; o As of December 31, 2003, Farmer Mac owned approximately $88.0 million of fixed rate preferred stock issued by AgFirst, which Farmer Mac purchased on the open market prior to 2003. o During 2003, Farmer Mac extended LTSPCs on 287 loans having an aggregate principal balance of approximately $174.3 million to Farm Credit West, ACA or its affiliates ("FCW"), and Farmer Mac received commitment fees of approximately $1.9 million. During third quarter 2003, FCW exercised the conversion feature incorporated in all existing LTSPCs, and Farmer Mac converted $722.3 million of FCW's LTSPCs into a Farmer Mac I Guaranteed Security in a swap transaction. Farmer Mac received guarantee fees of approximately $1.7 million on FCW's Farmer Mac I Guaranteed Security during 2003. As of December 31, 2003, the aggregate outstanding principal balance of the 157 loans underlying LTSPCs with FCW was $106.2 million, and the aggregate outstanding balance of the 885 loans underlying FCW's Farmer Mac I Guaranteed Security was $680.2 million. o During 2003, Farmer Mac extended LTSPCs on 295 loans having an aggregate principal balance of approximately $47.4 million to Farm Credit Bank of Texas (the aggregate outstanding principal balance of the 275 loans underlying LTSPCs with AgStar Financial Services, ACA was $40.8 million as of December 31, 2003), and Farmer Mac received commitment fees of approximately $89,000. o During 2003, Farmer Mac purchased 37 USDA-guaranteed portions having an aggregate principal amount of approximately $8.7 million from Bath State Bank under the Farmer Mac II program, and Farmer Mac received approximately $45,000 in guarantee fees on Farmer Mac II Guaranteed Securities whose underlying USDA-guaranteed portions were sold to Farmer Mac by Bath State Bank. o During 2003, Farmer Mac extended LTSPCs on 2,347 loans having an aggregate principal balance of approximately $194.2 million to AgStar Financial Services, ACA (the aggregate outstanding principal balance of the 3,570 loans underlying LTSPCs with AgStar Financial Services, ACA was $265.6 million as of December 31, 2003), and Farmer Mac received commitment fees of approximately $0.9 million. The following is a summary of the related party activity for the year ended December 31, 2002: o The following transactions occurred between Zions and Farmer Mac during 2002: o Farmer Mac purchased 183 loans having an aggregate principal amount of approximately $77.2 million from Zions under the Farmer Mac I program, representing approximately 4.1 percent of that program's volume for the year; o Farmer Mac purchased 16 USDA-guaranteed portions having an aggregate principal amount of approximately $3.6 million from Zions under the Farmer Mac II program, representing approximately 2.1 percent of that program's volume for the year; o Farmer Mac sold approximately $47.7 million of Farmer Mac Guaranteed Securities to Zions at no gain or loss; o Farmer Mac and Zions entered into interest rate swap transactions having an aggregate notional principal amount of approximately $41.6 million (the aggregate outstanding notional principal amount all interest rate swap transactions between Farmer Mac and Zions was $326.8 million as of December 31, 2002); o Farmer Mac received approximately $1.0 million in guarantee fees on Farmer Mac Guaranteed Securities whose underlying loans were swapped or sold to Farmer Mac by Zions; o Farmer Mac paid Zions approximately $51,000 in underwriting and loan file review fees; o Zions received approximately $1.2 million in servicing fees for acting as a central servicer in the Farmer Mac I program; o Zions received approximately $43,000 in fees for acting as agent with respect to approximately $28.3 million of Farmer Mac medium-term notes; and o Zions received approximately $89,000 in commissions for acting as dealer with respect to approximately $738.7 million par value of Farmer Mac discount notes. o The following transactions occurred between AgFirst and Farmer Mac during 2002: o Farmer Mac extended LTSPCs on 1,810 loans having an aggregate principal balance of approximately $314.1 million to AgFirst (the aggregate outstanding principal balance of the 2,840 total loans underlying LTSPCs with AgFirst was $431.3 million as of December 31, 2002); o Farmer Mac guaranteed approximately $161.0 million of Farmer Mac Guaranteed Securities backed by rural housing loans under which Farmer Mac is second-loss guarantor for the last 10 percent of the securities; o Farmer Mac received approximately $0.2 million in guarantee fees and approximately $1.3 million in commitment fees attributable to transactions with AgFirst; and o AgFirst received approximately $122,000 in servicing fees for acting as a central servicer in the Farmer Mac I program. o During 2002, Farmer Mac extended LTSPCs on 389 loans having an aggregate principal balance of approximately $388.6 million to FCW (the aggregate outstanding principal balance of the 777 loans underlying LTSPCs with FCW was $712.4 million as of December 31, 2002), and Farmer Mac received commitment fees of approximately $2.8 million. o During 2002, Farmer Mac purchased 28 USDA-guaranteed portions having an aggregate principal amount of approximately $4.6 million from Bath State Bank under the Farmer Mac II program, and Farmer Mac received approximately $50,000 in guarantee fees on Farmer Mac II Guaranteed Securities whose underlying USDA-guaranteed portions were sold to Farmer Mac by Bath State Bank. o During 2002, Farmer Mac extended LTSPCs on 56 loans having an aggregate principal balance of approximately $4.5 million to AgStar Financial Services, ACA (the aggregate outstanding principal balance of the 1,540 loans underlying LTSPCs with AgStar Financial Services, ACA was $103.3 million as of December 31, 2002), and Farmer Mac received commitment fees of approximately $0.5 million. o During 2002, GreenPoint Financial Corp. or its affiliates received approximately $25,000 in servicing fees for acting as a central servicer in the Farmer Mac I program. As of December 31, 2003 and 2002, Farmer Mac had net interest payable to Zions or its affiliates of approximately $6.2 million and $7.3 million, respectively. As of December 31, 2003 and 2002, Farmer Mac had the following commitment fees receivable from related parties:
As of As of December 31, December 31, 2003 2002 ----------- ---------- (in thousands) Farm Credit West, ACA or its affiliates $ 321 $ 291 AgStar Financial Services, ACA 100 38 AgFirst Farm Credit Bank 380 307
4. INVESTMENT SECURITIES Farmer Mac's investment portfolio is comprised of the following:
December 31, December 31, 2003 2002 ------------- ------------ (in thousands) Held-to-maturity $ 10,604 $ 10,604 Available-for-sale 1,039,673 795,234 Trading 14,505 24,571 ------------- ------------ $ 1,064,782 $ 830,409 ------------- ------------
The amortized cost and estimated fair values of investments as of December 31, 2003 and 2002 were as follows. Fair value was estimated based on quoted market prices.
2003 2002 --------------------------------------------------- --------------------------------------------- Amortized Unrealized Unrealized Amortized Unrealized Unrealized Cost Gain Loss Fair Value Cost Gain Loss Fair Value ------------ ------------ ------------ ------------ ----------- ---------- ----------- ----------- (in thousands) Held-to-maturity: Cash investment in fixed rate guaranteed investment contract $ 10,604 $ 342 $ - $ 10,946 $ 10,604 $ 890 $ - $ 11,494 ------------ ------------ ------------ ------------ ----------- ---------- ----------- ----------- Total held-to-maturity $ 10,604 $ 342 $ - $ 10,946 $ 10,604 $ 890 $ - $ 11,494 ------------ ------------ ------------ ------------ ----------- ---------- ----------- ----------- Available-for-sale: Floating rate asset-backed securities $ 78,817 $ 682 $ - $ 79,499 $ 12,543 $ - $ (345) $ 12,198 Floating rate corporate debt securities 370,145 573 (100) 370,618 344,330 - (1,464) 342,866 Fixed rate corporate debt securities - - - - 34,000 552 - 34,552 Fixed rate preferred stock 186,253 12,196 - 198,449 186,799 11,511 - 198,310 Fixed rate commercial paper 120,452 - - 120,452 - - - - Floating rate municipal bonds 2,820 - - 2,820 - - - - Floating rate mortgage- backed securities 268,522 198 (885) 267,835 207,394 - (86) 207,308 ------------ ------------ ------------ ------------ ----------- ---------- ----------- ----------- Total available-for-sale $1,027,009 $ 13,649 $ (985) $1,039,673 $785,066 $ 12,063 $ (1,895) $ 795,234 ------------ ------------ ------------ ------------ ----------- ---------- ----------- ----------- Trading: Adjustable rate mortgage- backed securities $ 14,296 $ 209 $ - $ 14,505 $ 23,944 $ 627 $ - $ 24,571 ------------- ----------- ----------- ------------------------ ----------- ----------- ----------- Total trading $ 14,296 $ 209 $ - $ 14,505 $ 23,944 $ 627 $ - $ 24,571 ------------- ----------- ----------- ------------------------ ----------- ----------- -----------
As of December 31, 2003 no unrealized losses were incurred on trading and held-to-maturity portfolios. Unrealized losses on available-for-sale securities were as follows as of December 31, 2003.
Available-for-Sale Securities --------------------------------- Fair Value Unrealized Loss ------------- ---------------- (in thousands) Unrealized loss position for less than 12 months $ 258,893 $ (961) Unrealized loss position for more than 12 months 10,171 (24) ------------- -------------- Total $ 269,064 $ (985) ------------- --------------
The amortized cost, fair value and yield of investments by remaining contractual maturity as of December 31, 2003 are set forth below. Asset- and mortgage-backed securities are included based on their final maturities, although the actual maturities may differ due to prepayments of the underlying assets or mortgages. As of December 31, 2003 Farmer Mac owned one held-to-maturity investment that matures after ten years with an amortized cost of $10.6 million, a fair value of $10.9 million, and a yield of six percent.
Available-for-Sale Trading Total ----------------------------------- -------------------------------- --------------------------------- Amortized Amortized Amortized Cost Fair Value Yield Cost Fair Value Yield Cost Fair Value Yield ----------------------------------- -------------------------------- --------------------------------- (dollars in thousands) Due within one year $ 218,891 $ 218,949 1.34% $ - $ - - $ 218,891 $ 218,949 1.34% Due after one year through five years 281,701 282,130 1.39% - - - 281,701 282,130 1.39% Due after five years through ten years 187,371 199,569 8.07% - - - 187,371 199,569 8.07% Due after ten years 339,046 339,025 1.60% 14,296 14,505 4.38% 353,342 353,530 1.71% --------------------------------- ------------- -------------------- --------------------------------- Total $1,027,009 $1,039,673 2.67% $ 14,296 $ 14,505 4.38% $1,041,305 $1,054,178 2.69% --------------------------------- ------------- -------------------- ---------------------------------
5. FARMER MAC GUARANTEED SECURITIES As of December 31, 2003 and 2002, Farmer Mac on-balance sheet Guaranteed Securities included the following:
As of December 31, ---------------------------------------------------------------------------- 2003 2002 ----------------------------------- --------------------------------------- Held-to- Available-for Held-to- Available-for Maturity Sale Total Maturity Sale Total ---------- ------------- ---------- ---------- --------------- ------------ (in thousands) Farmer Mac I $ 49,901 $779,560 $829,461 $ 60,519 $969,234 $1,029,753 Farmer Mac II 678,673 - 678,673 578,754 - 578,754 ---------- ------------- ---------- ---------- --------------- ------------ Total $728,574 $779,560 $1,508,134 $639,273 $969,234 $1,608,507 ---------- ------------- ---------- ---------- --------------- ------------
The following table sets forth the amortized costs, unrealized gains and losses and estimated fair values of the Farmer Mac Guaranteed Securities as of December 31, 2003 and 2002.
As of December 31, ---------------------------------------------------------------------------- 2003 2002 ----------------------------------- --------------------------------------- Held-to- Available-for Held-to- Available-for Maturity Sale Total Maturity Sale Total ---------- ------------- ---------- ---------- -------------- ------------ (in thousands) Amortized cost $728,574 $725,674 $1,454,248 $639,273 $883,120 $1,522,393 Unrealized gains 14,434 53,886 68,320 24,376 86,114 110,490 Unrealized losses - - - - - - ---------- ------------- ---------- ---------- -------------- ------------ Fair value $743,008 $779,560 $1,522,568 $663,649 $969,234 $1,632,883 ---------- ------------- ---------- ---------- -------------- ------------
Of the total Farmer Mac Guaranteed Securities held by Farmer Mac as of December 31, 2003, $969.6 million are fixed-rate or reprice after one year. The table below presents a sensitivity analysis for Farmer Mac's retained Farmer Mac Guaranteed Securities as of December 31, 2003.
December 31, 2003 ----------------------- (dollars in thousands) Fair value of beneficial interests retained in Farmer Mac Guaranteed Securities $ 1,522,568 Weighted-average remaining life (in years) 4.7 Weighted-average prepayment speed (annual rate) 9.9% Effect on fair value of a 10% adverse change $(811) Effect on fair value of a 20% adverse change $(1,531) Weighted-average discount rate 4.6% Effect on fair value of a 10% adverse change $(19,299) Effect on fair value of a 20% adverse change $(38,445)
These sensitivities are hypothetical. As the figures indicate, changes in fair value based on a 10 percent variation in assumptions generally cannot be extrapolated because the relationship of the change in assumptions to the change in fair value may not be linear. Also, in this table the effect of a variation in a particular assumption on the fair value of the retained interest is calculated without changing any other assumption. In fact, changes in one factor may result in changes in another (for example, increases in market interest rates may result in lower prepayments), which might amplify or counteract the sensitivities. Farmer Mac securitizes two types of assets: agricultural mortgage loans and USDA-guaranteed portions. Farmer Mac manages the credit risk of its securitized agricultural mortgage loans, both on- and off-balance sheet, together with its on-balance sheet agricultural mortgage loans and the agricultural mortgage loans underlying its off-balance sheet LTSPCs. See Note 8 for more information regarding this credit risk. Due to the differing interest rate and funding risk characteristics of on- and off-balance sheet asset classes, Farmer Mac manages its on-balance sheet agricultural mortgage loans held and securitized differently from its off-balance sheet securitized agricultural mortgage loans and off-balance sheet agricultural mortgage loans underlying LTSPCs. Farmer Mac separately manages its securitized USDA-guaranteed portions and manages those held on its balance sheet differently from those that are off-balance sheet - also due to their differing interest rate and funding risk characteristics. As part of fulfilling its guarantee obligations for Farmer Mac I Guaranteed Securities and commitments to purchase eligible loans underlying LTSPCs, Farmer Mac purchases defaulted loans, all of which are at least 90 days delinquent at the time of purchase, out of those securities and pools, and records the purchased loans as such on its balance sheet. The table below presents the outstanding principal balances, 90-day delinquencies and net credit losses as of and for the periods indicated for each managed asset class, both on- and off-balance sheet.
Outstanding Principal 90-Day Amount Delinquencies (1) Net Credit Losses ----------------------- ------------------ ------------------------------- As of December 31, For the Year Ended December 31, ------------------------------------------ ------------------------------- 2003 2002 2003 2002 2003 2002 2001 ----------- ---------- -------- --------- ---------- -------------------- (in thousands) On-balance sheet assets: Farmer Mac I: Loans $ 976,280 $ 949,378 $ 22,721 $ 54,679 $ 3,219 $ 3,728 $ 1,325 Guaranteed Securities 777,134 946,014 5,368 - 440 368 (211) Farmer Mac II: Guaranteed Securities 678,229 578,681 - - - - - ----------- ---------- -------- --------- -------- -------- -------- Total on-balance sheet $ 2,431,643 $ 2,474,073 $ 28,089 $ 54,679 $ 3,659 $ 4,096 $ 1,114 ----------- ---------- -------- --------- -------- -------- -------- Off-balance sheet assets: Farmer Mac I: LTSPCs $ 2,348,703 $ 2,681,240 $ 1,560 $ 3,535 $ - $ - $ - Guaranteed Securities 952,134 299,940 407 - - - 1,050 Farmer Mac II: Guaranteed Securities 51,241 67,109 - - - - - ----------- ---------- -------- --------- -------- -------- -------- Total off-balance sheet $ 3,352,078 $ 3,048,289 $ 1,967 $ 3,535 $ - $ - $ 1,050 ----------- ---------- -------- --------- -------- -------- -------- Total $ 5,783,721 $ 5,522,362 $ 30,056 $ 58,214 $ 3,659 $ 4,096 $ 2,164 ----------- ---------- -------- --------- -------- -------- -------- (1) Includes loans and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities that are 90 days or more past due, in foreclosure, restructured after delinquency, and in bankruptcy excluding loans performing under either their original loan terms or a court-approved bankruptcy plan. 90-day deliquencies do not include deliquencies on Farmer Mac II Guaranteed Securities because the portion of loans underlying these securities are obligations backed by full faith credit of the United States.
6. FINANCIAL DERIVATIVES Farmer Mac enters into interest rate swap contracts to adjust the characteristics of Farmer Mac's debt to match more closely the cash flow and duration characteristics of the Corporation's assets and to derive an overall lower effective fixed-rate cost of borrowing than would otherwise be available to Farmer Mac in the conventional debt market. Farmer Mac is also required to recognize certain contracts and commitments as derivatives when the characteristics of those contracts and commitments meet the definition of a derivative as promulgated by SFAS 133. Farmer Mac enters into financial derivatives as an end-user, not for trading or speculative purposes. As with any financial instrument, financial derivatives have inherent risks: market risk and credit risk. Market Risk: Market risk is the risk of an adverse effect resulting from changes in interest rates or spreads on the value of a financial instrument. Farmer Mac manages market risk associated with financial derivatives by establishing and monitoring limits as to the degree of risk that may be undertaken. This risk is periodically measured as part of Farmer Mac's overall risk monitoring processes, which include market value of equity measurements, net interest income modeling and other measures. Credit Risk: Credit risk is the risk that a counterparty will fail to perform according to the terms of a financial contract in which Farmer Mac has an unrealized gain. Credit losses could occur in the event of non-performance by counterparties to the financial derivative contracts. Farmer Mac mitigates this counterparty credit risk by contracting only with counterparties that have investment grade credit ratings (i.e., at least BBB), establishing and maintaining collateral requirements based upon credit ratings and entering into netting agreements. Netting agreements provide for the calculation of the net amount of all receivables and payables under all transactions covered by the netting agreement between Farmer Mac and a single counterparty. Farmer Mac's exposure to credit risk related to its financial derivatives is represented by those counterparties for which Farmer Mac has a net receivable, including the effect of any netting arrangements. As of December 31, 2003 and 2002, Farmer Mac's credit exposure, excluding netting arrangements, was $1.0 million and $0.4 million, respectively; however, including netting arrangements, Farmer Mac had no net receivables. Conversely, financial derivatives in a net payable position required Farmer Mac to pledge securities as collateral of approximately $16.9 million and $37.0 million as of December 31, 2003 and December 31, 2002, respectively. Interest Rate Risk: Farmer Mac uses financial derivatives to provide a cost- and capital-efficient way to manage its interest rate risk exposure by modifying the repricing or maturity characteristics of certain assets and liabilities and by locking in the rates for certain forecasted issuances of liabilities. The primary financial derivatives Farmer Mac uses include interest rate swaps and forward sale contracts. Farmer Mac uses interest-rate swaps to assume fixed rate interest payments in exchange for variable rate interest payments and vice versa. Depending on the hedging relationship, the effects of these agreements are (a) the conversion of variable rate liabilities to longer-term fixed rate liabilities, (b) the conversion of long-term fixed rate assets to shorter-term variable rate assets, or (c) the reduction of the variability of future changes in interest rates on forecasted issuances of liabilities. The net payments of these agreements are charged to either interest expense or interest income, depending on whether the agreement is designated to hedge an existing or forecasted liability or asset. Fair Value Hedges: Interest Rate Swaps: Farmer Mac uses interest rate swaps primarily to offset the change in value of certain fixed rate investments and liabilities caused by movements in the benchmark interest rate (LIBOR). In calculating the effective portion of the fair value hedges under SFAS 133, the change in fair value of the financial derivative is recognized currently in earnings, as is the change in the value of the hedged items attributable to the risk being hedged. Accordingly, the net difference or hedge ineffectiveness, if any, is recognized currently in the consolidated statement of operations as a gain or loss on financial derivatives and trading assets. Fair value hedge ineffectiveness for each of the years ended December 31, 2003 and 2002 was not significant. Forward Sale Agreements: Loans held for sale expose Farmer Mac to interest rate risk. Farmer Mac manages this risk for certain loans held for sale by selling forward government-sponsored enterprise debt and mortgage backed securities. The changes in fair values of the hedged loans and the related financial derivatives are recorded in the consolidated statements of operations as a gain or loss on financial derivatives and trading assets. The net change in the fair values of loans held for sale and the related financial derivatives for each of the years ended December 31, 2003 and 2002 was not significant. The following table summarizes information related to Farmer Mac's financial derivatives in fair value hedge relationships as of December 31, 2003:
Weighted- Weighted- Weighted- Weighted- Average Fair Value Average Average Average Remaining Notional --------------------------- Pay Receive Forward Life Amount Asset (Liability) Rate Rate Price (in Years) ----------- ------------- ------------- ------------ ------------ ------------ ------------ (dollars in thousands) Medium-term notes: Pay variable interest rate swaps $ 145,000 - (2,782) 1.93% 3.70% - 4.82 Loans: Agency forwards 26,332 76 - - - 1.07 0.04 ----------- ------------- ------------- ------------ ------------ Total fair value hedges $ 171,332 $ 76 $ (2,782) 1.93% 3.70% ----------- ------------- ------------- ------------ ------------
Cash Flow Hedges: Interest Rate Swaps: Farmer Mac uses interest rate swaps to hedge the variability of future cash flows associated with existing variable rate liabilities and forecasted issuances of liabilities. With respect to the variable rate liabilities (discount notes or medium-term notes) on its balance sheet, Farmer Mac uses interest rate swaps to hedge the risk of changes in the benchmark rate (LIBOR). With respect to the hedging of the forecasted issuance of discount notes or medium-term notes, Farmer Mac utilizes interest rate swaps with a longer maturity than the underlying liabilities. The use of interest rate swap contracts with longer maturities than the underlying liabilities allows Farmer Mac to hedge both the risk of changes in the benchmark rate (LIBOR) on existing liabilities and the replacement of such liabilities upon maturity. These cash flow hedge relationships are treated as effective hedges as long as the future issuances of liabilities remain probable and the hedges continue to meet the requirements of SFAS 133. Farmer Mac expects to hedge the forecasted issuance of liabilities over a period that ranges from a minimum of 1 year to a maximum of 15 years. Farmer Mac measures the ineffectiveness of cash flow hedges in accordance with SFAS 133 and reports this amount, if any, as a gain or loss on financial derivatives and trading assets in the consolidated statement of operations. The ineffectiveness for each of the years ended December 31, 2003 and 2002 was not significant. Basis Swaps: Farmer Mac uses basis swaps to create comparable asset-liability positions. Specifically, Farmer Mac uses basis swaps to hedge combined asset-liability positions in which an asset and a liability with variable cash flows have different interest rate bases. Basis swaps are used to convert the interest rate index of the asset to the same index as the variable rate liability or vice versa. These swaps are treated as effective hedge relationships if the index of one leg of the swap is the same as the index of the identified asset and the index of the other leg of the swap is the same as the index of the identified liability. Farmer Mac measures ineffectiveness for basis swaps in accordance with SFAS 133 and reports this amount as a gain or loss on financial derivatives and trading assets in the consolidated statement of operations. The ineffectiveness for each of the years ended December 31, 2003 and 2002 was not significant. A significant proportion of Farmer Mac's outstanding basis swaps are with a related party. See Note 3 for additional information on these related party transactions. Forward Sale Agreements and Future Contracts: Farmer Mac uses forward sale contracts involving government-sponsored enterprise debt instruments and mortgage backed securities and futures contracts involving U.S. Treasury securities to reduce the variability of future changes in interest rates on forecasted issuances of liabilities. Farmer Mac measures ineffectiveness in accordance with the provisions of SFAS 133. The ineffectiveness for each of the years ended December 31, 2003 and 2002 was not significant. The effective portion of the change in fair value of these contracts is recorded in accumulated other comprehensive income/(loss), net of tax. The amounts recorded in accumulated other comprehensive income/(loss) will be recognized in the statements of operations as the hedged transactions affect earnings. The following table summarizes information related to financial derivatives in cash flow hedging relationships, as of December 31, 2003:
Weighted- Weighted- Weighted- Weighted- Average Fair Value Average Average Average Remaining Notional --------------------------- Pay Receive Forward Life Amount Asset (Liability) Rate Rate Price (in Years) ----------- ------------- ------------- ------------ ------------ ------------ ------------ (dollars in thousands) Discount notes or medium-term notes: Pay fixed interest rate swaps $ 636,213 $ 885 $(56,282) 5.81% 1.16% - 7.74 Agency forwards 54,196 - (417) - - 1.03 0.04 Loans or Farmer Mac Guaranteed Securities and discount notes: Basis swaps 307,621 - (5,879) 4.80% 1.46% - 11.76 --------------- ------------ ------------ ------------ ------------ Total cash flow hedges $ 998,030 $ 885 $(62,578) 5.48% 1.26% --------------- ------------ ------------ ------------ ------------
As of December 31, 2003, Farmer Mac had approximately $45.6 million of net after-tax unrealized losses on cash flow hedges included in accumulated other comprehensive income/(loss). These amounts will be reclassified into earnings in the same period or periods during which the hedged forecasted transactions (either the payment of interest or issuance of discount notes or medium-term notes) affect earnings or immediately when it becomes probable that the original hedged forecasted transaction will not occur within two months of the originally specified date. During the next 12 months, Farmer Mac expects to reclassify approximately $8.1 million of the net after-tax unrealized losses included in accumulated other comprehensive income/(loss) as of December 31, 2003. Other Financial Derivatives: Farmer Mac employs certain hedging strategies that do not meet the hedge accounting criteria in SFAS 133. These financial derivatives are recorded on the balance sheet at fair value as freestanding assets or liabilities and the related changes in fair value are recognized in the consolidated statements of operations as gains or losses on financial derivatives and trading assets. The following table summarizes information related to Farmer Mac's other financial derivatives as of December 31, 2003:
Weighted- Weighted- Weighted- Average Fair Value Average Average Remaining Notional ------------------------ Pay Receive Life Amount Asset (Liability) Rate Rate (in Years) ----------- ---------- ------------- ------------ ----------- ------------ (dollars in thousands) Pay fixed callable interest rate swaps $ 138,177 $ - $ (2,023) 6.16% 2.70% 8.76 Basis swaps 14,296 - (260) 4.38% 1.43% 3.30 Other swaps 25,000 - (27) 1.67% 1.04% 2.83 Purchased caps 210,000 - - - - 0.75 ---------------------- ------------ ------------ ----------- Total other financial derivatives $ 387,473 $ - $ (2,310) 5.38% 2.36% ---------------------- ------------ ------------ -----------
For the years ended December 31, 2003 and 2002, Farmer Mac reported $2.4 million of gains and $8.4 million of losses, respectively, on financial derivatives that do not receive hedge accounting treatment and trading assets in the consolidated statements of operations. 7. NOTES PAYABLE Farmer Mac's borrowings consist of discount notes and medium-term notes, both of which are unsecured general obligations of the Corporation. Discount notes generally have maturities of one year or less, whereas medium-term notes have maturities of one to 15 years. The following table sets forth information related to Farmer Mac's borrowings for 2003 and 2002:
2003 2002 ------------------------------------------------------------------------------------------------------------ Average Average Outstanding as of Outstanding During Maximum Outstanding as of Outstanding During Maximum December 31, 2003 the Year Outstanding December 31, 2002 the Year Outstanding -------------------- --------------------- at Any ------------------- ------------------- at Any Amount Rate Amount Rate Month End Amount Rate Amount Rate Month End ----------- -------- ------------- ------ ------------ ------------ ------ ------------------- ------------ (dollars in thousands) Due within one year: Discount notes $2,645,624 1.04% $2,702,188 1.21% $2,781,377 $2,777,206 2.71% $2,533,762 2.65% $2,815,784 Current portion of medium- term notes 153,760 4.57% 118,540 4.61% ----------- --------- ------------ ------ $2,799,384 1.23% $2,895,746 2.79% ------------ ------ Due after one year: Medium-term notes due in: 2005 302,903 4.87% 2006 253,310 3.93% 2007 59,303 3.93% 2008 209,360 2.82% 2009 134,914 6.56% Thereafter 176,320 6.51% ------------ -------- 1,136,110 4.69% ------------ -------- Total $3,935,494 2.23% ------------ --------
Callable medium-term notes give Farmer Mac the option to redeem the debt at par value on a specified call date or at any time on or after a specified call date. The following table summarizes the maturities, amounts and costs for Farmer Mac callable debt by call period as of December 31, 2003.
Callable Debt as of December 31, 2003 ----------------------------------------- Maturity Amount Rate ------------ -------------- ------------ (dollars in thousands) Callable in: 2004 2005-2013 $ 167,748 2.68% 2005 2008 15,000 3.63% -------------- ------------ $ 182,748 2.76% -------------- ------------
The following schedule summarizes the earliest repricing date of total borrowings outstanding as of December 31, 2003, including callable and non-callable medium-term notes, assuming callable notes are redeemed at the initial call date.
Earliest Repricing Date of Borrowings Outstanding ----------------------------- Weighted- Average Amount Rate --------------- ----------- (dollars in thousands) 2004 $ 2,967,133 3.58% 2005 262,986 5.38% 2006 166,878 4.75% 2007 59,303 5.36% 2008 184,360 2.68% 2009 134,914 5.56% Thereafter 159,920 6.60% --------------- ----------- Total $ 3,935,494 3.96% --------------- -----------
During 2003 and 2002, Farmer Mac called $83.7 million and $49.3 million of callable medium-term notes, respectively. Authority to Borrow from the U.S. Treasury Farmer Mac's statutory charter authorizes Farmer Mac to borrow, in extreme circumstances, up to $1.5 billion from the Secretary of the Treasury, if necessary, to fulfill its obligations under any guarantee. The debt would bear interest at a rate determined by the Secretary of the Treasury based on the then current cost of funds to the United States. The charter requires the debt to be repaid within a reasonable time. To date, Farmer Mac has not utilized this borrowing authority. Gains and Losses on the Repurchase of Outstanding Debt During 2002, Farmer Mac recognized $1.4 million of net gains on the repurchase of $103.7 million of outstanding Farmer Mac debt. All of the repurchases were from outstanding Farmer Mac debt that had a maturity date of October 14, 2011 and an interest rate of 5.4 percent. Those debt securities were replaced with new fixed-rate funding to the same maturity dates at lower effective interest rates. 8. ALLOWANCE FOR LOSSES AND CONCENTRATIONS OF CREDIT RISK Allowance for Losses Farmer Mac maintains an allowance for losses to cover probable estimated principal and interest losses on all loans held (allowance for loan losses), loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs (reserve for losses and a portion of the guarantee and commitment obligation that represents Farmer Mac's contingent obligation for probable losses) and real estate owned (real estate owned valuation allowance). No allowance for losses has been provided for Farmer Mac I Guaranteed Securities issued prior to the 1996 Act or for Farmer Mac II Securities. See Note 2(e), Note 2(j), Note 5 and Note 12 for more information about Farmer Mac Guaranteed Securities. The allowance for losses is increased through periodic provisions for losses charged to expense and reduced by charge-offs for actual losses, net of recoveries. Charge-offs represent losses on the outstanding principal balance, any interest payments previously accrued or advanced and expected costs of liquidation. The following is a summary of the changes in the allowance for losses for each year in the three-year period ended December 31, 2003:
------------------------------------------------------------------------- Contingent Allowance REO Obligation Total for Loan Valuation Reserve for Probable Allowance Losses Allowance for Losses Losses for Losses -------------- -------------- ------------- -------------- ------------- (in thousands) Balances as of January 1, 2001 $ 420 $ - $ 10,903 $ - $ 11,323 -------------- -------------- ------------- -------------- ------------- Provision for losses 600 - 6,186 - 6,786 Net allocation of allowance (5) - 5 - - Net recoveries/(charge-offs) 337 - (2,562) - (2,225) -------------- -------------- ------------- -------------- ------------- Balances as of December 31, 2001 $ 1,352 $ - $ 14,532 $ - $ 15,884 -------------- -------------- ------------- -------------- ------------- Provision for losses 1,340 - 6,907 - 8,247 Net allocation of allowance 3,221 1,308 (4,529) - - Net charge-offs (3,251) (716) (153) - (4,120) -------------- -------------- ------------- -------------- ------------- Balances as of December 31, 2002 $ 2,662 $ 592 $ 16,757 $ - $ 20,011 -------------- -------------- ------------- -------------- ------------- Provision for losses 6,524 1,230 (3,145) 2,676 7,285 Net charge-offs (3,219) (1,584) (440) - (5,243) -------------- -------------- ------------- -------------- ------------- Balances as of December 31, 2003 $ 5,967 $ 238 $ 13,172 $ 2,676 $ 22,053 -------------- -------------- ------------- -------------- -------------
All loans that Farmer Mac purchases, issues guarantees with respect to, or commits to purchase under an LTSPC in the Farmer Mac I program are underwritten for conformance to Farmer Mac's underwriting and appraisal standards and Farmer Mac believes the ultimate credit risk is substantially the same. Accordingly, management establishes general allowances for loans held and loans underlying LTSPCs and Farmer Mac Guaranteed Securities collectively. The following table presents Farmer Mac's reserve for losses for all post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs on a pro rata basis as of December 31, 2003 and 2002.
Reserve for Losses on LTSPCs and Post-1996 Act Farmer Mac I Guaranteed Securities ----------------------------------------------------------------------------------------- December 31, December 31, 2003 2002 ----------------- --------------- (in thousands) On-balance sheet Farmer Mac I Guaranteed Securities $ 2,861 $ 4,036 Off-balance sheet Farmer Mac I Guaranteed Securities 1,070 1,280 LTSPCs 9,241 11,441 ----------------- --------------- Total reserve for losses $ 13,172 $ 16,757 ----------------- ---------------
When certain criteria are met, such as the default of the borrower, Farmer Mac may, in its sole discretion, repurchase the defaulted loans underlying Farmer Mac Guaranteed Securities and is obligated to purchase those underlying an LTSPC. These acquisitions are recorded in the consolidated financial statements at their fair value. Fair value is determined by appraisal or other appropriate valuation method. In September 2002, Farmer Mac adopted EITF 02-9, which requires that Farmer Mac record at acquisition the difference between each loan's acquisition cost and its fair value, if any, as a charge to the reserve for losses. Prior to the adoption of EITF 02-9, any specific allowance that had been established for the off-balance sheet obligation would be transferred from the reserve for losses to the allowance for loan losses (referred to as "net allocation of the allowance" in the summary of the changes in the allowance for losses). Upon the receipt of each loan's updated appraisal or estimation of value, the difference between the acquisition cost of the loan and its fair value, if any, was recorded as a charge to the allowance for loan losses. A portion of the allowance for losses is specifically allocated to impaired loans when the fair value of the collateral, less the estimated selling cost, is less than the cost basis in the loan. For this analysis and the allocation of specific reserves as of December 31, 2003, Farmer Mac expanded the population of loans specifically reviewed to include: o non-performing assets; o loans for which Farmer Mac had adjusted the timing of borrowers' payment schedules within the past three years, but still expects to collect all amounts due and has not made economic concessions; and o additional performing loans that have previously been delinquent or are secured by real estate that produces commodities currently under stress. Prior to December 31, 2003, the review consisted only of non-performing assets. The balance of impaired loans, both on- and off-balance sheet, and the related allowance specifically allocated to those impaired loans as of December 31, 2003 and 2002 are summarized in the following table:
December 31, 2003 December 31, 2002 --------------------------------------- ---------------------------------------- Specific Net Specific Net Balance Allowance Balance Balance Allowance Balance ------------- ------------------------- ------------- --------------------------- (in thousands) Assets specifically reviewed for impairment: Specific allowance for losses $ 18,213 $ (3,762) $ 14,451 $ 12,137 $ (2,036) $ 10,101 No specific allowance for losses 154,487 - 154,487 63,171 - 63,171 ------------- ------------ ------------ ------------ ------------ ------------- Total $ 172,700 $ (3,762) $ 168,938 $ 75,308 $ (2,036) $ 73,272 ------------- ------------ ------------ ------------ ------------ -------------
Farmer Mac recognized interest income of approximately $1.7 million and $0.6 million on impaired loans during the years ended December 31, 2003 and 2002, respectively. During 2003 and 2002, Farmer Mac's average investment in impaired loans and loans underlying on-balance sheet Farmer Mac Guaranteed Securities was $68.5 million and $71.0 million, respectively. In accordance with the terms of all applicable trust agreements, Farmer Mac acquires all loans that collateralize Farmer Mac Guarantee Securities that become and remain 90 days or more past due on the next subsequent loan payment date. During 2003, Farmer Mac purchased 81 defaulted loans having a principal balance of $55.6 million from pools underlying Farmer Mac Guaranteed Securities and LTSPCs. During 2002, Farmer Mac made 79 such purchases for a total of $46.4 million. The following table presents Farmer Mac's purchases of defaulted loans underlying Farmer Mac I Guaranteed Securities and LTSPCs.
For the Year Ended December 31, ------------------------------ 2003 2002 -------------- -------------- (in thousands) Defaulted loans purchased underlying off-balance sheet Farmer Mac I Guaranteed Securities $ 16,276 $ 17,386 Defaulted loans underlying on-balance sheet Farmer Mac I Guaranteed Securities transferred to loans 35,100 25,675 Defaulted loans purchased underlying LTSPCs 4,266 3,386 -------------- -------------- Total $ 55,642 $ 46,447 -------------- --------------
Concentrations of Credit Risk The following table sets forth the geographic and commodity diversification, as well as the range of original loan-to-value ratios, for all loans held and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs as of December 31, 2003 and 2002:
As of December 31, --------------------------------- 2003 2002 --------------- --------------- (in thousands) By geographic region (1): Northwest $ 1,066,399 $ 1,167,331 Southwest 2,307,812 2,273,846 Mid-North 677,755 518,439 Mid-South 257,664 233,997 Northeast 397,231 298,340 Southeast 313,171 329,681 --------------- --------------- Total $ 5,020,032 $ 4,821,634 --------------- --------------- By commodity: Crops $ 2,228,506 $ 2,085,963 Livestock 1,355,070 987,533 Permanent plantings 1,025,245 1,341,165 Part-time farms 374,057 367,823 Other 37,154 39,150 --------------- --------------- Total $ 5,020,032 $ 4,821,634 --------------- --------------- By original loan-to-value: 0.00% to 40.00% $ 1,300,869 $ 1,246,891 40.01% to 50.00% 1,082,540 1,046,915 50.01% to 60.00% 1,404,260 1,339,891 60.01% to 70.00% 1,107,888 1,066,419 70.01% to 80.00% 109,848 106,493 80.01% to 90.00% 14,627 15,025 --------------- --------------- Total $ 5,020,032 $ 4,821,634 --------------- --------------- (1) Geographic regions: Mid-North (IA, IL, IN, MI, MN, MO, WI); Mid-South (KS, OK, TX); Northeast (CT, DE, KY, MA, MD, ME, NC, NH, NJ, NY, OH, PA, RI, TN, VA, VT, WV); Northwest (AK, ID, MT, ND, NE, OR, SD, WA, WY); Southeast (AL, AR, FL, GA, LA, MS, SC); Southwest (AZ, CA, CO, HI, NM, NV, UT).
The original loan-to-value ratio is calculated by dividing the loan principal balance at the time of guarantee, purchase or commitment by the appraised value at the date of loan origination or, when available, updated appraised value at the time of guarantee, purchase or commitment. Current loan-to-value ratios may be higher or lower than the original loan-to-value ratios. 9. STOCKHOLDERS' EQUITY Common Stock Farmer Mac has three classes of common stock outstanding: o Class A voting common stock, which may be held only by banks, insurance companies and other financial institutions or similar entities that are not institutions of the Farm Credit System. By statute, no holder of Class A voting common stock may directly or indirectly be a beneficial owner of more than 33 percent of the outstanding shares of Class A voting common stock; o Class B voting common stock, which may be held only by institutions of the Farm Credit System. There are no restrictions on the maximum holdings of Class B voting common stock; and o Class C non-voting common stock, which has no ownership restrictions. Dividends have not been paid to any common stockholders nor does Farmer Mac expect to pay dividends in the foreseeable future. Farmer Mac's ability to declare and pay a dividend could be restricted if it failed to comply with regulatory capital requirements. Preferred Stock The Corporation has outstanding 700,000 shares of 6.40 percent Cumulative Preferred Stock, Series A, which has a redemption price and liquidation preference of $50.00 per share, plus accrued and unpaid dividends. The preferred stock does not have a maturity date. Beginning on June 30, 2012, Farmer Mac has the option to redeem the preferred stock at any time, in whole or in part, at the redemption price of $50.00 per share, plus accrued and unpaid dividends through and including the redemption date. Farmer Mac pays cumulative dividends on the preferred stock quarterly in arrears, when and if declared by the board of directors. Farmer Mac's ability to declare and pay a dividend could be restricted if it failed to comply with regulatory capital requirements. The costs of issuing the preferred stock were charged to additional paid-in capital. Stock Option Plan In 1996, Farmer Mac adopted a stock option plan for officers to acquire shares of Class C non-voting common stock. Under the 1996 plan, stock options awarded under the plan vested annually in thirds, with the last installment having vested in June 1998. If not exercised, any options granted under the 1996 plan will expire 10 years from the date of grant. The exercise price of options granted under the 1996 plan, which were issued in 1996, is $2.63. The maximum number of options that could be issued under the 1996 plan was 338,490, all of which were issued. In 1997, Farmer Mac adopted a new stock option plan for directors, officers and other employees, the terms of which are generally the same as for the 1996 plan, except that options issued to directors since June 1, 1998, if not exercised, will expire five years from the date of grant. Of the 3,750,000 shares authorized to be issued under the 1997 plan, 2,265,751 have been issued, net of cancellations. Options granted under the 1997 plan during 2003 have exercise prices ranging from $22.40 to $26.68 per share. For all stock options granted under both of Farmer Mac's plans, the exercise price was equal to the closing price of the Class C common stock on or immediately preceding the grant date. The following table summarizes stock option activity for 2003 and 2002:
2003 2002 ------------------------------ -------------------------- Weighted- Weighted- Average Average Exercise Exercise Shares Price Shares Price ------------- --------------- ------------- ----------- Outstanding, beginning of year 1,637,111 $ 19.45 1,416,426 $ 17.61 Granted 366,104 22.67 270,421 28.97 Exercised (422,236) 9.14 (39,736) 15.64 Canceled (4,999) 28.07 (10,000) 31.24 ------------- ------------ ------------- ----------- Outstanding, end of year 1,575,980 $ 22.92 1,637,111 $ 19.45 ------------- ------------ ------------- ----------- Options exercisable at year end 1,247,658 1,368,884 ------------- -------------
The cancellations of stock options during 2003 and 2002 were due to unvested options terminating in accordance with the provisions of the applicable stock option plans upon directors' or employees' departures from Farmer Mac. For 2003 and 2002 the additional paid in capital received as a result of the exercise of stock options was $3.4 million and $0.6 million, respectively. During 2003 and 2002 the reduction of income tax paid as a result of the deduction for the exercise of stock options was $2.8 million and $0.3 million, respectively. The following table summarizes information regarding options outstanding as of December 31, 2003:
Options Outstanding Exercisable ------------------------------ -------------- Weighted- Average Remaining Exercise Number of Contractual Number of Price Shares Life Shares ------------- -------------- --------------- -------------- $ 2.63 5,490 2.5 years 5,490 11.83 57,312 3.5 years 57,312 12.67 1,200 4.7 years 1,200 15.13 295,775 6.4 years 295,775 16.38 24,110 6.7 years 24,110 18.13 3,000 6.8 years 3,000 18.25 2,400 3.9 years 2,400 19.38 16,063 5.7 years 16,063 20.00 77,586 2.7 years 77,586 21.19 3,000 6.9 years 3,000 22.08 194,064 5.4 years 194,064 22.38 2,000 7.0 years 2,000 22.40 343,104 9.4 years 114,368 22.94 1,500 5.6 years 1,500 26.20 2,000 7.2 years 2,000 26.25 13,000 8.7 years 8,667 26.68 21,000 9.8 years 6,999 26.92 500 7.3 years 500 27.75 3,000 7.1 years 3,000 29.10 242,257 8.4 years 161,505 29.56 1,000 8.7 years 500 31.02 4,627 7.5 years 4,627 31.20 8,750 7.7 years 8,750 31.24 250,042 7.4 years 250,042 31.50 1,500 7.4 years 1,500 34.90 1,000 7.7 years 1,000 34.91 200 7.7 years 200 45.06 500 8.3 years 500 -------------- -------------- 1,575,980 1,247,658 -------------- --------------
The weighted-average fair values of options granted in 2003, 2002 and 2001 were $10.68, $13.50 and $11.61, respectively, which under the fair value-based method of accounting for stock-based compensation cost would have reduced net income available to common stockholders by $2.5 million, $2.4 million and $2.1 million for 2003, 2002 and 2001, respectively. The fair values were estimated using the Black-Scholes option pricing model based on the following assumptions:
2003 2002 2001 ----------- ---------- ----------- Risk-free interest rate 2.9% 5.2% 5.4% Expected years until exercise 5 years 5 years 5 years Expected stock volatility 47.8% 40.0% 47.1% Dividend yield 0.0% 0.0% 0.0%
Restricted Stock In addition to stock options, the Corporation, by authorization of the board of directors, issued restricted stock to employees during 2003, 2002 and 2001. Restricted stock entitles participants to all the rights of a stockholder, except that some of the shares awarded are subject to forfeiture if the participant is not employed by Farmer Mac at the end of the restriction period and other shares are not subject to forfeiture but may not be disposed of by the participant during the restriction period. The vesting or restriction period is usually one to two years. The value of restricted stock granted to employees is amortized over the vesting period. During 2003, 2002 and 2001, 37,045 shares, 32,338 shares and 28,602 shares of restricted stock, respectively, were granted, resulting in compensation expense of $0.8 million, $0.9 million and $0.9 million being recognized during the respective years. Statutory and Regulatory Capital Requirements Farmer Mac is subject to three statutory and regulatory capital requirements: o Minimum capital - Farmer Mac's minimum capital level is an amount of core capital (stockholders equity less accumulated other comprehensive income) equal to the sum of 2.75 percent of Farmer Mac's aggregate on-balance sheet assets, as calculated for regulatory purposes, plus 0.75 percent of the aggregate off-balance sheet obligations of Farmer Mac, specifically including: o the unpaid principal balance of outstanding Farmer Mac Guaranteed Securities; o instruments issued or guaranteed by Farmer Mac that are substantially equivalent to Farmer Mac Guaranteed Securities, including LTSPCs; and o other off-balance sheet obligations of Farmer Mac. o Critical capital - Farmer Mac's critical capital level is an amount of core capital equal to 50 percent of the total minimum capital requirement at that time. o Risk-based capital - The Act directs FCA to establish a risk-based capital stress test for Farmer Mac, using specified stress-test parameters. While the Act does not specify the required level of risk-based capital, that level is permitted to exceed the statutory minimum capital requirement applicable to Farmer Mac, if so indicated by the risk-based capital stress test. Farmer Mac is required to comply with the higher of the minimum capital requirement or the risk-based capital requirement. As of December 31, 2003, Farmer Mac's minimum and critical capital requirements were $142.0 million and $71.0 million, respectively, and its actual core capital level was $215.5 million, $73.5 million above the minimum capital requirement and $144.5 million above the critical capital requirement. Based on the risk-based capital stress test, Farmer Mac's risk-based capital requirement as of December 31, 2003 was $38.8 million and Farmer Mac's regulatory capital (core capital plus allowance for losses) of $237.6 million exceeded that amount by approximately $198.8 million. 10. INCOME TAXES The components of the provision for federal income taxes for the years ended December 31, 2003, 2002 and 2001 were as follows:
2003 2002 2001 ------------- ------------- ------------- (in thousands) Current $ 12,529 $ 12,768 $ 10,669 Deferred (221) (2,959) (2,250) ------------- ------------- ------------- $ 12,308 $ 9,809 $ 8,419 ------------- ------------- -------------
A reconciliation of tax at the statutory federal tax rate to the income tax provision for the years ended December 31, 2003, 2002 and 2001 is as follows:
2003 2002 2001 ----------- ----------- ------------ (dollars in thousands) Tax expense at statutory rate $ 13,852 $ 11,396 $ 8,899 Effect of non-taxable dividend income (1,694) (1,596) (386) Other 150 9 (94) ----------- ----------- ------------ Income tax expense $ 12,308 $ 9,809 $ 8,419 ----------- ----------- ------------ Statutory tax rate 35.0% 35.0% 35.0% Effective tax rate 31.1% 30.1% 33.1%
The components of the deferred tax assets and liabilities as of December 31, 2003 and 2002 were as follows:
2003 2002 ------------ ----------- (in thousands) Deferred tax assets: Allowance for losses $ 8,216 $ 7,004 Unrealized loss on financial derivatives designated as cash flow hedges 24,529 33,777 Other 1,439 2,442 ------------ ----------- Total deferred tax assets 34,184 43,223 Deferred tax liability: Unrealized gain on available-for-sale securities 23,293 33,557 ------------ ----------- Total deferred tax liability 23,293 33,557 ------------ ----------- Net deferred tax aset $10,891 $ 9,666 ------------ -----------
A valuation allowance is required to reduce the net deferred tax asset to an amount that is more likely than not to be realized. No valuation allowance was considered necessary as of December 31, 2003 and 2002. 11. EMPLOYEE BENEFITS On December 28, 1989, Farmer Mac adopted a defined contribution retirement plan for all of its employees. Through 2001, Farmer Mac contributed 13.2 percent of the lesser of an individual's gross salary or $170,000, plus 5.7 percent of the difference between (1) the lesser of the gross salary or $170,000 and (2) the Social Security Taxable Wage Base. The Economic Growth and Tax Relief Reconciliation Act of 2001 increased the $170,000 limit to $200,000 in 2002, to be adjusted from time to time for inflation. Employees are fully vested after having been employed for three years. Expense for this plan for the years ended December 31, 2003, 2002 and 2001 was $464,000, $384,000 and $376,000, respectively. 12. OFF-BALANCE SHEET GUARANTEES AND LTSPCs, COMMITMENTS AND CONTINGENCIES Farmer Mac offers approved agricultural and rural residential mortgage lenders two alternatives to increase their liquidity or lending capacity while retaining the cash flow benefits of their loans: (1) Farmer Mac Guaranteed Securities, which are available through either the Farmer Mac I program or the Farmer Mac II program, and (2) LTSPCs, which are available only through the Farmer Mac I program. Both of these alternatives result in off-balance sheet transactions for Farmer Mac. Off-Balance Sheet Farmer Mac Guaranteed Securities Periodically Farmer Mac transfers agricultural mortgage loans into trusts that are used as vehicles for the securitization of the transferred assets and the beneficial interests in the loans are sold to third party investors. The table below summarizes certain cash flows received from and paid to these trusts.
Year Ended December 31, ----------------------------- 2003 2002 2001 --------- --------- --------- (in thousands) Proceeds from new securitizations $ 78,254 $ 47,682 $ 82,995 Guarantee fees received 1,988 775 579 Purchase of assets from the trusts 16,276 17,386 6,005 Servicing advances 503 1,235 819 Repayments of servicing advances 107 1,134 52
Farmer Mac is liable under its guarantee to ensure that the securities make timely payments to investors of principal and interest based on the underlying loans, regardless of whether the trust has actually received such scheduled loan payments. As consideration for Farmer Mac's assumption of the credit risk on these mortgage pass-through certificates, Farmer Mac receives guarantee fees that are recognized as earned on an accrual basis over the life of the loan and based upon the outstanding balance of the Farmer Mac Guaranteed Security. Farmer Mac is required to perform under its obligation when the underlying loans for the off-balance sheet Farmer Mac Guaranteed Securities do not make their scheduled installment payments. When a loan underlying a Farmer Mac I Guaranteed Security becomes 90 days or more past due, Farmer Mac may, in its sole discretion, repurchase the loan from the trust and generally does repurchase such loans, thereby reducing the principal balance of the outstanding Farmer Mac I Guaranteed Security. The following table presents the maximum principal amount of potential undiscounted future payments that Farmer Mac could be required to make under off-balance sheet Farmer Mac Guaranteed Securities as of December 31, 2003 and 2002, not including offsets provided by any recourse provisions, recoveries from third parties or collateral for the underlying loans.
Outstanding Balance of Off-Balance Sheet Farmer Mac Guaranteed Securities ---------------------------------------------------------------------------- December 31, December 31, 2003 2002 ----------------- --------------- (in thousands) Farmer Mac I Guaranteed Securities: Post-1996 Act $ 952,134 $ 299,940 Pre-1996 Act - - ----------------- --------------- Total Farmer Mac I 952,134 299,940 Farmer Mac II Guaranteed Securities 51,241 67,109 ----------------- --------------- Total Farmer Mac I and II $ 1,003,375 $ 367,049 ----------------- ---------------
If Farmer Mac repurchases a loan that is collateral for a Farmer Mac I Guaranteed Security, Farmer Mac would have the right to enforce the terms of the loan, and in the event of a default, would have access to the underlying collateral. Farmer Mac typically recovers a significant portion of the value of defaulted loans purchased either through borrower payments, loan payoffs, payments by third parties or foreclosure and sale of the collateral. Farmer Mac has recourse to the USDA for any amounts advanced for the timely payment of principal and interest on Farmer Mac II Guaranteed Securities. That recourse is the USDA guarantee, a full faith and credit obligation of the United States that becomes enforceable if a lender fails to repurchase the USDA-guaranteed portion from its owner within 30 days after written demand from the owner when (a) the borrower under the guaranteed loan is in default not less than 60 days in the payment of any principal or interest due on the USDA-guaranteed portion, or (b) the lender has failed to remit to the owner the payment made by the borrower on the USDA-guaranteed portion or any related loan subsidy within 30 days after the lender's receipt thereof. As of December 31, 2003, the weighted-average remaining maturity of all loans underlying off-balance sheet Farmer Mac Guaranteed Securities was 16.4 years. As of December 31, 2003 and 2002, the portion of the allowance for losses attributable to off-balance sheet Farmer Mac Guaranteed Securities was $3.7 million and $1.3 million, respectively. The increase is largely a result of the contingent obligation for probable losses of $2.7 million, a component of the allowance for losses reported on the consolidated balance sheet as part of the guarantee and commitment obligation, which relates to an LTSPC converted into a Farmer Mac Guaranteed Security at the request of a program participant during 2003. The conversion resulted in a corresponding decrease in the portion of the allowance for losses attributable to LTSPCs. For additional detail on Farmer Mac's methodology for determining the allowance for losses, see Note 2(j) and Note 8. Long-Term Standby Purchase Commitments An LTSPC is a commitment by Farmer Mac to purchase eligible loans, either for cash or in exchange for Farmer Mac I Guaranteed Securities, on one or more undetermined future dates. As consideration for its assumption of the credit risk on loans underlying an LTSPC, Farmer Mac receives a commitment fee payable monthly in arrears, in an amount approximating what would have been the guarantee fee if the transaction were structured as a swap for Farmer Mac Guaranteed Securities. An LTSPC permits a seller to nominate from its portfolio a segregated pool of loans, which are retained in the seller's portfolio and serviced by the seller. Upon nomination, Farmer Mac reviews the loan pool to confirm that it conforms to Farmer Mac's underwriting standards. Upon Farmer Mac's acceptance of the eligible loans, the seller effectively transfers the credit risk on those loans to Farmer Mac, thereby reducing the seller's credit and concentration risk exposures and, consequently, its regulatory capital requirements and its loss reserve requirements. Credit risk is transferred through Farmer Mac's commitment to purchase the segregated loans from the counterparty based upon Farmer Mac's original credit review and acceptance of the credit risk on the loans. The specific events or circumstances that would require Farmer Mac to purchase some or all of the segregated loans under its LTSPCs include: (1) the failure of the borrower under any loan to make installment payments under that loan for a period of at least four months; or (2) the determination by the holder of the LTSPC to sell or exchange some or all of the loans under the LTSPC to Farmer Mac. Farmer Mac generally purchases loans subject to an LTSPC: o At par plus accrued interest, if the loans become four months delinquent; o At a mark-to-market price, if the loans are not delinquent and are standard Farmer Mac cash window loan products; or in exchange for Farmer Mac I Guaranteed Securities. o If the loans are not four months delinquent, either at a mark-to-market negotiated price for all (but not some) loans in the pool, based on the sale of Farmer Mac I Guaranteed Securities in the capital markets or the funding obtained by Farmer Mac through the issuance of matching debt in the capital markets; or in exchange for Farmer Mac I Guaranteed Securities. As of December 31, 2003 and 2002, the maximum principal amount of potential undiscounted future payments that Farmer Mac could be requested to make under LTSPCs, not including offsets provided by any recourse provisions, recoveries from third parties or collateral for the underlying loans, was $2.3 billion and $2.7 billion respectively. In the event of loan default, Farmer Mac would have the right to enforce the terms of the loans including the right to foreclose upon the collateral underlying such loans. Farmer Mac believes that it will generally recover a significant portion of the value of the defaulted loans purchased either through borrower payments, loan payoffs, payments by third parties or foreclosure and sale of the collateral. As of December 31, 2003, the weighted-average remaining maturity of all loans underlying LTSPCs was 14.5 years. The portion of the reserve for losses that was attributable to LTSPCs was $9.2 million and $11.4 million as of December 31, 2003 and 2002, respectively. The decrease is largely a result of the contingent obligation for probable losses, a component of the allowance for losses of $2.7 million created upon the conversion of an LTSPC into a Farmer Mac Guaranteed Security at the request of a program participant during 2003. The conversion resulted in a corresponding decrease in the portion of the allowance for losses attributable to LTSPCs. For additional detail on Farmer Mac's methodology for determining the reserve for losses, see Note 2(j) and Note 8. Commitments Farmer Mac enters into mandatory and optional delivery commitments to purchase loans. Most loan purchase commitments entered into by Farmer Mac are mandatory commitments, in which Farmer Mac charges a fee to extend or cancel the commitment. All optional loan purchase commitments are sold forward under optional commitments to deliver Farmer Mac Guaranteed Securities that may be cancelled by Farmer Mac without penalty. As of December 31, 2003, commitments to purchase Farmer Mac I and II loans totaled $11.2 million, none of which were optional commitments. Outstanding loan purchase commitments as of December 31, 2002, totaled $26.2 million, of which $4.5 million were optional commitments. Farmer Mac is exposed to interest rate risk from the time it commits to purchase a loan to the time it either: (a) sells Farmer Mac Guaranteed Securities backed by the loan or (b) issues debt to retain the loan in its portfolio. There were no commitments to sell Farmer Mac Guaranteed Securities as of December 31, 2003 and 2002. Farmer Mac manages the interest rate risk related to loans not yet sold or funded as a retained investment through the use of forward sale contracts involving government sponsored enterprise debt and mortgage-backed securities and futures contracts involving U.S. Treasury securities. See Note 2(h) and Note 6 for information regarding financial derivatives. Rental expense for Farmer Mac's office space for each of the years ended December 31, 2003, 2002 and 2001 was $0.5 million, $0.5 million and $0.3 million, respectively. The future minimum lease payments under Farmer Mac's non-cancelable lease for its office space are as follows:
Future Minimum Lease Payments ----------------------------------- (in thousands) 2004 $ 545 2005 558 2006 573 2007 586 2008 601 Thereafter 1,897 --------------- Total $ 4,760 ---------------
13. FAIR VALUE DISCLOSURES The following table sets forth the estimated fair values and the carrying values for financial assets, liabilities and guarantees and commitments as of December 31, 2003 and 2002. Significant estimates, assumptions and present value calculations are used for the following disclosure, resulting in a high degree of subjectivity in the indicated fair values. Accordingly, these estimated fair values are not necessarily indicative of what Farmer Mac would realize in an actual sale or purchase.
As of December 31, ---------------------------------------------------------- 2003 2002 --------------------------- ---------------------------- Carrying Carrying Fair Value Amount Fair Value Amount -------------- ----------- -------------- ------------ (in thousands) Financial assets: Cash and cash equivalents $623,674 $623,674 $723,800 $ 723,800 Investment securities 1,065,124 1,064,782 831,299 830,409 Farmer Mac Guaranteed Securities 1,522,568 1,508,134 1,632,883 1,608,507 Loans 1,038,247 983,624 1,008,706 963,461 Financial derivatives 961 961 317 317 Financial liabilities: Notes payable: Due within one year 2,801,616 2,799,384 2,863,224 2,895,746 Due after one year 1,213,623 1,136,110 1,168,760 985,318 Financial derivatives 67,670 67,670 94,314 94,314 Guarantee and commitment fees receivable: LTSPCs 26,547 4,136 27,102 - Off-balance sheet Farmer Mac Guaranteed Securities 8,032 7,333 5,452 -
Farmer Mac estimates the fair value of its loans and Farmer Mac Guaranteed Securities by discounting the projected cash flows of these instruments at projected interest rates. Because the cash flows of these instruments may be interest rate path dependent, these values and projected discount rates are derived using a Monte Carlo simulation model. Notes payable and interest rate contracts are valued using a similar methodology. For investment securities, futures contracts and commitments to purchase and sell government sponsored enterprise debt and mortgage-backed securities, fair values are based on market quotes. The carrying value of cash and cash equivalents approximates fair value. 14. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
2003 Quarter Ended 2002 Quarter Ended ------------------------------------------------ ------------------------------------------------ Dec. 31 Sept. 30 June 30 Mar. 31 Dec. 31 Sept. 30 June 30 Mar. 31 ----------- ------------ ----------- ----------- ----------- ------------ ----------- ----------- (dollars in thousands, except per share amounts) Interest income $39,405 $39,320 $40,866 $41,968 $44,062 $46,185 $43,935 $37,688 Interest expense 30,311 30,402 31,501 32,093 34,557 35,096 33,991 29,126 ----------- ------------ ----------- ----------- ----------- ------------ ----------- ----------- Net interest income 9,094 8,918 9,365 9,875 9,505 11,089 9,944 8,562 Provision for loan losses (509) (3,391) (1,416) (1,208) (1,340) - - - ----------- ------------ ----------- ----------- ----------- ------------ ----------- ----------- Net interest income after provision for loan losses 8,585 5,527 7,949 8,667 8,165 11,089 9,944 8,562 Guarantee and commitment fees 5,424 5,056 5,111 5,094 5,114 4,874 4,723 4,567 Gains/(Losses) on derivatives (1,297) (3,348) 3,669 3,333 (3,679) (2,563) (1,324) (868) Gains/(Losses) on the repurchase of debt - - - - (2,021) - 897 2,490 Gains/(Losses) on the sale of real estate owned 201 79 (225) 123 - 85 (27) (34) Miscellaneous 69 354 138 251 114 458 368 391 ----------- ------------ ----------- ----------- ----------- ------------ ----------- ----------- Total revenues 12,982 7,668 16,642 17,468 7,693 13,943 14,581 15,108 Total operating expenses 5,292 2,325 3,532 4,033 3,210 6,012 5,015 4,530 ----------- ------------ ----------- ----------- ----------- ------------ ----------- ----------- Income before income taxes 7,690 5,343 13,110 13,435 4,483 7,931 9,566 10,578 Income tax expense 2,234 1,438 4,184 4,452 1,146 2,341 2,944 3,376 ----------- ------------ ----------- ----------- ----------- ------------ ----------- ----------- Net income 5,456 3,905 8,926 8,983 3,337 5,590 6,622 7,202 ----------- ------------ ----------- ----------- ----------- ------------ ----------- ----------- Preferred stock dividends (560) (560) (560) (560) (560) (560) (336) - ----------- ------------ ----------- ----------- ----------- ------------ ----------- ----------- Net income available to common stockholders $ 4,896 $ 3,345 $ 8,366 $ 8,423 $ 2,777 $ 5,030 $ 6,286 $ 7,202 ----------- ------------ ----------- ----------- ----------- ------------ ----------- ----------- Earnings per share: Basic net earnings $ 0.42 $ 0.28 $ 0.72 $ 0.72 $ 0.24 $ 0.43 $ 0.54 $ 0.62 Diluted net earnings $ 0.40 $ 0.28 $ 0.70 $ 0.70 $ 0.23 $ 0.42 $ 0.52 $ 0.59
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure Not Applicable Item 9A. Controls and Procedures Farmer Mac maintains disclosure controls and procedures designed to ensure that information required to be disclosed in the Corporation's periodic filings under the Securities Exchange Act of 1934 (the "Exchange Act"), including this report, is recorded, processed, summarized and reported on a timely basis. These disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed under the Exchange Act is accumulated and communicated to the Corporation's management on a timely basis to allow decisions regarding required disclosure. Farmer Mac's Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the design and operation of the Corporation's disclosure controls and procedures (as defined under Rules 13a-15(e) and 15d-15(e) of the Exchange Act) as of December 31, 2003. Based upon that evaluation, Farmer Mac's Chief Executive Officer and Chief Financial Officer have concluded that the Corporation's disclosure controls and procedures are adequate and effective. For the quarter ended December 31, 2003, there were no significant changes in Farmer Mac's internal controls, or in other factors that could materially affect these controls, subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies or material weaknesses. PART III Item 10. Directors and Executive Officers of the Registrant Farmer Mac has adopted a code of business conduct and ethics (the "Code") that applies to all directors, officers, employees and agents of Farmer Mac, including Farmer Mac's principal executive officer, principal financial officer, principal accounting officer and other senior financial officers. A copy of the Code is available in the "Investors--Corporate Governance" section of Farmer Mac's Internet website (www.farmermac.com). Farmer Mac will post any amendment to, or waiver from, a provision of the Code in that same section of its Internet website. A print copy of the Code is available free of charge upon written request to Farmer Mac's Corporate Secretary. Additional information required by this item is incorporated by reference to the Corporation's Proxy Statement to be filed on or about April 19, 2004. Item 11. Executive Compensation The information required by this item is incorporated by reference to the Corporation's Proxy Statement to be filed on or about April 19, 2004. Item 12. Security Ownership of Certain Beneficial Owners and Management The information required by this item is incorporated by reference to the Corporation's Proxy Statement to be filed on or about April 19, 2004. Item 13. Certain Relationships and Related Transactions The information required by this item is incorporated by reference to the Corporation's Proxy Statement to be filed on or about April 19, 2004. Item 14. Principal Accounting Fees and Services The information required by this item is incorporated by reference to the Corporation's Proxy Statement to be filed on or about April 19, 2004. PART IV Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a) (1) Financial Statements. Refer to Item 8 above. (2) Financial Statement Schedules. All schedules are omitted since they are not applicable, not required or the information required to be set forth therein is included in the consolidated financial statements or in notes thereto. (3) Exhibits. * 3.1 - Title VIII of the Farm Credit Act of 1971, as most recently amended by the Farm Credit System Reform Act of 1996, P.L. 104-105 (Form 10-K filed March 29, 1996). * 3.2 - Amended and restated By-Laws of the Registrant (Form 10-Q filed August 12, 1999). * 4.1 - Specimen Certificate for Farmer Mac Class A Voting Common Stock (Form 10-Q filed May 15, 2003). * 4.2 - Specimen Certificate for Farmer Mac Class B Voting Common Stock (Form 10-Q filed May 15, 2003). * 4.3 - Specimen Certificate for Farmer Mac Class C Non-Voting Common Stock (Form 10-Q filed May 15, 2003). * 4.4 - Certificate of Designation of Terms and Conditions of Farmer Mac 6.40% Cumulative Preferred Stock, Series A (Form 10-Q filed May 15, 2003). +* 10.1 - Stock Option Plan (Previously filed as Exhibit 19.1 to Form 10-Q filed August 14, 1992). +* 10.1.1 - Amendment No. 1 to Stock Option Plan (Previously filed as Exhibit 10.2 to Form 10-Q filed August 16, 1993). +* 10.1.2 - 1996 Stock Option Plan (Form 10-Q filed August 14, 1996). __________________ * Incorporated by reference to the indicated prior filing. ** Filed herewith. + Management contract or compensatory plan. # Portions of this exhibit have been omitted pursuant to a request for confidential treatment. +* 10.1.3 - Amended and Restated 1997 Incentive Plan (Form 10-Q filed November 14, 2003). +* 10.2 - Employment Agreement dated May 5, 1989 between Henry D. Edelman and the Registrant (Previously filed as Exhibit 10.4 to Form 10-K filed February 14, 1990). +* 10.2.1 - Amendment No. 1 dated as of January 10, 1991 to Employment Contract between Henry D. Edelman and the Registrant (Previously filed as Exhibit 10.4 to Form 10-K filed April 1, 1991). +* 10.2.2 - Amendment to Employment Contract dated as of June 1, 1993 between Henry D. Edelman and the Registrant (Previously filed as Exhibit 10.5 to Form 10-Q filed November 15, 1993). +* 10.2.3 - Amendment No. 3 dated as of June 1, 1994 to Employment Contract between Henry D. Edelman and the Registrant (Previously filed as Exhibit 10.6 to Form 10-Q filed August 15, 1994). +* 10.2.4 - Amendment No. 4 dated as of February 8, 1996 to Employment Contract between Henry D. Edelman and the Registrant (Form 10-K filed March 29, 1996). +* 10.2.5 - Amendment No. 5 dated as of June 13, 1996 to Employment Contract between Henry D. Edelman and the Registrant (Form 10-Q filed August 14, 1996). +* 10.2.6 - Amendment No. 6 dated as of August 7, 1997 to Employment Contract between Henry D. Edelman and the Registrant (Form 10-Q filed November 14, 1997). +* 10.2.7 - Amendment No. 7 dated as of June 4, 1998 to Employment Contract between Henry D. Edelman and the Registrant (Form 10-Q filed August 14, 1998). +* 10.2.8 - Amendment No. 8 dated as of June 3, 1999 to Employment Contract between Henry D. Edelman and the Registrant (Form 10-Q filed August 12, 1999). +* 10.2.9 - Amendment No. 9 dated as of June 1, 2000 to Employment Contract between Henry D. Edelman and the Registrant Form 10-Q filed August 14, 2000). __________________ * Incorporated by reference to the indicated prior filing. ** Filed herewith. + Management contract or compensatory plan. # Portions of this exhibit have been omitted pursuant to a request for confidential treatment. +* 10.2.10 - Amendment No. 10 dated as of June 7, 2001 to Employment Contract between Henry D. Edelman and the Registrant (Form 10-Q filed August 14, 2001). +* 10.2.11 - Amendment No. 11 dated as of June 6, 2002 to Employment Contract between Henry D. Edelman and the Registrant (Form 10-Q filed August 14, 2002). +* 10.2.12 - Amendment No. 12 dated as of June 5, 2003 to Employment Contract between Henry D. Edelman and the Registrant (Form 10-Q filed August 14, 2003). +* 10.3 - Employment Agreement dated May 11, 1989 between Nancy E. Corsiglia and the Registrant (Previously filed as Exhibit 10.5 to Form 10-K filed February 14, 1990). +* 10.3.1 - Amendment dated December 14, 1989 to Employment Agreement between Nancy E. Corsiglia and the Registrant (Previously filed as Exhibit 10.5 to Form 10-K filed February 14, 1990). +* 10.3.2 - Amendment No. 2 dated February 14, 1991 to Employment Agreement between Nancy E. Corsiglia and the Registrant (Previously filed as Exhibit 10.7 to Form 10-K filed April 1, 1991). +* 10.3.3 - Amendment to Employment Contract dated as of June 1, 1993 between Nancy E. Corsiglia and the Registrant (Previously filed as Exhibit 10.9 to Form 10-Q filed November 15, 1993). +* 10.3.4 - Amendment No. 4 dated June 1, 1993 to Employment Contract between Nancy E. Corsiglia and the Registrant (Previously filed as Exhibit 10.10 to Form 10-K filed March 31, 1994). +* 10.3.5 - Amendment No. 5 dated as of June 1, 1994 to Employment Contract between Nancy E. Corsiglia and the Registrant (Previously filed as Exhibit 10.12 to Form 10-Q filed August 15, 1994). +* 10.3.6 - Amendment No. 6 dated as of June 1, 1995 to Employment Contract between Nancy E.Corsiglia and the Registrant(Form 10-Q filed August 14, 1995). +* 10.3.7 - Amendment No. 7 dated as of February 8, 1996 to Employment Contract between Nancy E. Corsiglia and the Registrant (Form 10-K filed March 29, 1996). __________________ * Incorporated by reference to the indicated prior filing. ** Filed herewith. + Management contract or compensatory plan. # Portions of this exhibit have been omitted pursuant to a request for confidential treatment. +* 10.3.8 - Amendment No. 8 dated as of June 13, 1996 to Employment Contract between Nancy E. Corsiglia and the Registrant (Form 10-Q filed August 14, 1996). +* 10.3.9 - Amendment No. 9 dated as of August 7, 1997 to Employment Contract between Nancy E. Corsiglia and the Registrant (Form 10-Q filed November 14, 1997). +* 10.3.10 - Amendment No. 10 dated as of June 4, 1998 to Employment Contract between Nancy E. Corsiglia and the Registrant (Form 10-Q filed August 14, 1998). +* 10.3.11 - Amendment No. 11 dated as of June 3, 1999 to Employment Contract between Nancy E. Corsiglia and the Registrant (Form 10-Q filed August 12, 1999). +* 10.3.12 - Amendment No. 12 dated as of June 1, 2000 to Employment Contract between Nancy E. Corsiglia and the Registrant (Form 10-Q filed August 14, 2000). +* 10.3.13 - Amendment No. 13 dated as of June 7, 2001 to Employment Contract between Nancy E. Corsiglia and the Registrant (Form 10-Q filed August 14, 2001). +* 10.3.14 - Amendment No. 14 dated as of June 6, 2002 to Employment Contract between Nancy E. Corsiglia and the Registrant (Form 10-Q filed August 14, 2002). +* 10.3.15 - Amendment No. 15 dated as of June 5, 2003 to Employment Contract between Nancy E. Corsiglia and the Registrant (Form 10-Q filed August 14, 2003). +* 10.4 - Employment Contract dated as of September 1, 1997 between Tom D. Stenson and the Registrant (Previously filed as Exhibit 10.8 to Form 10-Q filed November 14, 1997). +* 10.4.1 - Amendment No. 1 dated as of June 4, 1998 to Employment Contract between Tom D. Stenson and the Registrant (Previously filed as Exhibit 10.8.1 to Form 10-Q filed August 14, 1998). +* 10.4.2 - Amendment No. 2 dated as of June 3, 1999 to Employment Contract between Tom D. Stenson and the Registrant (Form 10-Q filed August 12, 1999). __________________ * Incorporated by reference to the indicated prior filing. ** Filed herewith. + Management contract or compensatory plan. # Portions of this exhibit have been omitted pursuant to a request for confidential treatment. +* 10.4.3 - Amendment No. 3 dated as of June 1, 2000 to Employment Contract between Tom D. Stenson and the Registrant (Form 10-Q filed August 14, 2000). +* 10.4.4 - Amendment No. 4 dated as of June 7, 2001 to Employment Contract between Tom D. Stenson and the Registrant (Form 10-Q filed August 14, 2001). +* 10.4.5 - Amendment No. 5 dated as of June 6, 2002 to Employment Contract between Tom D. Stenson and the Registrant (Form 10-Q filed August 14, 2002). +* 10.4.6 - Amendment No. 6 dated as of June 5, 2003 to Employment Contract between Tom D. Stenson and the Registrant (Form 10-Q filed August 14, 2003). +* 10.5 - Employment Contract dated February 1, 2000 between Jerome G. Oslick and the Registrant (Previously filed as Exhibit 10.6 to Form 10-Q filed May 11, 2000). +* 10.5.1 - Amendment No. 1 dated as of June 1, 2000 to Employment Contract between Jerome G. Oslick and the Registrant (Previously filed as Exhibit 10.6.1 to Form 10-Q filed August 14, 2000). +* 10.5.2 - Amendment No. 2 dated as of June 7, 2001 to Employment Contract between Jerome G. Oslick and the Registrant (Previously filed as Exhibit 10.6.2 to Form 10-Q filed August 14, 2001). +* 10.5.3 - Amendment No. 3 dated as of June 6, 2002 to Employment Contract between Jerome G. Oslick and the Registrant (Form 10-Q filed August 14, 2002). +* 10.5.4 - Amendment No. 4 dated as of June 5, 2003 to Employment Contract between Jerome G. Oslick and the Registrant (Form 10-Q filed August 14, 2003). +* 10.6 - Employment Contract dated June 5, 2003 between Timothy L. Buzby and the Registrant (Form 10-Q filed August 14, 2003). * 10.7 - Farmer Mac I Seller/Servicer Agreement dated as of August 7, 1996 between Zions First National Bank and the Registrant (Form 10-Q filed November 14, 2002). __________________ * Incorporated by reference to the indicated prior filing. ** Filed herewith. + Management contract or compensatory plan. # Portions of this exhibit have been omitted pursuant to a request for confidential treatment. * 10.8 - Medium-Term Notes U.S. Selling Agency Agreement dated as of October 1, 1998 between Zions First National Bank and the Registrant (Form 10-Q filed November 14, 2002). * 10.9 - Discount Note Dealer Agreement dated as of September 18, 1996 between Zions First National Bank and the Registrant (Form 10-Q filed November 14, 2002). *# 10.10 - ISDA Master Agreement and Credit Support Annex dated as of June 26, 1997 between Zions First National Bank and the Registrant (Form 10-Q filed November 14, 2002). *# 10.11 - Master Central Servicing Agreement dated as of December 17, 1996 between Zions First National Bank and the Registrant (Form 10-Q filed November 14, 2002). *# 10.11.1 - Amendment No. 1 dated as of February 26, 1997 to Master Central Servicing Agreement dated as of December 17, 1996 between Zions First National Bank and the Registrant (Form 10-Q filed November 14, 2002). *# 10.12 - Loan File Review and Underwriting Agreement dated as of December 17, 1996 between Zions First National Bank and the Registrant (Form 10-Q filed November 14, 2002). *# 10.12.1 - Amendment No. 1 dated as of January 20, 2000 to Loan File Review and Underwriting Agreement dated as of December 17, 1996 between Zions First National Bank and the Registrant (Form 10-Q filed November 14, 2002). *# 10.13 - Long Term Standby Commitment to Purchase dated as of August 1, 1998 between AgFirst Farm Credit Bank and the Registrant (Form 10-Q filed November 14, 2002). *# 10.13.1 - Amendment No. 1 dated as of January 1, 2000 to Long Term Standby Commitment to Purchase dated as of August 1, 1998 between AgFirst Farm Credit Bank and the Registrant (Form 10-Q filed November 14, 2002). * 10.13.2 - Amendment No. 2 dated as of September 1, 2002 to Long Term Standby Commitment to Purchase dated as of August 1, 1998, as amended by Amendment No. 1 dated as of January 1, 2000, between AgFirst Farm Credit Bank and the Registrant (Form 10-Q filed November 14, 2002). __________________ * Incorporated by reference to the indicated prior filing. ** Filed herewith. + Management contract or compensatory plan. # Portions of this exhibit have been omitted pursuant to a request for confidential treatment. * 10.14 - Lease Agreement, dated June 28, 2001 between EOP - Two Lafayette, L.L.C. and the Registrant (Previously filed as Exhibit 10.10 to Form 10-K filed March 27, 2002). +** 10.15 - Employment Contract dated October 31, 2003 between Michael P. Morris and the Registrant. 21 - Farmer Mac Mortgage Securities Corporation, a Delaware corporation. ** 31.1 - Certification of Chief Executive Officer relating to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 2003, pursuant to Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. ** 31.2 - Certification of Chief Financial Officer relating to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 2003, pursuant to Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. ** 32 - Certification of Chief Executive Officer and Chief Financial Officer relating to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 2003, pursuant to 18 U.S.C.ss.1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (b) Reports on Form 8-K. On October 16, 2003, Farmer Mac furnished to the Securities and Exchange Commission a Current Report on Form 8-K that attached a press release addressing a report issued by the U.S. General Accounting Office on Farmer Mac. On October 23, 2003, Farmer Mac furnished to the Securities and Exchange Commission a Current Report on Form 8-K that attached a press release announcing Farmer Mac's financial results for third quarter 2003. On November 14, 2003, Farmer Mac filed with the Securities and Exchange Commission a Current Report on Form 8-K reporting that Farmer Mac had filed its Quarterly Report on Form 10-Q for the quarter ended September 30, 2003 and that four of Farmer Mac's officers had each entered into a trading plan in compliance with Securities and Exchange Commission Rule 10b5-1. On December 5, 2003, Farmer Mac filed with the Securities and Exchange Commission a Current Report on Form 8-K announcing that, on December 4, 2003, the Board of Directors of Farmer Mac had declared a quarterly dividend on the Corporation's 6.40% Cumulative Preferred Stock, Series A. __________________ * Incorporated by reference to the indicated prior filing. ** Filed herewith. + Management contract or compensatory plan. # Portions of this exhibit have been omitted pursuant to a request for confidential treatment. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. FEDERAL AGRICULTURAL MORTGAGE CORPORATION /s/ Henry D. Edelman March 12, 2004 ------------------------------------- ------------------------------------- By: Henry D. Edelman Date President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Name Title Date /s/ Fred L. Dailey Chairman of the Board and March 12, 2004 -------------------------------- Director Fred L. Dailey /s/ Henry D. Edelman President and Chief Executive March 12, 2004 -------------------------------- Officer (Principal Executive Henry D. Edelman Officer) /s/ Nancy E. Corsiglia Vice President - Finance, March 12, 2004 -------------------------------- Chief Financial Officer Nancy E. Corsiglia and Treasurer (Principal Financial Officer) /s/ Timothy L. Buzby Vice President - Controller March 12, 2004 -------------------------------- (Principal Accounting Officer) Timothy L. Buzby Name Title Date /s/ Julia Bartling Director March 12, 2004 --------------------------------------- Julia Bartling /s/ Dennis L. Brack Director March 12, 2004 --------------------------------------- Dennis L. Brack /s/ Ralph W. Cortese Director March 12, 2004 --------------------------------------- Ralph W. Cortese /s/ Grace T. Daniel Director March 12, 2004 --------------------------------------- Grace T. Daniel /s/ Paul A. DeBriyn Director March 12, 2004 --------------------------------------- Paul A. DeBriyn /s/ Kenneth E. Graff Director March 12, 2004 --------------------------------------- Kenneth E. Graff /s/ W. David Hemingway Director March 12, 2004 --------------------------------------- W. David Hemingway /s/ Mitchell A. Johnson Director March 12, 2004 --------------------------------------- Mitchell A. Johnson /s/ Lowell L. Junkins Vice Chairman March 12, 2004 --------------------------------------- and Director Lowell L. Junkins /s/ Glen Klippenstein Director March 12, 2004 --------------------------------------- Glen Klippenstein /s/ Charles E. Kruse Director March 12, 2004 --------------------------------------- Charles E. Kruse /s/ John G. Nelson Director March 12, 2004 --------------------------------------- John G. Nelson /s/ Peter T. Paul Director March 12, 2004 --------------------------------------- Peter T. Paul /s/ John Dan Raines, Jr. Director March 12, 2004 --------------------------------------- John Dan Raines, Jr.