Note 7.

Fair Value Disclosure

Fair Value Measurement

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (also referred to as an exit price).

In determining fair value, Farmer Mac uses various valuation approaches, including market, income and/or cost approaches. The fair value hierarchy requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. When available, the fair value of Farmer Mac’s financial instruments is based on quoted market prices, valuation techniques that use observable market-based inputs or unobservable inputs that are corroborated by market data. Pricing information obtained from third parties is internally validated for reasonableness prior to use in the condensed consolidated financial statements.

When observable market prices are not readily available, Farmer Mac estimates fair value using techniques that rely on alternate market data or internally-developed models using significant inputs that are generally less readily observable. Market data includes prices of financial instruments with similar maturities and characteristics, interest rate yield curves, measures of volatility and prepayment rates. If market data needed to estimate fair value is not available, Farmer Mac estimates fair value using internally-developed models that employ a discounted cash flow approach. Even when market assumptions are not readily available, Farmer Mac’s assumptions reflect those that market participants would likely use in pricing the asset or liability at the measurement date.

The fair value hierarchy ranks the quality and reliability of the information used to determine fair values. The hierarchy gives highest priority to unadjusted quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The standard describes the following three levels used to classify fair value measurements:

Level 1

Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.

Level 2

Quoted prices in markets that are not active or financial instruments for which all significant inputs are observable, either directly or indirectly.

Level 3

Prices or valuations that require unobservable inputs that are significant to the fair value measurement.

Farmer Mac performs a detailed analysis of the assets and liabilities carried at fair value to determine the appropriate level based on the transparency of the inputs used in the valuation techniques. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, an instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. Farmer Mac’s assessment of the significance of a particular input to the fair value measurement of an instrument requires judgment and consideration of factors specific to the instrument. While Farmer Mac believes its valuation methods are appropriate and consistent with those of other market participants, using different methodologies or assumptions to determine fair value could result in a materially different estimate of the fair value of some financial instruments.

The following is a description of the fair value techniques used for instruments measured at fair value as well as the general classification of such instruments pursuant to the valuation hierarchy described above. Fair value measurements related to financial instruments that are reported at fair value in the consolidated financial statements each period are referred to as recurring fair value measurements. Fair value measurements related to financial instruments that are not reported at fair value each period but are subject to fair value adjustments in certain circumstances are referred to as non-recurring fair value measurements.

Recurring Fair Value Measurements and Classification

Available-for-Sale and Trading Investment Securities

The fair value of investments in U.S. Treasuries is based on unadjusted quoted prices in active markets. Farmer Mac classifies these fair value measurements as level 1.

For a significant portion of Farmer Mac’s investment portfolio, including most asset-backed securities, corporate debt securities, senior agency debt securities, Government/GSE guaranteed mortgage-backed securities and preferred stock issued by GSEs, fair value is primarily determined using a reputable and nationally recognized third party pricing service. The prices obtained are non-binding and generally representative of recent market trades. The fair value of certain asset-backed and Government guaranteed mortgage-backed securities are estimated based on quotations from brokers or dealers. Farmer Mac corroborates its primary valuation source by obtaining a secondary price from another independent third party pricing service. Farmer Mac classifies these fair value measurements as level 2.

For investment securities that are thinly traded or not quoted, Farmer Mac estimates fair value using internally-developed models that employ a discounted cash flow approach. Farmer Mac maximizes the use of observable market data, including prices of financial instruments with similar maturities and characteristics, interest rate yield curves, measures of volatility and prepayment rates. Farmer Mac generally considers a market to be thinly traded or not quoted if the following conditions exist: (1) there are few transactions for the financial instruments; (2) the prices in the market are not current; (3) the price quotes vary significantly either over time or among independent pricing services or dealers; or (4) there is a limited availability of public market information. Farmer Mac classifies these fair value measurements as level 3.

Farmer Mac classifies its estimates of fair value for auction-rate certificates (“ARCs”) as level 3 measurements. Farmer Mac uses unadjusted quotes from a broker specializing in these types of securities to determine the estimated fair value of these investments as of each quarter end. Farmer Mac believes these quotes are the best indication of fair value as of the measurement date, although there is uncertainty regarding the ability to transact at such levels. Considering (1) there is no active secondary market for these securities, although limited observable transactions do occasionally occur, (2) price quotes vary significantly among dealers or independent pricing services, if provided at all, and (3) there is little transparency in the price determination, Farmer Mac believes these measurements are appropriately classified as level 3. Prior to 2010, Farmer Mac used a discounted cash flow model to determine the estimated fair value of these investments as of each quarter end. The assumptions used in preparing the model included estimates for the amount and timing of future interest and principal payments and the rate of return required by investors to own these securities in the current environment. In making these assumptions, Farmer Mac considered relevant factors including: the formula for each security that defines the interest rate paid to investors in the event of a failed auction; forward projections of the interest rate benchmarks specified in such formulas; the likely timing of principal repayments; the probability of full repayment considering the underlying student loans are backed by the full faith and credit of the United States; and, publicly available pricing data for student loan asset-backed securities that are not subject to auctions. Farmer Mac classified these fair value measurements as level 3.

Net transfers in and/or out of the different levels within the fair value hierarchy are based on the fair values of the assets as of the beginning of the quarterly reporting period. Farmer Mac made no transfers within the fair value hierarchy for the fair value measurements of its investment securities in the first half of 2011. Transfers within the fair value hierarchy for the fair value measurements of investment securities in first quarter 2010 are described below.

During the first half of 2010, Farmer Mac transferred its investments in the subordinated debt and preferred stock of CoBank, ACB and its investment in the preferred stock of AgFirst Farm Credit Bank, with par values of $70.0 million, $88.5 million and $88.0 million, respectively, as of December 31, 2009, from level 3 measurements to level 2 measurements. Taking into consideration its own recently executed trades during first quarter 2010, along with an increase in observable trading activity for these securities, Farmer Mac determined that the best estimates of fair value for these securities as of March 31, 2010 and continuing through June 30, 2011, were the fair values provided by an independent third party pricing service. Farmer Mac transferred these securities out of level 3 based on their fair values as of the beginning of the first quarter 2010.

Available-for-Sale and Trading Farmer Mac Guaranteed Securities and USDA Guaranteed Securities

Farmer Mac estimates the fair value of its Farmer Mac Guaranteed Securities and USDA Guaranteed Securities by discounting the projected cash flows of these instruments at projected interest rates. The fair values are based on the present value of expected cash flows using management’s best estimate of certain key assumptions, which include prepayment speeds, forward yield curves and discount rates commensurate with the risks involved. Farmer Mac classifies these measurements as level 3 because there is limited market activity and therefore little or no price transparency. On a sample basis, Farmer Mac corroborates the fair value of its Farmer Mac Guaranteed Securities and USDA Guaranteed Securities by obtaining a secondary valuation from an independent third party service.

Farmer Mac made no transfers within the fair value hierarchy for the fair value measurements of Farmer Mac Guaranteed Securities and USDA Guaranteed Securities in the first six months of 2011. Transfers out of level 3 during first quarter 2010 resulted from the consolidation of certain trusts whereby the underlying assets were no longer reported at fair value on a recurring basis. Transfers out of level 3 are based on the fair values of the assets as of the beginning of the quarterly reporting period and are described in more detail below.

Upon the adoption of the new accounting guidance on consolidation on January 1, 2010, Farmer Mac was deemed to be the primary beneficiary of certain VIEs where Farmer Mac held beneficial interests in trusts used as vehicles for the securitization of agricultural real estate mortgage loans or rural utilities loans. Prior to 2010, Farmer Mac presented these beneficial interests as “Farmer Mac Guaranteed Securities” on the condensed consolidated balance sheet and reported them at their fair value. Upon consolidation, Farmer Mac transferred these assets from “Farmer Mac Guaranteed Securities” to “Loans held for investment in consolidated trusts.” These loans are reported at their amortized cost and are no longer included in recurring fair value measurements. Farmer Mac transferred these securities out of level 3 based on their fair values as of the beginning of the first quarter 2010.

Financial Derivatives

The fair value of exchange-traded U.S. Treasury futures is based on unadjusted quoted prices for identical financial instruments. Farmer Mac classifies these fair value measurements as level 1.

Farmer Mac’s derivative portfolio consists primarily of interest rate swaps, credit default swaps and forward sales contracts on the debt of other GSEs. Farmer Mac estimates the fair value of these financial instruments based upon the counterparty valuations. Farmer Mac internally values its derivative portfolio using a discounted cash flow valuation technique and obtains a secondary valuation for certain interest rate swaps to corroborate the counterparty valuations. Farmer Mac also regularly reviews the counterparty valuations as part of the collateral exchange process. Farmer Mac classifies these fair value measurements as level 2.

Certain basis swaps are nonstandard interest rate swap structures and are therefore internally modeled using significant assumptions and unobservable inputs, resulting in level 3 classification. Farmer Mac uses a discounted cash flow valuation technique, using management’s best estimate of certain key assumptions, which include prepayment speeds, forward yield curves and discounted rates commensurate with the risks involved.

As of June 30, 2011 and December 31, 2010, the consideration of credit risk related to both Farmer Mac and the counterparties resulted in an adjustment to the valuations of Farmer Mac’s derivative portfolio of $(0.2) million and $(0.4) million, respectively. See Note 1(c) for further information regarding Farmer Mac’s derivative portfolio.

Nonrecurring Fair Value Measurements and Classification

Loans Held for Sale

Loans held for sale are reported at the lower of cost or fair value in the condensed consolidated balance sheets. Farmer Mac internally models the fair value of loans by discounting the projected cash flows of these instruments at projected interest rates. The fair values are based on the present value of expected cash flows using management’s best estimate of certain key assumptions, which include prepayment speeds, forward yield curves and discount rates commensurate with the risks involved. The fair values of these instruments are classified as level 3 measurements. As of June 30, 2011, Farmer Mac recorded an adjustment of $9.9 million to report loans held for sale at the lower of cost or fair value. As of December 31, 2010, Farmer Mac recorded an adjustment of $8.7 million to report loans held for sale at the lower of cost or fair value.

Real Estate Owned

Farmer Mac initially records REO properties at fair value less costs to sell and subsequently records them at the lower of carrying value or fair value less costs to sell. The fair value of REO is determined by third-party appraisals when available. When third-party appraisals are not available, fair value is estimated based on factors such as prices for comparable properties in similar geographical areas and/or assessment through observation of such properties. Farmer Mac classifies the REO fair values as level 3 measurements.

Fair Value Classification and Transfers

As of June 30, 2011, Farmer Mac’s assets and liabilities recorded at fair value include financial instruments valued at $5.1 billion whose fair values were estimated by management in the absence of readily determinable fair values (i.e., level 3). These financial instruments measured as level 3 represented 49 percent of the total assets and 70 percent of financial instruments measured at fair value as of June 30, 2011. As of December 31, 2010, Farmer Mac’s asset and liabilities recorded at fair value included financial instruments valued at $4.6 billion whose fair values were estimated by management in the absence of readily determinable fair values (i.e., level 3). These financial instruments measured as level 3 represented 49 percent of the total assets and 71 percent of financial instruments measured at fair value as of December 31, 2010.

The following tables present information about Farmer Mac’s asset and liabilities measured at fair value on a recurring and nonrecurring basis as of June 30, 2011 and December 31, 2010, respectively, and indicate the fair value hierarchy of the valuation techniques used by Farmer Mac to determine such fair value.

Assets and Liabilities Measured at Fair Value as of June 30, 2011

	Level 1		Level 2		Level 3		Total
Recurring:	(in thousands)
Assets:
Investment Securities:
Available-for-sale:
Floating rate auction-rate certificates backed
by Government guaranteed student loans	$	-	$	-	$	64,682	$	64,682
Floating rate asset-backed securities		-		162,534		-		162,534
Floating rate corporate debt securities		-		113,290		-		113,290
Floating rate Government/GSE
guaranteed mortgage-backed securities		-		633,972		-		633,972
Fixed rate GSE guaranteed mortgage-backed
securities		-		4,167		-		4,167
Floating rate GSE subordinated debt		-		62,565		-		62,565
Fixed rate GSE preferred stock		-		82,377		-		82,377
Fixed rate corporate debt		-		34,382		-		34,382
U.S. Treasuries		834,744		-		-		834,744
Senior agency debt		-		13,001		-		13,001
Total available-for-sale		834,744		1,106,288		64,682		2,005,714
Trading:
Floating rate asset-backed securities		-		-		2,209		2,209
Fixed rate GSE preferred stock		-		85,942		-		85,942
Total trading		-		85,942		2,209		88,151
Total Investment Securities		834,744		1,192,230		66,891		2,093,865
Farmer Mac Guaranteed Securities:
Available-for-sale:
Farmer Mac I		-		-		1,759,205		1,759,205
Farmer Mac II		-		-		36,530		36,530
Rural Utilities		-		-		1,448,230		1,448,230
Total Farmer Mac Guaranteed Securities		-		-		3,243,965		3,243,965
USDA Guaranteed Securities:
Available-for-sale		-		-		1,120,397		1,120,397
Trading		-		-		249,074		249,074
Total USDA Guaranteed Securities		-		-		1,369,471		1,369,471
Financial derivatives		28		43,948		-		43,976
Total Assets at fair value	$	834,772	$	1,236,178	$	4,680,327	$	6,751,277
Liabilities:
Financial derivatives	$	-	$	107,396	$	1,755	$	109,151
Total Liabilities at fair value	$	-	$	107,396	$	1,755	$	109,151
Nonrecurring:
Assets:
Loans held for sale	$	-	$	-	$	441,890	$	441,890
Loans held for investment		-		-		12,246		12,246
REO		-		-		705		705
Total Nonrecurring Assets at fair value	$	-	$	-	$	454,841	$	454,841

Assets and Liabilities Measured at Fair Value as of December 31, 2010

	Level 1		Level 2		Level 3		Total
Recurring:	(in thousands)
Assets:
Investment Securities:
Available-for-sale:
Floating rate auction-rate certificates backed
by Government guaranteed student loans	$	-	$	-	$	64,335	$	64,335
Floating rate asset-backed securities		-		29,458		-		29,458
Floating rate corporate debt securities		-		163,188		-		163,188
Floating rate Government/GSE
guaranteed mortgage-backed securities		-		576,780		-		576,780
Fixed rate GSE guaranteed mortgage-backed
securities		-		4,821		-		4,821
Floating rate GSE subordinated debt		-		55,329		-		55,329
Fixed rate GSE preferred stock		-		84,828		-		84,828
U.S. Treasuries		692,994		-		-		692,994
Senior agency debt		-		5,500		-		5,500
Total available-for-sale		692,994		919,904		64,335		1,677,233
Trading:
Floating rate asset-backed securities		-		-		1,400		1,400
Fixed rate GSE preferred stock		-		84,696		-		84,696
Total trading		-		84,696		1,400		86,096
Total Investment Securities		692,994		1,004,600		65,735		1,763,329
Farmer Mac Guaranteed Securities:
Available-for-sale:
Farmer Mac I		-		-		942,809		942,809
Farmer Mac II		-		-		37,637		37,637
Rural Utilities		-		-		1,926,818		1,926,818
Total available-for-sale		-		-		2,907,264		2,907,264
Total Farmer Mac Guaranteed Securities		-		-		2,907,264		2,907,264
USDA Guaranteed Securities:
Available-for-sale		-		-		1,005,679		1,005,679
Trading		-		-		311,765		311,765
Total USDA Guaranteed Securities		-		-		1,317,444		1,317,444
Financial derivatives		-		41,492		-		41,492
Total Assets at fair value	$	692,994	$	1,046,092	$	4,290,443	$	6,029,529
Liabilities:
Financial derivatives	$	6	$	110,291	$	3,390	$	113,687
Total Liabilities at fair value	$	6	$	110,291	$	3,390	$	113,687
Nonrecurring:
Assets:
Loans held for sale	$	-	$	-	$	331,076	$	331,076
Loans held for investment		-		-		11,971		11,971
REO		-		-		1,925		1,925
Total Nonrecurring Assets at fair value	$	-	$	-	$	344,972	$	344,972

The following tables present additional information about assets and liabilities measured at fair value on a recurring and nonrecurring basis classified as level 3 measurements. Net transfers in and/or out of level 3 are based on the fair values of the assets and liabilities as of the beginning of the quarterly reporting period.

Level 3 Assets and Liabilities Measured at Fair Value for the Three Months Ended June 30, 2011
												Realized and			Unrealized
												Unrealized			Gains/(Losses)
												Gains/(Losses)			included in Other
	Beginning											included in			Comprehensive			Transfers		Transfers			Ending
	Balance			Purchases		Sales			Settlements			Income			Income			In		Out			Balance
Recurring:	(in thousands)
Assets:
Investment Securities:
Available-for-sale:
Floating rate auction-rate certificates backed
by Government guaranteed student loans	$	64,539		$	-	$	-		$	-		$	-		$	143		$	-	$	-		$	64,682
Trading:
Floating rate asset-backed securities(1)		1,690			-		-			(168	)		687			-			-		-			2,209
Total Investment Securities		66,229			-		-			(168	)		687			143			-		-			66,891
Farmer Mac Guaranteed Securities:
Available-for-sale:
Farmer Mac I		1,429,318			300,000		-			(6	)		-			29,893			-		-			1,759,205
Farmer Mac II		37,803			981		(1,041	)		(1,134	)		-			(79	)		-		-			36,530
Rural Utilities		1,442,793			-		-			-			-			5,437			-		-			1,448,230
Total Farmer Mac Guaranteed Securities		2,909,914			300,981		(1,041	)		(1,140	)		-			35,251			-		-			3,243,965
USDA Guaranteed Securities:
Available-for-sale		1,063,540			98,464		-			(48,951	)		-			7,344			-		-			1,120,397
Trading(2)		274,561			-		-			(26,985	)		1,498			-			-		-			249,074
Total USDA Guaranteed Securities		1,338,101			98,464		-			(75,936	)		1,498			7,344			-		-			1,369,471
Total Assets at fair value	$	4,314,244		$	399,445	$	(1,041	)	$	(77,244	)	$	2,185		$	42,738		$	-	$	-		$	4,680,327
Liabilities:
Financial derivatives(3)	$	(1,671	)	$	-	$	-		$	-		$	(84	)	$	-		$	-	$	-		$	(1,755	)
Total Liabilities at fair value	$	(1,671	)	$	-	$	-		$	-		$	(84	)	$	-		$	-	$	-		$	(1,755	)
Nonrecurring:
Assets:
Loans held for sale	$	406,168		$	-	$	-		$	-		$	(156	)	$	-		$	35,878	$	-		$	441,890
Loans held for investment		12,399			-		-			-			-			-			-		(153	)		12,246
REO		1,573			-		-			(974	)		(101	)		-			207		-			705
Total Nonrecurring Assets at fair value	$	420,140		$	-	$	-		$	(974	)	$	(257	)	$	-		$	36,085	$	(153	)	$	454,841

(1)	Unrealized gains are attributable to assets still held as of June 30, 2011 and are recorded in gains on trading assets.

(2)	Includes unrealized gains of $0.3 million attributable to assets still held as of June 30, 2011 that are recorded in gains on trading assets.

(3)	Unrealized losses are attributable to liabilities still held as of June 30, 2011 and are recorded in losses on financial derivatives.

Fair Value Option

Accounting guidance on the fair value option for financial instruments permits entities to make a one-time irrevocable election to report financial instruments at fair value with changes in fair value recorded in earnings as they occur. This guidance provides entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions.

Farmer Mac made no fair value option elections for the three and six months ended June 30, 2011 and 2010. For the three and six months ended June 30, 2011, Farmer Mac recorded net gains on trading assets of $1.3 million and $1.9 million, respectively, for changes in fair values of assets previously selected for the fair value option, compared to net gains of $4.9 million and $8.4 million, respectively, for the same periods ended June 30, 2010. These changes in fair value are presented as “Gains on trading assets” in the condensed consolidated statements of operations.

Disclosures about Fair Value of Financial Instruments

The following table sets forth the estimated fair values and the carrying amounts for financial assets, liabilities and guarantees and commitments as of June 30, 2011 and December 31, 2010 in accordance with accounting guidance on disclosures about fair value of financial instruments.

	June 30, 2011				December 31, 2010
	Fair Value		Carrying Amount		Fair Value		Carrying Amount
	(in thousands)
Financial assets:
Cash and cash equivalents	$	768,335	$	768,335	$	729,920	$	729,920
Investment securities		2,093,865		2,093,865		1,763,329		1,763,329
Farmer Mac Guaranteed Securities		3,243,965		3,243,965		2,907,264		2,907,264
USDA Guaranteed Securities		1,369,471		1,369,471		1,317,444		1,317,444
Loans		2,890,033		2,787,437		2,642,399		2,558,599
Financial derivatives		43,976		43,976		41,492		41,492
Interest receivable		88,852		88,852		90,295		90,295
Guarantee and commitment fees receivable:
LTSPCs		23,905		13,988		14,191		13,666
Farmer Mac Guaranteed Securities		20,608		17,836		19,058		21,086
Financial liabilities:
Notes payable:
Due within one year		5,205,836		5,201,832		4,510,758		4,509,419
Due after one year		3,868,825		3,744,877		3,530,656		3,430,656
Debt securities of consolidated trusts held by
third parties		818,189		755,357		883,669		827,411
Financial derivatives		109,151		109,151		113,687		113,687
Accrued interest payable		56,152		56,152		57,131		57,131
Guarantee and commitment obligations:
LTSPCs		23,018		13,100		13,152		12,627
Farmer Mac Guaranteed Securities		17,298		14,528		15,653		17,681

The carrying amount of cash and cash equivalents, certain short-term investment securities, interest receivable and accrued interest payable is a reasonable estimate of their approximate fair value. Farmer Mac estimates the fair value of its loans, guarantee and commitment fees receivable/obligation and notes payable by discounting the projected cash flows of these instruments at projected interest rates. The fair values are based on the present value of expected cash flows using management’s best estimate of certain key assumptions, which include prepayment speeds, forward yield curves and discount rates commensurate with the risks involved. 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. Different market assumptions and estimation methodologies could significantly affect estimated fair value amounts.