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Farm Credit System Reports 2012 Second Quarter and Six-Month Net Income

NEW YORK - The Farm Credit System today reported combined net income of $1.067 billion and $2.119 billion for the three and six months ended June 30, 2012, as compared with combined net income of $982 million and $1.986 billion for the same periods last year.

The System has managed well through the past few years of a strong agricultural economy, noted Tracey McCabe, CEO of the Farm Credit Funding Corporation. This is evidenced by our strong financial position as well as the healthy credit quality of our loan portfolio. In addition, our borrowers, overall, have taken these years to strengthen their own balance sheets. That said, an intrinsic part of our business is the variability in the weather and we continue to monitor the recent drought in the U.S. closely. Generally, the strong financial positions of our borrowers and risk mitigation efforts such as crop insurance and the hedging of input costs will tend to minimize the adverse effects of the present weather conditions. However, some borrowers that depend on crops for inputs may be negatively affected as the implications of the drought unfold.

Results of Operations

Second Quarter and Six-Month 2012 Results Compared to Second Quarter and Six-Month 2011 Results

Combined net income increased $85 million and $133 million for the three and six months ended June 30, 2012, as compared with the same periods in 2011. These increases resulted primarily from decreases in the provision for loan losses of $91 million and $167 million. Also net interest income increased $37 million and $49 million for the 2012 periods under comparison. Partially offsetting these improvements in net income were increases in net noninterest expense of $23 million and $65 million and in the provision for income taxes of $20 million and $18 million.

Net interest income was $1.600 billion and $3.181 billion for the three and six months ended June 30, 2012, as compared with $1.563 billion and $3.132 billion for the same periods of the prior year. The increase in net interest income for the three-month period of 2012, as compared to the same period of the prior year resulted from increased average earning assets and a higher net interest margin, while the increase for the six-month period of 2012, as compared to the same period in 2011 primarily resulted from a higher net interest margin.

The net interest margin was 2.86% and 2.87% for the three and six months ended June 30, 2012, as compared with 2.83% and 2.82% for the three and six months ended June 30, 2011. Positively impacting the net interest margin was an increase in the net interest spread to 2.71% and 2.72% for the three and six months ended June 30, 2012, as compared with 2.66% and 2.65% for the same periods of the prior year. The increase in the net interest spread was due, in part, to the Banks’ ability to refinance their outstanding debt at favorable interest rates in the current lower interest rate environment. The Banks called debt totaling $30.5 billion during the first six months of 2012, as compared with $20.0 billion for the first six months of 2011, and were able to lower their cost of funds relative to their assets, which did not reprice as quickly. Over time, as interest rates increase or assets prepay or reprice in a manner consistent with historical experience, the positive impact on the net interest spread that the System has experienced over the past several years from calling Systemwide Debt Securities will likely diminish. The net interest spread was also favorably impacted by the net accretion of the fair value adjustments related to the merger of two System Banks (see the section entitled Mergers below) of $25 million and $46 million for the three and six months ended June 30, 2012.

Partially offsetting these increases in the net interest spread was a change in asset mix resulting from the average loan volume declines in the System’s higher spread agribusiness loans. In addition, competition has increased for certain types of loans in certain areas of the U.S. putting additional pressure on the net interest spreads.

The System recognized provisions for loan losses of $35 million and $67 million for the three- and six-month periods ended June 30, 2012, as compared with provisions for loan losses of $126 million and $234 million for the three- and six-month periods ended June 30, 2011. The decreases in the provisions for loan losses reflect a lower level of probable and estimable losses recognized during the 2012 periods. The provisions for loan losses recorded during the first six months of 2012 and 2011 reflected credit deterioration primarily in those agricultural sectors impacted by the volatility in commodity prices, such as livestock, ethanol and dairy, as well as those sectors affected by the overall weakness in the general U.S. economy, such as forestry and nurseries. These factors, as well as the drought’s impact on crop prices and yields, are expected to weigh on the livestock, ethanol, dairy and poultry industries and other agricultural sectors in the future.

Noninterest income decreased $2 million and $14 million to $135 million and $257 million for the three and six months ended June 30, 2012, as compared with the same periods of the prior year. The decrease for the six-month period ended June 30, 2012 was primarily due to a $34 million increase in losses on extinguishment of debt and to a $14 million decrease in income earned on Insurance Fund assets, partially offset by a $22 million decrease in net other-than- temporary impairment losses on investments and to a $20 million increase in mineral income.

Noninterest expense increased $21 million and $51 million to $547 million and $1.098 billion for the three and six months ended June 30, 2012, as compared with the same periods of the prior year. The increases for the three- and six-month periods were primarily due to increases in salaries and employee benefits and to an increase in other operating expenses. The increase for the six-month period included a one-time pension charge of $14 million in the first quarter of 2012 related to the merger of two System Banks (see section entitled Mergers below).

The provisions for income taxes were $86 million and $154 million for the three and six months ended June 30, 2012, as compared with $66 million and $136 million for the three and six months ended June 30, 2011. The effective tax rate was 6.8% for the six months ended June 30, 2012, as compared with 6.4% for the six months ended June 30, 2011.

Second Quarter 2012 Compared to First Quarter 2012

Net income was $1.067 billion for the second quarter of 2012, as compared with net income of $1.052 billion for the first quarter of 2012. The increase in net income was due to an increase in net interest income of $19 million, an increase in noninterest income of $13 million and a decrease in noninterest expense of $4 million offset, in part, by increases in the provision for loan losses of $3 million and the provision for income taxes of $18 million.

Loan Portfolio Activity

Gross loans increased $6.855 billion or 3.9% to $181.519 billion at June 30, 2012, as compared with $174.664 billion at December 31, 2011, primarily due to increases in real estate mortgage and agribusiness loans, offset in part by a decrease in production and intermediate-term loans. Real estate mortgage loans increased primarily due to strong demand for cropland. Agribusiness loans increased due to seasonal increases in loans to agribusiness cooperatives largely in the farm supply and grain marketing sectors and to an increase in commodity prices. The decrease in production and intermediate-term loans was primarily due to lower than expected increases in operating lines of credit due to the strong financial positions of agricultural producers.

Credit Quality

The System’s accruing loan volume was $178.969 billion at June 30, 2012, as compared with $171.926 billion at December 31, 2011. Nonaccrual loans decreased $188 million to $2.550 billion at June 30, 2012, as compared with $2.738 billion at December 31, 2011. This decrease in nonaccrual loans was attributed to charge-offs, repayments and the improvement in the credit quality of certain loans. At June 30, 2012, 55.5% of nonaccrual loans were current as to principal and interest, as compared with 52.8% at December 31, 2011.

Nonperforming loans (which consist of nonaccrual loans, accruing restructured loans, and accruing loans 90 days or more past due) decreased $213 million to $2.784 billion at June 30, 2012, as compared with December 31, 2011. These nonperforming loans represented 1.53% of the System’s loans at June 30, 2012 and 1.72% at December 31, 2011.

The System’s other credit quality indicators also improved or remained at generally favorable levels during the second quarter of 2012. Loans classified under the Farm Credit Administration’s Uniform Loan Classification System as acceptable or other assets especially mentioned as a percentage of loans and accrued interest receivable were 96.6% at June 30, 2012 and 96.2% at December 31, 2011. Loan delinquencies (accruing loans 30 days or more past due) as a percentage of accruing loans remained at a low level of 0.28% at June 30, 2012, as compared with 0.39% at June 30, 2011.

Notwithstanding these generally favorable credit quality indicators, certain parts of the U.S., particularly the Midwest, have been experiencing extensive drought conditions over the past couple of months. Nevertheless, the majority of crop producers carry crop insurance and have generally enjoyed several years of favorable economic conditions, which should mitigate the impact of the drought on these borrowers. However, System borrowers who depend on crops as an input, including poultry, dairy, ethanol, beef and hog producers, may be negatively impacted by higher commodity prices that result from these drought conditions.

The allowance for loan losses was $1.241 billion at June 30, 2012, as compared with $1.290 billion at December 31, 2011. Net loan charge-offs of $93 million were recorded during the first six months of 2012, as compared with net loan charge-offs of $188 million for the same period of the prior year. The charge-offs recognized in both 2012 and 2011 primarily related to those sectors impacted by the continuing weakness in the general U.S. economy, particularly in specific industries such as forestry and nurseries.

The allowance for loan losses as a percentage of total loans was 0.68% at June 30, 2012 and 0.74% at December 31, 2011. The allowance for loan losses was 45% of the System’s total nonperforming loans and 49% of its nonaccrual loans at June 30, 2012, as compared with 43% and 47% at December 31, 2011. Total capital and the allowance for loan losses, which is a measure of risk-bearing capacity, totaled $38.719 billion at June 30, 2012 and $37.230 billion at December 31, 2011, and represented 21.3% of System loans at both June 30, 2012 and December 31, 2011.

Liquidity and Capital Resources

Cash and investments (principally all of which were held for liquidity purposes) was $46.625 billion at June 30, 2012 and $47.281 billion at December 31, 2011. The System’s liquidity position represented 180 days coverage of maturing debt obligations at June 30, 2012, as compared with 194 days at December 31, 2011.

Total capital increased $1.538 billion during the first six months of 2012 to $37.478 billion. The System’s surplus increased $1.158 billion to $30.891 billion during the first six months of 2012 due to net income earned and retained and from a $222 million transfer of restricted capital to surplus as a result of the declaration of premium refunds by the Farm Credit System Insurance Corporation (a U.S. government-controlled independent entity) offset, in part, by the re- characterization of $283 million of surplus as additional paid-in-capital in connection with the merger of two Associations and the net reduction of $469 million in surplus due to the fair value adjustments in connection with the merger of two System Banks effective January 1, 2012. This surplus reduction includes a recharacterization of $259 million of accumulated other comprehensive loss that resulted from the Bank merger. For additional information on the mergers, see the section entitled Mergers below. Capital as a percentage of total assets increased to 15.9% at June 30, 2012, as compared with 15.6% at December 31, 2011.

Mergers

On January 1, 2012, U.S. AgBank, FCB, one of the System Banks, merged with and into CoBank, FCB, a wholly-owned subsidiary of CoBank, ACB, another one of the System Banks. CoBank, ACB and CoBank, FCB (collectively, CoBank, ACB) are required to comply, on a consolidated basis, with applicable System regulatory requirements and are jointly and severally liable on each other’s debts and obligations, including Systemwide Debt Securities. As a result, the System now effectively has four System Banks (CoBank, ACB; AgFirst Farm Credit Bank; AgriBank, FCB; and Farm Credit Bank of Texas). In addition, on January 1, 2012, two Associations affiliated with the former U.S. AgBank merged. The mergers were accounted for under the acquisition method of accounting. The resulting fair value adjustments and the net accretion for the period of the adjustments required under the accounting guidance for these mergers were not material to the System’s combined financial position or results of operations.

About the Farm Credit System

The Farm Credit System is a federally chartered network of borrower-owned lending institutions and related service organizations. The System specializes in providing financing and related services to borrowers in the agricultural and rural sectors through the four Banks and 82 affiliated Associations. Unlike commercial banks, the Banks are not legally authorized to accept deposits and they principally obtain their funds through the issuance of Systemwide Debt Securities.

Additional Information

Copies of this press release, as well as other financial information regarding the System, including its annual and quarterly information statements, are available on the Federal Farm Credit Banks Funding Corporation’s website at www.farmcreditfunding.com. Additional information regarding the Farm Credit System is available on the System’s website at www.farmcredit.com.

For further information and copies of annual and quarterly information statements, contact:

H. John Marsh, Jr., Managing Director
Financial Management Division
Federal Farm Credit Banks Funding Corporation
10 Exchange Place, Suite 1401
Jersey City, NJ 07302 (201) 200-8071
jmarsh@farmcreditfunding.com

Forward-Looking Statements

Any forward-looking statements in this press release are based on current expectations and are subject to uncertainty and changes in circumstances. Actual results may differ materially from expectations due to a number of risks and uncertainties. More information about these risks and uncertainties is contained in the System’s annual and quarterly information statements. The System undertakes no duty to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

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