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Farm Credit System Reports Net Income of $4.118 Billion for 2012

NEW YORK - The Farm Credit System today reported combined net income of $4.118 billion for the year ended December 31, 2012, as compared with $3.940 billion for the prior year.  The System also reported combined net income of $960 million for the fourth quarter of 2012, as compared with $946 million for the fourth quarter of 2011.

Strong global and domestic demand for U.S. agricultural products continued throughout 2012, bolstering the earnings of agricultural producers and contributing to solid earnings recognized by the System, remarked Tracey McCabe, President and CEO of the Federal Farm Credit Banks Funding Corporation.   Despite the extensive drought in certain areas of the U.S., particularly in the Midwest, that reduced crop yields and increased crop prices, most crop and livestock producers’ incomes remained favorable as they took advantage of risk management tools such as crop insurance and hedges of input costs.  To date, the drought conditions in the Midwest,  while  moderating in  certain  areas,  have  continued  into  2013.  These  conditions, together with an uncertain global economic environment, may put pressure on certain of our borrowers and ultimately our results of operations in 2013.

2012 Results of Operations

The $178 million increase in combined net income for the year ended December 31, 2012, as compared with 2011 resulted from an increase in net interest income of $218 million and from decreases in the provision for loan losses of $117 million and provision for income taxes of $47 million, partially offset by an increase in noninterest expense of $138 million and a decrease in noninterest income of $66 million.

Net interest income increased to $6.477 billion or 3.5% for 2012, as compared with $6.259 billion for the prior year.  The increase in net interest income resulted primarily from a higher level of average earning assets, which grew $7.469 billion or 3.4% to $226.042 billion for 2012 largely due to increased loan volume.

Net interest margin increased one basis point to 2.87% for 2012, as compared with 2.86% for

2011.  Positively impacting the net interest margin was an increase in the net interest spread of three basis points to 2.71% for 2012, as compared with the net interest spread of 2.68% for

2011.  The increase in the net interest spread was primarily attributable to the System Banks’ ability to refinance outstanding debt at favorable interest rates in the current low interest rate environment.  During 2012, the Banks called debt totaling $62.7 billion and were able to lower their cost of funds relative to their earning assets, which did not reprice as quickly.   In this environment, a number of System institutions were also able to increase their net interest spreads on repriced assets, while at the same time providing borrowers with lower interest rate products.    As  interest rates  change and  as  assets  prepay  or  reprice  in  a  manner more consistent with historical experience, the positive impact on the net interest spread that the System has experienced over the last several years from calling Systemwide Debt Securities will likely diminish.

The net interest spread for 2012 was also favorably impacted by the $90 million of net accretion of asset and liability fair value adjustments related to the January 1, 2012 merger of two System Banks (see the section entitled Mergers below).  Offsetting these positive impacts on the net interest spread for the year ended December 31, 2012, as compared with the prior year, was increased competition in many areas of the U.S. for certain types of loans, placing downward pressure on the net interest spread.

The System recognized provisions for loan losses of $313 million and $430 million for the years ended December 31, 2012 and 2011.  While the overall agricultural economy has performed well during the year, credit stress in certain agricultural sectors continued to adversely impact certain System borrowers. The provisions for loan losses for both 2012 and 2011 were primarily due to credit deterioration in agricultural sectors that continue to be impacted by volatility in commodity and other input prices, such as livestock, ethanol and dairy, as well as those borrowers impacted by the overall continued weakness of the general U.S. economy and housing industry, such as forestry and nurseries.  These factors, including the U.S. drought’s impact on crop prices and yields, are expected to weigh on the livestock, ethanol, dairy and poultry industries and other agricultural sectors that are exposed to grains as an input cost. Also, the provision for loans losses for 2012 was impacted by specific credit challenges for a small number of communication and rural energy customers.

Noninterest income decreased $66 million or 11.6% to $502 million for 2012, as compared with $568  million  for  2011.    The  decrease  resulted  primarily  from  an  increase  in  losses  on extinguishment of debt of $73 million and to decreases in loan-related fee income of $31 million and income earned on Insurance Fund assets of $26 million, partially offset by an increase in mineral income of $27 million and a decrease in net other-than-temporary impairment losses on investment securities of $22 million.  The increase in losses on extinguishment of debt resulted from debt being called and repurchased in connection with increased loan prepayments and from one Bank’s repurchase of its subordinated debt.

Noninterest expense increased $138 million or 6.3% to $2.326 billion for 2012, as compared with $2.188 billion for 2011 primarily due to increases in salaries and employee benefits and other operating expenses. Salaries and employee benefit expense increased $109 million or 8.1%  to  $1.458  billion  for  2012  primarily  due  to  annual  merit  and  performance-based compensation increases, to higher pension-related costs and, to a lesser extent, higher staffing levels at certain System institutions.  Other operating expense increased $45 million for 2012, as compared with 2011, primarily due to increases in various administrative expenses.

The System recorded a provision for income taxes of $222 million for 2012, as compared with $269 million for 2011.  The effective tax rate decreased to 5.1% for 2012 from 6.4% for 2011. The decrease in the effective tax rate was primarily attributable to decreased taxable earnings at certain taxable System institutions and from a greater amount of patronage declared during 2012.

Fourth Quarter 2012 Results of Operations

Combined net income increased $14 million to $960 million for the fourth quarter of 2012, as compared with $946 million for the fourth quarter of 2011.  The increase in net income between the fourth-quarter periods primarily resulted from an increase in net interest income of $95 million and a decrease in the provision for income taxes of $51 million, partially offset by a $52 million increase in noninterest expense, a $47 million increase in the provision for loan losses, and a $33 million decrease in noninterest income.

Net interest income was $1.658 billion for the fourth quarter of 2012, as compared with $1.563 billion for the fourth quarter of 2011.  The increase in net interest income resulted primarily from a higher level of average earning assets. Average earning assets grew $16.974 billion or 7.9% to $231.897 billion for the fourth quarter of 2012, as compared with the same period of the prior year, primarily as a result of increases in loan volume.

The net interest margin for the fourth quarter of 2012 declined to 2.86%, as compared with 2.91% for the same period in the prior year.  The decline in net interest margin for the period resulted from a four basis point decline in income earned on earning assets funded by non- interest bearing sources (principally capital), as yields on average earning assets declined due to  lower interest rates and from a decrease in the net interest spread of one basis point to 2.72%, as compared with the fourth quarter of 2011.   The decline in the net interest spread resulted primarily from competitive pressures, which were principally offset by the positive impact derived from the Banks’ calling of debt of $14.9 billion during the quarter and from the $22 million net accretion of asset and liability fair value adjustments related to the merger of two System Banks.

The System reported provisions for loan losses of $125 million for the fourth quarter of 2012, as compared with $78 million for the fourth quarter of 2011.  The increase in the provision for loan losses between the periods was a result of a higher level of probable and estimable losses in the System’s loan portfolio.  The provisions for loan losses recorded in both periods reflected credit deterioration primarily in those agricultural sectors that continue to be impacted by the volatility in  commodity prices,  as  well  as  those  sectors affected  by  the  overall continued weakness of the U.S. economy. The provision for loan losses for the fourth quarter of 2012 also reflected specific credit challenges for a small number of communication and rural energy customers and to the impact of the drought recognized by certain System institutions.

Noninterest income decreased $33 million to $109 million for the fourth quarter of 2012, as compared with $142 million for the fourth quarter of 2011.   The decrease was due to an increase in losses on the extinguishment of debt of $39 million primarily from one Bank’s repurchase of its subordinated debt, and a decrease in loan-related fee income of $20 million, partially offset by an increase in fees for financially related services of $15 million.  Noninterest expense totaled $661 million for the fourth quarter of 2012, as compared with $609 million for the fourth quarter of 2011. The increase was primarily a result of an increase in salaries and employee benefits due to annual merit and performance-based compensation increases and, to a lesser extent, higher staffing levels at certain System institutions.

The provision for income taxes was $21 million for the fourth quarter of 2012 and $72 million for the fourth quarter of 2011.  The effective tax rate decreased to 2.1% for the fourth quarter of 2012 from 7.1% for the fourth quarter of 2011 primarily due to lower taxable earnings at taxable System institutions primarily resulting from increased provisions for loan losses, increased losses on extinguishment of debt and from a greater amount of patronage declared during the fourth quarter of 2012.

Fourth Quarter 2012 Compared to Third Quarter 2012

Combined net income decreased $79 million to $960 million for the fourth quarter of 2012, as compared with net income of $1.039 billion for the third quarter of 2012.  The decrease was due to increases in noninterest expense of $94 million and the provision for loan losses of $4 million, and to a decrease in noninterest income of $27 million, offset, in part, by an increase in net interest income of $20 million and a decrease in the provision for income taxes of $26 million. The increase in noninterest expense was primarily due to increases in salaries and employee benefits and other operating expenses.  Salaries and employee benefits increased primarily as a result of increases in performance-based compensation.

Loan Portfolio Activity

Gross loans increased $17.240 billion or 9.9% to $191.904 billion at December 31, 2012, as compared with $174.664 billion at December 31, 2011.  This increase was primarily attributable to  increases  in  real  estate  mortgage,  production and  intermediate-term, agribusiness and energy loans.  Real estate mortgage loans increased as a result of increased business activity for  cropland  in  the  Midwest  and  increased  land  transactions late  in  2012  related  to  the uncertainty regarding tax law changes after year end.  Production and intermediate-term loans increased primarily in December 2012, as agricultural producers prepaid 2013 input costs as part of their tax planning strategies.  Agribusiness loans increased due to seasonal loans to agribusiness cooperatives, largely in the farm supply and grain marketing sectors resulting from an increase in commodity prices driven by declines in grain supplies due to drought conditions in the Midwest portion of the U.S.  The increase in energy loans was primarily due to increased market penetration in the electric distribution sector and increased lending in the power supply sector.

Credit Quality

The System’s accruing loan volume was $189.604 billion at December 31, 2012, as compared with $171.926 billion at December 31, 2011. Nonaccrual loans were $2.300 billion at December 31, 2012, as compared with $2.738 billion at December 31, 2011.  The decrease of $438 million in nonaccrual loans during 2012 was primarily due to a lesser amount of loans being transferred into nonaccrual status than in the previous year and to charge-offs, loan repayments and an improvement in the credit quality of certain loans.  At December 31, 2012, 53.8% 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) were $2.608 billion at December 31, 2012, down from $2.997 billion at December 31, 2011.

Nonperforming assets (which consist of nonperforming loans and other property owned) were $2.932 billion at December 31, 2012, as compared with $3.455 billion at December 31, 2011. Other property owned was $324 million at December 31, 2012 and $458 million at December 31, 2011.  Nonperforming assets represented 1.53% of the System’s loans and other property owned at December 31, 2012, a decrease from 1.97% at December 31, 2011.  Nonperforming assets represented 7.6% of total capital at December 31, 2012, as compared with 9.6% at December 31, 2011.

The System’s other credit quality indicators also reflected improvement at December 31, 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 96.8% at December 31, 2012, as compared with 96.2% at December 31, 2011.  Loan delinquencies, which are defined as accruing loans 30 days or more past due, as a percentage of accruing loans were 0.28% at December 31, 2012, as compared with 0.38% at December 31, 2011.

Notwithstanding these generally favorable credit quality indicators, certain parts of the U.S., particularly the Midwest, experienced extensive drought conditions in 2012.  A majority of crop producers have  crop  insurance policies  and  generally have  experienced several years  of favorable economic conditions, which should help to mitigate the impact of the drought on these borrowers.  System borrowers’ who depend on crops as an input, including customers in the poultry, dairy, ethanol, beef and hog sectors, may be negatively impacted by higher commodity prices that result from a continuation of these drought conditions.

The allowance for loan losses was $1.343 billion at December 31, 2012, as compared with $1.290 billion at December 31, 2011. Net loan charge-offs of $236 million were recorded during 2012,  as  compared  with  net  loan  charge-offs  of  $500  million  for  2011.  The  charge-offs recognized for these periods primarily related to the dairy, ethanol and livestock industries and to  those sectors impacted by the overall continued weakness of the general U.S. economy, such as forestry and nurseries. The allowance for loan losses decreased an additional $24 million, primarily due to the transfer of $16 million to the reserve for unfunded commitments during the year ended December 31, 2012.

The allowance for loan losses as a percentage of total loans was 0.70% at December 31, 2012 and 0.74% at December 31, 2011.  The allowance for loan losses was 51% of the System’s total nonperforming loans and 58% of its nonaccrual loans at December 31, 2012, as compared with 43% and 47% at December 31, 2011. Capital and the allowance for loan losses, which is a measure of risk-bearing capacity, totaled $39.952 billion at December 31, 2012 and $37.230 billion at December 31, 2011, and represented 20.8% of System loans at December 31, 2012, as compared with 21.3% at December 31, 2011.

Agricultural Outlook

Overall, agricultural borrowers’ financial conditions remained very favorable due to the high levels of farmers’ net cash income over the past several years.   The February 2013 United States Department of Agriculture (USDA) forecast estimates 2012 farmers’ net cash income (a measure of the cash income after payment of business expenses) at $135.6 billion, up $900 million from 2011 and up $51.8 billion from its 10-year average of $83.8 billion.  The USDA’s February 2013 outlook for the farm economy, as a whole, forecasts 2013 farmers’ net cash income to decrease to $123.5 billion, a $12.1 billion decrease from 2012, but $39.7 billion above the 10-year average.  The projected decrease in farmers’ net cash income from 2012 to 2013 is primarily due to an expected increase in cash expenses of $18.8 billion.

Liquidity and Capital Resources

Cash and investments (principally all of which were held for liquidity purposes) decreased $353 million to $46.928 billion at December 31, 2012, as compared with $47.281 billion at year-end 2011.  The System’s liquidity position was 185 days and 194 days at December 31, 2012 and 2011.    The  Banks’  liquidity  management objectives  are  designed  to  meet  maturing  debt obligations, to provide a reliable source of funding to borrowers and to fund operations on a cost-effective basis.

Total capital increased $2.669 billion to $38.609 billion at December 31, 2012, as compared with $35.940 billion at December 31, 2011.  The System’s surplus increased $2.186 billion to $31.919 billion at December 31, 2012, as compared with $29.733 billion at December 31, 2011. The increase was due to net income earned 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).   The increase was offset, in part, by patronage distributions of $1.066 billion and the re-characterization of $299 million of surplus as additional paid-in-capital in connection with Association mergers 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 following section entitled Mergers.   Capital as a percentage of total assets was 15.7% at December 31, 2012, as compared with 15.6% at December 31, 2011.

Accumulated other comprehensive loss decreased $306 million during 2012 to $1.024 billion at December 31, 2012.  This decrease principally resulted from decreases in other-than-temporary impairment on investments of $251 million and unrealized losses on cash flow hedges of $22 million and an increase in unrealized gains on investments available-for-sale of $163 million. These were offset, in part, by an increase in accumulated other comprehensive loss on pension and other benefit plans of $130 million. The decrease in the amount of other-than-temporary impairment on investments and the increase in unrealized gains on investments available-for- sale during 2012 was primarily due to a recharacterization of accumulated other comprehensive loss  of  $259  million  that  resulted  from  the  Bank  merger,  and  to  a  lesser  extent,  to  the improvement in liquidity in the financial markets.  The increase in unrealized losses on pension and other benefits was primarily due to a decrease in the discount rate used to calculate pension obligations.

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 FCB; AgriBank, FCB; and Farm Credit Bank of Texas).   In addition, on January 1, 2012, two Associations affiliated with the former U.S. AgBank merged and on July 1, 2012, two Associations affiliated with AgFirst FCB merged.  The mergers were accounted for under the acquisition method of accounting.

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 System Banks and 82 affiliated  Associations.    Unlike  commercial  banks,  the  Banks  and  Associations  are  not 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 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.   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
E-mail - jmarsh@farmcreditfunding.com

Karen R. Brenner, Senior Vice President
Federal Farm Credit Banks Funding Corporation
10 Exchange Place, Suite 1401
Jersey City, NJ 07302 (201) 200-8081
E-mail – kbrenner@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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