Federal Agricultural Mortgage Corporation 10-Q/A 1 3-31-2006
As filed with the Securities and Exchange Commission on
November 9, 2006 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q/A
Amendment No. 1 to Form 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2006

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
incorporation or organization)
  
(I.R.S. employer identification number)
     
1133 Twenty-First 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)

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 12 months (or for 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  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o
Accelerated filer x
Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes   o
No  x

As of May 2, 2006, the registrant had 1,030,780 shares of Class A Voting Common Stock, 500,301 shares of Class B Voting Common Stock and 9,555,548 shares of Class C Non-Voting Common Stock outstanding.
 

 
 
FEDERAL AGRICULTURAL MORTGAGE CORPORATION
FORM 10-Q/A FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2006

EXPLANATORY NOTE

This Amendment No. 1 on Form 10-Q/A (the “Amendment”) to the Quarterly Report on Form 10-Q of the Federal Agricultural Mortgage Corporation (“Farmer Mac”) for the quarterly period ended March 31, 2006, initially filed with the Securities and Exchange Commission on May 10, 2006 (the “Original Filing”) is being filed to amend and restate financial and other information contained in Item 1 (Condensed Consolidated Financial Statements), Item 2 (Management’s Discussion and Analysis of Operating Results and Financial Condition), Item 3 (Quantitative and Qualitative Disclosures About Market Risk) and Item 4 (Controls and Procedures) of Part I, and Item 6 (Exhibits) of Part II of the Original Filing.

This Amendment restates the Corporation’s unaudited interim condensed consolidated financial statements as of March 31, 2006 and December 31, 2005 and for the three months ended March 31, 2006 and 2005. The Corporation is concurrently filing amendments to (1) its Form 10-K for the year ended December 31, 2005 to restate the Corporation’s consolidated financial statements as of December 31, 2005 and 2004, and for the years ended December 31, 2005, 2004 and 2003, and other financial information as of and for the years ended December 31, 2002 and 2001 and the quarterly unaudited data for 2005 and 2004 and (2) its Form 10-Q for the quarter ended June 30, 2006 to restate the quarterly unaudited interim consolidated financial statements and other financial information contained in that report. In this regard, investors should rely on the restated financial results for the years and each of the quarters in the years 2005, 2004, 2003, 2002 and 2001 and the first and second quarters of 2006 and, as the Corporation previously reported on Form 8-K on October 6, 2006, should not rely on the Corporation’s previously issued consolidated financial statements and other financial information for these reporting periods.

The Corporation, in light of SEC staff comments, has recently concluded a reassessment of its documentation and accounting treatment of financial derivative transactions under Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities (“SFAS 133”), interpretations of which have evolved. Based on the reassessment, while the transactions engaged in by the Corporation were highly effective economic hedges of interest rate risk, the Corporation has determined that it was not appropriately applying hedge accounting in accordance with SFAS 133. See “Note 6 - Restatement of Condensed Consolidated Financial Statements” in Item 1 of Part I and the discussion under the caption “Restatement of Previously Issued Quarterly Financial Statements” in Item 2 of Part I for further information related to the restatement with respect to the hedge accounting that had been employed and the effects of this treatment on the restated consolidated financial statements.

This Amendment also addresses management’s re-evaluation of disclosure controls and procedures and management’s report on internal control over financial reporting resulting from management’s reassessment and identification of a material weakness in internal control over financial reporting relating to Farmer Mac’s accounting for derivatives under SFAS 133. See Item 4 (Controls and Procedures) of Part I for further discussion. New certifications of the principal executive officer and principal financial officer are included as exhibits to this Amendment.

-2-
 
Except as described above, no attempt has been made in this Amendment to amend or update other disclosures presented in this Form 10-Q/A. Therefore, this Amendment does not reflect events occurring after the filing of the Original Filing or amend or update those disclosures, or related exhibits, affected by subsequent events. Accordingly, this Amendment should be read in conjunction with Farmer Mac’s other filings with the SEC subsequent to the filing of the Original Filing.
 
 
-3-
 
PART I - FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements

The following restated interim unaudited condensed consolidated financial statements of the Federal Agricultural Mortgage Corporation (“Farmer Mac” or the “Corporation”) have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). These interim unaudited condensed consolidated financial statements reflect all normal and recurring adjustments that are, in the opinion of management, necessary to present a fair statement of the financial condition and the results of operations and cash flows of Farmer Mac for the interim periods presented. Certain information and footnote disclosures normally included in annual consolidated financial statements have been condensed or omitted as permitted by SEC rules and regulations. The December 31, 2005 consolidated balance sheet presented in this report has been derived from the Corporation’s audited 2005 restated consolidated financial statements. Management believes that the disclosures are adequate to present fairly the condensed consolidated financial position, condensed consolidated results of operations and condensed consolidated cash flows as of the dates and for the periods presented. These interim unaudited condensed consolidated financial statements should be read in conjunction with the audited 2005 restated consolidated financial statements of Farmer Mac included in the Corporation’s Annual Report on Form 10-K/A for the year ended December 31, 2005. Results for interim periods are not necessarily indicative of those that may be expected for the fiscal year.

The following information concerning Farmer Mac’s restated interim unaudited condensed consolidated financial statements is included in this report beginning on the pages listed below:

Condensed Consolidated Balance Sheets (as restated) as of March 31, 2006 and December 31, 2005
5
Condensed Consolidated Statements of Operations (as restated) for the three months ended March 31, 2006 and 2005
6
Condensed Consolidated Statements of Cash Flows (as restated) for the three months ended March 31, 2006 and 2005
7
Notes to Condensed Consolidated Financial Statements (as restated)
8

-4-

FEDERAL AGRICULTURAL MORTGAGE CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)

   
March 31,
  
December 31,
  
   
2006
  
2005
  
   
(As Restated)*
  
(As Restated)*
  
   
(in thousands)
  
Assets:
          
Cash and cash equivalents
  
$
413,619
  
$
458,852
  
Investment securities
    
1,884,011
    
1,621,941
  
Farmer Mac Guaranteed Securities
    
1,297,401
    
1,330,976
  
Loans held for sale
    
39,477
    
41,956
  
Loans held for investment
    
747,778
    
762,436
  
Allowance for loan losses
    
(3,883
)
  
(4,876
)
Loans held for investment, net
    
743,895
    
757,560
  
Real estate owned
    
2,655
    
3,532
  
Financial derivatives
    
16,332
    
8,719
  
Interest receivable
    
43,344
    
67,509
  
Guarantee and commitment fees receivable
    
20,139
    
22,170
  
Deferred tax asset, net
    
2,906
    
3,223
  
Prepaid expenses and other assets
    
10,816
    
25,007
  
Total Assets
  
$
4,474,595
  
$
4,341,445
  
               
Liabilities and Stockholders' Equity:
              
Liabilities:
              
Notes payable:
              
Due within one year
  
$
2,771,106
  
$
2,587,704
  
Due after one year
    
1,340,385
    
1,406,527
  
Total notes payable
    
4,111,491
    
3,994,231
  
Financial derivatives
    
24,280
    
29,162
  
Accrued interest payable
    
22,554
    
29,250
  
Guarantee and commitment obligation
    
16,998
    
17,625
  
Accounts payable and accrued expenses
    
45,089
    
21,371
  
Reserve for losses
    
2,931
    
3,777
  
Total Liabilities
    
4,223,343
    
4,095,416
  
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,9,570,301 and 9,559,554 shares issued and outstanding as of March 31, 2006 and December 31, 2005, respectively
    
9,570
    
9,560
  
Additional paid-in capital
    
83,962
    
83,058
  
Accumulated other comprehensive income
    
6,336
    
15,247
  
Retained earnings
    
114,853
    
101,633
  
Total Stockholders' Equity
    
251,252
    
246,029
  
Total Liabilities and Stockholders' Equity
  
$
4,474,595
  
$
4,341,445
  

See accompanying notes to condensed consolidated financial statements.
 
* See Note 6 to the condensed consolidated financial statements

-5-
 
FEDERAL AGRICULTURAL MORTGAGE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(in thousands, except per share amounts)
 
   
Three Months Ended
  
   
March 31, 2006
  
March 31, 2005
  
   
(As Restated)*
  
(As Restated)*
  
Interest income:
          
Investments and cash equivalents
  
$
26,698
  
$
12,587
  
Farmer Mac Guaranteed Securities
    
18,037
    
18,327
  
Loans
    
11,383
    
12,121
  
Total interest income
    
56,118
    
43,035
  
               
Interest expense
    
45,451
    
29,154
  
Net interest income
    
10,667
    
13,881
  
Recovery/(provision) for loan losses
    
1,013
    
584
  
Net interest income after recovery/(provision) for loan losses
    
11,680
    
14,465
  
               
Guarantee and commitment fees
    
5,049
    
4,956
  
Gains on financial derivatives and trading assets
    
11,700
    
9,866
  
Gains/(losses) on the sale of real estate owned
    
210
    
(13
)
Representation and warranty claims income
    
-
    
79
  
Other income
    
169
    
320
  
Total revenues
    
28,808
    
29,673
  
               
Expenses:
              
Compensation and employee benefits
    
2,904
    
1,775
  
General and administrative
    
2,758
    
1,990
  
Regulatory fees
    
588
    
576
  
Real estate owned operating costs, net
    
115
    
(22
)
Provision/(recovery) for losses
    
(696
)
  
(101
)
Total operating expenses
    
5,669
    
4,218
  
               
Income before income taxes
    
23,139
    
25,455
  
               
Income tax expense
    
7,488
    
8,510
  
Net income
    
15,651
    
16,945
  
Preferred stock dividends
    
(560
)
  
(560
)
Net income available to common stockholders
  
$
15,091
  
$
16,385
  
               
Earnings per common share:
              
Basic earnings per common share
  
$
1.36
  
$
1.40
  
Diluted earnings per common share
  
$
1.32
  
$
1.39
  
Common stock dividends per common share
  
$
0.10
  
$
0.10
  
 
See accompanying notes to condensed consolidated financial statements

* See Note 6 to the condensed consolidated financial statements

-6-

FEDERAL AGRICULTURAL MORTGAGE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited; in thousands)
 
   
Three Months Ended
  
   
March 31, 2006
  
March 31, 2005
  
   
(As Restated)*
  
(As Restated)*
  
Cash flows from operating activities:
          
Net income
  
$
15,651
  
$
16,945
  
Adjustments to reconcile net income to net cash provided by operating activities:
              
 Net amortization of investment premiums and discounts
    
(234
)
  
554
  
 Amortization of debt premiums, discounts and issuance costs
    
26,639
    
12,114
  
 Proceeds from repayment of trading investment securities
    
467
    
651
  
 Purchases of loans held for sale
    
(13,328
)
  
(16,876
)
 Proceeds from repayment of loans held for sale
    
3,723
    
4,822
  
 Net change in fair value of trading securities and financial derivatives
    
(12,501
)
  
(15,216
)
 Amortization of SFAS 133 transition adjusment on financial derivatives
    
131
    
169
  
 (Gains)/losses on the sale of real estate owned
    
(210
)
  
13
  
 Total (recovery)/provision for losses
    
(1,709
)
  
(685
)
 Deferred income taxes
    
5,112
    
(5,385
)
 Stock-based compensation expense
    
426
     -   
 Decrease in interest receivable
    
24,165
    
19,998
  
 Decrease in guarantee and commitment fees receivable
    
2,031
    
1,885
  
 Decrease in other assets
    
13,228
    
12,871
  
 Decrease in accrued interest payable
    
(6,696
)
  
(740
)
 (Decrease)/increase in other liabilities
    
21,799
    
(8,947
)
 Net cash provided by operating activities
    
78,694
    
22,173
  
 
              
Cash flows from investing activities:
              
Purchases of available-for-sale investment securities
    
(899,793
)
  
(696,142
)
Purchases of Farmer Mac II Guaranteed Securities and AgVantage Farmer Mac Guaranteed Securities
    
(47,528
)
  
(44,175
)
Purchases of loans held for investment
    
(16,932
)
  
(1,664
)
Purchases of defaulted loans
    
(4,054
)
  
(3,399
)
Proceeds from repayment of investment securities
    
639,816
    
600,386
  
Proceeds from repayment of Farmer Mac Guaranteed Securities
    
68,723
    
74,356
  
Proceeds from repayment of loans
    
44,582
    
45,957
  
Proceeds from sale of loans and Farmer Mac Guaranteed Securities
    
1,485
    
2,414
  
Proceeds from sale of real estate owned
    
818
    
117
  
 Net cash used in investing activities
    
(212,883
)
  
(22,150
)
               
Cash flows from financing activities:
              
Proceeds from issuance of discount notes
    
15,145,352
    
13,260,608
  
Proceeds from issuance of medium-term notes
    
86,200
    
75,000
  
Payments to redeem discount notes
   
(15,095,392
)
  
(13,169,737
)
Payments to redeem medium-term notes
    
(45,500
)
  
(164,740
)
Tax benefit from tax deductions in excess of compensation cost recognized
    
239
    
-
  
Proceeds from common stock issuance
    
815
    
45
  
Purchases of common stock
    
(1,085
)
  
(5,942
)
Dividends paid
    
(1,673
)
  
(1,720
)
Net cash provided by/(used in) financing activities
    
88,956
    
(6,486
)
Net decrease in cash and cash equivalents
    
(45,233
)
  
(6,463
)
               
Cash and cash equivalents at beginning of period
    
458,852
    
430,504
  
Cash and cash equivalents at end of period
  
$
413,619
  
$
424,041
  

See accompanying notes to condensed consolidated financial statements.
 
* See Note 6 to the condensed consolidated financial statements

-7-

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 1. Accounting Policies

 
(a)
Cash and Cash Equivalents

Farmer Mac considers highly liquid investment securities with 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 condensed consolidated statements of cash flows. The following table sets forth information regarding certain cash and non-cash transactions for the three months ended March 31, 2006 and 2005.
 
   
Three Months Ended
  
   
March 31, 2006
  
March 31, 2005
  
   
(in thousands)
  
Cash paid for:
          
Interest
  
$
26,119
  
$
17,250
  
Income taxes
    
-
   
700
 
Non-cash activity:
              
Real estate owned acquired through foreclosure
    
-
   
460
 
Loans acquired and securitized as Farmer Mac Guaranteed Securities
    
1,485
   
1,914
 

(b)
Allowance for Losses

As of March 31, 2006, Farmer Mac maintained an allowance for losses to cover estimated probable losses on loans held for investment, real estate owned, and loans underlying long-term standby purchase commitments (“LTSPCs”) and Farmer Mac I Guaranteed Securities issued after the Farm Credit System Reform Act of 1996 (the “1996 Act”) in accordance with Statement of Financial Accounting Standards No. 5, Accounting for Contingencies (“SFAS 5”) and Statement of Financial Accounting Standards No. 114, Accounting by Creditors for Impairment of a Loan, as amended (“SFAS 114”).

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. Negative provisions for loan losses or negative provisions for losses are recorded in the event that the estimate of probable losses as of the end of a period is lower than the estimate at the beginning of the period.

Historically, Farmer Mac estimated probable losses using a systematic process that began with management’s evaluation of the results of a proprietary loan pool simulation and guarantee fee model. That model drew upon historical information from a data set of agricultural mortgage loans screened to include only those loans with credit characteristics similar to those eligible for Farmer Mac’s programs. The results generated by that model were then modified, as necessary, by the application of management’s judgment.

-8-

During 2005, Farmer Mac completed the planned migration of its methodology for determining its allowance for losses away from one based on its loan pool simulation and guarantee fee model to one based on its own historical portfolio loss experience and credit trends. Farmer Mac recorded the effects of that change as a change in accounting estimate of $4.8 million as of September 30, 2005.

Farmer Mac’s current methodology for determining its allowance for losses incorporates the Corporation’s proprietary automated loan classification system. That system scores loans based on criteria such as historical repayment performance, loan seasoning, loan size and loan-to-value ratio. For the purposes of the loss allowance methodology, the loans in Farmer Mac’s portfolio of loans and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs have been scored and classified for each calendar quarter since first quarter 2000. The allowance methodology captures the migration of loan scores across concurrent and overlapping 3-year time horizons and calculates loss rates separately within each loan classification for (1) loans underlying LTSPCs and (2) loans held and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities. The calculated loss rates are applied to the current classification distribution of Farmer Mac’s portfolio to estimate inherent losses, on the assumption that the historical credit losses and trends used to calculate loss rates will continue in the future. Management evaluates this assumption by taking into consideration several factors, including:
 
 
·
economic conditions;
 
·
geographic and agricultural commodity/product concentrations in the portfolio;
 
·
the credit profile of the portfolio;
 
·
delinquency trends of the portfolio; and
 
·
historical charge-off and recovery activities of the portfolio.
 
If, based on that evaluation, management concludes that the assumption is not valid due to other more compelling indicators, the loss allowance calculation is modified by the addition of further assumptions to capture current portfolio trends and characteristics that differ from historical experience.

As of March 31, 2006, Farmer Mac concluded that the credit profile of its portfolio was consistent with Farmer Mac’s historical credit profile and trends. Management believes that its use of this methodology produces a reliable estimate of inherent probable losses, as of the balance sheet date, for all loans held, real estate owned and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs in accordance with SFAS 5 and SFAS 114.

-9-

The following table summarizes the changes in the components of Farmer Mac’s allowance for losses for the three months ended March 31, 2006 and 2005:
 
   
Three Months Ended
  
   
March 31, 2006
  
   
Allowance for Loan Losses
  
REO Valuation Allowance
  
Reserve for Losses
  
Total Allowance for Losses
  
   
(in thousands)
  
                   
Beginning balance
  
$
4,876
  
$
-
  
$
3,777
  
$
8,653
  
Provision/(recovery) for losses
    
(1,013
)
  
150
   
(846
)
  
(1,709
)
Net (charge-offs)/recoveries
    
20
   
(150
)
  
-
   
(130
)
Ending balance
  
$
3,883
  
$
-
  
$
2,931
  
$
6,814
  

   
Three Months Ended
  
   
March 31, 2005
  
   
Allowance for Loan Losses
  
REO Valuation Allowance
  
Reserve for Losses
  
Total Allowance for Losses
  
   
(in thousands)
  
                   
Beginning balance
  
$
4,395
  
$
-
  
$
12,706
  
$
17,101
  
Provision/(recovery) for losses
    
(584
)
  
120
   
(221
)
  
(685
)
Net (charge-offs)/recoveries
    
35
   
(120
)
  
-
   
(85
)
Ending balance
  
$
3,846
  
$
-
  
$
12,485
  
$
16,331
  
 
The table below summarizes the components of Farmer Mac’s allowance for losses as of March 31, 2006 and December 31, 2005:
 
   
March 31,
2006
  
December 31,
2005
  
   
(in thousands)
      
Allowance for loan losses
  
$
3,883
  
$
4,876
  
Real estate owned valuation allowance
    
-
   
-
 
Reserve for losses:
              
On-balance sheet Farmer Mac I Guaranteed Securities
    
1,579
   
2,068
 
Off-balance sheet Farmer Mac I Guaranteed Securities
    
691
   
1,078
 
LTSPCs
    
661
   
631
 
Total
 
$
6,814
  
$
8,653
  

No allowance for losses has been made for loans underlying Farmer Mac I Guaranteed Securities issued prior to the 1996 Act, AgVantage securities or securities issued under the Farmer Mac II program (“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. Each AgVantage security is a general obligation of an issuing institution approved by Farmer Mac and is collateralized by eligible mortgage loans. As of March 31, 2006, there were no probable losses inherent in Farmer Mac’s AgVantage securities. The guaranteed portions collateralizing Farmer Mac II Guaranteed Securities are guaranteed by the United States Department of Agriculture (“USDA”). Each USDA guarantee is an obligation backed by the full faith and credit of the United States. As of March 31, 2006, Farmer Mac had experienced no credit losses on any Farmer Mac I Guaranteed Securities issued prior to the 1996 Act, AgVantage securities or Farmer Mac II Guaranteed Securities and does not expect to incur any such losses in the future.

-10-

As of March 31, 2006, Farmer Mac individually analyzed $32.3 million of its $68.0 million of impaired assets for collateral shortfalls against updated appraised values, other updated collateral valuations or discounted values. Farmer Mac evaluated the remaining $35.7 million of impaired assets for which updated valuations were not available in the aggregate in consideration of their similar risk characteristics and historical statistics. Of the $32.3 million of assets analyzed individually, $28.8 million were adequately collateralized. For the $3.5 million of assets that were not adequately collateralized, individual collateral shortfalls totaled $47 thousand. Accordingly, Farmer Mac recorded specific allowances of $47 thousand for those under-collateralized assets as of March 31, 2006. In addition to the specific allowances provided, Farmer Mac recorded non-specific or general allowances of $6.7 million, bringing the total allowance for losses to $6.8 million as of March 31, 2006.

The balance of impaired assets, both on- and off-balance sheet, and the related allowance specifically allocated to those impaired assets as of March 31, 2006 and December 31, 2005 are summarized in the following table:
 

   
March 31, 2006
  
December 31, 2005
  
   
Balance
  
Specific Allowance
  
Net Balance
  
Balance
  
Specific Allowance
  
Net Balance
  
   
(in thousands)
  
Impaired assets:
                          
 Specific allowance for losses
  
$
3,502
  
$
(47
)
$
3,455
  
$
2,445
  
$
(161
)
$
2,284
  
 No specific allowance for losses
    
64,534
   
-
   
64,534
   
71,177
   
-
   
71,177
 
 Total
  
$
68,036
  
$
(47
)
$
67,989
  
$
73,622
  
$
(161
)
$
73,461
  

(c)
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.

-11-

All financial derivatives are recorded on the balance sheet at fair value as a freestanding asset or liability in accordance with Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended (“SFAS 133”). As discussed in Note 6, Farmer Mac does not designate its financial derivatives as fair value hedges or cash flow hedges; therefore, the changes in the fair values of financial derivatives are reported as gains or losses on financial derivatives and trading assets in the consolidated statements of operations.

The following table summarizes information related to Farmer Mac’s financial derivatives as of March 31, 2006 and December 31, 2005:

   
As of March 31, 2006
  
As of December 31, 2005
  
   
Notional
Amount
  
Fair
Value
  
Notional
Amount
  
Fair
Value
  
                   
Interest rate swaps:
                  
Pay-fixed
  
$
777,021
  
$
(3,813
)
$
710,678
   $
(17,228
 ) 
Receive-fixed
    
259,000
   
(9,923
)
  
205,000
   
(5,752
)
Basis
    
373,434
   
5,804
   
389,496
   
2,801
 
Treasury futures
    
49
    
22
    
-
    
-
  
Agency forwards
    
31,157
   
(38
)
  
91,178
   
(264
)
                           
Total
  
$
1,440,661
  
$
(7,948
)
$
1,396,352
  
$
(20,443
)


As of March 31, 2006, Farmer Mac had approximately $1.3 million of net after-tax unrealized losses on financial derivatives included in accumulated other comprehensive income related to the SFAS 133 transition adjustment. 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 the issuance of discount 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. Over the next twelve months, Farmer Mac estimates that $0.5 million of the amount currently reported in accumulated other comprehensive income will be reclassified into earnings.

(d)
Earnings Per Common Share

Basic earnings per common share are based on the weighted-average number of shares of common stock outstanding. Diluted earnings per common share are based on the weighted-average number of shares of common stock outstanding adjusted to include all potentially dilutive common stock options. The following schedule reconciles basic and diluted earnings per common share (“EPS”) for the three months ended March 31, 2006 and 2005:
 

-12-
 
   
Three Months Ended
  
   
March 31, 2006
  
March 31, 2005
  
   
Basic EPS
  
Dilutive stock options
  
Diluted EPS
  
Basic EPS
  
Dilutive stock options
  
Diluted EPS
  
   
(in thousands, except per share amounts)
  
   
 
  
 
  
 
  
 
  
 
  
 
  
Net income available to common stockholders
  
$
15,091
      
$
15,091
  
$
16,385
      
$
16,385
  
Weighted-average shares
    
11,107
   
318
    
11,425
   
11,687
   
69
    
11,756
 
Earnings per common share
  
$
1.36
      
$
1.32
  
$
1.40
      
$
1.39
  

During first quarter 2006, Farmer Mac repurchased 38,950 shares of its Class C Non-Voting Common Stock at an average price of $27.81 per share pursuant to the Corporation’s previously announced stock repurchase program. These repurchases reduced the Corporation’s capital by approximately $1.1 million.

(e)
Stock-Based Compensation

In 1997, Farmer Mac adopted a stock option plan for directors, officers and other employees to acquire shares of Class C Non-Voting Common Stock. Under the plan, stock options awarded vest annually in thirds, with the first third vesting one year after the date of grant. If not exercised, any options granted under the 1997 plan expire 10 years from the date of grant, except that options issued to directors since June 1, 1998, if not exercised, expire five years from the date of grant. Of the 3,750,000 shares authorized to be issued under the plan, 774,760 remain available for future issuance as of March 31, 2006. For all stock options granted, the exercise price is equal to the closing price of the Class C Non-Voting Common Stock on or immediately preceding the date of grant.

Effective January 1, 2006, Farmer Mac adopted Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payments (“SFAS 123(R)”) using the modified prospective method of transition, which requires (1) the recordation of compensation expense for the non-vested portion of previously issued awards that remain outstanding as of the initial date of adoption and (2) the recordation of compensation expense for any awards issued or modified after December 31, 2005. Accordingly, prior period amounts have not been retrospectively adjusted for this change. The adoption resulted in the recognition of $0.4 million of compensation expense during first quarter 2006 related to the non-vested portion of previously issued stock option awards that were outstanding as of the initial date of adoption. The effect of the recognition of that compensation expense on both basic and diluted EPS for first quarter 2006 was a reduction of $0.02 per diluted share. Prior to the adoption of SFAS 123(R), Farmer Mac accounted for its stock-based employee compensation plans under the intrinsic value method of accounting for employee stock options pursuant to Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”), and had adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, as amended (“SFAS 123”). Accordingly, no compensation expense was recognized in first quarter 2005 for employee stock option plans.

-13-

As of March 31, 2006, there was $2.7 million of total unrecognized compensation cost related to outstanding and unvested options. Of that cost, $1.3 million and $1.4 million is expected to be recognized in the remainder of 2006 and 2007, respectively.

The following table summarizes stock option activity for the three months ended March 31, 2006 and 2005:
 
   
Three Months Ended
  
   
March 31, 2006
  
March 31, 2005
  
   
Shares
  
Weighted-
Average
Exercise
Price
  
Shares
  
Weighted-
Average
Exercise
Price
  
                   
Outstanding, beginning of period
    
2,153,008
 
$
22.41
    
1,812,222
 
$
22.67
  
Granted
    
-
   
-
   
-
   
-
 
Exercised
    
(61,800
)
  
13.14
   
(1,737
)
  
16.38
 
Canceled
    
-
   
-
   
(7,001
)
  
24.28
 
Outstanding, end of period
    
2,091,208
 
$
22.68
    
1,803,484
 
$
22.72
  
                           
Options exercisable at end of period
    
1,390,475
         
1,348,577
       

As shown above, Farmer Mac granted no new stock options during first quarter 2006. Any new stock option grants would have resulted in additional compensation expense in the quarter.

There were no cancellations of stock options during first quarter 2006. The cancellations of stock options during first quarter 2005 were due either to unvested options terminating in accordance with the provisions of the applicable stock option plans upon directors’ or employees’ departures from Farmer Mac or vested options terminating unexercised on their expiration date. For first quarter 2006 and first quarter 2005, the additional paid-in capital received from the exercise of stock options was $750 thousand and $27 thousand, respectively. During first quarter 2006 and first quarter 2005, the reduction of income taxes to be paid as a result of the deduction for the exercise of stock options was $375 thousand and $2 thousand, respectively.

-14-

The following table summarizes information regarding options outstanding as of March 31, 2006:

           
Options
  
   
Options Outstanding
 
Exercisable
  
       
Weighted-
     
       
Average
     
Range of
     
Remaining
     
Exercise
 
Number of
 
Contractual
 
Number of
  
Prices
 
Shares
 
Life
 
Shares
  
 
 
 
 
 
 
 
 
$ 15.00 - $19.99
 
 
453,720
 
 
6.2 years
 
 
304,215
 
     20.00 - 24.99
 
 
1,139,816
 
 
6.1 years
 
 
594,588
 
     25.00 - 29.99
 
 
258,421
 
 
5.4 years
 
 
252,421
 
     30.00 - 34.99
 
 
238,751
 
 
4.2 years
 
 
238,751
 
     35.00 - 39.99
 
 
-
 
 
-
 
 
-
 
     40.00 - 44.99
 
 
-
 
 
-
 
 
-
 
     45.00 - 50.00
 
 
500
 
 
6.0 years
 
 
500
 
 
 
 
2,091,208
 
 
 
 
 
1,390,475
 


There were no stock options granted in either first quarter 2006 or first quarter 2005. The weighted-average grant date fair values of options granted in 2005 and 2004 were $6.69 and $7.34 per share, respectively. The fair values were estimated using the Black-Scholes option pricing model based on the following assumptions:
 
   
2005
  
2004
  
Risk-free interest rate
    
3.9
%
  
4.3
%
Expected years until exercise
    
7 years
    
5 years
  
Expected stock volatility
    
46.3
%
  
47.8
%
Dividend yield
    
1.9
%
  
0.0
%
 
(f)
Reclassifications

Certain reclassifications of prior period information were made to conform to the current period presentation.

(g)
New Accounting Standards

In March 2004, the Emerging Issues Task Force (“EITF”) amended EITF 03-1, The Meaning of Other-Than-Temporary Impairment. This amendment, which was originally effective for financial periods beginning after June 15, 2004, introduced qualitative and quantitative guidance for determining whether securities are other-than-temporarily impaired. In November 2005, the Financial Accounting Standards Board (“FASB”) issued Staff Position No. 115-1 and No. 124-1 (“FSP”), which supersedes the guidance in paragraphs 10-18 of EITF 03-1 and references existing other-than-temporary impairment guidance. The FSP clarifies that an investor should recognize an impairment loss no later than when the impairment is deemed other-than-temporary, even if a decision to sell the security has not been made, and also provides guidance on the subsequent accounting for impaired debt securities. The FSP is effective for reporting periods beginning after December 15, 2005. Farmer Mac’s adoption of the FSP effective January 1, 2006 has not had a material effect on Farmer Mac’s results of operations or financial position.

-15-

In May 2005, FASB issued Statement of Financial Accounting Standards No. 154, Accounting Changes and Error Corrections (“SFAS 154”), which replaced Accounting Principles Board Opinion No. 20, Accounting Changes, and FASB Statement No. 3, Reporting Accounting Changes in Interim Financial Statements. SFAS 154 requires retrospective application to prior periods’ financial statements for changes in accounting principles, unless determination of either the period specific effects or the cumulative effect of the change is impracticable or otherwise promulgated. SFAS 154 is effective for fiscal years beginning after December 15, 2005. Farmer Mac’s adoption of SFAS 154 effective January 1, 2006 did not have a material effect on Farmer Mac’s results of operations or financial position.

In February 2006, FASB issued Statement of Financial Accounting Standards No. 155, Accounting for Certain Hybrid Financial Instruments - an Amendment of FASB Statements No. 133 and 140 (“SFAS 155”), which resolves issues addressed in Statement 133 Implementation Issue No. D1, Application of Statement 133 to Beneficial Interests in Securitized Financial Assets. SFAS 155, among other things, permits the fair value re-measurement of any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation; clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS 133; and establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation. SFAS 155 is effective for all financial instruments acquired or issued in a fiscal year beginning after September 15, 2006. SFAS 155 is not expected to have a material effect on Farmer Mac’s results of operations and financial position.

In March 2006, FASB issued Statement of Financial Accounting Standards No. 156, Accounting for Servicing of Financial Assets (“SFAS 156”), which requires that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable and permits the entities to elect either fair value measurement with changes in fair value reflected in earnings or the amortization and impairment requirements of Statement of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, for subsequent measurement. SFAS 156 is effective on January 1, 2007. The adoption of SFAS 156 is not expected to have a material effect on Farmer Mac’s results of operations or financial position.

-16-

Note 2.
Farmer Mac Guaranteed Securities

The following table sets forth information about Farmer Mac Guaranteed Securities retained by Farmer Mac as of March 31, 2006 and December 31, 2005.
 
   
March 31, 2006
  
December 31, 2005
  
   
Available-
  
Held-to-
      
Available-
  
Held-to-
      
   
for-Sale
  
Maturity
  
Total
  
for-Sale
  
Maturity
  
Total
  
   
(in thousands)
  
Farmer Mac I
  
$
447,379
  
$
41,865
  
$
489,244
  
$
492,158
  
$
41,573
  
$
533,731
  
Farmer Mac II
    
-
   
808,157
   
808,157
   
-
   
797,245
   
797,245
 
Total
  
$
447,379
  
$
850,022
  
$
1,297,401
  
$
492,158
  
$
838,818
  
$
1,330,976
  
                                       
Amortized cost
  
$
437,510
  
$
850,022
  
$
1,287,532
  
$
477,561
  
$
838,818
  
$
1,316,379
  
Unrealized gains
    
13,596
   
298
   
13,894
   
18,395
   
448
   
18,843
 
Unrealized losses
    
(3,727
)
  
(12,931
)
  
(16,658
)
  
(3,798
)
  
(8,339
)
  
(12,137
)
Fair value
  
$
447,379
  
$
837,389
  
$
1,284,768
  
$
492,158
  
$
830,927
  
$
1,323,085
  


The table below presents a sensitivity analysis for Farmer Mac’s retained Farmer Mac Guaranteed Securities as of March 31, 2006.

 
 
March 31, 2006
 
 
 
(dollars in thousands)
  
       
Fair value of beneficial interests retained in Farmer Mac Guaranteed Securities
  
$
1,284,768
  
         
Weighted-average remaining life (in years)
    
4.7
 
         
Weighted-average prepayment speed (annual rate)
    
10.7
%
Effect on fair value of a 10% adverse change
  
$
66
  
Effect on fair value of a 20% adverse change
  
$
143
  
         
Weighted-average discount rate
    
5.5
%
Effect on fair value of a 10% adverse change
  
$
(18,262
)
Effect on fair value of a 20% adverse change
  
$
(36,609
)
 
These sensitivities are hypothetical. Changes in fair value based on 10 percent or 20 percent variations 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.

-17-

The table below presents the outstanding principal balances as of the periods indicated for Farmer Mac Guaranteed Securities, loans, and LTSPCs.

   
March 31,
  
December 31,
  
   
2006
  
2005
  
   
(in thousands)
  
On-balance sheet assets:
          
Farmer Mac I:
          
Loans
  
$
779,475
  
$
784,422
  
Guaranteed Securities
    
478,619
   
518,250
 
Farmer Mac II:
              
Guaranteed Securities
    
806,984
   
796,224
 
Total on-balance sheet
  
$
2,065,078
  
$
2,098,896
  
               
               
Off-balance sheet assets:
              
Farmer Mac I:
              
LTSPCs
  
$
2,243,259
  
$
2,329,798
  
Guaranteed Securities
    
1,262,549
    
804,785
  
Farmer Mac II:
              
Guaranteed Securities
    
35,379
   
39,508
 
Total off-balance sheet
  
$
3,541,187
  
$
3,174,091
  
               
Total
  
$
5,606,265
  
$
5,272,987
  
 
Net credit losses and 90-day delinquencies as of and for the periods indicated for Farmer Mac Guaranteed Securities, loans and LTSPCs are presented in the table below. Information is not presented 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. The guaranteed portions collateralizing Farmer Mac II Guaranteed Securities are guaranteed by the USDA. Each USDA guarantee is an obligation backed by the full faith and credit of the United States. As of March 31, 2006, Farmer Mac had experienced no credit losses on any Farmer Mac I Guaranteed Securities issued prior to the 1996 Act or on any Farmer Mac II Guaranteed Securities and does not expect to incur any such losses in the future.

-18-

   
90-Day
Delinquencies (1)
  
Net Credit
Losses/(Recoveries)
  
   
As of
March 31,
  
As of
December 31,
  
Three Months Ended
March 31,
  
   
2006
  
2005
  
2006
  
2005
  
   
(in thousands)
  
On-balance sheet assets:
                  
Farmer Mac I:
                          
Loans
  
$
25,535
  
$
23,308
  
$
(20
)
$
(35
)
Guaranteed Securities
    
-
   
-
   
-
   
-
 
Total on-balance sheet
  
$
25,535
  
$
23,308
  
$
(20
)
$
(35
)
                           
                           
Off-balance sheet assets:
                          
Farmer Mac I:
                          
LTSPCs
  
$
3,227
  
$
2,153
  
$
-
  
$
-
  
Guaranteed Securities
    
-
   
-
   
-
   
-
 
Total off-balance sheet
  
$
3,227
  
$
2,153
  
$
-
  
$
-
  
                           
Total
  
$
28,762
  
$
25,461
  
$
(20
)
$
(35
)

(1)
Includes loans and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs 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. 
 
Note 3.
Off-Balance Sheet Guarantees and Long-Term Standby Purchase Commitments

Overview

Farmer Mac offers approved agricultural and rural residential mortgage lenders two off-balance sheet 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 the creation of off-balance sheet obligations for Farmer Mac in the ordinary course of its business.

-19-

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 trusts are sold to third party investors. The following table summarizes certain cash flows received from and paid to these trusts:

   
Three Months Ended
  
   
March 31, 2006
  
March 31, 2005
  
   
(in thousands)
  
           
Proceeds from new securitizations
  
$
1,485
  
$
1,914
  
Guarantee fees received
    
670
    
726
  
Purchases of assets from the trusts
    
506
    
1,595
  
Servicing advances
    
1
    
3
  
Repayment of servicing advances
    
4
    
12
  
 
The following table presents the outstanding balance of off-balance sheet Farmer Mac Guaranteed Securities, which represents the maximum principal amount of potential undiscounted future payments that Farmer Mac could be required to make with respect to those securities as of March 31, 2006 and December 31, 2005, 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
  
   
March 31,
2006
  
December 31,
2005
  
   
(in thousands)
  
           
Farmer Mac I Guaranteed Securities
  
$
1,262,549
  
$
804,785
  
Farmer Mac II Guaranteed Securities
    
35,379
   
39,508
 
Total Farmer Mac I and II
  
$
1,297,928
  
$
844,293
  
 
As of March 31, 2006, the weighted-average remaining maturity of all loans underlying off-balance sheet Farmer Mac Guaranteed Securities, excluding AgVantage securities, was 15 years. For those securities issued or modified on or after January 1, 2003, Farmer Mac has recorded a liability for its obligation to stand ready under the guarantee in the guarantee and commitment obligation on the condensed consolidated balance sheet. This liability approximated $5.0 million as of March 31, 2006 and $5.2 million as of December 31, 2005.

Long-Term Standby Purchase Commitments (LTSPCs)

An LTSPC is a commitment by Farmer Mac to purchase eligible loans from a segregated pool of loans, either for cash or in exchange for Farmer Mac I Guaranteed Securities, on one or more undetermined future dates.

-20-

As of March 31, 2006 and December 31, 2005, 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 $2.2 billion and $2.3 billion, respectively.

As of March 31, 2006, the weighted-average remaining maturity of all loans underlying LTSPCs was 14.2 years. For those LTSPCs issued or modified on or after January 1, 2003, Farmer Mac has recorded a liability for its obligation to stand ready under the commitment in the guarantee and commitment obligation on the condensed consolidated balance sheet. This liability approximated $12.0 million as of March 31, 2006 and $12.4 million as of December 31, 2005.

Note 4.
Comprehensive Income

Comprehensive income represents all changes in stockholders’ equity except those resulting from investments by or distributions to stockholders, and is comprised primarily of net income available to common stockholders and unrealized gains and losses on securities available-for-sale net of related taxes. The following table sets forth Farmer Mac’s comprehensive income for the three months ended March 31, 2006 and 2005:

   
Three Months Ended
  
   
March 31, 2006
  
March 31, 2005
  
   
(in thousands)
  
           
Net income available to common stockholders
  
$
15,091
  
$
16,385
  
               
Unrealized gains/(losses) on securities
    
(13,911
)
  
(16,357
)
Amortization of FAS 133 transition adjustment on financial derivatives
    
202
   
260
 
 Other compehensive income, before tax
    
(13,709
)
  
(16,097
)
 
              
Income tax related to items of other comprehensive income
    
(4,798
)
  
(5,634
)
               
Other comprehensive income/(loss), net of tax
    
(8,911
)
  
(10,463
)
               
Comprehensive income available to common stockholders
  
$
6,180
  
$
5,922
  
 
Note 5.
Investments

As of the dates indicated below, Farmer Mac’s investment portfolio was comprised of the following investment securities:

   
March 31,
  
December 31,
  
   
2006
  
2005
  
   
(in thousands)
  
           
Held-to-maturity
  
$
10,602
  
$
10,602
  
Available-for-sale
    
1,866,951
   
1,604,419
 
Trading
    
6,458
   
6,920
 
   
$
1,884,011
  
$
1,621,941
  
 
-21-

The amortized cost and estimated fair values of investments as of March 31, 2006 and December 31, 2005 were as follows:
 
   
As of March 31, 2006
  
As of December 31, 2005
  
   
Amortized Cost
  
Unrealized Gains
  
Unrealized Losses
  
Fair Value
  
Amortized Cost
  
Unrealized Gains
  
Unrealized Losses
  
Fair Value
  
   
(in thousands)
  
Held-to-maturity:
                                  
Cash investment in fixed rate guaranteed investment contract
  
$
10,602
  
$
-
  
$
(5
)
$
10,597
  
$
10,602
  
$
18
  
$
-
  
$
10,620
  
Total held-to-maturity
  
$
10,602
  
$
-
  
$
(5
)
$
10,597
  
$
10,602
  
$
18
  
$
-
  
$
10,620
  
                                                   
Available-for-sale:
                                                  
Floating rate asset-backed securities
  
$
417,672
  
$
1,048
  
$
-
  
$
418,720
  
$
336,647
  
$
941
  
$
-
  
$
337,588
  
Floating rate corporate debt securities
    
325,732
   
488
   
(16
)
  
326,204
   
230,787
    
515
   
(10
)
  
231,673
 
Fixed rate corporate debt securities
    
544,574
   
-
   
(5,810
)
  
538,764
   
520,381
    
-
   
(1,950
)
  
518,050
 
Fixed rate preferred stock
    
238,469
   
6,515
   
(220
)
  
244,764
   
239,033
   
11,687
   
(304
)
  
250,416
 
Fixed rate commercial paper
    
158,724
   
-
   
-
   
158,724
   
90,848
   
-
   
-
   
90,848
 
Floating rate mortgage-backed securities
    
169,110
   
448
   
(52
)
  
169,506
   
175,441
   
481
   
(78
)
  
175,844
 
Fixed rate mortgage-backed securities
    
10,570
   
-
   
(301
)
  
10,269
   
-
   
-
   
-
   
-
 
Total available-for-sale
  
$
1,864,851
  
$
8,499
  
$
(6,399
)
$
1,866,951
  
$
1,593,137
  
$
13,624
  
$
(2,342
)
$
1,604,419
  
                                                   
Trading:
                                                  
Adjustable rate mortgage-backed securities
  
$
6,399
  
$
59
  
$
-
  
$
6,458
  
$
6,867
  
$
53
  
$
-
  
$
6,920
  
Total trading
  
$
6,399
  
$
59
  
$
-
  
$
6,458
  
$
6,867
  
$
53
  
$
-
  
$
6,920
  


The temporary unrealized losses presented above are principally due to changes in interest rates from the date of acquisition to March 31, 2006 and December 31, 2005. Farmer Mac has the intent and ability to hold its investment securities in unrealized loss positions as of March 31, 2006 for the foreseeable future.

As of March 31, 2006, Farmer Mac owned one held-to-maturity investment that matures in 2006 with an amortized cost of $10.6 million, a fair value of $10.6 million, and a yield of 6.15 percent. As of March 31, 2006, Farmer Mac owned trading investment securities that mature after 10 years with an amortized cost of $6.4 million, a fair value of $6.5 million, and a weighted average yield of 4.38 percent. The amortized cost, fair value and yield of investments by remaining contractual maturity for available-for-sale investment securities as of March 31, 2006 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.

-22-


   
Investment Securities
  
   
Available-for-Sale
  
   
as of March 31, 2006
  
   
Amortized Cost
 
Fair Value
 
Yield
  
   
(dollars in thousands)
  
Due within one year
  
$
204,113
  
$
204,153
    
4.57
%
Due after one year through five years
    
889,849
    
884,278
    
4.94
%
Due after five years through ten years
    
113,129
    
115,696
    
7.32
%
Due after ten years
    
657,760
    
662,824
    
5.43
%
Total
  
$
1,864,851
  
$
1,866,951
    
5.22
%

Note 6.
Restatement of Condensed Consolidated Financial Statements

Subsequent to the issuance of its March 31, 2006 unaudited condensed consolidated financial statements, the Corporation determined that it needed to restate prior financial results to correct its accounting for financial derivatives. The Corporation determined that it had inappropriately recorded changes in the fair value of cash flow hedges in other comprehensive income, net of income taxes, and recorded changes in the fair value of fair value hedges as basis adjustments on the hedged item rather than account for the financial derivatives as undesignated financial derivatives with all changes in the fair value of the financial derivatives recognized in the consolidated statements of operations.

The Corporation, in light of SEC staff comments, has recently concluded a reassessment of its documentation and accounting treatment of financial derivative transactions under SFAS 133 and related interpretations. Based on the reassessment, while the transactions engaged in by the Corporation were highly effective economic hedges of interest rate risk, the Corporation has determined that it was not appropriately applying hedge accounting in accordance with SFAS 133.

As a result, the condensed consolidated financial statements have been restated from the amounts previously reported to correct the accounting for financial derivatives. The corrections related to the Corporation’s accounting for fair value hedges and cash flow hedges as described in more detail below.

The Corporation reduced its stockholders’ equity by $0.9 million as of January 1, 2003 as the cumulative effect of the correction of its accounting for financial derivatives for all periods preceding January 1, 2003, and restated its consolidated statements of operations and cash flows for the years ended December 31, 2005, 2004 and 2003 and its consolidated balance sheet as of December 31, 2005 and 2004. The restatement resulted in increases to previously reported net income available to common stockholders of $10.1 million ($0.88 per diluted common share) and $11.5 million ($0.97 per diluted common share) for the three months ended March 31, 2006 and 2005, respectively. There was no effect on net cash flows or the amount of dividends declared for any periods presented. 

-23-

Fair Value Hedges:

The Corporation has determined that it did not meet the specific documentation requirements required by SFAS 133 to assume no ineffectiveness in its fair value hedge relationships or to apply hedge accounting to its fair value hedges. As a result, the Corporation’s designation of its financial derivatives as fair value hedges for the period from January 1, 2001 to March 31, 2006 did not meet the requirements of SFAS 133.

The impact of the restatement on the consolidated statements of operations related to fair value hedges was to reverse previously applied hedge accounting for affected hedging relationships in the relevant periods. For financial derivatives previously accounted for as fair value hedges, the net accruals for the derivatives were previously recorded to net interest income, and net changes in fair values of the financial derivatives were previously recorded as basis adjustments to the hedged items, such as notes payable, loans held for sale, or investment securities. As a result of the restatement, the previous accounting treatment was reversed (i.e., the net accruals recorded to net interest income were reclassified to gains and losses on financial derivatives and basis adjustments for the hedged items was reversed), and the total changes in the fair values of the derivative instruments, including interest accrual settlements, were recorded directly to gains/(losses) on financial derivatives and trading assets.

Cash Flow Hedges:

The Corporation determined also that it did not meet specific documentation and other requirements of SFAS 133 to apply hedge accounting to its cash flow hedges. In this regard, the Corporation has determined that its forecasted transactions were not documented with sufficient specificity at the inception of the hedge relationship to allow those transactions to be identified as the intended “hedged transactions” when they occurred; some of its forecasted transactions related to the acquisitions of assets, or incurrences of liabilities, involved subsequent remeasurements with changes in fair value attributable to the hedged risk reported currently in earnings; and the benchmark index identified for its basis swaps did not meet the definition of a “benchmark interest rate” as that term is defined in SFAS 133. As a result, the Corporation’s designation of its financial derivatives as cash flow hedges for the period from January 1, 2001 to March 31, 2006 did not meet the requirements of SFAS 133. 

The impact of the restatement on the consolidated statements of operations related to cash flow hedges was to reverse previously applied hedge accounting for affected hedging relationships in the relevant periods. For financial derivatives previously accounted for as cash flow hedges, the Corporation recorded accruals from the financial derivatives to net interest income and recorded net changes in the fair values of the derivatives, net-of-tax, to accumulated other comprehensive income (“OCI”). As a result of the restatement, the previous accounting treatment for cash flow hedges was reversed from accumulated OCI and net interest income, and recorded to gains/(losses) on financial derivatives and trading assets.

The following tables set forth the previously reported and restated amounts of selected items within the condensed consolidated balance sheets as of March 31, 2006 and December 31, 2005 and within the consolidated statements of operations and consolidated statements of cash flows for the three months ended March 31, 2006 and 2005.

-24-
 
   
March 31, 2006
  
December 31, 2005
  
   
As Previously
  
As
  
As Previously
  
As
  
Selected Balance Sheet Data:  
Reported
  
Restated
  
Reported
  
Restated
  
   
(in thousands)
  
Assets:                  
Deferred tax asset, net
  
$
1,647
  
$
2,906
  
$
2,397
  
$
3,223
  
Total Assets
    
4,473,336
   
4,474,595
   
4,340,619
   
4,341,445
 
Liabilities and Stockholder's Equity:                          
Notes payable: Due after one year
    
1,336,215
   
1,340,385
   
1,403,598
   
1,406,527
 
Total notes payable
    
4,107,321
   
4,111,491
   
3,991,302
   
3,994,231
 
Total Liabilities
    
4,219,173
   
4,223,343
   
4,092,487
   
4,095,416
 
                           
Accumulated other comprehensive income
    
5,290
   
6,336
   
3,339
   
15,247
 
Retained earnings
    
118,810
   
114,853
   
115,644
   
101,633
 
Total Stockholders' Equity
    
254,163
   
251,252
   
248,132
   
246,029
 
Total Liabilities and Stockholders' Equity
    
4,473,336
   
4,474,595
   
4,340,619
   
4,341,445
 

 
  
For the three months ended,
March 31, 2006
  
For the three months ended,
March 31, 2006
  
 
  
As Previously
  
As
  
As Previously
  
As
  
Selected Statements of Operations Data:
  
Reported
  
Restated
  
Reported
  
Restated
  
 
  
(in thousands, except per share amounts)
  
Interest income:
  
 
  
 
  
 
  
 
  
Farmer Mac Guaranteed Securities
  
$
18,095
  
$
18,037
  
$
17,081
  
$
18,327
  
Total interest income
    
56,176
   
56,118
   
41,789
   
43,035
 
Interest expense
    
47,276
   
45,451
   
33,983
   
29,154
 
Net interest income
    
8,900
   
10,667
   
7,806
   
13,881
 
Net interest income after recovery/ (provision) for loan losses
    
9,913
   
11,680
   
8,390
   
14,465
 
                           
Gains on financial derivatives and trading assets
    
(2,001
)
  
11,700
   
(1,709
)
  
9,866
 
Total revenues
    
13,340
   
28,808
   
12,023
   
29,673
 
Income before income taxes
    
7,671
   
23,139
   
7,805
   
25,455
 
Income tax expense
    
2,074
   
7,488
   
2,333
   
8,510
 
Net income
    
5,597
   
15,651
   
5,472
   
16,945
 
Net income available to common stockholders
    
5,037
   
15,091
   
4,912
   
16,385
 
                           
Earnings per common share:
                  
Basic earnings per common share
    
0.45
   
1.36
   
0.42
   
1.40
 
Diluted earnings per common share
    
0.44
   
1.32
   
0.42
   
1.39
 

-25-
 
   
For the three months ended
  
For the three months ended
  
   
March 31, 2006
  
March 31, 2005
  
   
As Previously
  
As
  
As Previously
  
As
  
Selected Statements of Cash Flows Data:
  
Reported
  
Restated
  
Reported
  
Restated
  
   
(in thousands)
  
Cash flows from operating activities:
                  
Net income
  
$
5,597
  
$
15,651
  
$
5,472
  
$
16,945
  
Adjustments to reconcile net income to net cash provided by operating activities:
                          
Net change in fair value of trading securities and financial derivatives
    
1,902
   
(12,501
)
  
2,107
   
(15,216
)
Amortization of  SFAS 133 transition adjustment on financial derivatives
    
89
   
131
   
438
   
169
 
Deferred income taxes
    
(302
)
  
5,112
   
(794
)
  
(5,385
)
Decrease in other assets
    
13,741
   
13,228
   
2,053
   
12,871
 
Net cash provided by operating activities
    
78,100
   
78,694
   
22,065
   
22,173
 
                           
Cash flows from financing activities:
                          
Settlement of financial derivatives
    
594
   
-
   
108
   
-
 
Net cash provided by/(used in) financing activities
    
89,550
   
88,956
   
(6,378
)
  
(6,486
)
 
-26-

Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following management’s discussion and analysis of financial condition and results of operations set forth in this Item 2 reflects revisions in financial reporting resulting from the Corporation’s restatement to correct for errors relating to its accounting for financial derivative transactions under SFAS 133 that were contained in the Corporation’s unaudited condensed consolidated financial statements and other financial information as of March 31, 2006 and December 31 2005 and for the three months ended March 31, 2006 and 2005 as discussed below and in Note 6 of the restated unaudited condensed consolidated financial statements. Financial information is consolidated to include the accounts of Farmer Mac and its wholly-owned subsidiary, Farmer Mac Mortgage Securities Corporation.

This discussion and analysis of financial condition and results of operations should be read together with: (1) the restated unaudited condensed consolidated financial statements and the related notes that appear elsewhere in this report; and (2) Farmer Mac’s Annual Report on Form 10-K/A for the fiscal year ended December 31, 2005.

The discussion below is not necessarily indicative of future results.
 
Special Note Regarding Forward-Looking Statements

Some statements made in this report 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:
 
·
prospects for earnings;
·
prospects for growth in loan purchase, guarantee, securitization and LTSPC volume;
·
trends in net interest income;
·
trends in provisions for losses;
·
trends in expenses;
·
changes in capital position; and
·
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 or events could cause Farmer Mac’s actual results to differ materially from the expectations as expressed or implied by the forward-looking statements, including the factors discussed under “Risk Factors” in Part I, Item 1A of Farmer Mac’s Annual Report on Form 10-K/A for the year ended December 31, 2005, as filed with the SEC concurrently with this report, and uncertainties regarding:
 
-27-

·
increases in general and administrative expenses attributable to growth of the business and the regulatory environment, including the hiring of additional personnel with expertise in key functional areas;
·
the rate and direction of development of the secondary market for agricultural mortgage loans;
·
the general rate of growth in agricultural mortgage indebtedness;
·
lender interest in Farmer Mac credit products and the Farmer Mac secondary market;
·
borrower preferences for fixed-rate agricultural mortgage indebtedness;
·
the willingness of investors to invest in Farmer Mac Guaranteed Securities; and
·
possible reaction in the financial markets to events involving government-sponsored enterprises other than Farmer Mac.

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 new information or any future events or circumstances, except as otherwise mandated by law.

Restatement of Previously Issued Quarterly Financial Statements

The Corporation is restating its unaudited interim condensed consolidated financial statements as of March 31, 2006 and December 31, 2005 and for the three months ended March 31, 2006 and 2005. The Corporation is concurrently filing amendments to (1)  its Form 10-K for the year ended December 31, 2005 to restate the Corporation’s consolidated financial statements as of December 31, 2005 and 2004, and for the years ended December 31, 2005, 2004 and 2003, and other financial information as of and for the years ended December 31, 2002 and 2001 and the quarterly unaudited data for 2005 and 2004 and (2) its Form 10-Q for the quarter ended June 30, 2006 to restate the quarterly unaudited interim consolidated financial statements and other financial information contained in that report. These restatements and resulting revisions relate to the accounting treatment for derivative transactions under SFAS 133. In this regard, investors should rely on the restated financial results for the years and each of the quarters in the years 2005, 2004, 2003, 2002 and 2001 and the first and second quarters of 2006 and, as the Corporation previously reported on Form 8-K on October 6, 2006, should not rely on the Corporation’s previously issued consolidated financial statements and other financial information for these reporting periods.

The Corporation, in light of SEC staff comments, has recently concluded a reassessment of its documentation and accounting treatment of financial derivative transactions under SFAS 133, interpretations of which have evolved. Based on the reassessment, while the transactions engaged in by the Corporation were highly effective economic hedges of interest rate risk, the Corporation has determined that it was not appropriately applying hedge accounting in accordance with SFAS 133.

As a result, the condensed consolidated financial statements included in Item 1 have been restated from the amounts previously reported to correct the accounting for financial derivatives. The corrections related to the Corporation’s accounting for fair value hedges and cash flow hedges as described in more detail below.

-28-

The Corporation reduced its stockholders’ equity by $0.9 million as of January 1, 2003 as the cumulative effect of the correction of its accounting for financial derivatives for all periods preceding January 1, 2003, and restated its consolidated statements of operations and cash flows for the years ended December 31, 2005, 2004 and 2003 and its consolidated balance sheet as of December 31, 2005 and 2004. The restatement resulted in increases to previously reported net income available to common stockholders of $10.1 million ($0.88 per diluted common share) and $11.5 million ($0.97 per diluted common share) for the three months ended March 31, 2006 and 2005, respectively. In addition to the increases in net income available to common stockholders described above, the net impact related to the correction of these errors for fair value and cash flow hedges was to increase net interest income by $1.8 million and $6.1 million for the three months ended March 31, 2006 and 2005, respectively. Gains/(losses) on financial derivatives increased $13.7 million and $11.6 million for the three months ended March 31, 2006 and 2005, respectively. There was no effect on net cash flows, core earnings, or the amount of dividends declared for any years presented.

Fair Value Hedges:

The Corporation has determined that it did not meet the specific documentation requirements required by SFAS 133 to assume no ineffectiveness in its fair value hedge relationships or to apply hedge accounting to its fair value hedges. As a result, the Corporation’s designation of its financial derivatives as fair value hedges for the period from January 1, 2001 to March 31, 2006 did not meet the requirements of SFAS 133.

The impact of the restatement on the consolidated statements of operations related to fair value hedges was to reverse previously applied hedge accounting for affected hedging relationships in the relevant periods. For financial derivatives previously accounted for as fair value hedges, the net accruals for the derivatives were previously recorded to net interest income, and net changes in fair values of the financial derivatives were previously recorded as basis adjustments to the hedged items, such as notes payable, loans held for sale, or investment securities. As a result of the restatement, the previous accounting treatment was reversed (i.e., the net accruals recorded to net interest income were reclassified to gains and losses on financial derivatives and basis adjustments for the hedged items was reversed), and the total changes in the fair values of the derivative instruments, including interest accrual settlements, were recorded directly to gains/(losses) on financial derivatives and trading assets.

Cash Flow Hedges:

The Corporation determined also that it did not meet specific documentation and other requirements of SFAS 133 to apply hedge accounting to its cash flow hedges. In this regard, the Corporation has determined that its forecasted transactions were not documented with sufficient specificity at the inception of the hedge relationship to allow those transactions to be identified as the intended “hedged transactions” when they occurred; some of its forecasted transactions related to the acquisitions of assets, or incurrences of liabilities, involved subsequent remeasurements with changes in fair value attributable to the hedged risk reported currently in earnings; and the benchmark index identified for its basis swaps did not meet the definition of a “benchmark interest rate” as that term is defined in SFAS 133. As a result, the Corporation’s designation of its financial derivatives as cash flow hedges for the period from January 1, 2001 to March 31, 2006 did not meet the requirements of SFAS 133. 

-29-

The impact of the restatement on the consolidated statements of operations related to cash flow hedges was to reverse previously applied hedge accounting for affected hedging relationships in the relevant periods. For financial derivatives previously accounted for as cash flow hedges, the Corporation recorded accruals from the financial derivatives to net interest income and recorded net changes in the fair values of the derivatives, net-of-tax, to accumulated other comprehensive income (“OCI”). As a result of the restatement, the previous accounting treatment for cash flow hedges was reversed from accumulated OCI and net interest income, and recorded to gains/(losses) on financial derivatives and trading assets.

Critical Accounting Policy and 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. For a discussion of Farmer Mac’s critical accounting policy, changes implemented in its methodology for determining its allowance for losses during third quarter 2005, as well as Farmer Mac’s use of estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and related notes for the periods presented, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policy and Estimates” in the Corporation’s Annual Report on Form 10-K/A for the year ended December 31, 2005, as filed with the SEC on November 9, 2006.
 
Results of Operations
 
Overview. Net income available to common stockholders for first quarter 2006 was $15.1 million or $1.32 per diluted common share, compared to $16.4 million or $1.39 per diluted common share for first quarter 2005. The decrease was due principally to the after-tax effects of increased compensation and employee benefits and professional fees.

As part of Farmer Mac’s continuing evaluation of the overall credit quality of its portfolio, the state of the U.S. agricultural economy, the recent upward trends in agricultural land values, and the level of Farmer Mac’s outstanding guarantees and commitments, Farmer Mac determined that the appropriate allowance for losses as of March 31, 2006 was $6.8 million. This resulted in the release of approximately $1.7 million from the allowance for losses in first quarter 2006. As of March 31, 2006, the allowance for losses was $6.8 million and 16 basis points relative to the outstanding post-1996 Act Farmer Mac I portfolio, compared to $8.7 million and 20 basis points as of December 31, 2005 and $16.3 million and 37 basis points as of March 31, 2005.

As of March 31, 2006, Farmer Mac’s 90-day delinquencies (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, or in bankruptcy, excluding loans performing under either their original loan terms or a court-approved bankruptcy plan) were $28.8 million, representing 0.68 percent of the principal balance of all loans held and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs, down from $45.8 million (1.04 percent) as of March 31, 2005.

-30-

During first quarter 2006, Farmer Mac:
 
·
added $73.2 million of Farmer Mac I loans under LTSPCs;
·
guaranteed $500.0 million of AgVantage securities;
·
purchased $30.3 million of newly originated and current seasoned Farmer Mac I loans; and
·
purchased $45.1 million of Farmer Mac II USDA-guaranteed portions of loans.
 
As of March 31, 2006, Farmer Mac’s outstanding program volume was $5.6 billion, which represented approximately 12 percent of management’s estimate of a $48.0 billion market of eligible agricultural mortgage loans. In addition, Farmer Mac entered into a $486.7 million LTSPC on April 3, 2006, bringing Farmer Mac’s outstanding program volume to more than $6.0 billion at that time. Farmer Mac’s ongoing guarantee and commitment fee income is earned on the cumulative outstanding principal balance of Farmer Mac Guaranteed Securities and loans underlying LTSPCs. Accordingly, guarantee and commitment fees